I am preparing a write-up on the new General Electric/Baker Hughes oil services colossus that will be publicly traded, but I was struck at how the significant reshuffling of the business is setting General Electric up for high single digit growth a few years down the road at the expense of lower dividend growth now.
The very first question we should ask ourselves as we analyze General Electric’s asset reshuffling decisions is this: Is it all necessary?
My view is that the answer is no.
At Synchrony right now, the profits are $2.1 billion. That profit is base is expected to grow to $3 billion in the next five years. Incidentally, this makes Synchrony one of the undervalued stocks in the market. Also, the sale of the $25 billion portfolio in commercial assets to Wells Fargo represented another $700 million in net profits
Right now, General Electric makes $13.3 billion in profits. Had they never sold/spun off Synchrony and the commercial real estate portfolio, the company would be earning $16.1 billion in net profits. At the pre-existing share count, that worked out to $1.58 per share.
Now, GE has used the funds to retire an insane-sounding billion shares of stock, with an additional 200 million shares pending as the result of these GE Capital divestments. When you have $13.3 billion in profits being divided up 8.8 billion ways, you are left with $1.52 per share in earnings.
Due to the taxes and transaction costs of the deal, General Electric shareholders are about $0.06 per share poorer than they would have been had GE maintained the status quo.
The objective upside of General Electric’s finance divestment is that it has been able to get rid of its systematically important financial institution (SIFI) status, and this restores GE’s autonomy over liquidity, dividends, buybacks, and other capital allocation decisions. The subjective upside, trumped by GE, is that the divestment of the financial assets makes the company less riskier during bad times and enables it to carry a higher valuation.
The company line from General Electric is factually correct, but incomplete because it casts GE as a passive actor rather than a company that can take charge of its own fate. Namely, I have never heard an analyst covering General Electric ask: “Why don’t you just hold the lucrative GE Capital financial assets—clearly institutions from Wells Fargo to Blackrock to the current Synchrony shareholder base want them—and keep the liquidity extra high so worst-case storms can be weathered, and a higher valuation will come from this self-created guarantee of safety?”
Although the stock price has risen since GE started shedding GE Capital, you can’t yet argue that the shareholders are richer on a fundamental basis. In fact, they are about 3.8% poorer than had GE merely stuck with its pre-existing assets.
Because General Electric has needed to contribute upfront to pay the taxes and transaction costs associated with these sales, the dividend growth has been slow moving the past few years. At the start of 2014, GE paid out a $0.22 dividend quarterly. Here at the end of 2016, the figure is only up a penny to $0.23.
What do I think is going to happen?
With an oil recovery, as well as the integration of Alstom assets and the termination of the share repurchase program, General Electric ought to be able to get its earnings about to about $2.75 per share within the next five years.
Because it is no longer systematically important, my guess is that you will be seeing a dividend payout ratio in the 60-65% range instead of the 50-55% range that you’d see with government oversight. That means GE shareholders stand to collect about $1.71 per share five years from now.
At a current price of $28 and some change, GE shareholders are looking at a future yield of about 6% five or so years from now. If they reinvest until then, and start collecting, the higher share count from reinvested dividends makes it plausible that every $1,000 invested today will be collecting $100 annually in five or so years.
For a company generating about $125 billion in annual revenues, it is an impressive accomplishment to grow the dividend by a high single digit rate. This will be accomplished through industrial growth and a bit of expansion in the dividend payout ratio.
Even with the dividend frozen, GE has had a good 2011-2016 stretch. The stock traded at $14 per share in 2011, and has paid out $4.87 per share in dividends since then. At a price of $28.50, you ended up with total value of $33.37 for a compounding rate of almost 19%. Without dividend reinvestment, each share today collects 6.5% annually on the initial investment of 2011. With dividend reinvestment, each 100 shares grew to 122 shares. Someone who reinvested the dividends along the way would be collecting about 8.5% on their initial investment right now. Knock that dividend up to $0.25, and reinvest for a few more quarters in the meanwhile, and you’re collecting 10% on your initial investment just for waiting five years. And you are doing it by owning one of the twenty most profitable corporations in existence—an impressively low-risk way to ratchet up your future dividend yield on cost.
I still need to review the Baker Hughes deal. But as I digest the recent Synchrony and GE Capital spinoff, I’m not sure that value is being created by these transactions. It has given GE the ability to raise its dividend payout ratio so higher dividends ought to be forthcoming. But you cannot yet point and say that the GE profit engine itself is in better shape for having done the transaction. But that does not mean that GE is a bad investment. The industrial assets are so strong, lucrative, and have such a high barrier to entry that it can survive a lot of capital allocation abuse elsewhere and still create shareholder wealth. Higher dividends ought to come, the industrial division remains a beast, but the financial engineering from management isn’t a net contributor to GE’s rebound story at this point.