Fri, 8 May 2015
In winding down its financial-services business, GE is refocusing on what it does best, which should offer long-term dividend growth in the high single digits, says Morningstar's Josh Peters.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The market has generally cheered GE's move away from its finance businesses. I'm here with Josh Peters--he is the editor of Morningstar DividendInvestor newsletter and also our director of equity-income strategy--to see what impact this move is going to have on the long-term health of the GE dividend.
Josh, thanks for joining me.
Josh Peters: Good to be here.
Glaser: So, could you walk us through some of the changes that GE has recently announced?
Peters: Well, the biggest change that you've had is a massive acceleration in their plan to wind down their financial-services business, GE Capital. You might remember that prior to the crash in 2008-09, GE Capital represented more than half of GE's earnings. So, you could add together all of the businesses that they had at that time from locomotives to power-generation equipment to NBC to the lightbulb business, and that was still less than GE as a bank.
Then, they went through the crisis period, which led to a dividend cut. I was on scene for that; I actually bought GE for the first time in April 2008. That wasn't great timing on my part; but I felt like the dividend would come back, and it has made some steps coming back. But what's been more encouraging, as I look out over what the stock is likely to do over the next five, 10, or 15 years--as opposed to the rotten five, 10, or 15 past years--is that it's going to be the infrastructure company that, at its core, it has always been best at being. And you're going to see that financial-services business shrink to less than 10% of earnings probably within the next couple of years.
Glaser: So, what do you think the prospects are for dividend increases from here, then? Is that infrastructure business strong enough to support big dividend hikes?
Peters: In the short term, you've got a lot of moving parts associated with winding down GE Capital. They are keeping some businesses; they are going to continue to finance aircraft and power projects and health-care equipment--what they call their three verticals. Those support the sales of their industrial products. So, that's not that much different from any other kind of vendor financing. They work together; two plus two should equal five--synergy, if you will. But the other businesses are being wound down much more quickly. And frankly, this is a good time to be a seller of things like middle-market-lending portfolios. They should find ready markets, as they already have for a big piece of their real estate business; but it's going to take some time. It's going to be expensive. They are not going to be able to shift all of the equity capital they eventually hope to take out of GE Capital immediately. It's going to take a couple of years. So, when they announced this, they said the dividend will be just flat at its current rate--$0.23 a share per quarter--through the end of 2016. That wasn't what I was hoping. I was actually a little bit disappointed that the dividend increase was smaller than I thought it would be at the end of last year. Now, this year, we won't get one at all. GE typically announces a dividend increase in late December, payable in the upcoming year.
But I think that's a worthwhile trade-off because this is going to get them to being that infrastructure wide-moat business--where GE is doing the things they are the best at, where they are earning the highest returns on capital--much faster than they would've otherwise. And the math works out pretty well; GE is getting out of these businesses for a lot of reasons, but one is just that the industry has shifted. They no longer have a funding cost advantage. If they are lending money and borrowing it from somebody else in order to make loans, their cost of borrowing is a lot higher relative to their competitors than it used to be because they are not a bank, principally. And they're competing with banks that are paying, as you know, virtually nothing on deposits today. So, these loan portfolios that had done well in the past now provide very low returns on capital.
By shifting that money out of GE Capital and buying back stock, they are essentially liquidating a big piece of the company in the process. That's actually, I think, a fair use of the share repurchase program--a massive one like this one. But when you come out the other end, you are going to have a collection of infrastructure businesses that, I think, grow at least as fast as nominal GDP globally. Let's call that 5%. You'll get other additions from acquisition activity or ongoing share repurchases that are smaller.
The one thing I think you have to watch here over the next couple of years is to see those industrial businesses harvest some of the fruits of the investments they've been making--spending more on R&D, accelerated product development. We've seen a lot of the costs of those initiatives in the last few years, but we haven't really seen the benefits. Now, we're starting to see some of those benefits with the new turbines that they're offering, new engines and locomotives. We're going to see more of that, and I think that that's going to set GE up for high-single-digit dividend growth over the long run--7%, 8%. And that will be more sustainable, it won't have the same financial risk that GE had before the crash, and the stock still yields well over 3%. I still think that's a good total-return prospect.
Glaser: So, even after the runup and knowing that the dividend is going to be kind of on hold for a while, you still think shares make sense at today's prices?
Peters: I do. The stock had a terrific leap when they first announced this transaction. It has actually given back a fair amount of those gains. GE has left a really sour taste in the mouths of lots of investors. This was a $60 stock 15 years ago. Now, it was wildly overvalued then, and those were the days when GE's growth was being mostly driven by finance. So, it was not a very high-quality business trading at a very rich price.
Today, especially with the stock having pulled back a little bit--yet knowing that the finance business is going to shrink quickly and get you to that infrastructure play that I think you really want as a long-term investor in GE--the valuation is not excessive. It's, frankly, attractive. And although there are going to be some costs and some bumps along the way, I think what you want to turn your attention to is seeing them bringing more new products to market and seeing them gain share that perhaps they lost to competitors while they were focusing on managing through the financial crisis. I think that's what you're going to see happen. And in the meantime, even if the dividend is not going to be raised again until late 2016 for some payment in 2017, the dividend yield is certainly very attractive compensation for waiting while we see this turnaround finally start to take shape under Jeff Immelt.
Glaser: Josh, thanks so much for your thoughts on GE today.
Peters: Thank you, too, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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