GE's Dividend Is on Solid Footing

Barbara Noverini: The sustainability of GE's dividend has been a controversial issue with investors lately, as first-quarter earnings revealed a hefty use of cash by GE's industrial businesses despite strong year-over-year organic revenue growth of 7% and 130 basis points of industrial operating margin expansion. There is no question that investors are hard-pressed to forget that GE cut its dividend in 2009; however, we believe that the confluence of events leading to this outcome is unlikely to repeat.

As is always the case with GE, there are a lot of moving parts to this debate, so let's take a moment to break it down. First, quarter-to-quarter cash flows in GE’s industrial businesses can be very lumpy, and industrial free cash flow is often back-half loaded. We expect that GE can deliver 3% of organic revenue growth for the year, along with about 100 basis points of industrial operating margin expansion. This, combined with an additional $1 billion of structural cost outs and better working capital management gives us line of sight to industrial free cash flow in 2017 just over $9 billion, enough to cover approximately $8 billion of common stock dividends without help from GE Capital.

That said, we recognize that payout ratios have been climbing lately, which only exacerbates investor concern over the sustainability of the dividend. We'll counter by saying that GE's industrial businesses have been in investment mode lately. GE is rolling out two major product launches--the LEAP engine and the HA Turbine--which require higher levels of investment in inventory; plus the company has been funding the build-out of its digital initiatives, an endeavor we believe comes at a significant cost, but has the potential for attractive longer-term returns. Industrial free cash flow generation will strengthen as these products roll out and gain traction, which we expect will normalize payout ratios and return the dividend to modest growth over the medium-term.

At the end of the day, we believe that GE's portfolio looks better than ever. A growing backlog, plus the appointment of a new CEO who will likely continue to seek additional sources of efficiency within the portfolio, we believe, protects the foundation of GE's dividend.