No Love for GE

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Tuesday October 24, 2017

One of our mantras at Contra the Heard is “Never fall in love with a stock. It will not love you back.” Though we are known for our patience in holding a position, there is nothing sentimental about the relationship.

General Electric has been in the President’s Portfolio — one of the two that we manage — since 2010. It was acquired at US$15.56. If we had not been such ’fraidy cats, it could have been acquired during the worst of the stock market meltdown for less than $7 in March 2009. Alas, we did not have the guts to dive in towards the bottom.

New chief executive John Flannery is promising “sweeping changes,” which is somewhat ironic given that Jeff Immelt, who recently exited that position, did a major organizational makeover, gutting the financial aspects of the business while adding others, including the megasized Baker Hughes, an oilfield services company. Unfortunately, even with all of the machinations, GE is suffering an “Immeltdown.”

Trian Fund Management, headed by Nelson Peltz, likely will have major input on the transformation. Ed Garden, one of Trian’s founding partners, has just been placed on the GE board.

Odds are that many employees, likely thousands, will be bid adieu, with some top management already shown the door. Chief financial officer Jeffrey Bornstein was one of the casualties and was gracious enough to take much of the blame for the corporate failures.

Flannery promises $2 billion of expense cuts in 2018. There is talk that $20 billion of assets could be sold off. Those kinds of decisions obviously are far more reaching than the recent sale of six corporate jets and the top 700 people who lost their company cars. Uber, anyone?

One area where we can see that GE must improve is the balance sheet. Though the debt load has been falling, it still remains heavy. In our ideal world, the money received from sales would be applied to the $130 billion or so that is owing. While important now, that could become crucial if interest rates continue to climb, which is likely to happen.

Another note of concern is the pension shortfall, currently over $30 billion. That is the highest of any S&P 500 company. One reason that more money was likely not stashed here is because of share buybacks that have not proved fruitful. Indeed, they proved quite costly as the current share price is lower than when most of the purchases were made.

Worth noting is that the folks at Trian pushed GE to do those buybacks to boost the stock price. Yes, this can be classified as a short-term Band-Aid at long-term expense.

We bought GE soon after the quarterly dividend was slashed from 31 cents to a dime. This is the kind of thing that tempts us when buying into some companies; if one gets it right, there is both the possibility of capital and dividend appreciation, effectively the best of both worlds. That is something that we were banking on when the investment was made.

At this point, though, for those looking to throw dollars in this direction, it is also a risk, as there is lots of talk about the quarterly dividend, now at 24 cents, being sliced. We have no idea if that will come to pass, but it would not be surprising.

While Flannery has suggested that he wants to save the dividend, he is unhappy with the downsized cash flow, and one way to easily improve it would be to trim the payout. Historically, that has occurred a number of times in the past, which makes the possibility of it happening in the future more likely. Most of the time, when a dividend is chopped the stock price drops. One would think that would also be the case here.

Followers of this corporation should mark Nov. 13 in their agendas. That is when Flannery will outline GE’s new strategic focus.

It could prove unacceptable to many shareholders, and they might decide to opt out and sell their shares. The reasoning could be twofold: the plan does not appeal to their palates, and given that the stock price was higher over the past couple of years, many institutions and retail investors might play the tax-loss game.

That could easily compound a stock-price fall, ultimately offering a very reasonable entry point for those who believe that this company, which has been around for 125 years, has some good times left. Our initial sell target is $35.24, way below the price of better than $57 where the stock traded at the turn of the century.

Though the near-term outlook is poor, we’re happy to hang onto our position, and there is consideration amongst the Contra rank and file of purchases for their individual portfolios. If that happens, it will not be a marriage, to be sure, but ideally a lucrative dalliance that will likely last a few years.