A Contrarian Call on General Electric

The General Electric (NYSE: GE) stock has been a huge under performer in 2017. It has fallen more than 43%, year to date while the S&P 500 is up about 15%. That says the kind of negativity surrounding the stock.

Important points

  1. GE stock is being clobbered after it slashed its dividend by 50%
  2. The company will sell $20 billion of assets
  3. CEO John Flannery has laid out plans to turnaround the company
  4. We like GE as a contrarian bet

On Monday, during an investor day presentation, the new CEO of the company John Flannery outlined plans to turnaround the company. The stock reacted by falling more than 7% on the same day. If that was not enough, it was followed by another 5.89% drop on Tuesday.

The investors are bailing out of their positions in a hurry, plunging the stock below $18 levels. We, however, would like to go contrarian here and add GE to our portfolio. We believe that at the current prices, the downside risk is minimum while the upside potential is huge, if the management can walk the talk.

What are the reasons for our optimism, especially when others are in a hurry to sell their holdings.

GE is the original Dow stock

The company was originally established by the great Thomas Alva Edison in 1890. A company that has survived for the past 127 odd years certainly deserves credit for its resilience. From the first light bulb to the age of super computers, the company has seen it all.

It has been able to reinvent itself and survive all the technological changes. It is the only original surviving Dow stock that was first included in the index in 1896.

However, we have seen many erstwhile companies flounder and go bankrupt. Is there a chance that GE will also follow suit? Let’s look at GE’s results and analyze how bad is the situation.

GE’s financial performance

The company’s performance has been sluggish in the past five years, which shows that the management did not take the necessary steps to overcome the plaguing issues.

  2012 2013 2014 2015 2016 YTD 5-Yr Growth
Revenue in billions 146.68 113.25 117.18 117.39 123.69 90.69 -3.33
Operating Margin % 20.31 13.65 14.19 14.36 14.42 11.9 -9.38
Diluted Earnings Per Share 1.29 1.27 1.5 -0.62 0.89 0.41 -0.06

Source: Morningstar

The above figures show that if the management doesn’t take the corrective steps soon, the company is unlikely to emerge from its downward spiral.

However, though the results are poor, GE is unlikely to go out of business anytime soon. It still has leadership position in its niche sectors. It only has to reorganize itself to emerge stronger.

What are some of the steps announced by the new CEO

We like a company’s CEO who accepts that there is a problem, which needs to be addressed. If the CEO backs his words with some unpopular measures for the long-term betterment of the company, we start to believe in the turnaround story.

Flannery did just that. He slashed GE’s dividend by 50%, from 24 cents quarterly to 12 cents, a move that is likely to hurt a lot of investors who had bought the stock for its dividend yield. This explains the plunge of the past two days.

However, the dividend cut will save the company $4 billion annually, which can be put to use for the turnaround.

Recent history shows that a dividend cut has been positive in the long-term

The S&P Global points to four companies – Pfizer, Abbott Labs, Kinder Morgan and Conoco Phillips – that have seen the largest dividend cuts since the financial crisis. A year after cutting their dividends, Pfizer rose 28%, Abbott 44% and Conoco Phillips 49%. The only laggard was Kinder Morgan, which was lower by about 4%.

Though this is not a very dependable reason to buy GE, it certainly shows that the companies that have used the money saved from dividend cuts smartly have rewarded the long-term investors.

What else does Flannery plan to do other than cutting its dividend?

Many analysts have said that GE had become unmanageable. On that front, Flannery has said that GE will be “more focused” and will shed assets worth about $20 billion. This is in contrast to the earlier two CEO’s Jeff Immelt and Jack Welch, but this is what the company needs at the moment. Power, aviation and health care are going to be the main area of focus.

GE will induct three new members into the board of directors, but will reduce the board’s size from 18 to 12. The board has also given a seat to Ed Garden, co-founder with Nelson Peltz of the $13 billion Trian Partners hedge fund. Peltz has taken more than a billion-dollar hit on his GE stake of about 70.9 million shares, disclosed in October 2015.

The lower guidance for 2018 is a welcome reset

Few analysts are negative following GE’s dismal guidance for the next year. The company cut its 2018 EPS guidance to $1.00-$1.07, well below the consensus street expectation of $1.28. However, we view this as a positive.

By doing this, Flannery has given himself enough room to maneuver without having to worry about disappointing the street. Also, he would want to start his innings at GE on a positive note, therefore, he is likely to give a guidance that he can easily beat. Hence, unlike others, we are not downbeat after seeing the lower guidance.

Shouldn’t we buy after the turnaround happens?

GE is looking to undo its previous mistakes and work towards a turnaround. Though turning a $155 billion behemoth is unlikely to happen quickly, we believe that positive indications can be seen within a year. As the stock markets are forward-looking, the stock price will start to recover well before the results turn positive.

What does the chart forecast?

GE has been in a long-term downtrend. With the plunge of the past two days, price has reached the downtrend line, which is likely to act as a support. Additionally, the 61.8% Fibonacci retracement level of the rise from the lows of 2009 to the highs in 2016 is at $17.17. As these two supports are close by, we expect the stock to find some support at the $17 levels. The RSI has also fallen into the oversold zone. Previous oversold readings on the RSI have led to a recovery in price. However, if the support breaks, the stock is likely to slide to its next major support of $14.

As the stock is currently in a downward momentum, we recommend buying GE in batches, instead of buying it all at once. The first lot of about 2% of the portfolio can be bought at the current levels. We, eventually, want to increase the stake to about 5% of our portfolio. Sharp intraday dips can be used to accumulate positions on the long side in the next few days or weeks.

For ease of calculation, we shall consider the purchase price as $18. This is the second stock in our portfolio, after the purchase of AT&T a couple of days back.

Risks

GE’s turnaround will suffer if the world economy slows down. The Chinese slowdown, the middle east unrest, the Brexit issues and other geopolitical issues can put brakes on the already anemic global recovery.

Flannery has a tough job at hand. Any misstep in the execution of the turnaround plan can sink the stock further.

Featured image courtesy of Shutterstock. 

Author:
Rakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.