Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

At General Electric Co., it's out with the old and in with the new. And its looking increasingly likely that some of the "old" on the way out could include the industrial giant's accounting methods and dividend.

GE rounded out a bunch of management changes by designating Rafael Santana head of its transportation business on Monday. The former leader of that business, Jamie Miller, was named CFO of the entire company on Oct. 6 after Jeff Bornstein said he was stepping down. Bornstein's departure comes just months after new CEO John Flannery (himself having only been on the job since August) hailed him as a partner in his effort to mend GE's languishing stock price and worrisome cash flow trends.

The shake-up shows Flannery is taking shareholders' dissatisfaction seriously, but he's yet to rip off the biggest Band-Aid of resetting earnings expectations. And the fact that these management changes had to be announced now -- in the case of the CFO job before a new transportation head could be officially named -- suggests what's underneath the dressings is going to be an eyesore of a wound that could put the company's dividend at risk

Penny Pinching
Expectations currently point to a dividend cut, per data compiled by Bloomberg
Source: Bloomberg Dividend Forecasting analysts

We should get some clues as to the state of things when GE reports third-quarter results this Friday, at least as far as 2017 is concerned. Weakening demand for gas turbines has made analysts more skeptical of its earnings power. On average, they're now targeting $1.52 in 2017 adjusted EPS, well below GE's guidance of toward the low end of a $1.60 to $1.70 range. But the real damage assessment will happen in November, when Flannery is scheduled to reveal the results of his review of GE's portfolio and outlook for the future.

It's now apparent that GE's goal of $2 in EPS by 2018 was based on the same cockeyed optimism that fueled its overly aggressive sales growth targets in years past (analysts on average are expecting just $1.65). But there's another problem with that number: it's based on a bevy of adjustments that investors are simply no longer willing to take the company's word on.

Fun with Numbers
GE has one of the widest discrepancies between its adjusted and GAAP numbers among major industrials. For one, GE backs out pension obligations, a variance from standard practice at peers like United Technologies.
Source: JPMorgan analyst Steve Tusa

Going back to reporting headline numbers on a GAAP basis would be a drastic move, but it's one that Flannery should take if he's serious about a clean slate. It would have been more difficult to explain such a switch with Bornstein still acting as CFO -- after all, he enabled the current reporting approach since 2013. His departure also does raise questions about what sort of nasty surprises could be lurking in the numbers. As it is, analysts are forecasting GAAP earnings per share of $1.48 in 2018, down from expectations of $1.90 a year ago. 

As GE's earnings outlook darkens, that means less cash is coming in the door. Couple that with the potential for more meaningful restructuring expenses, not to mention the risk of a multi-billion dollar tax bill should President Donald Trump's administration pursue a mandatory levy on cash that's been stockpiled abroad, and you could have a problem. GE's dividend already looks set to soak up the bulk of its industrial cash flow over the next few years, leaving Flannery very little in the way of resources to help ignite growth.

Money Suck
GE's dividend soaks up a lot of its available resources
Source: Vertical Research Partners analyst Jeff Sprague

The company has maintained that its dividend is sacrosanct. But GE may have no choice but to start thinking the unthinkable. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net