Is GE’s Dividend Safe?

02/02/2009 12:00 pm EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, and analyst Daniel Holland say GE may face the choice between keeping its triple-A rating and cutting its dividend.

Few dividends have become more controversial than that of General Electric (NYSE:GE). Though the mighty GE recently traded for only one-fourth of its 2000 all-time high (it closed above $12 Friday—Editor), its dividend had continued to grow at a double-digit clip.

In late 2008, however, a streak of dividend growth dating to 1976 came to a halt. Though management vigorously defends its intent to preserve the current 31-cent-per-share quarterly rate through all of 2009, the stock’s recent yield near 9% bears ample witness of investors’ collective skepticism.

GE’s current troubles are rooted at GE Capital Services. Historically, GECS has been a solidly profitable lender, leveraging superior business practices and GE’s triple-A credit ratings to generate solid returns. GECS accounted for $10.3 billion (46%) of GE’s 2007 profit of $22.2 billion, when the company’s total dividend payout was $11.5 billion (52% of earnings).

GE might be able to pay its dividend from nonfinancial earnings and liquidity. [But]  when capital markets conditions turned vicious in the second half of 2008, investors began betting against GECS’ ability to maintain those triple-A ratings, and the rating agencies themselves have expressed some doubt in this area.

The company was forced to seek outside assistance, first from Warren Buffett, who invested $3 billion in a special preferred issue to fund a capital contribution from the parent to GECS, and then from the FDIC, which—implicitly recognizing GECS as “too big to fail”—provided the firm with a set of loan guarantees.

These moves are virtually certain to keep GECS from imploding. What they can’t do is preserve GE’s triple-A credit ratings. GE may soon face a choice between maintaining its current dividend rate, which would block the parent from providing much additional capital to GECS, or letting its credit rating fall.

A downgrade would not be the end of the world; GE would have to come up with $20 billion of cash to support certain collateralization requirements, but it has $65 billion of undrawn credit-line capacity. A double-A credit rating would also lead to a higher cost of funds, but GE is already paying much more than a double-A rating would suggest long term.

We think the dividend’s fate has more to do with GE’s long-run earnings power. GECS is unlikely to be the same kind of contributor to profits that it has been in the past, and GE’s nonfinancial businesses are now suffering cyclical profit declines as well. Although GE’s payout ratio looked to be around 55% in 2008—not far above the roughly 45% of prior years—the earnings power of GECS has eroded somewhat. And if this erosion would place the current dividend rate at much more than 60%–70% of average long-run earnings, some reduction becomes likely.

But even if the dividend is reduced, we believe GE will continue sporting an attractive yield with good long-term dividend growth prospects.

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