GE Revs Up the Dividend Engine

09/02/2010 1:00 pm EST

Focus: STOCKS

Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, and analyst Daniel Holland say GE’s recent payout boost, after last year’s cut, renews its appeal to dividend investors.

On July 23rd, out of the blue, General Electric (NYSE: GE) increased its quarterly dividend by 20%, to 12 cents a share.

Now that GE has demonstrated its willingness to begin restoring shareholders’ pay [after last year’s dividend cut,] the question turns to how much growth we can expect. I’m still using a long-term dividend growth forecast of 8%, but there’s a potential for the dividend rate to reach 81 cents to 90 cents a share in 2014—that is, a yield on my $16 Dividend Buy price between 5.1% and 5.6%.

Even that won’t mark a full recovery to the pre-crash rate of $1.24, and by no means will I forget what GE did, but perhaps we can start thinking about forgiveness.

The financial unit, GE Capital Services, has been the source of most of GE’s problems of late, although we see this abating as the global economy heals.

Exiting the recession, [chief executive officer] Jeff Immelt finally has the portfolio he wants, in our opinion. He essentially put the company on a diet, trimming the business to an impressive core portfolio. NBC Universal should move out of the picture by year’s end, leaving the energy, health care, and aviation pieces intact. All of these are wide-moat franchises, in our opinion.

[Also,] GE shifted its growth focus from acquisitions to heavy research and development, giving the company one of the strongest new product portfolios in recent memory.

With a swelling cash hoard and falling leverage at GE Capital Services, GE’s balance sheet has improved materially. The company intends to pay out 45% of profits, in line with historical (pre-bubble-era) practices. So, as earnings prospects start to improve, the board’s recent move to raise its quarterly payment 20% signals considerable confidence.

While we believe a full reinstatement of the $1.24-a-share dividend rate of 2008 will take many years, we also think GE’s industrial businesses are capable of surpassing their 2008 peak in earnings as soon as 2012. The main swing factor is the contribution of GE Capital, which management is shrinking permanently:

Our [five-year] forecasts anticipate the financial unit’s annual profits reaching levels only about half those of 2006–2007. Still, a 45% payout ratio on 2014 profits of $1.80–$2.00 a share points to a dividend rate of [81 cents to 90 cents], which in turn could grow at a mid- to high-single-digit pace thereafter.

As these assumptions are sensitive to economic conditions, our dividend growth forecast of 8% annually is deliberately conservative. GE would provide a 2.5% yield at our Dividend Buy price of $19 and a 3% yield if purchased at $16. (It closed at around $15 Wednesday—Editor.)

Based on an 8% dividend growth rate, our Dividend Buy price represents a 24% discount to our fair value estimate of $25, [and] would offer an annual total return prospect of 11% on average.

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