By Michael Rapoport
No matter what happens with General Electric Co.'s dividend, investors will still have to grapple with the fact it is nearly impossible to tell how much of its earnings are backed by cash.
Until investors can figure that out, a pall could hang over the battered stock and questions linger about the dividend, analysts said. "I can't really build a quarterly cash flow for these guys that has any credibility," said Scott Davis, an analyst with Melius Research.
Mr. Davis recently blasted GE in a research note as "a company in disarray." In an interview, he compared GE's earnings releases to "an IQ test -- they give you 10,000 numbers and you have to figure out which 10 matter."
In a statement, GE said, "Our goal is consistency and transparency with data that our shareowners can digest. We are looking at how we can report in a cleaner way, including a simpler presentation."
On Monday, GE executives led by CEO John Flannery plan to unveil a major update to its corporate strategy, which is expected to address the fate of the dividend, plans for asset sales and attempts to simplify the company's accounting.
The latter is a sticking point for investors and is tied to questions about the company's ability to convert earnings into cash.
The earnings-cash flow relationship has come to the fore since GE last month slashed guidance for the rest of the year for both measures.
"It's kind of opaque," said Brad Ginesin of hedge fund Polar Capital LP, which owns GE shares. "There's a certain leap of faith you take."
Ideally, a company's earnings should be fully backed by cash, to demonstrate that earnings are high quality and that there is money to do things like pay dividends to shareholders. But GE's accounting has so many moving parts -- different ways of measuring its performance, corporate changes and special items as well as areas without a lot of disclosure -- that analysts say they have trouble determining cash flow.
"When you're disposing of a lot of businesses as they are, it's difficult to separate out what assets are here, what assets are gone, and their effects on cash flow," said Charles Mulford, an accounting professor at the Georgia Institute of Technology.
Even before last month's change to guidance, analysts had been concerned about a divergence between earnings and cash flow. In May, the company changed its methodology for calculating the rate at which its operating earnings convert into free cash flow, in a way that made it look better. Under the new method, the conversion rate was 91% for 2016, versus 76% under the old.
The October outlook cut exacerbated fears. GE reduced its earnings target by about a third but its cash-flow target by close to half. That seemingly leaves the company needing a hefty fourth-quarter slug of cash, far exceeding newly booked earnings, to meet its target.
"The number looks extraordinarily challenging, and it's a little unclear how they're measuring the number," said Jeffrey Sprague, an analyst with Vertical Research Partners.
How challenging? GE spent $6.4 billion on dividends to shareholders in the first nine months of this year, nearly double the amount of cash it generated from operations, as calculated under standard accounting rules. And that doesn't even take into account the company's billions of dollars in capital spending.
Even under GE's preferred measures of earnings and cash flow, there was a shortfall. In the year's first nine months, GE reported $6.8 billion in industrial operating earnings with some GE Capital businesses added in, compared with only $1.6 billion of adjusted industrial operating cash flow.
To hit the sharply reduced 2017 financial targets GE issued last month, that trend would have to reverse itself in the fourth quarter. Calculations by The Wall Street Journal suggest that for GE to meet its earnings outlook for the year, it would have to produce about $2.3 billion to $2.8 billion in adjusted fourth-quarter earnings. To hit reduced industrial operating cash-flow targets it would have to generate an additional $5.4 billion.
GE's cash flow does historically tend to be weighted toward the fourth quarter -- the company's customers tend to spend their capital budgets toward the end of the year. And cash does often come into a company at a time different from when the corresponding earnings are booked -- that is partly why cash flow is reported separately in the first place.
Part of the reason for the earnings-cash flow disconnect, GE indicated during its third-quarter conference call, is a buildup of inventory in its power-generation segment, which performed worse than expected. The increased inventory means GE has committed capital to build equipment that it hasn't yet been able to reap cash flow from.
GE has also acknowledged part of the reason its cash-flow outlook got slashed so much relates to its growing portfolio of contract assets -- revenue the company books on long-term service and equipment contracts before it has the cash in hand.
GE has assured analysts the company will ultimately realize all the cash related to those contract assets. But "we need to get some comfort and confidence that that is going to be the case," Vertical Research's Mr. Sprague said.
Write to Michael Rapoport at Michael.Rapoport@wsj.com