GE Shows Higher Margins For Industrials Despite Mixed Performance Among Units

by Trefis Team
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General Electric
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    Quick Take
  • In the second quarter, GE improved its industrial margins by 50 basis points on cost-cutting which drove growth in its industrial profits.
  • However, the company’s top-line was impacted by lower sales at the power & water segment which faced headwinds from low wind turbine shipments.
  • On the bright side, the performance at GE’s other industrial segments, especially oil & gas and aviation, continued to be strong driven by industry-specific trends.
  • Separately, GE returned around $6 billion to shareholders through dividends and share buybacks in the second quarter. Looking ahead, the significant cash return from GE Capital will enable the company to return the planned $18 billion to shareholders in 2013.

General Electric (NYSE:GE) posted marginally lower industrial revenues in the second quarter due to a sharp decline in wind turbine shipments, partially offset by growth in oil & gas, aviation and transportation businesses. However, despite a fall in industrial top line, the company’s industrial profits grew by 2% annually to $3.8 billion on margin expansion supported by cost cuts. [1] Looking ahead, GE anticipates the industrial segment to perform better in the second half of 2013 on recovery in wind turbine shipments.

Separately, GE Capital, the company’s financial arm, posted lower year-over-year sales and profits in the second quarter, in line with asset reduction.

See our complete analysis of GE here

Industrial Margins Expand By 50 Basis Points

GE saw its industrial margins expand by 50 basis points during the quarter, which led to profit growth. The company lowered its industrial structural costs by $274 million through multiple initiatives such as headcount reductions and the removal of excessive ERP systems and significant structural costs from Europe. [1] [2] We believe the Q2 margin improvement will help the company achieve its 2013 target of expanding industrial margins by 70 basis points.

This margin expansion is all the more crucial for GE’s future growth as it continues to cut the size of GE Capital by selling off non-core assets.

Mixed Top Line Performance Across Industrial Businesses

Power & Water Is Down

The decline in GE’s second quarter top line was largely due to a 17% fall in sales from the power & water segment, which sells turbines and generators that harness wind, gas, oil and water resources for power. [1] During the quarter, GE shipped 351 wind turbines down from 726 in the prior year period. Its gas turbine shipments also declined to 19 from 31 last year. The company attributed this decline largely to shipment timing and said it expects 70% of its full year wind turbine, gas turbine and distributed power equipment to be shipped in the second half of 2013. [3]

We believe this anticipated increase in volume at power & water segment, which constitutes around a quarter of GE’s total industrial sales, will help the company achieve its 2013 industrial margin expansion target.

Oil & Gas, Aviation, Healthcare, Transportation Are Up

Excluding power & water, sales from GE’s remaining industrial segments grew at over 5% annually in the second quarter with positive growth from each segment, except healthcare, where sales were flat. [1] The top line growth was led by aviation and oil & gas segments.

In aviation where GE is a major jet engine manufacturer, sales grew driven by higher demand from aircraft manufacturers like Boeing (NYSE:BA) and Airbus, which are increasing their production rates to make timely deliveries against their surging order books. In oil & gas, sales rose due to increasing global demand for oil & gas driven by rising energy consumption from emerging countries. In the oil & gas sector, GE provides primarily oil and gas drilling machinery and equipment.

A Smaller GE Capital

GE Capital continued to sell off non-core assets as GE focused on lowering the financial arm’s share in its overall earnings. During the quarter, GE Capital’s ending net investment excluding cash, which provides a measure of its size, was reduced by $11 billion to $391 billion. [2] This in turn slashed the segment’s profits by 9% annually. Nevertheless, GE Capital returned significant cash of around $1.9 billion to its parent company during the quarter. For full year 2013, GE anticipates to receive around $6.5 billion in cash from GE Capital. [1]

Significant Cash Return To Shareholders

This cash from GE Capital will help GE return the targeted $18 billion to shareholders in 2013. In the first half, the company returned $9.9 billion, of which $4 billion came from dividends and the remaining $5.9 billion was from stock repurchases. [4]

All in all, GE fulfilled its major objectives of industrial profit growth and margin expansion, a smaller GE Capital, and returning significant cash to shareholders during the second quarter.

Outlook

Looking ahead, the company anticipates its earnings from power & water segment, which has been the biggest drag on earnings so far in 2013, to be higher in the second half on a year-over-year basis. This will help GE achieve its 2013 objectives of 2-6% organic industrial revenue growth and double-digit industrial earnings growth.

We currently have a stock price estimate of $22 for GE, around 10% below its current market price. We are in the process of incorporating second quarter earnings in our analysis and shall update the same shortly.

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Notes:
  1. GE’s Q2 2013 earnings form 8-K, July 19 2013, www.ge.com [] [] [] [] []
  2. GE’s Q1 2013 earnings form 8-K, April 19 2013, www.ge.com [] []
  3. GE’s Q2 2013, earnings transcript, July 19 2013, www.ge.com []
  4. GE’s Q2 2013 earnings presentation, July 19 2013, www.ge.com []
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