GE’s Net Rises But It Misses Margin Expansion Target

by Trefis Team
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GE
General Electric
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    Quick Take
  • In the fourth quarter, GE posted moderate growth in its revenues and profits driven by its industrial segments, particularly oil & gas and aviation.
  • The company also expanded its industrial operating margins by 100 basis points in the fourth quarter, but failed to achieve its 70 basis point margin expansion target for full year 2013.
  • GE’s order inflows also remained strong in the quarter and lifted its backlog to a record $244 billion.
  • Going forward, we figure with an improving macro environment, strong order inflows, higher backlog and lower cost structures, GE is well positioned for growth in 2014.

General Electric‘s (NYSE:GE) profits rose by 5% annually to $4.2 billion in the fourth quarter driven by industrial revenue growth. The company’s fourth quarter revenues also rose by 3% annually to over $40 billion driven by higher power turbine and airplane engine shipments, partially offset by lower revenues from GE Capital due to its smaller size. The industrial conglomerate also posted year-over-year growth of 100 basis points in its fourth quarter industrial operating margins. However, it missed its 70 basis points industrial margin expansion target for full year 2013. GE could manage to expand its 2013 industrial operating margins by 66 basis points annually on cost cutbacks. [1]

In our view, this marginal target miss is not a big deal since GE made significant progress in reducing its cost structures through 2013. The company slashed headcount and removed excess ERP systems. It consolidated production facilities to ensure greater sharing of common resources and also took out significant structural costs from Europe where its returns have been impacted by slowdown. In all, through these measures and others, GE reduced its structural costs by $1.6 billion in 2013. Looking ahead, the company expects to take out over $1 billion from its cost structures in 2014. [1] We figure this cost reduction is critical to drive profits in the current slow revenue growth environment. However, the company must do more to meet its own targets, as more target misses in the future will dent investor confidence in the management and stock. On its part, GE insisted that it missed the 70 basis point margin expansion target due to supply chain quality issues in some wind and energy management projects.

We currently have a stock price estimate of $27.03 for GE, approximately in line with its current market price.

See our complete analysis of GE here

Sector Specific Growth Trends Lifted Industrial Revenue

GE’s revenues rose in six out of its seven industrial segments in the fourth quarter. Growth was led by its oil & gas and aviation segments where the company benefited from sector specific trends. In oil & gas, sales of GE’s oil drilling machinery and equipment rose driven by rising demand for oil/gas worldwide, particularly from the emerging countries. In aviation, GE’s airplane engine and parts shipments rose driven by higher demand from airplane manufacturers like Boeing (NYSE:BA) and Airbus, which are hiking their production rates.

During the quarter, GE also saw its orders rise strongly across geographies including from Europe. The company’s fourth quarter orders from the U.S. rose by 8% annually, from China by 25% annually and from Europe by 3% annually. [2] These strong order inflows took GE’s backlog to an all time high of $244 billion at the end of 2013. We believe this high backlog coupled with lower cost structures and an improving macro environment will aid GE’s profit growth this year.

GE Capital Continues To Become Smaller & More Focused On Mid-Market Financing

In the fourth quarter, GE’s financial arm – GE Capital – also continued with its strategy of exiting from non-core, riskier assets to sharpen focus on mid-market financing. GE Capital ended the year with an ending net investment (ENI) of $380 billion, down from $417 billion at the start of 2013. [2] ENI provides a measure of GE Capital’s asset size. GE followed this strategy of shrinking GE Capital’s size since the financial crisis of 2008-09, during which a high degree of dependence on the financial business saw the company’s profits and stock price plunge sharply. GE plans to reduce GE Capital’s size further to around $300-350 billion ENI by the end of 2014. In pursuit of this, GE is expected to file for an initial public offering for GE Capital’s North American retail lending unit in the coming months. The company had made an announcement on this late last year. (See GE Trims Its Retail Lending Unit To Intensify Focus On Industrials)

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Notes:
  1. GE’s 2013 Q4 earnings 8-K filing, January 17 2014, www.ge.com [] []
  2. GE’s 2013 Q4 earnings presentation, January 17 2014, www.ge.com [] []
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