Industrial Segment Growth & Gains From Cost Cuts Will Likely Lift GE’s Results

by Trefis Team
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General Electric (NYSE:GE) will announce its first quarter earnings on April 17. The industrial conglomerate is coming off a good last year in which its earnings rose by 7% annually to $1.47 per share. [1] GE’s 2013 results benefited from strong growth in some of its industrial segments like aviation and oil & gas. Cost cuts implemented across the company’s segments also played a key role in shoring up its profits. Throughout 2013, GE slashed its employee headcount and removed excess enterprise resource planning (ERP) systems. It consolidated production facilities to ensure greater sharing of common resources and also removed significant structural costs from Europe where its results have been impacted by slowdown. These measures enabled GE to reduce its structural costs by $1.6 billion in 2013, expanding its margins by 66 basis points. [2]

As these cost reduction measures continue in 2014, we figure gains from these will further expand GE’s margins and profits in the first quarter. In its latest guidance, GE estimates to take out an additional $1 billion from its structural costs in 2014. [2] We will be noting how much of this is achieved in the first quarter. In our view, GE’s cost reduction is crucial for its profit growth, as the current macro environment does not support strong top line growth. Additionally, we also anticipate GE’s first quarter results to gain from strong growth in some of its industrial segments, particularly aviation and oil & gas. This growth could be offset in part by weaker results from GE’s financial arm, GE Capital, due to its smaller size.

Separately, we will watch GE’s earnings for any new information on the IPO of its North American retail finance unit. We currently have a stock price estimate of $26.66 for GE, marginally ahead of its current market price.

See our complete analysis of GE here

Lower Cost Structures Will Enable GE To Compete More Aggressively

GE is slashing its cost structures across its industrial segments, which include power & water, oil & gas, energy management, aviation, healthcare, transportation and appliances & lighting, under an initiative called simplification. Through this initiative, GE is seeking to not only reduce its costs but also make itself more agile to customers. We figure simplification is very important for GE as it will help the company compete more aggressively with smaller companies, which due to their size are able to respond faster to changing customer demands. At the same time, GE considers cost savings realized through simplification as important as investments in technology for maintaining market leadership.

In technology, the company already leads in most industries it is present in. For instance, GE’s strong showing at the Dubai Air Show where it won airplane engine orders worth $40 billion – more than its competitors – was due to its technologically advanced portfolio. [3] In our view, if the company can support its technological lead with lower costs, which translates into competitive pricing, then competitors will find it very difficult to take market share from GE.

Aviation And Oil & Gas Will Lift GE’s First Quarter Results

In addition to gains from lower costs, we anticipate GE’s first quarter results to benefit from strong growth in some of its industrial businesses, especially aviation and oil & gas. In aviation, demand for engines from airplane makers such as Boeing (NYSE:BA) and Airbus is growing as they are hiking their production rates in response to rising orders from airlines. This is raising engine shipments of GE. At the same time, GE’s services revenue from aviation is also rising as the worldwide airplane fleet is growing in size. More planes flying with GE engines are generating higher revenues for GE from engine servicing, repair and overhaul. In oil & gas, where GE provides oil/gas drilling equipment and machinery, the company’s sales are rising driven by growing demand for oil and gas worldwide, especially from the emerging countries.

On the flip side, we figure this growth in GE’s first quarter industrial results from aviation and oil & gas will be partially offset by weakness in its transportation segment, which apart from providing locomotives serves the global mining industry. And the ongoing weakness in the mining sector caused by lower capital and cost spending from mining companies, will impact results at GE’s transportation segment.

Overall, we anticipate results at GE’s industrial segment, which constitutes over 55% of its total earnings, to grow in the first quarter.

Smaller GE Capital Could Weigh On GE’s Sales and Profits

In comparison, GE’s financial business – GE Capital – will continue to contract in the first quarter. This will likely weigh on GE’s revenues and profits from GE Capital. The reduction in GE Capital’s size is not a fallout of an external change, but an intended outcome of a GE strategy. Since the financial crisis of 2009, GE has slashed GE Capital’s size in an attempt to lower its dependence on the financial sector. The company seeks to ultimately raise the share of its industrial segment to 70% of its total earnings.

As part of this process, GE in March, filed a statement with the Securities and Exchange Commission for the initial public offering of its North American retail finance unit. [4] This unit, which provides credit on store sales, is the largest issuer of private-label credit cards in the U.S.. GE plans to dilute around 20% of its stake in this unit through an IPO later this year. Thereafter, the company will divest its remaining stake in this unit next year. Read here in greater detail about GE’s exit from this business. For GE, this exit from its North American retail finance unit will play a key role in reducing the share of GE Capital to 30% in its total earnings.

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Notes:
  1. GE’s 2013 10-K, February 27 2014, www.ge.com []
  2. GE’s 2013 Q4 earnings 8-K filing, January 17 2014, www.ge.com [] []
  3. $40 billion for GE and CFM International at Dubai Show, November 19 2013, www.geaviation.com []
  4. GE’s form S-1 filing for the IPO of its North American retail finance arm, March 13 2014, www.sec.gov []
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