GE’s Earnings Will Likely Rise on its Industrial Segment Growth & Gains from Cost Cuts

General Electric (NYSE:GE) will announce its second quarter earnings Friday, July 18. The industrial conglomerate is coming off a good first quarter in which its earnings rose by 9% annually, excluding the impact from the NBCU sale that was executed at the start of 2013. ^[1] Driven by strong growth from some of its industrial businesses such as aviation and oil & gas, and gains from cost cuts, GE posted this healthy growth in its first quarter earnings.

In the second quarter, we anticipate the trend to continue. The company’s airplane engine deliveries and shipments of oil & gas drilling equipment have continued to rise. At the same time, GE has continued to execute cost reduction measures which will likely further expand its margins and profits in the second quarter. On the flip side, this growth from GE’s industrial segment could be partially offset by its finance segment, GE Capital, due to the latter’s shrinking size. GE has shrunk GE Capital since the financial crisis of 2008-09 in an attempt to lower its dependence on the global financial sector. This in turn has impacted revenues and profits from the finance segment. Strategically, we figure the company’s shift away from the financial sector, towards its industrial roots will benefit it over the long term, as this shift will insulate the company from sudden declines in future in the global financial sector. Currently, GE generates over 55% of its total earnings from its industrial segment and the remaining from its finance segment. This earnings-mix will however change by the end of 2015, at which time, the company will likely be generating about 70% of its earnings from its industrial segment. This significant shift in GE’s earnings-mix towards its industrial segment will be brought about by the planned divestiture of the company’s North American retail finance unit and its recent acquisition of Alstom’s power and grid businesses.

All in all, we anticipate GE to post strong second quarter results. We currently have a stock price estimate of $26.20 for GE, marginally below its current market price.

See our complete analysis of GE here

Industrial Segment’s Revenue Growth Will Drive GE’s Second Quarter Results

GE’s second quarter results will likely be driven by strong growth from some of its industrial segments, especially aviation and oil & gas. In aviation, as airplane makers such as Boeing (NYSE:BA) and Airbus are hiking their production rates in response to the growing global demand for new airplanes, shipments of jet engines manufactured by GE are rising. At the same time, GE Aviation’s revenues from jet engine servicing are also rising driven by the expanding worldwide fleet of commercial airplanes. Separately, in GE’s oil & gas unit, growing consumption of oil and gas in the emerging countries is raising sales of the company’s oil & gas drilling machinery and equipment. We figure, driven by these trends, GE’s aviation and oil & gas units will post solid growth in the second quarter. In the last quarter as well, driven by these trends, sales at GE’s oil & gas and aviation units grew by 27% and 14% respectively, on a year-over-year basis. ^[1] Additionally, this strong growth from aviation and oil & gas units has a considerable impact on GE’s overall industrial segment, as together these two units constitute nearly 40% of GE’s industrial segment revenues.

On the flip side, this strong growth from aviation and oil & gas units, will likely be tempered by lower sales from GE’s transportation unit, which apart from providing locomotives serves the global mining industry. And, with the ongoing weakness in the global mining sector caused by lower cost and capital spending from mining companies, sales at GE’s transportation unit will likely fall in the second quarter. All in all, we figure GE’s industrial segment will likely be able to achieve its goal of 4-7% annual organic sales growth in the second quarter.

Cost Cutbacks Will Help Expand Industrial Margin & Profits

The company’s second quarter industrial profits will also benefit from its cost reduction activities. Last year, GE was able to expand its industrial segment margin by 66 basis points on gains from cost cutbacks, which included headcount reductions, plant consolidations and removal of excess enterprise resource planning (ERP) systems. In 2014, the company has set itself a target of slashing $1 billion from its structural costs through similar cost reduction measures. In the first quarter, the company was able to take out $254 million from its structural costs, expanding its industrial margin by 50 basis points to 13.4%. ^[1] We anticipate GE to continue to expand its industrial margin in the second quarter on savings realized from these ongoing cost reduction measures. We will be noting how much of the remaining $756 million is GE able to take out from its structural costs in the second quarter. During the last quarter’s earnings presentation, the company had emphasized that it remains on track to achieve its goal of 17% industrial margin by 2016. ^[2] In all, expanded margins will help grow the company’s second quarter industrial profits.

GE is cutting its costs under a simplification initiative, which apart from reducing costs seeks to make the company more agile to customers. We figure simplification is 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 crucial for maintaining market leadership, as lower costs will provide the company with greater cushion to slash its product prices. Aggressive pricing in turn will help GE maintain its market share. Additionally, in our view, profit growth driven by this cost reduction is extremely helpful in the current macro environment which does not allow strong top line growth.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)
Get Trefis Technology

1. GE’s 2014 Q1 earnings form 8-K, April 17 2014, www.ge.com [↩] [↩] [↩]
2. GE’s 2014 Q1 earnings transcript, April 17 2014, www.seekingalpha.com [↩]