GE Remains On Track To Achieve Annual Targets With Strong Growth In Its Industrial Segment

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General Electric

General Electric (NYSE:GE) posted healthy growth in its second quarter results as higher airplane engine deliveries and oil & gas equipment shipments outweighed weakness from the global mining sector and the U.S. healthcare industry. The industrial conglomerate’s revenues rose by 3% annually to $36.2 billion and its earnings rose by 5% annually to $3.6 billion in the second quarter. [1] The company also expanded its industrial segment margin in the second quarter on gains from cost cutbacks. All in all, in our view, the company remains on track to achieve its annual targets for revenue and profit growth.

At the start of this year, GE set a target of 10% industrial profit growth and 4-7% industrial organic sales growth. [2] After the strong performance in the second quarter, the company in the first half of this year, has grown its industrial profits by 10% annually and its industrial organic sales by 6% annually. So, the company remains on track to achieve its annual revenue and profit growth targets. Additionally, with GE’s backlog rising to a record $246 billion at the end of the second quarter, we figure it is well positioned to maintain its revenue and profit growth momentum in the second half of this year. [1]

Separately, GE announced that it will file for the initial public offering (IPO) of its North American retail finance unit by the end of July. This unit, which has been named Synchrony Financial, is the largest issuer of private-label credit cards in the U.S., ahead of Citigroup and Capital One Financial Corp.. GE plans to sell about 15% of its stake in this unit through the IPO, which is expected to raise about $3.1 billion in all. [3] GE will continue to hold its remaining stake in Synchrony till a complete split-off, which is expected around the end of next year.

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GE also remains on track to close its acquisition of the power and grid businesses of Alstom in 2015. Earlier this year, Alstom’s board unanimously accepted GE’s revised bid and the French government also approved of GE’s offer to buy Alstom’s core assets. We figure the divestiture of Synchrony and acquisition of Alstom’s power and grid businesses will help GE generate a much greater portion of its earnings from its industrial businesses. Currently, the company generates about 55% of its earnings from its industrial businesses and the remaining from its finance businesses. However, post the Synchrony divestiture and acquisition of Alstom’s power and grid businesses, the company will generate about 75% of its earnings from its industrial businesses. [1] In our opinion, this shift in GE’s business away from the financial sector, towards its industrial roots will benefit it over the long term, as this shift will protect the company from sudden declines in the global financial sector.

We currently have a stock price estimate of $26.20 for GE, marginally below its current market price. We are in the process of incorporating GE’s second quarter earnings and shall update our analysis shortly.

See our complete analysis of GE here

Industrial Segment Revenue Growth Drove GE’s Second Quarter Results

In the second quarter, GE’s revenue growth was driven by double-digit sales growth from its aviation and oil & gas segments, which together constitute nearly 40% of its overall industrial revenue. In aviation, as airplane makers such as Boeing (NYSE:BA) and Airbus hiked their production rates in response to the growing global demand for new airplanes, shipments of jet engines manufactured by GE rose. At the same time, GE Aviation’s revenues from jet engine servicing also rose driven by the expanding worldwide fleet of commercial airplanes. At the recently held Farnborough Airshow, GE and CFM (GE’s 50/50 joint venture with Snecma of France) also won engine supply and servicing orders worth $36 billion highlighting both GE’s leading position as an airplane engine supplier and the strong growth anticipated in the coming years in the global commercial aviation industry. [1] Separately, in GE’s oil & gas segment, growing consumption of oil and gas in the emerging countries raised sales of the company’s oil & gas drilling machinery and equipment. Driven by these trends, sales at GE’s aviation and oil & gas segments rose by 15% and 20% respectively, in the second quarter.

This strong growth from its aviation and oil & gas segments was however tempered by lower sales from GE’s transportation segment. The transportation segment apart from providing locomotives also serves the global mining industry, which is currently undergoing a downturn caused by lower cost and capital spending from mining companies such as Vale, BHP Billiton and Rio Tinto. Going forward, with the recovery in the global mining sector not in sight in the near term, we figure the pressure on GE’s transportation segment from mining weakness will likely persist through 2014.

Additionally, revenues from GE’s finance segment, GE Capital, also fell in the second quarter due to the segment’s smaller asset base, which translated into lower lease and loan revenues. Ever since the financial crisis of 2008-09, GE has shrunk GE Capital in an attempt to lower its dependence on the global financial sector. This in turn has impacted revenues and profits from the finance segment. Overall, in the second quarter, GE Capital and the transportation segment tempered GE’s top line growth from its aviation and oil & gas segments.

Cost Cutbacks Boost Profit Growth

GE also derived additional gains from its cost cutbacks in the second quarter. The company had taken out $254 million from its structural costs in the first quarter of this year through various measures which included headcount reductions, plant consolidations and removal of excess enterprise resource planning (ERP) systems. [4] In the second quarter, as these measures continued, the company was able to further slash its structural costs by $128 million. With this, GE has taken out $382 million from its structural costs in the first half of 2014. [1] For the full year however, the company plans to remove at least $1 billion from its structural costs. So, GE has a huge cost-out left to achieve in the second half, but the company expressed confidence during its earnings presentation that it will be able to achieve this target. We figure profit growth driven by this cost reduction is important as the current macro environment does not allow for strong top line growth. Thus, as these cost cutbacks continue, GE’s profits in the coming quarters will likely continue to receive a boost through expanded margins driven by these cutbacks.

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Notes:
  1. GE’s 2014 Q2 earnings form 8-K, July 18 2014, www.ge.com [] [] [] [] []
  2. GE’s 2014 Q2 earnings presentation, July 18 2014, www.ge.com []
  3. GE’s 2014 Q2 earnings transcript, July 18 2014, www.ge.com []
  4. GE’s 2014 Q1 earnings form 8-K, April 17 2014, www.ge.com []