How Will GE Fare In The Low Oil Price Environment?

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General Electric

General Electric (NYSE:GE) has spent many billions on acquisitions over the past decade to build its oil and gas business. Today, the infrastructure company is one of the largest suppliers of oil and gas drilling machinery and equipment to energy companies. In recent years, this business has been a key driver of GE’s growth, as rising oil prices drove up orders for machinery and equipment from energy companies. In the first nine months of 2014, GE’s oil and gas revenue rose in double-digits, constituting nearly 13% of the company’s total revenue. [1] But, with the recent decline in oil prices, GE’s oil and gas business is bound to be impacted. Brent crude oil has fallen from about $100 per barrel in early September, to about $60 per barrel currently. And with U.S. oil production rising and OPEC not resorting to production cuts, the supply glut in the market will likely persist in the near term, maintaining pressure on oil prices. So, how will GE fare in this low oil price environment, which will weigh on its oil and gas business? We think GE will do fine, as the decline in its oil and gas business will likely be more than offset by growth from its other businesses, especially aviation, power and transportation. Rising sales of aircraft engines, gas turbines and locomotives will likely outweigh lower sales of oil and gas machinery in 2015, growing GE’s overall results.

We currently have a price estimate of $28 for GE, about 15% ahead of its current market price.

See our complete analysis of GE here

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GE’s Oil And Gas Revenue Will Likely Fall In 2015

With oil trading around $60 per barrel, energy companies will slash their investment in new machinery and equipment, weighing on GE’s oil and gas business. To assess the extent of this impact on GE’s oil and gas business, we need to dig deeper into the business. GE generates roughly 60% of its oil and gas revenue from turbomachinery, measurement and control equipment, and downstream oil and gas businesses. With the share of LNG growing in the overall fuel consumption-mix and relatively lower impact on the downstream segment from the recent decline in oil prices, GE figures that this portion of its oil and gas revenue will likely not be affected as much in the near term through 2015. The company generates another 15% of its oil and gas revenue from subsea projects. GE’s revenue from these projects will likely also not be impacted significantly in 2015, as these projects are more long-term in nature. As a result, a significant portion of GE’s subsea revenue anticipated in 2015 is already present in its backlog. GE generates the remaining portion – roughly 25% – of its oil and gas revenue from surface and drilling, which will likely see the biggest impact from lower oil prices. All in all, GE anticipates that its oil and gas revenue could fall by up to 5% in 2015 due to the decline in oil prices. [2]

On its part, the company will try to keep its oil and gas margin stable in this falling revenue environment, so that the impact on its oil and gas profit is minimal. GE aims to sustain its oil and gas margin by cutting costs, so the from the business could also fall by up to 5% in 2015. [2]

Over the long term though, we figure GE’s oil and gas business will likely grow driven by the rising global energy demand, especially from the emerging countries. As production peaks off in the U.S. or demand picks up from major emerging economies like India, oil prices will again begin to rise. Higher prices will attract greater capital investment from energy companies, growing machinery and equipment sales of GE. So, over the long term, GE’s oil and gas business will act as a growth driver.

Aviation, Power And Transportation To Offset Weakness In 2015

In 2015, despite lower revenue and profit from its oil and gas segment, GE will likely be able to grow its overall revenue and profit, as its other businesses continue to perform well. GE’s aviation business, which constitutes about 16% of its top line, will likely continue to see strong growth in 2015 driven by higher engine shipments. As global air passenger traffic continues to rise, airlines are continuing to buy new airplanes, growing shipments of engines and other aircraft components from suppliers like GE. Rising rail traffic is also lifting GE’s locomotive sales, and with the acquisition of Alstom, GE’s power business is also set to grow in 2015. The U.S. economy also continues to steadily grow providing support to GE, which derives nearly half of its total revenue from the country. So, despite the decline in its oil and gas business in 2015 due to lower oil prices, GE, on strength of its diversified product portfolio, will likely perform well, reporting healthy growth in its overall results.

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Notes:
  1. GE’s 2014 Q3 earnings form 8-K, October 17 2014, www.ge.com []
  2. GE’s 2014 annual investor outlook meet, December 16 2014, www.ge.com [] []