Commercial Aviation Upcycle Could Lift GE’s Results Despite Oil Weakness & A Smaller GE Capital

General Electric (NYSE:GE) will announce its fourth quarter and full year 2014 results on Friday, January 23. The industrial conglomerate is coming off a good performance in the first three quarters of 2014, in which its revenue and profit rose on higher shipments of airplane engines and oil & gas drilling equipment. In the fourth quarter, we anticipate GE’s aviation business to continue to drive growth in its results. However, this growth will be tempered by falling revenue and profit from a smaller GE Capital. Separately, we will be noting the cost reduction that GE is able to achieve in its industrial business in the fourth quarter.

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

See our complete analysis of GE here

Industrial Business, Particularly Aviation, Will Drive Growth

At the start of 2014, GE had set itself a target of 4-7% industrial organic sales growth and 10% industrial profit growth. Through the first nine months of 2014, the company has stayed on track to achieve these targets, growing its industrial organic sales by 6% annually and its industrial profit by 10% annually. ^[1] This growth in GE’s industrial business has been driven by its aviation and oil & gas segments, which together constitute nearly 40% of its total industrial revenue.

In the fourth quarter results, we anticipate that GE’s aviation segment will continue to post solid growth, but the company’s oil & gas segment could report weaker growth due to the recent decline in global crude oil prices.

In the aviation segment, as airplane makers such as Boeing (NYSE:BA) and Airbus have hiked their production rates, shipment of jet engines manufactured by GE has risen. At the same time, the company’s revenue from engine servicing has also grown, driven by the growing worldwide fleet of commercial airplanes. These higher engine shipments and higher revenue from engine servicing have grown GE Aviation’s revenue by roughly 12% annually in the first three quarters of 2014. ^[1] In the fourth quarter, we anticipate this trend to continue, with aviation driving growth in GE’s results.

On the other hand, in GE’s oil & gas segment, which is one of the largest suppliers of drilling machinery and equipment to energy companies, growth could fall in the fourth quarter. Lower oil prices have compelled many energy companies to cut their investment in new machinery and equipment. This will weigh on shipments of drilling machinery and equipment from GE’s oil & gas segment. That said, a lag in impact on GE from lower oil prices is likely, as the existing backlog will cover near term revenue. So, GE’s fourth quarter results may not show the full impact from lower global crude oil prices.

Other GE segments like healthcare and transportation will likely post moderate growth based on sustained growth in the U.S. economy. Rising rail traffic has lifted GE’s locomotive sales in recent months, which will likely grow its transportation segment results in the fourth quarter.

On the margin front, we will be noting the cost reduction which GE is able to achieve in the fourth quarter. At the start of 2014, the company had committed to slashing $1 billion from its structural costs through headcount reductions, plant consolidations, and removal of excess enterprise resource planning systems. In the first three quarters, the company has been able to take out $674 million from its structural costs. ^[2] In our opinion, cost reduction is essential for GE to achieve its 10% industrial profit growth target, as the current macro environment across many GE businesses is not allowing healthy revenue growth. So, additional gains from cost cutbacks will play a key role in enabling GE to post good profit growth in the fourth quarter.

Smaller GE Capital Will Temper Growth From Industrial Businesses

Growth driven by industrial segments will be partially offset by falling revenue and profit from GE’s financial arm, GE Capital. In the nine months ended September 30, 2014, revenue and profit from GE Capital fell by 5% and 9% annually, respectively. ^[1] This is because GE steadily reduced the size of GE Capital by selling its non-core assets, such as real estate and retail-focused businesses. From a long-term perspective, we figure a smaller GE Capital is good for GE, as it will reduce GE’s vulnerability to future shocks to the global financial market. (See A Look At GE’s Strategic Portfolio Repositioning In 2014)

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1. GE’s 2014 Q3 earnings form 8-K, October 17 2014, www.ge.com [↩] [↩] [↩]
2. GE’s 2014 Q3 earnings form 8-K, October 17 2014, www.ge.com [↩]