Weakness In Oil Industry Continues to Haunt GE

General Electric (NYSE: GE) reported its Q2 late last week, and beat consensus estimates for both the top and bottom line. However, there were some issues in the earnings, as GE’s overall revenues declined by nearly 12% and its profits nearly halved in Q2’17. The weakness in Oil & Gas continued in the quarter and resulted in pricing pressure for GE, which led to a nearly 760 bps decline in GE’s overall GAAP margins. These were partially offset by strength in the Renewable Energy and Power business. Going forward, GE bagged huge orders in Aviation and Oil, but that may not be enough to turn around GE’s declining profits as GE increased its oil dependence through the Baker Hughes merger. The volatility of oil prices may further hurt GE given the fact that oil prices remain low despite the extension of the OPEC deal to cap their oil production. Overall, we believe that the trouble for GE is far from over, but its diversified revenue streams may be able to prevent further declines.

Key Takeaways, What To Watch Going Forward

GE Aviation bagged nearly $30 billion of orders at the Paris Air show, which will help grow GE’s revenues in the coming quarters. The Renewable Energy segment has also shown strong organic growth over the last few quarters, especially from its Europe and Asia Pacific operations. GE’s diversified revenue streams and vast international presence may bring the revenue decline to a halt in the coming quarters, but we don’t expect much growth in revenues or profits in the near term. Cash flows from operating activities, which declined by nearly 70%, remain a concern for GE investors.

GE’s Increased Dependence on Oil May Hurt Due to Unpredictability of Oil Prices

GE completed the acquisition of Baker Hughes recently, which further increased its exposure to oil prices. The GE-Baker Hughes deal was made with the expectation that oil prices could reach $60 by 2018. Given the volatile environment in the oil industry, despite the OPEC deal to cut oil production, that $60 target looks a bit optimistic. As crude oil prices remain suppressed, oil companies are being forced to cut costs. This has led to some pricing pressure on equipment manufacturers including GE, resulting in margin pressure. GE grew its oil and gas equipment orders by 50% in the quarter, including one of the few big project deals in the industry with Eni in Mozambique. Although this may boost GE’s revenues going forward, the margin pressure will likely remain due to persistent unpredictability in oil prices and pricing pressure in the industry.

For our model and valuation, please refer to our complete analysis of General Electric

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