GE Q3 Operating Earnings Marginally Beat with Core Focus

Sustained focus on core industrial business enabled diversified conglomerate General Electric Company (GE) to report strong third quarter 2014 results, with solid industrial segment profit growth and margin expansion.

Operating earnings for the reported quarter improved to $3.8 billion or 38 cents a share from $3.7 billion or 36 cents a share in the year-ago quarter. The increase in year-over-year earnings was primarily attributable to top-line growth. Operating earnings for the reported quarter marginally exceeded the Zacks Consensus Estimate by a penny.

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On a GAAP basis, the company reported quarterly earnings of $3.5 billion or 35 cents per share compared with $3.2 billion or 31 cents in third-quarter 2013.

Revenues

Total revenue for the reported quarter increased 1% year over year to $36.2 billion and fell short of the Zacks Consensus Estimate of $37.0 billion. While overall Industrial segment revenue increased 3% to $26.6 billion, GE Capital revenue dropped 1% year over year to $10.5 billion. The decrease in GE Capital’s revenue was in accordance with the corporate strategy to lower top-line growth from the financial unit. Organic revenue growth for the industrial segment aggregated 4% for the quarter. Management remained upbeat to achieve industrial organic revenue growth at the higher end of the 4-7% range in 2014.

The company received strong orders during the quarter across the globe. Five of the seven industrial segments reported solid orders as industrial segment orders were up 22% year over year. Orders from growth markets increased 34% as five out of nine regions witnessed revenue rise. Services orders were up 10% during the quarter. Total backlog of equipment and services at quarter-end reached a record high $250 billion as new technologies drove a 31% increase in equipment orders in the quarter.

During the reported quarter, General Electric spun off its consumer-lending arm Synchrony Financial (SYF) in an initial public offering (IPO) as the first concrete step to shrink its finance business by 2015. This strategic move is arguably the biggest step in restructuring GE Capital’s portfolio to shield the parent company from intense market volatilities that plagued the market during the 2008-09 financial crisis. The spin-off will realign the corporate strategy of General Electric to a manufacturing-based entity with emphasis on big-ticket items such as medical equipment and scanners.

The company also inked a definitive agreement with premier electronics manufacturer Electrolux AB to divest its appliance unit for $3.3 billion. The divestiture, valued at 8.0x trailing EBITDA (earnings before interest, taxes, depreciation, and amortization), will generate an approximate after-tax gain of 5–7 cents per share at closing. With this transaction, General Electric brought the tally for announced divestments during the year to $4.7 billion.

At the same time, the company is successfully working to obtain approvals for acquiring the Power and Grid business of French conglomerate Alstom. The deal, expected to close in 2015, is likely to be accretive to General Electric earnings in 2016 by 6-9 cents per share. Consequently, General Electric is expected to achieve its target of 75% of total earnings from its Industrial business by 2016.

Revenue by Segment

During the reported quarter, Oil & Gas revenues improved 7% year over year to $4.6 billion, while Energy Management revenues decreased 1% to $1.8 billion. Revenues from Aviation and Transportation segments climbed 6% and 10% year over year to $5.7 billion and $1.5 billion, respectively.

Both Healthcare and Appliances & Lighting segment revenues were up 4% and 1%, respectively, to $4.5 billion and $2.1 billion. Revenues from the Power & Water segment decreased 2% year over year to $6.4 billion.

Revenues from the GE Capital segment declined 1% year over year to $10.5 billion as the company continued its strategy to reduce the overall size of its non-core portfolio while focusing on core growth. Year-to-date, GE Capital paid $2.2 billion in dividends to parent General Electric. Ending net investment or ENI (excluding cash and cash equivalents) for GE Capital was $365 billion at quarter-end, down 5% year over year. GE Capital finished the quarter with a Tier 1 common ratio of 12.1% with net interest margin at 5.0%.

In accordance with its core industrial focus, GE Capital is on track to close the divesture of its GE Money Bank AB (Nordics) consumer finance business in the fourth quarter of 2014. Subsequent to the quarter end, GE Capital Aviation Services acquired helicopter lessor Milestone Aviation Group for $1.78 billion, in tune with the strategic plan of growing in core areas that are aligned with General Electric’s industrial business.

Margins, Balance Sheet and Cash Flow

The company is currently on track to achieve its goal of $1 billion cost-cuts in the year. During the first nine months of the year, General Electric was able to reduce industrial structural costs by $674 million versus the prior-year period, driven by simplification initiatives and benefits from restructuring investments. The company reported strong margin expansion of 90 basis points in the quarter as six of seven businesses showed positive margin growth.

Operating profit in the Industrial segment increased 9% to $4.3 billion with cost productivity while GE Capital profit declined 22% year over year to $1.5 billion. General Electric’s total segment profit for the reported quarter decreased 1% year over year to $5.8 billion, with a rise in profits from Oil & Gas (up 27%), Aviation (up 16%), Appliances & Lighting (up 14%), and Transportation (up 12%), partially offset by a considerable decline in profit in the Power & Water segment (down 8%).

Year-to-date, cash generated from operating activities was $7.2 billion, with $5.0 billion generated from industrial activities. Management was confident to achieve its goal of $14-$17 billion in cash from operating activities in 2014. Cash and marketable securities at quarter end aggregated $137.5 billion. General Electric returned $8.4 billion to shareholders during the first nine months of the year through $6.6 billion dividend payouts and $1.8 billion share buybacks. General Electric ended the quarter with $90 billion of consolidated cash and cash equivalents.

Outlook

With a focused and dedicated execution of its strategic plans as reflected in solid third quarter results, General Electric expects to continue its bull run in 2014 with an unchanged framework and simultaneously benefit the shareholders with a healthy return on investments. The company has started its exit from the financial business and has increased its investments in core industrial businesses through restructuring, state-of-the-art technology, and R&D initiatives. General Electric also remains focused on its stringent cost-cutting measures. We remain encouraged with these endeavors of the company.

Moving Forward

Driven by relatively strong quarterly results that exceeded expectations, market sentiments appear to be positive. Share prices were on its way up in pre-market trading as investors reacted positively on a strong outlook and focused approach to realign the corporate structure to a manufacturing-based entity.

General Electric presently retains a Zacks Rank #3 (Hold). Some better-ranked stocks in the industry include CLARCOR Inc. (CLC), Compass Diversified Holdings (CODI), both of which carry a Zacks Rank #2 (Buy).

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