Margin Expansion Driven By Cost Cuts Will Boost GE's Profits

Oct.16.13 | About: General Electric (GE)

General Electric (NYSE:GE) will announce its third quarter results Friday, October 18. The industrial conglomerate will likely post higher profits on margin expansion driven by cost cuts. In the previous quarter, GE improved its industrial margins by 50 basis points through cost controlling initiatives. [1] In the current quarter, we anticipate benefits from the previous and ongoing cost cuts, which include headcount reductions and removal of excessive ERP systems to continue to expand the company’s margins. GE’s focus on removing nearly 20% of its structural costs from Europe where it is facing a tough operating environment due to economic slowdown will also support its margin expansion. [2]

Apart from cost reduction, a moderate top-line growth driven by strong performances at aviation and oil and gas segments supported by an anticipated recovery in wind and gas turbine delivery volumes will also boost GE’s margins. In all, we anticipate GE to post a good third quarter. We currently have a stock price estimate of $24.56 for General Electric, approximately in line with its current market price.

Strong Execution On Reducing Costs Will Drive Margin Expansion

GE is targeting to expand its industrial operating margin by 70 basis points in 2013 from 2012. [3] In light of the soft demand environment especially in Europe, which is putting pressure on top-line growth, the company is planning to achieve its targeted margin expansion through cost reduction. Accordingly, in the first half of the year, GE reduced its structural costs by $474 million through multiple initiatives that included employee layoffs and trimmed IT systems. [1] As these cost initiatives continued in the current quarter, operating margins are likely to expand further.

Anticipated Recovery In Power And Water Segment Will Aid Margin Expansion

In its second quarter earnings release, GE indicated that nearly 70% of its full year wind turbine, gas turbine and distributed power equipment shipments will fall in the second half. [4] This will likely lead to a recovery in the company’s Power and Water segment results in the third quarter. Profits from this segment had declined by 27% annually in the first half due to lower wind and gas turbine shipments, which GE largely attributed to timing. [1] This decline significantly impacted the company’s earnings in the first two quarters as the Power and Water segment constitutes around a quarter of its total industrial sales. Thus, the expected recovery in wind and gas turbine shipments in the third quarter should support GE’s margin growth. GE’s Power and Water segment sells turbines and generators that harness wind, gas, oil and water resources for power.

Other Industrial Segments Expected To Continue To Grow

GE’s other industrial segments namely oil and gas, aviation, healthcare, energy management and transportation will also likely continue to post growth in the third quarter driven by industry specific trends. For instance, in aviation, where GE is a major jet engine manufacturer, sales are rising driven by higher demand from aircraft manufacturers like Boeing (NYSE:BA) and Airbus, which are increasing their production rates to make timely deliveries against their surging order books. While at the oil and gas segment, sales are rising due to increasing global demand for oil and gas driven by rising energy consumption from emerging countries. In this segment, GE primarily provides oil and gas drilling machinery and equipment.

All in all, a strong operational focus around expanding margins through cost cuts and moderate top line growth will likely boost GE’s third quarter results.

Disclosure: No positions.