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General Electric (NYSE:GE) posted earnings slightly above the consensus for the 3rd quarter and shares have jumped 5% since the report. Strong cost reductions from the merger of its financial business and industrial growth that could surprise the market next year are driving the shares higher. Even at 52-week highs, I think the market is missing some upside potential in the outlook and have established a $29 price target over the next year.

3rd quarter marginal but with stronger backlog

General Electric reported $35.7 billion in sales for the third quarter, short of estimates and down 1% from the same period last year. Excluding one-time items, the company was able to post earnings of $0.36 per share, ahead of the $0.35 in earnings expected by analysts.

Six of the seven business segments showed higher earnings with CEO Jeffrey Immelt drawing particular attention to power & water which saw profits increase 9% over same period last year. Oil and gas was also strong with an 18% increase to $4.3 billion.

Most important for the fourth quarter was that the company reported its highest ever backlog of orders at $229 billion with a 19% increase over the quarter. The continued strength in industrials, despite market skepticism, and over a billion in cost reductions could surprise the market in the fourth quarter and into next year.

Cost-cutting and strong industrials will lead higher

Weakness in the general economy has led many analysts to question the sustainability of GE's margin expansion across its industrial segments. The company's net margin has increased each year from 8.3% in 2010 to over 11% expected for fiscal 2013.

The transportation division has been posting slower growth off of double-digit sales growth in 2011 and 2012. The segment could see a sales decline next year on a slowdown in locomotive deliveries. Other than transportation, all other industrial segments should post sales growth next year with particular strength continuing in the power & water and oil & gas segments.

The company merged its General Electric Capital Services division into its General Electric Capital Corporation last year to simplify the financial services' corporate structure and regulatory reporting. The merger has resulted in a significant cost reduction over the last year and should come through with another $1 billion in cost cuts for 2014.

Capital expenditures jumped 20% in 2012 to $15 billion on higher research & development spending in aviation engines but spending has leveled off over the last four quarters. This lower spending and higher sales is a theme across the company's financial statements and I think cash flow should improve materially next year.

General Electric books 47% of sales in the United States and 20% from the Eurozone. I think both of these regions could surprise on the upside next year as energy production continues to spur economic growth and lower manufacturing costs in the U.S. and the E.U. finally rebounds out of recession.

Estimates are for an increase of just 2.7% in 2014 sales to $150 billion and earnings growth of 10% to $1.79 per share. Revenue is still down almost 20% from 2008 mostly a result of a $19 billion drop in revenue at GE Capital as the company divests some assets and moves away from financial services.

Over the longer-term, GE continues to innovate and could be on the cusp of a breakthrough in 3D-enabled manufacturing. The company is making capital plans to construct fuel nozzle components with 3D printing lasers that will produce stronger and lighter parts.

The new process, called additive manufacturing, involves spraying alloy powder onto a platform and heating it with a laser to create successive layers of the component. New printers in development promise to have three to four times the capacity of existing machines. The technology can be used well beyond fuel nozzles and could help General Electric lower costs and increase production of higher quality component pieces.

Valuation

Analysts have cut quarterly earnings estimates leading up to the release in every quarter this year only to see the company report earnings ahead of expectations by an average of 5%. Current quarter estimates are for $0.53 per share and will be reported mid-January. I would wait a month to see if estimates come down and then start accumulating shares. The company is scheduled to host an analyst meeting on November 15th and the shares could move on any analyst comments. Cost-cutting and higher oil & gas revenue in the fourth quarter may help General Electric beat on the top- and bottom-line.

Shares of General Electric are trading at 17 times trailing earnings, in-line with the general market, and higher than the five-year average multiple of 14 times earnings. I am estimating sales of just under $151 billion and $18.2 billion in earnings or $1.83 per share accounting for a reduction of shares to 9.9 billion. With some contraction in the price multiple to 16 times, this leads to a conservative target of $29.28 over the next year.

Source: General Electric Earnings Were Better Than You Think