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Summary

  • GE posts results which are in line with expectations. Industrial moves along fine as GE Capital continues its slow wind down.
  • Immelt's transformation strategy is applauded but has moved slowly in recent years.
  • Alstom deal is a big addition to industrial activities, while the Synchrony Financial IPO should shed a lot of financial assets.
  • Shares already trade at a premium valuation to the market despite the modest growth and past mistakes.

General Electric (NYSE:GE) posted second quarter earnings which were largely in line with consensus estimates. The big news was the definitive timeline on the IPO of its financial unit in North America, which marks another big step in the company's transformation back towards its industrial roots.

With shares trading at premium multiples I see no compelling upside at current levels, while the current yield of 3.3% remains very appealing to many investors.

Highlights For The Quarter

General Electric reported second quarter sales of $36.23 billion, which were up by 3.3% compared to last year. Sales came in roughly in line with consensus estimates at $36.3 billion.

Reported earnings were up by 13.2% to $3.55 billion. Thanks to modest share repurchases, which reduced the share count towards 10 billion, earnings per share rose by nearly 17% to $0.35 per share.

Adjusted earnings of $0.39 per share were in line with expectations.

Looking Into The Numbers

CEO Jeff Immelt was pleased with the performance including double-digit industrial segment earnings and margin expansion. He also stated that the economic environment remains positive. The continued wind-down of the capital business limit earnings growth while the industrial activities are showing continued healthy growth.

Industrial sales rose by 6.5% to $26.10 billion. While acquisitions added to growth in the industrial base, GE stressed the 5% organic growth rate as well as solid order intake for the quarter.

GE Capital posted sales of $9.80 billion, which was down by 6.3% compared to last year. Despite the continued wind down of the business, the capital business still generates 27% of total revenues. The Tier 1 common ratio based on Basel I stands at 11.7%, up 50 basis points from last year.

As discussed above, the industrial activities continue to drive growth driven by Oil & Gas, Power & Water and Aviation. Power & Water posted sales of $6.29 billion, up 10%. Despite the growth, operating earnings were up just 4% to $1.13 billion.

Oil & Gas revenues were up by 20% to $4.76 billion amidst the energy revolution with operating earnings increasing by a quarter to $665 million. The aviation business is the firm's most profitable business and posted earnings of $1.20 billion as sales rose by 15% to $6.09 billion. Acquisitions in this area added to the reported growth.

Sales were stagnant at the healthcare unit and the appliances unit, which GE is rumored to be looking to divest. Sales fell by 6% at the smaller energy management unit while transportation sales dropped by 18%. Fortunately, this is the smallest business of the company.

Total operating earnings from the industrial business and GE Capital rose by 4% to $5.87 billion. "Corporate items" and eliminations fell by 16% to $1.47 billion being a driver behind the bottom line. Interesting in today's tax debate, GE paid just $409 million in income taxes on its earnings during this quarter.

Valuation

Given the growth in the industrial business and decline in the capital business, GE managed to reduce its total assets by roughly $4 billion so far this year. The total balance sheet still counts a sizable $652 billion in assets, due to the large asset base of the Capital business.

The industrial business held $10.5 billion in cash and equivalents, while borrowings of $16.6 billion results in a modest $6 billion net debt position.

On a trailing basis, GE has now posted sales of more than $146 billion on which it posted net earnings of close to $13 billion. With shares trading around $26.50 per share, equity is valued at $266 billion. This values the company at around 1.8 times sales and 20-21 times earnings.

Looking At The Past, And Near-Term Performance

GE has traditionally been seen as a true bellwether for the economy, yet the company's performance has lagged a lot over the past decade. Back in 2004, sales were $135 billion and they have risen to a little over $145 billion at the moment. This is as sales peaked at $182 billion back in 2008 before the financial crisis, and the impact on GE Capital in particular, nearly bankrupted the company. The oracle of Omaha stepped in and rescued the business at the time.

While the company has managed to avoid severe dilution, it has been shedding assets and refocused operations from GE Capital towards the industrial business in what has been a slow process. It still derives 30% of sales from the Capital business although this percentage will decline further following the company's anticipated IPO of Synchrony Financial (NYSE:SYF) and the purchase of Alstom (OTCPK:ALSMY), which adds to the industrial business.

These transformation efforts are paying off, although progress is still rather slow. GE took in a lot of orders again during the quarter, notably in locomotives, gas turbines and the oil & gas business. As such the backlog rose by $23 billion compared to last year, coming in at $246 billion. While year-on-year growth was impressive, the backlog was up just a billion compared to last year.

At the Farnborough air show, GE announced new multi-billion orders totaling $36 billion at list prices. Note that these orders for plane engines benefit its 50/50 joint ventures with CFM. Furthermore, these orders are not reflected in the second quarter backlog.

Critics have accused GE for not quickly winding down its Capital unit as some five years following the crisis the company is still in the transformation phase. As a matter of fact, it could still take quite a few more years to complete this process at this pace. The lack of investor patience, lack of quick margin gains and much criticized move to acquire Alstom in a difficult and political process has weighted on shares.

So far this year shares are down 5%, while returns of 10% over the past year marks a severe underperformance versus the wider markets.

Final Takeaway

The earnings, which GE released were more of the same, and did not contain any huge surprises. Shares have rebounded of course from the crisis, yet investors are not happy at all.

Perhaps the timeline of the Synchrony IPO could create some enthusiasm in Immelt's transformation progress. GE expects to sell a 15% stake in Synchrony as soon as the end of this month for $3.1 billion. The company furthermore targets the full separation of the assets by the end of this year, in a move, which could raise $20 billion.

This money is welcomed of course to finance the Alstom deal, which is anticipated to close in 2015. The company will own the attractive Power & Grid business. In exchange, Alstom will keep the Transportation business and acquire GE's Signaling business. GE priced the deal at $13.9 billion, or 7.9 times pro-forma EBITDA. Anticipated accretion is seen at $0.06-$0.09 by 2016, with increased accretion seen thereafter.

This shift towards the industrial activities is applauded, however GE is hardly showing net overall revenue growth. Reported 3% revenue is not impressive, given the numerous acquisitions being made by the business over the past year. As such, a valuation at 20-21 times earnings, which is a 15-20% premium to the general market multiple, is already quite stretched.

While I applaud the strategy, I simply do not see compelling upside from these levels. The real upside is for buy-and-hold investors, currently collecting a 3.3% dividend yield.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: General Electric - Steady Results, Investors Are Happy With Financial IPO Timeline