Will GE's Energy Innovation Provide Earnings Growth?

Apr.10.11 | About: General Electric (GE)
Fast Company identified General Electric Co. (NYSE:GE) as one of its 50 Most Innovative Companies in 2011. GE's ranking had declined to 45th from the previous year's 19th place ranking. Fast Company's rationale for including GE was its focus on finding greener energy solutions across of host of industrial challenges from railways to power production. However, while GE is clearly innovating, high level analysis shows that GE is also scrambling to feed its need to grow earnings.

GE has made recent headlines with several high profile acquisitions in the energy space. The most recent news includes GE’s plans to build the largest solar panel factory in the United States. GE has also been making headlines in the shale gas space with its acquisition of the Well Support division of John Wood Group PLC. Earlier this year, GE completed its acquisition of Dresser Inc. Dresser Inc. is an oil field equipment manufacturer and posted earnings of around $319 million in 2009. GE has also acquired Wellstream Holdings PLC to strengthen its presence in floating storage, production and offloading that is critical to deep sea oil operations.

GE is most commonly recognized as an industrial giant, but until 2008 a lot of its growth was driven by GE Capital. Since the Great Recession, GE appears to be focusing additional efforts on Energy Infrastructure.

GE Segment Revenue ($ Millions)
Segment Revenue
2006 to 2010 Growth
Energy Infra-
Technology Infra-
GE Capital
Home & Business Solutions
Corporate items & eliminations
Total Revenue
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Source: GE 2010 10-K Filing from sec.gov

So, despite almost no change in total revenue from 2006, the Energy Infrastructure segment has grown over 30%. GE’s Energy Infrastructure segment has two subsegments: Energy and Oil & Gas. The Energy subsegment had about $31 billion in revenue in 2010 with a segment operating margin slightly above 20%, while the Oil & Gas subsegment revenue totaled $7.6 billion with a 15.9% segment operating margin. In contrast, GE Capital surged to almost $70 billion in revenue in 2007 and then again in 2008, but has since declined to under $50 billion.

The Energy subsegment spans numerous technologies and includes water treatment solutions. It also provides products and services for energy production, distribution and management. It covers technologies from wind to solar to Integrated Gasification Combined Cycle (IGCC), which is also commonly referred to as clean coal technology, to nuclear (reactors and services) and gas turbines and generators. GE also provides a wide range of services and support as well as a variety of equipment to ensure efficient plant operations.

Oil & Gas is a smaller segment:

Oil & Gas supplies mission critical equipment for the global oil and gas industry, used in applications spanning the entire value chain from drilling and completion through production, liquefied natural gas (LNG) and pipeline compression, pipeline inspection, and including downstream processing in refineries and petrochemical plants. The business designs and manufactures surface and subsea drilling and production systems, equipment for floating production platforms, compressors, turbines, turboexpanders, high pressure reactors, industrial power generation and a broad portfolio of auxiliary equipment. – (GE 2010 10-K filing.)

These activities are positioning GE for future growth and profit from the world's growing appetite for energy. GE's focus on the Energy Infrastructure segment should provide several benefits by refocusing efforts on a growing segment with expanding margins.

Historical Segment Margins
Segment 2010 2009 2008 2007 2006
Energy Infrastructure 19.4% 17.5% 15.1% 15.0% 13.2%
Technology Infrastructure 16.7% 17.6% 17.9% 18.7% 19.8%
NBC Universal 13.4% 14.7% 18.5% 20.2% 18.0%
GE Capital 6.9% 2.9% 11.9% 18.3% 17.8%
Home & Business Solutions 5.3% 4.4% 3.6% 8.9% 8.0%
Average 13.2% 11.8% 14.2% 17.3% 16.6%
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Source: GE 10-K Filings. Note that segment margins reflect segment profit relative to segment revenue and exclude the impacts of corporate costs and other eliminations. Average margin reflects total segment profit divided by total segment revenue.

This should lessen its overall exposure to Financials from GE Capital. Also, by shifting resources to the expanding Energy Infrastructure segment this should help improve GE's P/E multiple which has not recovered yet to earlier levels seen.

Historical P/E
Year Shares outstanding (Millions) Share Price ($) Market Capitalization ($ Millions) Net Income ($ Millions) Implied P/E
2010 10,618 18.29 194,203 11,644 16.7
2009 10,670 15.13 161,437 11,025 14.6
2008 10,560 16.20 171,072 17,410 9.8
2007 9,986 37.07 370,181 22,208 16.7
2006 10,283 37.21 382,630 20,742 18.4
2005 10,423 35.05 365,326 16,353 22.3
2004 10,600 36.50 386,900 16,819 23.0
2003 10,079 30.98 312,247 15,236 20.5
2002 9,993 24.35 243,330 14,167 17.2
2001 9,935 40.08 398,195 13,791 28.9
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Source: GE 10-K filings for outstanding shares (Taken from approximately February of the subsequent year) and net income. Share price is from Yahoo!Finance as the last closing price of each calendar year. Market capitalization is the product of outstanding shares and the closing share price.

As GE establishes a new track record of growth, its multiple should continue to expand; however, it might not achieve the level from 2001. Furthermore, its current P/E is similar to the P/E at the end of 2007 which most likely assumed reasonably strong growth prospects.


GE's rapid acquisition pace in the energy industry is probably driven by a need to continue to grow earnings to meet Wall Street expectations. GE has aggressively tracked two major energy trends in renewable power (in particular solar energy) as well as shale gas. Furthermore, if performance at GE Capital does not maintain its improvement (while revenue declined from 2009, margins improved), GE would probably look to make additional acquisitions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.