GE Earnings - What Will The Company Look Like In 5 Years?

| About: General Electric (GE)

Summary

Q2 earnings were the catalyst for a 10% to 12% drop in GE stock price.

Between $2 and $2.525 might be "core" or "peak" EPS for the new company (newco).

The fact is that the company is in the midst of a generational transition -- what will it look like in five years ?

2017 is a pivotal year, with revenue growth looking flat to -1%.

GE (NYSE:GE), the iconic Dow Jones 30 Industrial component, reports Q3 2016 financial results before the opening bell on Friday, Oct. 21, 2016. The analyst consensus, which has eroded in the last 90 days, is looking for $0.30 in earnings per share on $29.6 billion in revenue, for expected year-over-year growth of 3% and 12%, respectively.

The consensus EPS estimate is down from $0.33 exiting the Q2 report, to $0.30 today, while the consensus revenue estimate is down from $30.05 billion as of late July 2016 to $29.6 billion today.

  • The full-year 2016 consensus is $1.49 on $126.0 billion in revenue for expected full-year growth of 14% and 8%.
  • Full-year 2017's consensus is $1.69 on $124.5 billion in revenue for expected year-over-year growth of 13% and -1%.

EPS growth looks very solid, and "mid-teens" over the next few years. Revenue growth is in the low single digits.

Trading at 19(x) and 17(x) expected 2016 and 2017 EPS, respectively, GE looks cheap or more attractive on a P/E and PEG basis, but that is where the attractive valuations metrics end. It looks as if all of the GE Industrial cash flow was the function of a credit in Q1 2016, which leads me to believe that it wasn't really cash flow at all.

The company is in the midst of such an enormous transformation that I've come to put less emphasis on the murky financials, and simply look at what the Street consensus is expecting for the next few years.

Here is the trend in GE's organic industrial equipment orders:

Qtr end equipment orders
Q2 '16 -16%
Q1 '16 -7%
Q2 '15 -15%
Click to enlarge

Source: Conference call notes, Street research

The one positive to GE could be the renewed emphasis on energy, which, according to this preview in Spring 2016, leaves GE with 45% of their "newco" revenue in Energy and Energy-related businesses, and almost two-thirds of their operating income. Another positive is the presence of Nelson Peltz and Trian. I expect that they will keep GE on the right track, but that falling 2018 EPS estimate also has caught my eye.

And therein lies the rub: Despite the emphasis on energy and the presence of Trian, the 2018 consensus EPs estimate has fallen from $2.08 to $1.95 in the last five quarters, and the 2017 estimate has fallen from $1.95 to $1.69 in the last eight quarters. There needs to be a quarterly report in the next two to three quarters that gets investors exited about the prospects for the business, and therefore start to either stabilize or revise higher the 2017, 2018, and 2019 estimates for GE.

Just watching the forward estimates unfold since the GE Capital divestiture was announced, what I thought might be core, organic EPS of $2 to $2.50 for 2018, 2019, looks to be slipping now.

Here is what I'll be looking for and listening to on the call:

  1. The trend in industrial equipment orders.
  2. The margins on GE Industrial, currently 14%. I thought Trian was going to make that a specific goal of GE. Some of the models I've looked at have the operating margin rising to 18% by the end of 2018, or roughly 1% a year, which means that at the end of 2016, the overall margin should be 16% -- we seem well shy of that mark currently.
  3. Has the bounce in crude oil in 2016 helped any of the Energy businesses?
  4. Is GE feeling any of Aerospace/Aviation softening?
  5. What is Q4 2016 and 2017 guidance?

Technically, the chart below indicates that GE is testing its long-term uptrend line off the 2009 low. The stock is at a critical level.

Click to enlarge

Conclusion

The question of what GE will look like in five years is a valid one. What if Tesla's (NASDAQ:TSLA) battery technology sets gasoline consumption on the long-term trend to zero? Obviously, that will take many years, but are GE's energy and energy alternative industries prepared for a non-fossil fuel world?

Both GE and Honeywell (NYSE:HON) are headed at full-speed to becoming significant software developers. Honeywell announced it was building or staffing a 1,000-person software center in Atlanta not too long ago. These days, every business is a technology business. Presumably these are support functions, but readers should remember that Amazon (NASDAQ:AMZN) sold books over the Internet until they decided to create the Cloud.

Disclosure: I am/we are long GE, AMZN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.