General Electric (GE) reported EPS of $0.36, which was slightly shy of the Street's consensus of $0.37. The company's revenue figure of $36.3 billion also missed estimates by $500 million. The stock was down 3.5% after the company announced that full year revenue growth would be 3%, rather than the 5% announced earlier. Energy infrastructure orders were also down on a YoY basis. Investors may have a bearish outlook on GE, given that some of America's large companies, like McDonald's (MCD), International Business Machines (IBM), Google (GOOG), Intel (INTC) and Microsoft (MSFT) reported lower quarterly sale for the first time in three years. However, GE's future seems bright with forecasted expansion in industrial margins and sales.
Operating Earnings of $3.8 billion were up 10% YoY. EPS of $0.36 was up 50% YoY. Overall revenue of $36.3 billion was up 3% YoY. The revenues of the industrial segment, at $24.8 billion, increased by 6% YoY and 10% YTD. Revenues for GE Capital (GECC) declined 5% YoY. Operating cash flows for the quarter totaled $10.7 billion, almost 63% higher on a YoY basis. In the industrial segment, however, cash generated from operating activities totaled $5.2 billion, 20% less than the previous year.
The industrial segment comprises aviation, healthcare, transportation, energy infrastructure, and oil & gas. Investors were delighted by the strong performance of the industrial segment. Along with 6% organic revenue growth, the earnings of the segment also increased by 11% to $3.6 billion. All the industrial sub-segments posted positive earnings, for the first time since 2005. Among the sub-segments, energy infrastructure and transportation posted double-digit growth in earnings (13% and 35%, respectively). The growth was driven by increased demand for GE's products in China, Latin America and Africa.
The industrial margins have been a sore spot for investors. However, this quarter, the margins finally improved from 13.7% in the same period last year to 14.5%. The company is well on its way to achieve the target of 15.9% by the end of 2013 that CEO Jeff Immelt set recently. The following table shows the margin improvement in different industrial segments:
Infrastructure orders were $21.5 billion, down 5% YoY. They were down largely because of a decline in orders for wind turbines. Excluding them, orders were up 4%. The pricing also improved 0.1% YoY, though it was slower than the 1.1% rate in 2Q2012. The following chart shows the historical data on infrastructure orders:
Some more on the GE growth story
As already mentioned, GE is well on its way to achieve expansion in margins in the industrial segment. However, GE is also expected to achieve organic sales growth in the next couple of years. The following is an in-depth discussion of growth in the aviation segment:
The Global Engine model is used to determine the aftermarket revenue growth rate. The model uses the database containing currently installed aircraft engines in the US market. It projects size and age distribution of the active engine fleet for the upcoming future, using forecasts of new deliveries and retirements. The final outcome is the year-over-year growth rate of installed engines that are more than five years old. This is a good proxy for aftermarket revenue growth rate, given the fact that on average engines below five years of age do not require repairs and maintenance.
Applying the model to GE's current range of installed engines gives a 10.6% overall aftermarket growth rate. For instance, the 3-year CAGR for GE90-110/115B and CFM56 (both are engine types) second generation is 85.7% and 12.2%, respectively.
One potential risk to GE's aftermarket revenue is that an airline is not bound to get engine maintenance from the same OEM. However, in this context, OEMs have come up with a power-by-the-hour service in which the airlines pay a regular monthly fee and the OEM provides complete maintenance and repair services.
In the narrowbody OE market, there is clearly a fierce battle underway between GE and Pratt on the A320 Neo, a product of Airbus. In its recent analyst meeting, Pratt claimed that it got 51% of the total orders of A320 Neo. Overall, GE is expected to retain 45-50% share on NEO. Also, it has 100% share on Boeing's (BA) hit 737 Max series. The following are the engine types of GE:
- CFM 56
After a complex calculation, the expected CAGR organic OE revenue growth turns out to be 12% for the next three years.
In wide bodies, GE currently holds 52% of the installed base. However, Rolls Royce is the fastest growing player in the industry. And it is expected that it will overtake GE in the next five years. The following table gives a brief overview of the current aircraft engine market:
* Engine alliance of GE and Pratt
The current market share of GE in the wide body market is 50%. Pratt and Rolls Royce have 24% and 22% of the market, respectively.
GE is a dividend king with a 3% yield, which is the second highest in the industrial sector after Emerson Electric Co. (EMR). The company is one of the 2012 Dogs of the Dow. Sell-sides expect the company's earnings to grow by 12.2% per annum for the next five years. Despite the earnings and revenue miss, the stock is still recommended as a buy, given the company's bright prospects for an expansion in industrial margins and sales.
This article only discusses the aviation segment. Other industrial sub-segments will be discussed in upcoming articles on GE.