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Anyone who has watched the classic sales movie Glengarry Glen Ross or
worked in sales will know that the acronym ‘ABC’ stands for ‘always be
closing.’ However anyone who hasn’t and instead has solely listened to
US blue chip conference calls over the last few years will probably
conclude that it actually stands for ‘always be cost-cutting.’ In other
words, investing for growth is still on the back-burner in favor of
pruning and consolidating measures made in light of uncertain end
demand. Such considerations came to mind when considering General Electric’s $GE latest results.
A mixed Industrial Environment
The earliest indication of how the industrial sector was faring was outlined by Alcoa $AA
recently, and it was pretty positive in my view. Other than a slight
weakening of its European automotive outlook, Alcoa kept its end markets
prognosis constant. However, on closer inspection it is clear that
Alcoa’s growth prospects in 2013 are highly reliant upon China. In
addition it is exposed to a few industries that are doing relatively
better.
As this article demonstrates,
global aerospace is doing well with airlines surprising on the upside
and passenger growth numbers growing at a decent clip. This is obviously
good news for General Electric and its aviation segment. In addition,
Alcoa’s North American outlooks for its automotive and commercial
building & construction segments respectively were for 0-4% and 1-2%
with China growing up to 10% in both. Europe is expected to decline in
both of these segments. So while China is doing well and some global
industrial sectors are doing okay, it is far from a universal situation.
More evidence of this divergence in the industrial sector can be gleaned from looking at what the industrial suppliers like Fastenal and MSC Industrial are saying. Aerospace and auto are fine but elsewhere there was weakness in Q1.
What GE Said
Fast forward to GE’s latest results and the company reported that its
industrial segment profits were $200 million lighter than had been
expected largely due to Europe being weaker than forecast. The power
& water segment was particularly affected while elsewhere GE
reported some reluctance to close orders in a few of its shorter cycle
industries. Again, the latter statement correlates with what the
industrial suppliers (who are as about as short cycle as you can get)
indicated.
In order to see the relevance of the power & water segment here
is a breakdown of GE’s segmental profitability in the quarter.
As the chart indicates the industrial segments that increased
profitability were aviation, healthcare and transportation. GE capital
profits improved in line with its rationalization strategy. Overall
segment profits were down 4%, but net earnings rose 16% thanks to lower
charges and eliminations.
See what I mean about ABC? Indeed, the immediate response to the
weakness in the quarter was to announce more cost cutting measures. Plus
ca change and all that.
What the Results Mean to The Market
Another area of interest was US healthcare, which GE said was a bit weaker than expected. Investors got an early read on this when Johnson & Johnson
gave results and noted (within its medical devices and diagnostics
segment) that US hospital procedures were weaker than the hospitals had
forecast going into 2013. In addition hospital spending wasn’t as
strong. It’s nothing dramatic for Johnson & Johnson
because it has plenty of other profit drivers within pharma and consumer
products, but for a company like Varian Medical Systems $VAR it is a cause for concern.
I like Varian, and based ona SWOT analysis
think it has some very impressive long term growth prospects with its
proton therapy solutions. In the near term it can expand its radiation
therapy into indications like lung cancer, particularly within emerging
markets. In addition its new deal (GE was its former partner) with Siemens (which
is pulling out of radiation oncology) gives it a large installed base
on which to target. On the other hand its systems require significant
outlays, and with Johnson & Johnson and GE reporting some weaker
conditions, can we really expect immediate upside from Varian?
On a more positive note GE forecast that its oil & gas and home
& business segments are going to be ‘pretty solid’ for the year.
Within the latter segment one of its key rivals is Whirlpool $WHR
I think Whirlpool has good growth prospects in 2013. The US housing
market is recovering, and Whirlpool is starting to anniversary the
housing boom of 10 years ago. In other words, the white goods purchased
back then should have depreciated by now and a replacement cycle should
kick in. Furthermore, GE reported good results in emerging markets so we
have reason to believe that Whirlpool will do okay in its key Brazilian
market.
Where Next for GE?
Cost cutting isn’t sexy, but it does represent a key bottom line
opportunity for GE this year. Europe was weaker than expected but
China’s strength was a welcome positive note. As noted above GE’s end
markets will be variable this year with areas like aviation,
transportation and health care (especially in emerging markets) likely
to remain strong and counteract areas more exposed to austerity measures
like US military spending and European infrastructural spending.
Investors looking for a more focused exposure to their favorite
end markets will not buy GE because of its diversification, but those
looking for a 3.5% yielding global GDP type play will view this mini
sell-off as a buying opportunity.
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