Thursday, December 6, 2012

Tough Times Ahead for General Electric?

I think Jack Welch would have cause for optimism after General Electric (NYSE: GE) gave its latest results. It’s not that they were particularly good, but rather that the management tried their best to make it sound like everything was firing on all cylinders. The market had other ideas and sent the stock down.

My view is that GE has seen the best of its operational performance for the foreseeable future but it may not matter to the stock price performance. In the end its yield is sustainable and the stock will be supported on that basis. However if you are looking for growth then GE is not going to be attractive, and here is why.

GE’s Unfavorable Mix

My thesis with GE is that it is performing well in areas that are longer cycle and about to turn down (Aviation and Energy) but it is not performing well in the less cyclical Healthcare segment. Moreover, GE Capital’s extensive European exposure is not the best place to be right now. GE Transportation is doing great but it’s not big enough to make a substantive difference.

Here is how GE makes its profits:

As the graph shows, Energy and GE Capital make up nearly two thirds of profits. This will be the last quarter that GE reports Energy in the current basis and in the future it will report in three separate businesses as Power & Water, Oil & Gas and Energy Management. The segment is doing fine for now, but Wind orders were down massively and future growth will be challenged if oil prices slip. The good news within Energy is coming from gas. As Alcoa’s (NYSE: AA) recent results confirmed, orders for gas turbines are strong and GE is well positioned in LNG infrastructure. As gas turbines are increasingly being run (thanks to low gas prices) this means that Alcoa and GE can profit from replacement and servicing revenues. As for GE Capital, the company is trying to cut down on non-core assets, and revenues and net income were down single digits accordingly.

Aviation revenues were down slightly but profits were up 7%. New orders declined 8% but GE explained this away as a consequence of backlog lumpiness due to the length of the order cycle. It also explained that $500 million in orders for two customers in Asia were pushed out this quarter. Frankly I’m not buying it, because this is exactly the sort of thing that happens in the aviation cycle. Certain loud mouthed journalists on television make noises about Boeing’ s (NYSE: BA) order book as if they have discovered something the market doesn’t know about. The truth is that if there is a slowdown coming then orders will get canceled, delayed or pushed out. This goes for Boeing and it also applies to GE’s engines. Neither is immune and pointing at a full order book now will not protect you in future when the market prices in these issues. Is it a coincidence that the two ‘push-outs’ are in Asia? Time will tell.

The next biggest segment is healthcare, and GE still isn’t performing here. I’m going to demonstrate revenue movements for all the segments here.

Healthcare is a laggard and has been so for some time and this is unfortunate because this segment is supposed to help support GE when the economy slows.

The star performer in the quarter was Transportation where revenues grew 9.5% and profits were up 35%; despite a slowing economy, orders were up 21%. All of this spells good news for Wabtec (NYSE: WAB) stockholders who will see results given soon. I’m a fan of the company but am hoping for a dip to go back in. GE’s results are suggesting that this is unlikely to happen when Wabtec reports, but we shall see.


GE Stock Analysis?

This report is a tale of declining order books and ongoing restructuring with GE Capital.  Healthcare is performing poorly, and Aviation and Energy both saw some worrying order declines. Transportation is doing fine, but it is not enough. As for the general economic environment much will depend on China because that is where the big driver for aviation and energy demand is coming from. Fellow industrial giant Honeywell International (NYSE: HON) also gave results recently and pointed out that it felt China’s growth could dip below 7% in 2013. This is a level significantly below what most forecasters are predicting and given that Honeywell shares many end markets with GE, it is not a forecast to be taken lightly. If it happens, then GE’s exposure will hurt the stock operationally.

The good news is that I’m not sure the market can’t tolerate these issues as long as the dividend is sustainable and at a premium to long bond yields. GE isn’t a stock I fancy very much, but then again dividend investing isn’t my thing. No matter, the market likes the theme at the moment, so don’t be surprised if any weakness is followed by support flowing into the stock.

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