Thursday, January 24, 2013

GE Surprises on the Upside

It’s hard to ignore General Electric’s (NYSE: GE) results so I am not going to! Without doubt this is the most impressive set of results that the company has delivered in a while, and a number of positives can be drawn for GE stockholders and for investors at large. A company of this size and diversification is never going to have all its divisions firing on all cylinders at the same time, but GE gave it a really good go in this quarter.

Earnings were up in every segment and overall orders increased 7% ex wind and foreign exchange, leaving the end of year book-to-bill ratio at 1.2x, an impressive quarter by any measure. In particular GE surprised the market with some strength in its orders towards the end of the year.

GE Delivers Growth

The industrial sector has been somewhat difficult in recent months as global growth did not turn out as expected in the second half. The script for 2013 now reads for some stabilization in Europe, modest growth in the US and a lot of hope for the new regime in China to stimulate growth back up to above 7.5%. Indeed if we look at Alcoa’s (NYSE: AA) recent results it is clear (from the chart in the link) that most of its forecast growth is dependent on China. This is not a general rule over industrials and China--different companies sell to different end markets--but I think the argument does apply to GE.
Firstly here is how GE makes its money and an idea of the importance of its end markets.

Keen eyed investors will note that this is the first quarter that the previous Energy segment is now split into power & water, oil & gas and energy management.

There are some good things in GE’s results even for those of us who are somewhat skeptical on China in 2013. For example, while the indications are that the stimulus program will be different to 2008-09 and will focus on developing domestic demand. In addition, certain areas like healthcare, transportation and energy are likely to be invested in and GE is strong in these areas.
What is more puzzling in these results was that China was described as ‘shrinking’ late in the quarter yet GE saw international strength in December. So if it wasn’t China, who was it?

GE’s Order Growth

I’ve summarized order growth in the quarter here.

Power & water had a tougher year with deliveries and orders down on the previous year. Indeed, GE is forecasting around 100 gas turbines this year, which would be down from the 108 ordered in 2012 and 134 in 2011. Thermal orders subsided in line with Government cutbacks in spending on renewable energy.

The most impressive performance came with the return to growth in oil & gas and healthcare orders. As discussed previously healthcare has been an underperforming segment for GE and this looks like a return to form. Moreover the big swing in December’s performance seemed to come from healthcare. My hunch is that orders that were delayed through 2012 got signed at the end of the year. A good read across for the healthcare industry? Similarly oil & gas remains strong, although how long that will last if oil prices slip is another question.

Aviation equipment orders were strong but, here again, China is a large part of that. Indeed Boeing’s (NYSE: BA) order book is largely made up of airlines servicing emerging markets or leasing companies with activities in the Far East. Any sign of a cyclical slowdown and these orders could get delayed. Furthermore it is not an area of spending that the Chinese Government will support strategically unlike, say, health care or transportation. GE did see some aviation orders pushed out again, so look out for some lumpiness in the next quarter.

The ongoing star of GE’s segments in transportation and strong order growth coupled with segment profit growth of 36% for the full year suggest that this sector of the economy will do well in 2013. My favorite play in the sector is Wabtec (NYSE: WAB), which also benefits from US regulatory legislation on positive train control (PTC) adoption. GE’s results and order book indicate a lot more growth in the industry and China’s need to invest in railway infrastructure in the center of the country is well noted.

Key Conclusions from GE’s Results

The positive surprise was in healthcare so investors should look for capital machinery companies in the sector to report some decent orders in the quarter. Elsewhere transportation, oil & gas and aviation remained strong. I’m wondering out loud whether Honeywell (NYSE: HON) is going to confirm much of this next week. The company was cautionary on China in the last quarter but it shares a lot of end markets with GE and what it says may confirm or cast doubt on a nascent theory over a China recovery. We shall see.

GE is still a global growth play but its execution appears to be better now and I think it can be looked at as a good option for income seeking investors looking for some cyclical risk. For me, it’s time to try to find some healthcare and transportation names.

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