General Electric (NYSE: GE ) is such a diverse enterprise that media outlets often gloss over details with broad strokes about the company's performance. The common refrain is something like "A mixed showing from GE's industrial businesses. Meanwhile, GE Capital is shrinking." How's that for a summary of three months of activity at a $258 billion company?
Let's face it: Industrial stocks just aren't worth the breath when there's a new iWatch rumor to tweet out.
So, for a deeper dive into GE's second-quarter earnings release, here's a breakdown of five management insights you don't want to miss.
GE's accelerating in (almost) every industrial segment
It's true that GE shareholders are focused on a few key metrics when it reports, and one of those is the rate of growth in the manufacturing businesses. Simply put: Is GE selling more railroads, jet engines, drilling equipment, and CT scanners than last year at this time? These are the businesses that will shape GE's future, and here's CEO Jeff Immelt on how they're doing:
Industrial segment growth is up 10% with 6% organic revenue growth ... Backlog is at a record high, as I said, of $246 billion, up $23 billion from last year ... [G]rowth markets remain a highlight with 14% order expansion and growth in six of nine regions ... [S]ix of our seven Industrial segments had earnings growth.
All told, six out of seven is not too shabby, especially when GE's up against a strong showing during last year's second quarter. The transportation segment proved to be the biggest drag with operating profit down 14%. Apparently, railroads are still booming but mining is going bust: Mining revenue is expected to collapse at least 50% during 2015.
GE expects Alstom to generate handsome returns
As investors watch GE fork over roughly $13.5 billion in cash for Alstom's power businesses, they're probably wondering what the payback's going to look like. GE's CEO of Power and Water, Steve Bolze, provided an overview of the game plan for wringing out cost savings:
So now let's look at our plans for execution. We still see $300 million in year one synergies, growing to $1.2 billion in year five. We expect to realize 80% of the $1.2 billion in synergies by the third year. There are four main categories for synergies. The first is optimizing the manufacturing and services footprints. The combined businesses have 16 major manufacturing sites and many more feeder sites, and about 70 service sites across the globe. We estimate roughly $400 million of our savings here over the period.
If these synergies workout, GE's cost savings alone will enhance the bottom line and provide a return on investment of 2% in the first year, 7% in year three, and 8% in year five. Add in the profit bump GE should get from Alstom and those figures increase, of course. By year five, GE's investment would generate a return of 12% according to my colleague Asit Sharma's calculations.
Believe it or not: As mining goes bust, rail is booming
Companies like GE and Caterpillar thumbed a ride on the gravy train when the mining industry skyrocketed a few years back. But those picks and shovels just aren't selling like they used to in today's lackluster commodity market. Here's what GE's CFO Jeff Bornstein had to say about mining during the conference call:
Mining volume for both units and parts are weak. We guided an expectation of being down almost 50% in 2014 versus 2013, and now expect Mining to be slightly weaker than that.
Some of the mining slump is due to a slowdown in China's demand for coal. The coal market in general seemed poised to falloff a cliff in 2014, but it hasn't lost too much steam yet. Stockpiles are being replenished ahead of what could be another wild winter, which is proving to be one driver of increased rail locomotive demand:
Higher volume in conjunction with the first-quarter weather effect have affected velocity on the lines. As a result, parked locos are at their lowest level since 2007, 2008.
The numbers that matter for GE Capital: size, liquidity, profits
When it comes to GE Capital, investors want to know just three things: Is it taking backseat to manufacturing? Is it profitable? Is it robust and safe? Jeff Bornstein expounded on these key topics.
First off, GE Capital's assets are measured in terms of ending net investment (ENI). This figure stood at an eye-popping $630 billion in 2007, but today it's a much different story according to Bornstein: "ENI of $371 billion was down $19 billion, or 5% from last year and down $2 billion sequentially. Noncore ENI was down 15% to $51 billion versus last year."
For perspective, GE defines ENI in its annual reports as "the total capital we have invested in the financial services business." Over time, then, the company is just pulling back on its investments, also known as "divesting", and redirecting excess cash to the parent rather than growing its banking business. Still, GE Capital remains immensely profitable, growing segment profits from $1.3 billion in 2009 to $8.3 billion in 2013.
Secondly, second-quarter profits stayed flat but healthy, and liquidity improved against the Tier 1 ratio of 5.7 reported by GE in 2008:
Net interest margins in the quarter at 5% were essentially flat. GE Capital's liquidity and capital levels continue to be strong. We ended the quarter with $76 billion of cash and Tier 1 common ratio on a Basel 1 basis improved 28 basis points sequentially and 51 basis points year over year to 11.7%.
Healthy cash flow will continue to fuel dividend
GE has one of the best dividend yields in its industry, clocking in at 3.3% versus its sector's average of 2.1%. Investors can take comfort in the fact that GE Capital will continue to serve as a cash cow for the parent company, fueling dividend growth:
As previously communicated, we expect the Capital dividend to be about $3 billion in 2014. We ended the quarter with $87 billion of cash and we expect CFOA for 2014 to be in the $14 billion to $17 billion range as outlined in our 2014 framework. We have a similar first half/second half profile that we had in 2013. Capital allocation continues to be disciplined and balanced. We have raised the dividend by 16% for 2014.
The takeaway for investors
Following the second quarter, GE is on track to meet key goals in 2014. In particular, the company is working toward a healthier industrial and banking mix (aiming for 70% versus 30% of earnings), organic growth of 4%-7%, and $90 billion in cash for dividends, buybacks, acquisitions, and reinvestment.
Investors can check the boxes in those categories through the first six months. To bolster its stock price, however, GE will need to top expectations in the quarters to come.
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