The third quarter for General Electric (GE -3.19%) revealed a company finding its usual rhythm after a summer filled with a blockbuster acquisition and high-profile IPO spinoff. Solid results sent shares of the conglomerate 4% higher on the day of the earnings release, and they're up a total of 9% in the three weeks since.
Source: Flickr/Jeffrey Turner.
This could be a turning point for a stock that's been on a tumultuous ride in 2014. The upcoming fourth quarter is typically GE's strongest, and management seems to be comfortably in the driver's seat when it comes to meeting goals for growth, cost-cutting, and profit margins.
The tone was positive on the latest quarterly conference call, both from a business and macro perspective. Arranged according to GE's 2014 initiatives, here are the key insights from GE's executive team I found most relevant for investors:
1. Grow revenue organically by 4%-7%
At the beginning of the year, GE set a goal to reach 4%-7% organic growth in its industrial (non-banking) businesses for 2014. In the third quarter, GE reached the low end of that target, posting 4% organic revenue growth.
More important, however, GE's management team was uncharacteristically optimistic about the company's ability to hit the high end of that range -- 7% -- once the fourth quarter is all said and done. This is a crew that tends to play its cards close to the vest, but GE's CFO Jeff Bornstein gave the following rationale for his outlook when pressed by analysts:
[W]e have a fourth quarter in front of us that we think is going to be very strong. Just for instance, year-over-year in the fourth quarter our gas turbine shipments are going to be up more than 40% year-over-year; our wind shipments will be up more than 30% year-over-year; aero shipments up 16%. Even commercial and military engines are going to be up mid double-digits, and we are looking for a 30% increase in locos year-over-year.
So we are looking at a fourth quarter that we think is going to be very strong. And we expect the Power business to be up substantially in the fourth quarter.
When the oil and gas, power, and aviation businesses start moving in the same direction for GE, this can generate some outsize returns on the bottom line. Barring major economic headwinds, the last few months look promising.
2. Trim the fat
Moving down the income statement, I think GE needs to reel in spending on many of its back-office activities. This effort would boost operating profit margins and push managers and executives into the field to keep their fingers on the pulse of the business instead of camping out in Fairfield, Connecticut -- GE's main campus.
This has been a major initiative for CEO Jeffrey Immelt, who is intent on having his company behave more like a start-up. It's true that GE will never be as decentralized as, say, Berkshire Hathaway, but it could really bolster the bottom line if it brought selling, general, and administrative expenses down from 25% of total revenue to somewhere closer to competitor Honeywell's 13.5% mark.
GE is making headway in this area in 2014, and here's what Immelt had to say about the progress in the third quarter:
Operating margins expanded 90 basis points year over year. We continue to generate benefits from our simplification efforts and are on track for more than $1 billion of cost-out for the year. Margins improved in six of seven businesses, and our cost-out momentum is strong.
Digging deeper, the services business has generated a margin improvement of 170 basis points, or 1.7%. As services continues to post double-digit growth rates, the hefty margins in this segment will bolster the bottom line for all of GE's industrial businesses.
Source: GE.
3. Keep the banking business on track
GE's focus is squarely on industrial growth, but that doesn't mean GE Capital is not in its line of sight. Lending continues to be an important element of a revamped GE portfolio: GE Capital earnings are expected to dip to $5 billion this year, but it generates a hefty amount of cash that can be distributed to the parent -- and ultimately to shareholders.
With that in mind, it's good to see two things taking shape at GE Capital:
- A balance sheet that continues to get stronger
- A focus on the lending activities most relevant to GE's industrial business
Regarding the first priority, GE Capital upped its Tier 1 ratio to 12.1%, a gain of 80 basis points. This is the most commonly referenced metric for gauging balance sheet strength, and GE has increased its ratio from 5.7% in 2008 to 11% last year to 12.1% today. This is a good sign that GE continues to remove risk from banking.
Second, GE's carving out non-core businesses like its North American consumer credit card unit -- now Synchrony Financial -- but also investing in areas that make good business sense. One of the more interesting comments came from Bornstein when he explained to an analyst why the $1.78 billion purchase of a helicopter financing business, Milestone Aviation, made sense at this juncture:
This is a strike-zone deal for what we do in GECAS [GE Capital Aviation Services]. We know how to do this. It is an operating lease business. It matches very well with our footprint geographically ... We know how to manage businesses like this that are very asset intensive. And we really like what the returns look like over time.
It also lines up, like GECAS does, with our Aviation business. A very high percentage of this portfolio are GE-powered helicopters, and we think that provides a lot of synergy ...
So we have been, I think, reasonably consistent saying that we were going to continue to grow our core midmarket and industrially aligned verticals as we move forward. At the same time, we are very aggressively working the $135 billion of nonstrategic parts of the portfolio, and we have got a lot of things in motion there.
I think the other way you need to think about it a bit is we have got capital available. And we would rather deploy the capital at very attractive returns than put the capital to work in a bank at a negative carry.
In short, Milestone's right in GE's wheelhouse given its expertise in aviation, it will be accretive to earnings, and it's a good use of cash that would otherwise idly lose value because of inflation.
That sounds like a good rationale to this long-term focused investor.
Why GE's heading in the right direction
All things considered, these three takeaways show that GE's balancing growth while cutting costs, and it's pushing and pulling different levers to keep the banking business humming along. The stock has responded nicely in the past few weeks, recognizing the progress made thus far.
What's more, there's good reason to believe the fourth quarter will be the best one yet. Last year, we saw a surge of 10% in backlog orders to wrap up 2013, and all signs point to a stronger tailwind this time around. Now could be an optimal time for long-term investors to pick up a few more shares.
