Source: GE.
About six months ago, General Electric (GE 1.30%) announced an historic deal to divest the majority of its financial services arm, GE Capital, so that it could become more focused on its industrial businesses, and less exposed to financial shocks. In the last month, shares of General Electric have moved sharply higher after an activist hedge fund bought a $2.5 billion stake to hold management more accountable throughout this massive transformation.
But what will it take for GE's stock to keep rising over the long haul? Here are three factors that could make it happen.
1. Asian and resource-rich economies improve.
With a presence in more than 170 countries, GE's industrial businesses act as a barometer for global economic activity. Last quarter, CEO Jeff Immelt noted on the earnings call that the U.S. has been improving, Europe has stabilized, and emerging markets remain volatile. All told, GE's industrial revenue, which accounted for nearly 83% of total revenue, declined by 1% year over year, and increased by 4% on an organic basis, after excluding the impact of acquisitions, dispositions, and currency headwinds.
By region, the biggest detractors were Asia and resource-rich regions, representing 37% of GE's industrial revenue in the third quarter, which declined by 7% year over year. Clearly, the slowdown in China and the slump in oil prices are weighing on GE's overall performance:
Source: GE. Resource Rich: Australia and New Zealand, Canada, Latin America, MENAT, Russia and CIS, and Sub-saharan Africa. Asia: ASEAN, China, and India. Developed: U.S., Europe, Japan, & Korea.
Ultimately, if these regions improve and the rest of the world remains stable, it would likely have a meaningful impact on GE's overall performance.
2. Margins expand and fuel earnings growth.
As margins expand, more dollars have the potential to flow to GE's bottom line and drive earnings growth. GE's industrial operating margins have expanded for 10 straight quarters, indicating that the company is maintaining its value proposition, and staying disciplined in a challenging environment. Most recently, GE's third-quarter industrial operating margin increased by 100 basis points, to 17.3%.
Source: GE. OP = Operating. Industrial operating margins includes GE Corporate activities, excluding gains and restructuring.
Looking ahead, Immelt believes there's room for GE to continue expanding its margins, fueled by long-term initiatives that the company is pursuing, like the Brilliant Factory, which aims to improve factory productivity in real time by leveraging sensors, connected machines, and advanced analytics. According to GE, a 1% improvement in productivity across its manufacturing footprint translates to $500 million in cost savings. Over the long haul, the goal for the Brilliant Factory is to increase GE's manufacturing productivity by 20%.
3. Oil prices rebound and revitalize the industry.
GE's oil and gas segment continues to get punished from the effect that lower oil prices are having on the industry's activity. The segment's third-quarter sales declined by 16% year over year, to $3.9 billion, sending profits lower by 12%, to $584 million. Overall, oil and gas accounted for 15% of GE's industrial revenue, and 13% of its profit.
To combat the headwinds that the oil industry is facing, GE remains on track to cut $600 million of expenses this year from the segment, and another $1 billion of expenses in 2016. The goal here is to reduce the impact that declining sales will have on the segment's profitability.
Although GE isn't banking on an oil and gas recovery anytime soon, the cost-cutting measures puts the segment in a better position to profit from an eventual rebound in oil prices that drives industry growth.
Putting it all together
For General Electric's stock to move higher, there are factors that are in its control, and others that are not. What it can control is how it executes on its transformation, whether it can continue expanding margins, and operate more efficiently. It obviously can't control if oil prices rebound, growth markets recover, and the world economy doesn't deteriorate.
Ultimately, the better that GE executes in areas it can control, the better the stock's long-term growth prospects.
