As General Electric (GE -1.57%) works to complete its massive transformation into a highly focused industrial company, its future earnings prospects differ from when about half of its operating earnings came from its financial services arm, GE Capital. By 2018, GE expects to generate 90% of its operating earnings from industrial activities. Going forward, three of GE's biggest opportunities are the Industrial Internet, Alstom, and an expansion of its breadth of services.
The Industrial Internet is the Internet of Things for industry. It sits at the intersection of industrial assets, internet-connected sensors, big-data analytics, and real-time optimization. The goal of the Industrial Internet is to improve the efficiency and productivity of an industrial asset, whether it's an entire wind farm, a single factory, a power plant, or an aircraft engine. GE is leveraging the power of the Industrial Internet to benefit its own industrial operations, as well as offering solutions to the marketplace.
Internally, GE's Brilliant Factory initiative aims to improve the efficiency of its existing manufacturing base by connecting the factory and its components to the internet. Thus far, GE's early investments in upgrading its factories with Industrial Internet capabilities have been promising. In one instance, GE upgraded its Greenville, South Carolina, factory and increased productivity by 25% over a three-month period. GE estimates that for every 1% improvement in productivity it can realize across its manufacturing base, it'll save $500 million annually.
For the marketplace, GE has developed the world's only cloud-based industrial operating system -- Predix -- which enables users to develop and purchase apps designed to take advantage of the Industrial Internet. With this platform, GE hopes to spark an industrial app revolution, and in the process, turn its $5-billion-a-year software business into a $15-billion-a-year business by the end of 2020.
Last November, GE purchased French multinational Alstom's thermal, renewable, and grid businesses for $10.1 billion, as a way to bolster its renewable-energy portfolio, emerging market presence, power-generation installed base, and competitive positioning in the power market. Additionally, management sees Alstom as a way to create synergies, drive cost savings, and open up GE to new growth and cross-selling opportunities.
Within the first five years of the acquisition, GE hopes to realize about $3 billion in synergies. Thus far, GE has realized more than $400 million in synergies and savings during the first half of 2016, and remains on track to hit its goal of $1.1 billion this year. Alstom has also helped GE achieve revenue growth in a sluggish global growth environment that's caused its legacy industrial businesses to stagnate.
For every piece of industrial equipment that GE sells, it aims to sell a suite of ancillary services that supports the equipment over its lifetime. GE doesn't regularly break out its industrial margins by product or service, but CEO Jeff Immelt once revealed that service-related operating margins tend to be in the 30% range -- far higher than the 11.7% total industrial operating margin it reported in the first half of 2016. During this same period, GE's industrial service revenue made up 46.4% of its total industrial revenue, an increase of about 250 basis points year over year.
Historically, these services have consisted of performing warranty and maintenance service agreements. In the future, GE is seeking to expand the scope of services it offers as an effort to drive higher margins and more predictable revenue streams.
One such expansion is GE's Digital Twin initiative, which creates a virtual replica of any product and is augmented with real-world data. This can help customers test new configurations, better respond to problems, and improve overall operating efficiency. In other words, the Digital Twin serves as a sophisticated proving ground before customers have to put physical assets at risk.
The bigger picture
Including Alstom, Wall Street analysts expect GE to grow its 2016 sales 7% year over year to nearly $126 billion. After this one-time benefit is realized, Wall Street expects GE's sales to essentially flatline in 2017. In other words, the consensus expects that being a large industrial company in a sluggish growth environment won't be kind to GE's sales trajectory.
Without sales growth, GE can focus on improving margins by cutting costs, becoming more efficient, and driving higher-margin revenue. That's where the opportunities lie.