Is General Electric's Transportation Unit Back on the Right Track?

The transportation business of the top industrial conglomerate has seen a downward trend in sales. Will these new developments lead to outperformance?

John Bromels
John Bromels
Jun 28, 2017 at 12:06PM

Things literally couldn't have gotten any worse for General Electric's (NYSE:GE) locomotive sales in 2016. The company didn't sell a single locomotive all year. That's right: zip, nada, none. And as the top product of the company's transportation unit, locomotive sales -- or the lack thereof -- have an outsized impact on the unit.

But there may be a light at the end of the tunnel, because the trend seems to be reversing for the unit. Or is that light just an oncoming train?

Let's look at what's happening with GE Transportation and its industry, and how it's likely to affect the company's bottom line.

Oil cars on moving train.

Downward trends in oil shipments and coal mining have hampered growth for GE Transportation and the North American railroads it serves. Image source: Getty Images.

Hero to zero

When you hear that GE sold no locomotives for a year, that actually sounds worse than it is. Just because GE Transportation sold no locomotives doesn't mean it didn't sell anything. Although locomotives are the unit's flagship product, it also manufactures mining and marine equipment, and services and maintains the locomotives it's already sold to train operators like Canadian National Railway (NYSE:CNI), a major GE client and a Class 1 North American railroad.

Additionally, GE Transportation -- like the rest of its parent company -- has a massive backlog of projects. These represent equipment (or in some cases, services) that are already sold, but which take time to build and deliver. Currently, the unit is sitting on a backlog of $20.1 billion. That includes, for example, some of the 1,000 diesel locomotives the company sold to Indian Railways in 2015, which are scheduled to be delivered over 11 years.

Even with a backlog of that size, though, things have been rough in the railway space recently. Slumping oil prices and a weak coal market have depressed the amount of North American railway oil and coal shipments, which make up a substantial portion of freight rail traffic in North America. With revenue declining in 2016, Class 1 railroads, like Canadian National, also cut costs, which is bad for GE.

International edition

However, while North American rail companies may have been suffering for the past couple of years, GE management says it's starting to see a turnaround, with more optimism among its clients. Also, the company has many opportunities overseas.

Many foreign countries have much more robust passenger rail systems than in the United States, and many aren't as dependent on oil or coal shipments for their freight traffic. Some countries also have nationalized railway systems, which provide lucrative opportunities for any company -- like GE -- that can score a contract with the system. (It's worth noting that Canadian National -- despite its name -- isn't a nationalized system any more: It was privatized in 1995.)

Recently, GE has inked two high-profile deals to provide locomotives overseas. The first, which was announced on June 8, is with Pakistan Railways for 20 locomotives.

The second deal, announced June 19, is a $575 million deal with Egyptian National Railways to supply 100 locomotives, as well as a 15-year agreement for parts and technical support for GE locomotives in Egyptian National's new and current fleets. It also includes technical training for Egyptian National engineers and employees. The agreement is the largest ever between the two companies.

The unit is making some sales, in contrast to 2016. That's good, of course. But here's what these deals mean for the company, as a whole.

The bottom line

Like the rest of the company, GE Transportation has been restructuring and cutting costs over the past few years. Even though it's GE's smallest division in terms of revenue, by far -- just $5.4 billion, on average, over the last three years -- it has one of the best profit margins in the company, at 22.6% (only Aviation's 23.3% is higher).

But even with those high margins, Transportation's recent underperformance didn't have much of an effect on GE's overall bottom line. Although revenue dropped by $1.2 billion, profits only fell by $200 million, a drop in the bucket for a company with $8.2 billion in annual net income.

However, the unit's backlog also took a big hit, dropping by 11% in 2016. Not only is that the worst performance of the company, but it's bad for GE's overall backlog, which grew only slightly in 2016. And if GE's backlog starts to shrink, the stock will almost certainly take a hit. Luckily, with these two new projects -- and hopefully more to come -- that seems less likely than it did a year ago.

Investor takeaway

It's refreshing to see a couple of big deals coming out of GE's beleaguered transportation unit. With the high margins it generates, this will not only help the bottom line, but also help to preserve the company's giant backlog. However, it's going to take more than just a couple of deals to make a real impact on the company's overall fortunes. 

For now, though, investors should take comfort from the fact that the unit's long sales drought has ended.