It's no secret that the industrial sector is facing soaring raw material costs and supply chain constraints impacting its costs and sales. However, General Electric's (GE 8.28%) management has demonstrated an ability to wring every bit of earnings and cash flow possible from its revenues.
And, just like its highly rated peer Honeywell International (HON 0.30%), in its third-quarter earnings report, GE lowered its full-year sales guidance but raised margin expectations. The result -- for both companies -- was a hike in full-year earnings guidance. That's impressive under the circumstances -- and at GE, it's all about management's execution.
Image source: Getty Images.
GE's guidance changes
Let's start with a quick look at GE's guidance changes and the details around them. Management lowered its full-year revenue outlook for two primary reasons.
First, supply chain constraints are holding back growth, particularly in aviation and healthcare. Within aviation, GE (like Honeywell) is suffering supply chain challenges that are negatively impacting its military business. Meanwhile, management confirmed that supply chain disruptions would hinder its healthcare unit in the first half of 2022.
Second, the planned extension of production tax credits (PTC) in renewable energy is negatively affecting near-term demand. Typically, companies rush to place orders when a period under which those credits can be claimed is about to end, but the extension is allowing them to push out orders.
As CFO Carolina Dybeck Happe said on the earnings call, "for equipment and repower, the market is now expected to decline from 14 gigawatts of wind installments this year to approximately 10 gigawatts in 2022." While the PTC extension is good news for GE over the long term, it will create a near-term revenue headwind.
Nevertheless, even with the revenue cut, GE's management forecast that profit margin would expand, raised its earnings expectations, and kept the midpoint of its free cash flow (FCF) guidance intact. For reference, Honeywell did the same, primarily down to taking productivity actions and increasing prices to offset inflation.
| Metric |
New Guidance |
Prior Guidance (July 2021) |
|---|---|---|
|
GE industrial organic revenue |
flat |
low single-digit percentage growth |
|
Adjusted GE industrial profit margin |
expansion of 350 basis points |
expansion of 250 basis points |
|
Adjusted earnings per share (EPS) |
$1.80 to $2.10 |
$1.20 to $2 |
|
GE industrial free cash flow |
$3.75 billion to $4.75 billion |
$3.5 billion to $5 billion |
Data source: General Electric presentations. 100 basis points equal 1%.
Favorable factors for GE's margin
The critical question is, how was GE's management able to raise margin guidance despite its supply chain pressures?
The key factors were:
- GE is benefiting from a favorable margin mix as its growing relatively more in higher-margin activities.
- Management is doing an outstanding job of executing and reducing costs.
Within the "margin mix" category, there are three separate things to look at.
First, Dybeck Happe confirmed that in the aviation segment, margins would land in the low double-digit percentages for the year. "We now expect '21 shop visits to be up at least mid-single-digit year over year versus about flat," she said. That's a significant plus as GE Aviation's major profit center is its commercial aviation services business.
Second, Dybeck Happe said, "Gas power services was up high single-digits, trending better than our initial outlook due to strong CSA volume. We now expect gas power services to grow high single-digits this year." This, too, is a higher-margin activity for GE, and management declared itself confident in the margin outlook for 2021 and beyond at GE Power.
Image source: Getty Images.
Third, even with the supply chain challenges at GE Healthcare, management continues to maintain its guidance for 100 basis points of margin expansion in 2021 in the business. CEO Larry Culp put this down to productivity improvements and better inventory management.
The company's ability to maintain its healthcare margin guidance demonstrates the success of the self-help initiatives it took to reduce supply chain constraints. For further evidence of this, Dybeck Happe noted that "We are now expecting corporate costs to be about $1 billion for the year, and this is better than our prior $1.2 billion to $1.3 billion guidance."
Together, these factors are helping GE offset its lowered revenue expectations.
Looking ahead
GE certainly faces more supply chain headwinds in 2022, but the good news is that management is doing a great job of navigating them. Moreover, year-over-year order growth of 42% in the quarter (up 19% year to date) suggests the company's problems are not so much matters of demand, but rather matters of working through supply chain constraints to meet the demand.
If supply chain pressures ease up in 2022, then the productivity improvements put in place by GE management will position the company well to expand its margins even further as revenue growth kicks back in. That could be a significant plus, but GE investors will have to wait a while to see the full benefits.
