So said General Electric (NYSE:GE) CEO Jeff Immelt regarding the various challenges he has faced, including the recent plunge in the price of oil. At the company's investors meeting in December, Immelt sought to instill confidence in shareholders jittery over the American conglomerate's acknowledgement that falling oil prices will affect its oil and gas business. Let's see how GE can rise to this challenge and produce healthy numbers for investors in 2015.
The oil exposure
GE has built a $17 billion oil and gas operation that offers equipment, drilling and production systems, and services to global oil and gas extraction companies. Operations are classified into several segments: drilling and surface; subsea; turbomachinery; measurement and controls; and downstream. The global demand for GE's equipment and services depends on energy companies' capital spending plans. With the price of Brent crude halved in recent months on a glut of supply, a number of energy companies are reassessing projects.
This worries GE investors because oil and gas has been the fastest-growing business in the company's industrial portfolio. Roughly 47% of industrial revenue growth and 40% of profit growth in the last five years have been driven by this segment. The two charts below show the growing proportion of oil and gas revenue and earnings in GE's industrial segment performance.
A stumble, not a fall
GE has said that revenue and profit from oil and gas would be flat to down 5% in 2015. While this is worrisome, Immelt has explained that the entire oil and gas portfolio is not susceptible to the oil price dip. In fact, 60% of the segment's revenue, which comes from measurement and controls, turbomachinery, and downstream operations, is not expected to be hit.
Apart from oil and gas companies, GE provides asset measurement and control equipment to other industries such as power generation, aerospace, transportation, and healthcare. And even for the oil and gas industry, a lot of this business is related to maintenance and repair that's not susceptible to the oil price drop.
Turbomachinery is guarded, as this business has a decent backlog. GE supplies turbomachinery (turbines and compressors) to liquefied natural gas mega-projects around the world. The downstream operations that involve refining of crude petroleum to produce gasoline, kerosene, and jet fuel are not just protected but could even fare better as low oil prices reduce raw material costs and boost profitability. As refiners increase capital spending, GE can get more business.
In Immelt's words, "the most volatile piece of mix" is drilling and surface, which serves shale fracking customers in the U.S., and generates 25% of GE's oil and gas revenue. While opinions vary regarding the breakeven oil price for fracking operations, analysts estimate that it would be in the range of $60 to $80 per barrel for North Dakota's Bakken region. With oil prices nosediving to under $50 per barrel in January, GE estimates the drilling and surface business will take a 10% revenue hit in 2015.
Subsea or offshore drilling projects generate 15% of the division's revenue. Offshore oil drilling is a high-cost operation, and GE's orders are likely to get affected if producers limit their capital spending. However, GE has adequate backlog in this business line to tide it through 2015.
Segments acting as a shield
Fortunately, GE's other industrial businesses are holding up well. The power unit, which accounts for about one-quarter of the company's industrial revenue, is poised to expand in a big way with the $16.9 billion acquisition of Alstom's gas turbine business. Management expects the Alstom acquisition to be accretive to earnings by $0.01 per share in 2015, by $0.06-$0.09 per share in 2016, and to grow from there.
GE's aviation business, which makes aircraft engines, has a robust backlog that was valued at $125.1 billion in 2013, up more than 22% from 2012. It made up 21% of the industrial revenue in 2013, with profit margin expanding to 19.8% from 18.7% in 2012. The growth momentum is expected to continue as airlines buy greater number of planes. GE has also said it could "set record orders this year in locomotives" and that the average daily order rates in aviation and transportation businesses are at all-time highs.
The oil debacle happened as GE tries to position itself as a core industrial company. It is slowly exiting the GE Capital business that is perceived to be more risky. To prove to investors that focusing on industrials is the right strategy, GE must post good numbers.
The company has forecast 2015 earnings from industrials to reach $1.10 to $1.20 per share, and earnings from GE Capital to be $0.60 per share. This is in line with analysts' expectation of $1.76-per-share earnings for the company as a whole. For 2014, the Street is expecting $1.65 per share
GE is keeping the worst-case scenario for 2015 oil prices in the $60 to $65 per barrel range, although Immelt said projected earnings from the industrial segment could be met even if prices went below that range. But as Scott Davis from Barclays Capital told The Wall Street Journal, "It's really hard to get your arms around, because you don't know the duration. If oil is low for six months, it's one thing. But if it's low for three years, that's another thing entirely."
ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.