As usual, there were a lot of moving parts to General Electric's (GE 1.04%) second-quarter earnings, released last week. The big picture takeaway was that GE divested additional non-core assets from its financial services business, GE Capital, and the company's industrial segment reported healthy growth in operating earnings.
On the industrial front, GE grew its operating earnings by 18% year over year to $0.26 per share. Including the assets that General Electric will be retaining after it exits its traditional financial services businesses, the company generated $0.31 per share in operating earnings, representing an increase of 19% year over year.
The conference call that GE hosted along with its earnings release gave investors the opportunity to gain a greater understanding of GE's various businesses. In total, there were five major takeaways from management during the call.
1. Running the operations
By and large, as reflected by increases in profit margins across five of General Electric's seven industrial segments, GE appears to be operating and executing well.
On the call, CEO Jeff Immelt provided the margin highlights:
Margins expanded with 70 basis points of growth. Gross margins were up 60 basis points with strength in value gap and productivity. We're making progress broadly with five of seven segments having margin growth.
Simplification continues to deliver results and our SG&A targets are on track. First-half margins are up 100 basis points.
Service margins were particularly strong, up 130 basis points year to date as the impact of our analytical tools are being felt. Equipment margins, meanwhile, are up 30 basis points year to date. So we're running the company well.
2. Competitiveness
During the question and answer session of the earnings call, an analyst asked whether General Electric's apparent market share gains across its businesses had resulted in competitors responding with lower prices.
Although Immelt didn't answer the question directly, he weighed in about the importance of technology to remain competitive:
Look, in our world technology matters. And so if you look at the aviation business, if you look at locomotives, if you look at gas turbines, if you look at healthcare we have a great lineup of technologies that are quite robust. And in the end that's the way you can gain good market position and margins at the same time.
Then on the service side I think our analytics are starting to play through both from a pricing standpoint and also from a productivity standpoint. So that's another example of technology and what it can drive.
3. Staying productive in a challenging environment
In light of challenging market conditions, General Electric's oil and gas revenues fell by 12% year over year, and declined by 2% organically through the first half of 2015. Yet GE's oil and gas profit margins improved by 40 basis points in the second quarter, and by 120 basis points organically for the first half. Much of this improvement was attributed to gains in manufacturing productivity and executing on its plan to cut oil and gas costs by $600 million this year.
When management was asked during the Q&A session whether it can maintain its margins in oil and gas in a challenging environment, it became clear that managing costs will be a crucial component going forward.
Immelt weighed in first:
We'll take out $600 million-ish of [oil and gas] cost[s] this year. That will be more next year so we've been able to do a good job on cost and I think the combination of those things and the mix of businesses we have I think gives us a perspective that we should be able to hold our margins going forward despite a more challenging market.
Immediately after, GE CFO Jeff Bornstein added the following:
Yes, the only thing I would add is that $1 billion cost-out target for 2016 is absolutely critical to me. There's no question that although we've not repriced any of the existing order book there's no question that new orders are going to be challenging from a pricing perspective. That's why all the work around restructuring and product service cost is so critical in terms of profitability and operating margins.
In other words, investors should expect that GE will cut an additional $1 billion in oil and gas-related costs in 2016 to help maintain the segment's profitability.
4. Better-than-expected prices for GE Capital asset sales
General Electric is officially ahead of its planned schedule to sell its non-core financial assets held at GE Capital, and now expects to divest up to $100 billion in assets this year, up from the $90 billion it anticipated in April. The company is also getting better prices for the assets than it had initially projected.
However, because the assets are being sold at a faster pace, the benefit of higher prices is likely to be offset with lower earnings.
Bornstein explained the situation on the call:
... if you think about it in terms of deals that Keith [Sherin] and the team have signed, right now we're roughly excluding real estate we're about 5%, a little over 5% ahead of the fair values we used on the April 10 call of the baseline if you will for the Hubble [divestment plan].
So, so far I think we're doing better on price than that baseline. Having said that, because we're accelerating the sales of these portfolios and franchises that means the earnings that we're going to enjoy over what we thought the hold period was going to be is shortened.
So right now I would say that those two things more or less offset each other. Better on price for what we've signed so far but we're selling them quick and we'll earn less as a result of not owning them as long as we thought.
5. Clearing regulatory hurdles
General Electric has two deals that it's working to clear with regulators: The sale of its appliances unit to Electrolux and the purchase of Alstom. Unfortunately, management wasn't able to disclose the specifics of any recent developments with regulators, but Immelt remained optimistic that the integrity of the deals will remain intact and should close:
Appliances and Alstom are in the middle of regulatory reviews but we still expect both deals to close by the end of the year. We remain committed to doing good deals for investors.
Staying encouraged
Last April, GE announced a plan for 90% of the company's operating earnings to come from industrial activities by 2018. During the second quarter, GE's industrial segment produced nearly 84% of its operating earnings after adjusting for one-time items and accounting for the financial assets it will retain from GE Capital.
In other words, investors should remain encouraged that General Electric appears to be delivering on its promise of becoming a highly focused industrial powerhouse.
