General Electric (NYSE:GE) is set to report its third-quarter earnings on Friday morning before the market opens. Going into the report, Wall Street expects the industrial giant's revenue to fall by 21% year over year to $28.6 billion and earn $0.26 per share. Beyond the headline figures, investors should also familiarize themselves with General Electric's underlying business and ongoing transformation to help determine how the company is faring.
In total, there are three key areas to watch when GE reports earnings.
1. Industrial + verticals earnings per share
To help investors get a better sense of how GE is performing as it divests the majority of its financial services businesses that aren't relevant to support its industrial businesses, the company reports a supplemental "industrials + vertical" EPS metric. It combines GE's industrial businesses EPS with those of the financial services businesses that it expects to retain.
In the second quarter, GE's industrial + vertical EPS increased by 19% year over year to $0.31, suggesting underlying strength from the businesses that GE is keeping. Ideally, investors want to see continued strength from GE's industrial + verticals EPS in the third quarter. After all, the company is undergoing a massive transformation so that it can become a more focused industrial company that's capable of producing consistent growth. A decline from GE's industrial + vertical EPS could indicate early signs of trouble for GE's core businesses.
2. SIFI status update
This week, GE announced a $30 billion deal to sell GE Capital's commercial lending and leasing business to Wells Fargo, and Synchrony Financial, GE's consumer banking spinoff, received approval from the Federal Reserve Board to become a stand-alone savings and loan holding company after GE spins off the remainder of the unit.
Aside from showing that GE is returning to its industrial roots, these developments strengthen the company's case to regulators that it doesn't need to retain its systemically important financial institution, or SIFI, status when it applies to remove the designation in the first quarter of next year.
Ultimately, if GE can lose its SIFI status, it would subject the company to less oversight and give it added financial flexibility in terms of how it can operate. In other words, it's an important item to monitor because losing SIFI status may free up additional capital that could be returned to shareholders or poured back into the business.
3. Industrial margins and cash flow
Two signs of a healthy business are expanding profit margins, which can indicate pricing power and improved operational efficiency, and healthy cash flows that can sustainably fund its operations, growth initiatives, and returning capital to shareholders. Specifically, GE investors want to focus on its industrial margins and cash flows because the segment contributes the most to the company's operating results, and is expected to eventually represent 90% of its operating earnings by the end of 2018.
In the second quarter, GE's industrial gross margins increased by 60 basis points year over year to 26.6% and its operating margins increased by 70 basis points to 16.2%. Through the first half of 2015, the company generated $3.5 billion in cash from its industrial operations, representing an increase of 79% year over year. Combined, these figures suggest that GE's underlying industrial business remains healthy, which investors will want see again in the third quarter.
All eyes on Friday
When General Electric reports earnings tomorrow, focus on how the underlying business is performing, rather than how investors react to the news. Be on the lookout for GE's industrial + vertical EPS results, an update on its SIFI status, and how its industrial margins and cash flows fared. These are great places to start assessing whether GE's business remains on track.