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Will GE's Transformation Be a Success or a Failure?

By Robert Stephens – Jan 12, 2016 at 9:46AM

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Will GE’s pivot from finance-dominated conglomerate to nimble, fast-moving industrial be good news for its investors?

Forget the idea that mature companies move at a slow pace. General Electric (GE -2.88%) is 124 years old yet is undergoing arguably the greatest, fastest, and most exciting period of transformation in its history. While this change could mean a relatively high degree of risk for longstanding investors who have viewed GE as a quasi-financial-conglomerate income play, it also looks set to rejuvenate the company's bottom line and make it a much greater success.

A key reason for this potential is GE's focus on breaking down the walls between its different divisions, which, in the past, have generally operated on a nearly mutually exclusive basis. Through the adoption and focus on the GE Store, the company is intent on developing its horizontal capabilities through shared innovation, with technological advancements, ideas, and support from one part of the business being made available across all parts of the business.

Undoubtedly, such a scheme has little value when the different divisions have limited common ground. For example, GE's consumer credit arm, Synchrony, had little to share with GE's healthcare department, and vice versa. However, with the company disposing of multiple financial assets, including Synchrony, as it seeks to become an industrial company that is enhanced rather than dominated by its capital arm, scope for a more collaborative, value-added approach is likely to enhance innovation, productivity, and, most important, profitability.

GE is well on the road to generating its targeted 75% of profit from its industrials division, with the remainder to be derived from its capital division. This split makes good sense, since GE envisions a world in which financial volatility, geopolitical uncertainty, and development opportunities in the developing world are emphasized in future years. To take advantage of those factors, GE must innovate, become more productive, and tap into the $70 trillion that is forecast to be spent on global infrastructure between 2014 and 2030.

By pivoting from financial to industrial operations, GE is giving itself a much better chance of doing just that, with its industrial division having a return on capital of 14% in 2014, versus a return on capital that's lower than the cost of capital in its finance arm. Furthermore, with the "new" GE having a leaner management structure that can better leverage its scale, efficiencies are likely to be far easier to achieve.

Additionally, a lower cost base, greater innovation, and a more nimble management structure mean an even greater competitive advantage over GE's industrial competitors. This advantage should have a positive impact on the company's margins, and, with GE reporting a rise in industrial segment operating margins of 100 basis points in its Q3 results, the impact of its transformation appears to be very positive thus far. Furthermore, with GE expecting to deliver an operating profit increase for its industrial division in the double digits in 2015, the potential for faster growth as it becomes better integrated seems to be significant.

Meanwhile, the Alstom acquisition is also likely to make the "new" GE even more successful, with total annualized cost synergies of around $3 billion due to be realized by 2020. This addition, plus highly complementary technology and a global presence, mean that the addition of Alstom to GE not only enhances the latter's project capabilities but also improves the function of the GE Store and adds value to the wider GE business.

Of course, there is a chance that GE will lose its reputation as a highly diversified business that offers a relatively stable income outlook. While GE may be viewed as taking a major risk in staking its future on greater global demand for innovation, rising productivity, and higher efficiencies, such qualities have always been highly desirable in companies across all industries. Furthermore, GE intends to maintain a focus on growing dividends and returning capital to its investors, with a dividend of $8 billion and a buyback of $18 billion being penciled in for 2016. This activity is likely to maintain interest in the stock from "traditional" GE investors who value diversity and, more important, the return of capital.

Therefore, while GE is undergoing a hugely transformational period, it is changing for the better. It is maintaining its high degree of diversity across a wide range of sectors and is aiming to remain a dividend stalwart for income-seeking investors. However, it's in the process of adding to this a more integrated business that seeks to gain a greater competitive advantage in a more competitive world.

As a result, GE's transformation looks set to be a major success, and with increasing margins, rising operating profit, and robust capital returns having been delivered, it is already showing signs of improved performance, which looks set to continue in the long run.

Robert Stephens has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. 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.

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