Please ensure Javascript is enabled for purposes of website accessibility

The Key to General Electric Company's Growth Prospects

By Lee Samaha - Feb 17, 2016 at 11:14AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The industrial giant's investments in the industrial Internet should enable it to grow its all-important service revenue.

The market didn't receive General Electric Company's (GE 0.94%) latest earnings report very well, even though the industrial giant maintained full-year 2016 guidance. For obvious reasons, most of the immediate attention focused on its oil and gas segment, but I think its overall services business, and particularly services orders, is the key metric to follow this year. Here's why.

What really matters to General Electric Company
Here's what CEO Jeff Immelt said on the latest earnings call:

We primarily ship from backlog, so orders and backlog growth matter. In 2015, six of seven businesses grew backlog, some substantially. When we do our analytics around convertible backlog and business performance, we see a path to 2% to 4% organic growth for '16, even with a very difficult oil and gas market.

On top of organic revenue growth of 2% to 4% for 2016, the company is guiding toward core margin expansion. Given Immelt's commentary, it's safe to say the company will struggle to hit these targets unless orders hold up. The good news is that backlog, excluding the impact of the Alstom energy acquisition, grew around 6% sequentially in the fourth quarter, and 7.5% compared with the end of 2014:

 

IMAGE SOURCE: GENERAL ELECTRIC COMPANY PRESENTATIONS.

Service orders growth
Backlog grew nicely, and the integration of Alstom helped equipment order growth turn positive. But the really impressive outcome was organic service growth of 3% in the quarter (5% including Alstom). Why is this impressive?

The following chart shows how equipment orders tend to lead into service orders, and since services tend to be higher margin, any decline in service orders will be felt in revenue and earnings in future quarters. Incidentally, the equipment orders line is negatively affected because of a comparison with a very strong fourth quarter of 2014, where the company won $4.9 billion worth of orders for its aircraft engines.

Nonetheless, equipment order declines are equipment order declines, and the company did a good job increasing organic service orders 3% in the fourth quarter.

DATA SOURCE: GENERAL ELECTRIC COMPANY PRESENTATIONS.

Of course, the next question is: Can it continue?

Immelt was asked this on the earnings call, and here's part of his answer: "I would start again with the digital focus, which is growing 20% not just in power, but in other businesses. But we also have very targeted programs in all of our businesses."

He went on to outline the opportunities to sell services into Alstom's installed base, and opportunities within aviation and healthcare, but he said the "No. 1 driver" is its digital activities.

Super industry growth
By "digital," Immelt is talking about the industrial Internet. Readers already know the five ways the industrial Internet can benefit General Electric. Adding Internet-enabled devices onto hardware and then using data analytics to analyze performance benefits future service orders in three ways:

  • It helps retain General Electric equipment customers.
  • It gives a value-add for its services offerings, especially with its big data analytics platform-as-a-service cloud solution, which helps customers capture and analyze data.
  • Data analytics will more efficiently inform customers of when their equipment needs services.

While much of this is well known, it's time for the company to demonstrate the efficacy of these arguments, because General Electric needs service orders to continue growing -- particularly in a slowing global environment.

Looking ahead
All told, the key metric to follow this year will be service orders. If the company can keep them in the 3%-to-5% range, then investors will be able to see the tangible benefits of the company's investments in the industrial Internet.

Moreover, such an occurrence would highlight the growth opportunities from investing in digital solutions -- an area where the company is leading the way. The economy may not be helping much, but General Electric's investments in the industrial Internet look set to generate tangible benefits to the bottom line in 2016.

Lee Samaha has 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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
GE
$74.36 (0.94%) $0.69

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
377%
 
S&P 500 Returns
123%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.