General Electric: Cleaned Up And Reloaded

By Stephen D. Simpson, CFA | July 27, 2011 AAA

Fans and sports reporters talk about how perennially competitive teams "don't rebuild, they reload" and the same could be said for General Electric (NYSE:GE). Though far too much has been made of Six Sigma (which was actually created at Motorola), the managerial abilities of its CEOs, and the "inevitability" of GE's diversification bringing solid results, the fact remains that GE is a very competitive player in numerous key growth markets. With the company having repaired a fair bit of the damage done in the credit crunch, this industrial conglomerate looks poised again for some growth.
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Q2 Results - Always Complicated, But Showing Improvement
To its credit, GE gives investors a large amount of data to chew on every quarter. While GE reported that reported revenue (including GE Capital) fell 4% and industrial revenue fell 6%, organic industrial revenue looked to be positive to the tune of about 5%. Segment operating profit margin compressed about two points (due to weakness in energy, particularly wind power), but reported operating earnings from continuing operations rose 18%.

Equipment orders were up 33% this quarter and the strongest in quite some time. Aviation orders were far and away the strongest, while energy and oil & gas were also quite strong. On a separate note, GE Capital posted solid results and seems to have worked through a lot of the problems caused by (or revealed by) the credit crisis.

R&D - Cash Today, Revenue Tomorrow
For a company its size, GE is unusually interested in R&D. The company has established sizable research centers in China and India and will soon be opening one in Brazil as well - close to customers like Petrobras (NYSE:PBR) and Embraer (NYSE:ERJ). Given the demand in these regions for better technology in power generation, transportation, and mineral resource exploitation, this seems like a no-brainer. Still, there are always those investors that would rather see larger buybacks today in lieu of better growth tomorrow.

GE Always a Mix of Markets
The good and bad of GE's diverse business mix is that it is rare for all of its major markets to be in bull or bear cycles. Oil and gas, for instance, has not operating at full steam lately, but commentary from major service providers like Halliburton (NYSE:HAL) has been encouraging and it looks like capital equipment players like National Oilwell (NYSE:NOV) and GE are going to see more orders shortly.

Energy (power generation) is another mixed bag. GE and other companies like SPX (NYSE:SPW) are seeing a decent environment in thermal power generation, while wind power and nuclear are not doing so well. Here too is another example where GE's diversification pays off - it is not in the same corner as Areva with its high exposure to nuclear power.

Then there's aviation. Commercial aviation looks like it is setting up for a solid rebound in orders and revenue, and GE is making headway with competitive wins like the AMR (NYSE:AMR) order (which opted to go with engines from a GE joint venture instead of United Technologies (NYSE:UTX)) and the decision by Boeing (NYSE:BA) to re-engine the 737 platform with GE engines.

Healthcare, too, should not be forgotten. Big-ticket hospital capital equipment demand has not fully rebounded, but it is better than it was a year ago. Moreover, GE is investing in the R&D that it will take to stay competitive with companies like Hologic (Nasdaq:HOLX), while also looking into new growth opportunities like oncology diagnostics.

The Bottom Line
Investment advisors will often mistakenly claim that companies like GE are simply leveraged plays on global growth. The reality is that well-managed companies like GE, Illinois Tool Works (NYSE:ITW), and Siemens (NYSE:SI) often manage to grow better than many of their supposedly more nimble rivals. Superior R&D is part of how that happens, and GE does not seem to be stinting in that regard.

GE does not need to return to its prior average free cash flow margins to be a successful investment from here. GE does not look all that cheap by common ratios like P/E or EV/EBITDA, but that understates the extent to which earnings performance should start to improve. Provided that investors are not expecting Apple-like growth, GE looks to be a solid mix of potential capital gains and ongoing dividend growth. (These decision-making tools play an integral role in corporate finance and economic forecasting. To learn more, see Using Decision Trees In Finance.)

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