Sales down, earnings up
Of all the Dow stocks, General Electric’s results are among the most influential in terms of their impact on investor sentiment. The company’s operations span such a diverse range of industries that its performance serves as a proxy for the US economy as a whole. Although it is not a view shared by us, there is still a groundswell of opinion that considers a double-dip US recession as the most likely near term outcome.
As we foreshadowed ahead of the event, US Q2 earnings season would be significant with regards to either lending support to the double-dippers, or providing evidence that the recovery is still in place. The two key aspects of the results season in this regard are the extent of top line sales growth and the optimism or otherwise of managements’ outlook statements.
The market reacted negatively to General Electric’s second quarter result, primarily because of its weaker than expected sales figures. There were however a number of positives within the result. Not least of which was the fact that the company delivered its first quarterly earnings gain since 2007. Even so, GE was unfortunate to release its results at the same time that US consumer confidence fell to an eleven month low, which certainly contributed to the market’s negative initial opinion.
The number that did the damage for General Electric was the $37.4 billion of sales, which fell 4% from the same period last year. This was never going to be well-received in a market looking for sales growth, particularly given the accompanying fall in consumer sentiment.
Sales for the core industrial businesses shed 6% to $24.4 billion, while Financial Services revenue fell 2% to $13.1 billion. .
Management had previously flagged the likelihood of a decline in industrial revenues this year to the tune of 5-10%, simply based on the order book as at the end of 2009. Most of this has come through in the first half, with equipment revenues down 8% so far. The decline in Financial Services’ revenue is consistent with management’s strategy of reducing the size of this area of the group, after it wrought so much damage on General Electric through the GFC.
GE Capital
GE Capital’s revenue fell 3% to $12.3 billion, which was primarily a reflection of the division’s smaller asset base. The division’s assets were pared back 6% to $588 billion. It is encouraging to see that GE Capital benefited from a $500 million reduction in losses and impairments from the previous quarter. The consumer business was a significant contributor to the improved loan losses, which is a positive indicator for the broader recovery.
Less severe loan losses and the benefit of other cost reductions saw GE Capital improve its margins and deliver net income growth of 93% to $830 million.
An area of uncertainty for GE Capital is the impact of America’s financial regulation reforms. While the reforms are still in a state of flux, the impact does not at this stage appear likely to be particularly significant. Management will not have to divest GE Capital, while it is likely to meet its capital requirements without any significant deviation from management’s current earnings growth and asset reduction plan.
The overall outlook for GE Capital is positive, with margins likely to continue improving on the back of further cost and loan-loss reductions.
Industrial
Moving on to the industrial operations, The NBC Universal media division had a great quarter, with sales up 5% to $3.75 billion and operating earnings growing a healthy 13% to $607 million. Cable revenue, which accounts for about a third of the division’s sales, expanded 7% to $1.2 billion. This was driven by a strong performance across the various cable assets.
NBC Universal’s “America’s Got Talent” is leading the ratings, which should support continued advertising revenue growth. The division has also benefited from the return of Jay Leno.
At the core of General Electric’s industrial division is of course Technology Infrastructure and Energy Infrastructure. As we outlined above, this is where the company saw its sales revenue slip somewhat through the quarter. Technology Infrastructure’s sales fell 6% to $9 billion, while operating earnings came in 11% slimmer at $1.6 billion.
Technology Infrastructure is comprised of three sub-divisions; Aviation, Healthcare and Transportation. Aviation and Healthcare are by far the biggest contributors to the division’s sales and earnings.
Aviation’s sales declined 8% to $4.3 billion, which is essentially a result of the tough operating environment for commercial airlines, most of which are deferring major capital expenditure. The impact of Aviation’s sales decline on its operating earnings was less severe, with a 5% fall to $879 million.
Healthcare continues to provide a welcome defensive buffer for General Electric’s industrial operations. The sub-division contributed a 3% increase in its sales revenue to $4.1 billion. The benefits of last year’s restructuring efforts were clearly apparent, with Healthcare’s operating earnings gaining a whopping 12% to $661 million.
Energy Infrastructure also suffered from lower volume, which saw its sales fall 9% to $9.54 billion. Nevertheless, management was able to more than offset the sales weakness, to deliver a 3% gain in operating earnings to $1.91 billion.
From a valuation perspective, General Electric trades on an undemanding PE of around 13.4 times consensus 2010 earnings. This falls to 11.3 times consensus 2011 earnings, while the stock is expected to deliver a dividend yield of around 3% per annum.
General Electric will remain held in the Fat Prophets Portfolio.
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