What the Market Got Wrong on GE's Earnings
Oct 20th 2012 2:30PM
Updated Oct 20th 2012 2:32PM
General Electric (NYS: GE) reported earnings on Friday, and a layman would have thought the results were pretty strong. In a challenging business environment, GE managed to grow revenue 3%, while strong gains in operational efficiency allowed the company to streamline costs and grow earnings by 10%. GE also appears ahead of schedule in its long-term strategy to shift focus away from financial services, committing instead to global leadership in energy infrastructure.
The result? Shares of GE fell 3.4% on Friday. What gives?
Some analysts have blamed the poor showing for management's "cautious" tone over 2013. What CEO Jeff Immelt actually said was that between strength in Asia, weakness in Europe, and pockets of growth in North America, 2013 would look a lot like 2012. So far in 2012, GE has seen its stock price rise 23%, outperforming the S&P 500 by 10 percentage points, all while paying out a 3%-plus dividend and buying back $3 billion in shares. A repeat performance in 2013 doesn't seem like a reason to sell to this GE shareholder.
General Electric did deliver revenue slightly lower than Wall Street analysts' expectations, bringing in $36.35 billion rather than the $36.94 billion consensus estimate. GE noted that a stronger dollar compared with the third quarter in 2011 caused a loss, and without foreign exchange fluctuations the company would have recorded an additional $1.1 billion in revenue.
A capital idea
As far as GE's actual results, sellers seemed focused on two things during trading on Friday: GE Capital's smaller revenue footprint, and lower sales of wind turbines. GE Capital, which contributes about a third of revenue and an even greater share of income, reported a 5% drop in revenue Friday on the back of a 6% contraction in the size of its assets, or ending net investment. But far from being an ill omen, this is a sign that the company is executing well. Since GE Capital's bloated loan portfolio forced GE to issue new shares and take on debt during the recession to survive, the company has purposefully set out to shrink the unit, creating a more profitable and more manageable GE Capital that won't blow holes in the balance sheet again.
I wrote on Thursday that "another quarter of a smaller but more profitable GE Capital would be a good indicator that General Electric's strategy ... is working," and that's exactly what we saw. Despite the 5% cut to revenue and 6% drop in assets, the unit's net income actually rose 11%. I applaud GE's determination to rein in GE Capital. If I wanted to invest in a bank, I have plenty of opportunities to do so, but I believe GE's real strength is its world-class array of energy and transportation products, positioning it squarely in the center of a richer, greener, more productive world.
Blowin' in the wind
GE's line of energy infrastructure equipment brings us to the second item of concern -- wind turbines. The Energy Infrastructure segment is GE's largest revenue driver -- so large, in fact, that next quarter's results will be broken down into Power and Water, Oil and Gas, and Energy Management. In the third quarter, orders for the Energy Infrastructure segment were down 17% because of the impact of abysmal sales of wind turbines.
An American tax credit for wind turbine buyers makes wind energy competitive, and while both parties have periodically renewed this credit, current partisan bickering leaves its future in doubt after it expires Dec. 31. Accordingly, GE's renewable-energy orders were down 72%. If the credit isn't renewed, GE doubts that any wind turbines will be sold in the United States in the near future.
Investors should keep in mind, however, that despite this disastrous decline in wind sales, CFO Keith Sherin affirmed that GE was on track to hit its goal of double-digit profit growth for 2012. This speaks to the age-old wisdom that diversification is the only free lunch. Weak wind sales are being more than offset by the rapid adoption of GE's locomotive offerings, high volumes in its Power Generation business, and the strength of its young Oil and Gas division. Oil and Gas is a particularly instructive tale, because General Electric was criticized for making big investments in the field in a time when natural gas prices were scraping the bottom. Yet GE had the foresight to realize it was entering a profitable business near the bottom of a cycle, not simply throwing good money after bad in a dying industry, showing that General Electric's legendary reputation for cultivating managers into disciplined capital allocators remains intact.
Of course, General Electric's diverse product portfolio doesn't just shelter the company from risks in any one industry; it also makes it more difficult for investors to see exactly what business the company is in and where it makes its money. To help, we're offering comprehensive coverage for investors in a premium report on General Electric, in which our industrials analyst breaks down GE's multiple businesses. You'll find reasons to buy or sell GE, and you'll receive continuing updates as major events unfold during the year. To get started, click here now.
The article What the Market Got Wrong on GE's Earnings originally appeared on Fool.com.Fool contributor Daniel Ferry and The Motley Fool own shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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