GE's Double Digit Profit Growth Expectations Backed by Strong Divisions

By Maxwell Fisher - July 30, 2012 | Tickers: GE, JNJ, MRK, UTX | 0 Comments

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General Electric (NYSE: GE) is among the world's largest companies, and the largest industrial conglomerate in this country by a wide margin. As such, it is something of a barometer of the industrial economy. It recently posted second quarter earnings, generally in line with analysts' expectations. GE earnings have become quite predictable, which is hardly a bad thing. It reported GAAP earnings of $3.7 billion, or $0.34 per share in the quarter, a 2.6% advance from the year before. It reported operating BBTH (before bad things happen) earnings of $4 billion, or $0.38 per share, or a penny above analysts' expectations for the quarter. Revenues came to $36.5 billion in the quarter, two percent ahead of last year's second quarter. This was despite a strong dollar versus the euro, which drove revenues down by $0.9 billion, along with continuing intentional shrinkage at GE Capital. To best understand GE, it is best to examine it one division at a time. Each of these divisions would typically be a large capitalization company if independent. 

GE Capital once was the largest division of GE overall and historically pays its parent dividends equal to 40% to 50% of GE Capital earnings. In 2007, that dividend payment equaled $8.6 billion, as GE Capital was a leading mortgage bank, consumer bank, and investment bank in addition to providing lending services to General Electric customers. Then, as the financial industry collapsed, GE Capital suffered enormous loan losses, dragging the entire company down. In response, GE worked to reign in its capital arm, selling various divisions. It is no longer the company's largest division, as it has ceded that title to GE's energy arm. But it is still a substantial finance company, and was allowed by the FDIC this year to pay a dividend to its parent for the first time since 2008, in the amount of a cool $4.5 billion, plus quarterly payments going forward of $475 million. 

If it were an independent bank, GE Capital would be this country's fifth largest by assets, with $559 billion as of June 30, 2012, down from about $585 billion a year earlier. Its profit came to $2.12 billion in the second quarter, up 31% from the same quarter of 2011. The $2.12 billion profit amounts to an annualized 1.51% return on assets. This division is set up to earn $8 billion both this year and next, and pay dividends of cash approaching $2 billion or more annually. What a nice division to own, now that much of the risk has been greatly reduced from the division. 

As nice an accessory business as GE Capital is, GE is an industrial and not a financial company. Its energy and infrastructure division has become its largest, and the principal driver of company growth.  It has doubled down on green energy. There is uncertainty in that sector due to tax and political issues worldwide. Yet, I am confident that whether it is three years, ten years, thirty years or more, the United States and the rest of the world will move toward getting the majority of their energy from non-fossil fuel sources, and GE is well set up in solar and, especially, wind energy markets. The energy unit sold $44 billion in product last year, and is aiming at $100 billion by the end of this decade. I am not about to question that goal under the leadership of energy and infrastructure division chief John Krenicki. 

GE's energy unit recently announced a modest restructuring, in which it will be divided into three divisions, all of which will report to the CEO's office. This move is supposed to save some $250 million in annual costs. 

The wind turbine division is the only domestic manufacturer among the world's top 10, and, with the backing of its parent, should have greater ability to weather political storms than industry leader Vestas (VWSYF), which has announced a series of layoffs and plant closings. This is reason number two why I like GE's long term future.

In aviation, GE is taking advantage of new, more fuel efficient technologies to create jet engines going on many of the newest aircraft around the world such as the new Boeing 900 extended range and the Boeing Dreamliner. Airlines are in a more profitable mode, especially with fuel costs having retreated, and are in a position to take advantage of more modern and efficient planes and engines. European uncertainty and currency issues limited 2^nd quarter aviation revenues to a 3% year over year gain in the second quarter of $4.85 billion, but the opportunities within the industry are compelling. I like the opportunity for growth, more than for Pratt and Whitney, a division of United Technologies (NYSE: UTX). Pratt and Whitney sold about 20% less in dollar volume of jet engines last year than did GE, and the GE name is much better known and respected in developing countries. I like United Technologies as a company very much, but primarily for its Carrier HVAC, Otis Elevator, and other divisions. The company recently raised its dividend 11%, and pays a yield of 2.9%. I think of this as a fine holding for conservative investors.

GE's health care division posted $4.5 billion in sales, essentially the same as the second quarter of 2011. GE is known for big ticket, sophisticated medical equipment, such as magnetic resonance imaging systems. But it sells scores of different machines, and has a pharmaceutical division as well. There are many manufacturers of similar equipment, and I doubt the pharmaceutical division will ever become a Merck (NYSE: MRK) or Johnson & Johnson (NYSE: JNJ), because it does not need to be. One advantage of being a conglomerate is that no one division needs to “hit” on all possible cylinders. Merck is expected to report its second quarter earnings very soon. Meanwhile, Johnson & Johnson had revenues of $16.48 billion in the second quarter. 

The other two divisions, transportation and home and business solutions, are combined not as large as any of the aforementioned divisions. I like the fact that GE's locomotive orders increased nearly one third from the second quarter of last year to 176 units, helping to drive transportation revenues up 27% over the year earlier amount, to $1.56 billion. A slow new housing market limited appliance sales, and revenue in that division only increased 2% to $2.2 billion. 

So we have a widely diversified company with every division, large and small, contributing. For that reason, GE management repeated its confidence that it will earn double digit profit growth for the year. GE has a five year PEG of 1.02, a dividend yield of 3.4%, and an impeccable balance sheet. I know of no better situation for a buy and hold type company than General Electric. 

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