GE Q1 2016

The good news is that, aided by Alstom acquisition, while GE’s Q116 revenue of $27.85 billion barely met the estimate, earnings per share $0.21, beating the estimate of $0.19.  The good news is that, aided by the GE Capital (Capital) divestiture, the free cash flow increased by $7 billion.  GE was able to return $6.1 billion to shareholders through stock buybacks, and $2.2 billion through cash dividends.

The good news is that, aside from the financial business, the industrial division did well with earnings of $0.16, a 14% increase year on year. GE’s backlog also grew, again with the help of Alstom, by $1 billion sequentially, and $48 billion year on year (18% increase).  It is more impressive, though, that the current backlog amounts to three years’ worth of revenues.  This would suggest predictable short-term revenues and cash flows.

GE beat its revenue estimates only once in last eight quarters. In contrast, GE did beat its earnings estimates recently more often by consolidating its operations and controlling expenses.  After its Alstom acquisition, GE announced in January that it plans to lay off more than 6500 employees in Europe to save administrative costs.  Due to the decline in oil & gas equipment segment, similar layoffs were announced at its equipment facilities.  That being said, GE’s EBITA margin, 14%, has been lower than the industrial peers’ 22% (such as 3M, Honeywell, and Illinois Tool Works) for 16 consecutive quarters.  The return on invested capital is 3% below the peers’.

Admit or not, this is it!  The Alstom acquisition added 8% GE revenue growth for Q1, 11% increase in backlog, $0.05 EPS for 2016. The next biggest potential deal in sight is the purchase of some or all of Baker Hughes, a $20 billion oil & gas equipment company.   The deal may prove to be too little too late. But, the fact that GE starts sniffing around for fire sales in the same sector which has severely bruised the company is encouraging.

The other piece of the puzzle is that there was only one GE Capital for sale.  It may have been debatable if GE made the right decision to return to the industrial platform by selling its financial section.  But just like Bank of America finally got over “Countrywide,” what GE has done to Capital has done.  To be fair, the execution of the sale has been better than expected.  The $166 billion apparently good-quality Capital’s assets have already been divested ahead of the $200 billion 2016 year end target.

Second, the cash dividend from the Capital sales has funded the $6.1 billion stock buyback in Q1, which turned out to be the only short-term driver for GE’s valuation now.   GE recent years’ declines in revenues and earnings were exacerbated by the announcement Capital’s divestiture one year ago.  The cash dividend from Capital is expected to be smaller for the remainder of 2016 for $10.5 billion.  It is unrealistic to assume that GE will be able to keep the same aggressive pace of stock buybacks and cash dividends.

Eventually, the real issue shareholders will have to face is that Capital used to contribute more than 40% of GE’s bottom line profit.  After 2016, what would GE do?

A more subtle but important issue is that there is some evidence the shareholders may have finally caught on the modern corporate gaming to inflate fundamentals through acquisitions, stock buybacks, and cash dividends.  GE Q1’s seemingly positive Q1 reported result was not met with stockholders’ applause.  As a result, some may argue that GE is wasting money on cash returns.  We can only surmise that the reason Immelt and his crew devising the big turnaround plan to divest the financial division is to return GE to the industrial and manufacturing powerhouse once it was known for.  In other words, if GE growth story is simply built around oil & gas acquisitions, buybacks and cash dividends, we should look for more convincing catalysts for future sustainable growth.

Or should we?

GE has been long considered the poster child of defensive stocks.  Should we look for a Netflix, Facebook-like growth story in GE, especially during a slow growth economy?  Or, should GE investors be totally content with a 3% dividend yield plus another 2% stock buyback return, especially in a zero interest rate environment?  All in all, GE investors have received around 95% total return over the last three years, compared with its industrial peer’s 120% (Honeywell and 3M).

If GE short-term investors insist in finding some growth catalysts, the oil & gas market recovery should be the deal breaker.  However, long-term investors should rely on the prospect of its industrial segments that all start showing encouraging revenue numbers.  Backlog is growing, and the Power, Renewable Energy, Aviation and Healthcare are the bright spots.  Specifically, the Aviation segment reported double digit increases for both revenue and profit, a top performer for the last few quarters.

Furthermore, what GE has that other large firms don’t have is their loyal shareholder.  You would never want to criticize Jeff Immelt with GE’s shareholders, just like you don’t pick on Warren Buffett with Berkshire’s.  As a tradition, GE shareholders have given the management all the benefit of all doubts.  Today’s GE stock valued at 20 times current earnings, 24 times trailing earnings, 18 times forward earnings, is roughly in line with the general market.  But, where can you find a 5% cash return nowadays from the general market?


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