Since 2012, General Electric (GE), a heavy equipment and financing giant, has sought to refocus its operations on its core business of heavy industries and away from its reliance on financial services. GE CEO Jeff Immelt aims to reorganize the company so that more than 70% of its earnings will be derived from the industrial side of the business.
Such a shift will position the company well for growth — and it makes GE stock more attractive to investors.
Immelt has solidified a deal to buy Alstom’s electrical generation business for $17 billion in June of this year, has spun off a large piece of its consumer finance unit, now named Synchrony Financial (SYF), and is looking to possibly sell its appliance business to Electrolux (ELUXF).
General Electric plans to have its portfolio of businesses be No. 1 or No. 2 in their respective marketplaces. In its continuing efforts to shed underperforming or lower-margin businesses, GE’s acquisition of Alstom makes it clear that energy infrastructure is where the company wants to head in the future.
General Electric has made a business of doing acquisitions and divestures; many business school case studies have been modeled after GE’s formula for successful transactions. A key tenet to its success is General Electric’s ability to combine businesses that have strong synergies and provide information-sharing and cross-selling opportunities among portfolio business units.
General Electric’s ability to leverage its significant balance sheet allows it to enter into high-growth, capital-intensive businesses — such as energy infrastructure — to reap economic profits. Post-acquisition, General Electric is known for a relentless push to improve operating efficiency that drives a high return on invested capital.
GE: Free Cash Flow and Profitability Not What They Used to Be
General Electric’s free cash flow as a percentaage of sales is down from nearly 18% in 2008 to under 10% on a trailing twelve-month (TTM) basis. Its net margins have declined from 9.5% to about 8.8% over the same time period. The lower margins and related cash flow have been reflected in GE’s return on invested capital, which has hovered between 4.5% and 4.7% since its high in 2008 of 6.7%. The cause of this decline is no doubt macroeconomic as result of the recession. Although down from recent history, General Electric has been able to hold profitability relatively steady; the numbers have not continued to deteriorate. GE’s new focus is no doubt a push to get margins back to pre-recession levels and return General Electric to its previous profitability.
GE: Will Benefit From a Recovering Global Economy
As the world has changed, so has General Electric’s portfolio of businesses. General Electric has significant holdings in clean energy, gas and wind turbine technologies in addition to its more traditional gas turbines and steam generation businesses. Although it still owns 85% of Synchrony Financial, going forward its in-house credit business should stay focused on middle-market commercial and industrial loans, equipment leasing, and aircraft leasing.
With its greater focus on energy infrastructure and heavy industry, General Electric is well positioned to supply critical infrastructure for global economic development. As global growth continues to accelerate, credit markets improve and global demand increases the world will need more power, jet engines, trains and other heavy equipment to get goods and people to where they need to be. The risk of continued unrest in Eastern Europe and the Middle East pose a headwind against this growth and should be considered before investing.
Over the past year, GE’s stock price has returned slightly less than the Dow Jones Industrial Average (.DJI), returning 12.5% to the Dow’s 15%. General Electric should see some margin benefits with its new focus on industrial operations and continued cost cutting which should also be reflected in future EPS growth. In addition to potential earnings growth its current 3.3% dividend yield makes it an attractive hold for many investors.
As of this writing, Kenneth Fick did not hold a position in any of the aforementioned securities. Email him at kfick@piercethefog.com or follow him at www.piercethefog.com.
