General Electric (NYSE:GE) hasn't been looking all that "GE-like" in recent quarters, and investors have reacted badly to soft margins and disappointments in the Industrial business, as well as uncertainty with regard to the future of GE Capital. I wouldn't go so far as to say that one clean quarter proves that things are back to normal, but a generally surprise-free second quarter at least allows investors a chance to appreciate GE for the virtues it does have. GE shares aren't a major bargain today, and the expectations for Industrial are still pretty high, but I think owning GE is still likely a money-making proposition from these levels.
A Calming Quarter From GE
Volatile margins and big quarter-to-quarter swings in the Industrial line items have made holding GE shares through earnings reports a little more interesting than the typical GE investor probably likes. With that, I think there will be more than a few sighs of relief for this second quarter report.
Overall corporate revenue fell about 4% for the quarter, a bit below estimates (about 1%) but not enough to really cause concern. Industrial revenue was down about 1% and basically in line with expectations, while revenue from GE Capital was down more than 4% with widespread weakness across the segments (with leasing down almost 6%, aviation down almost 3%, and consumer down more than 2%).
Margins were pretty good, though, and that may be the big positive take-away for the quarter. Overall corporate operating earnings were down 12%, with segment earnings growth of 2% for industrial and 9% contraction for GE Capital. Industrial margins were better than expected, up about a half point and higher than the flat-to-down expectations, and aviation and transportation margins were significantly improved.
GE Isn't Alone
It's probably lucky for GE shareholders that the company reported good (or at least better than expected) results from the industrial business, as many of the company's peers are coming in with solid reports. Dover (NYSE:DOV) had very good organic growth this quarter, and the two companies saw broadly similar success in their energy businesses. That should bode well for other companies like Pentair (NYSE:PNR) with exposure to this end market.
Aviation was also strong (revenue up 9%, margins up about a point) and better than the results from Honeywell (NYSE:HON), though that's not an entirely fair peer-to-peer comparison. Nevertheless, Honeywell also had a pretty good all-around quarter and I would expect United Technology (NYSE:UTX) to be in relatively solid shape with its quarter.
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GE is also unlikely to be unusual with its weak (down 0.2%) results in healthcare. There haven't been too many hospital/healthcare capex vendors to report yet, but Stryker (NYSE:SYK) suggested that the market for big-ticket items is still tough, and that seems to gel with GE's experience.
What's Next For GE Capital?
I believe investors are still waiting to hear more clarity from management on the future plans for GE Capital. In particular, attention is centering on the plans for the company's private label credit card business – a surprisingly large business relative to the likes of Capital One (NYSE:COF) and Wells Fargo (NYSE:WFC). With a stated preference to focus more on middle-market activities and leasing, a sale of this business could bring in a considerable sum, but it will be interesting to see who comes up with the cash to buy it.
The Bottom Line
I continue to value GE on a two-part basis, treating the industrial and capital operations as separate entities. I value Industrial on the basis of expectations for 5% revenue and 10% free cash flow growth, which are perhaps bullish estimates but not outrageously so. On that basis, GE Industrial appears to be worth about $19 per share. I value GE Capital on the basis of a 10% long-term return on equity and a slightly elevated discount rate, which results in a value of $7.25.
Combined, I believe fair value on GE shares is just under $26.50. That doesn't make GE a striking bargain today, but there actually aren't many bargain-priced industrial stocks out there anymore and I believe the combination of GE's attractive end-markets exposure, capital flexibility, and potential outperformance from GE Capital make it no worse than a worthwhile hold at today's price.
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