Summary
- GE's share price has thoroughly outperformed the market this year.
- The recent advance has led me to review my initial bullish thesis on GE.
- Upon thorough review of GE Capital strategy and the recent earnings release, I am selling my shares as detailed below.
General Electric (NYSE:GE) recently announced widespread changes that will allow it to return to its industrial roots. The move is predicated on the timely disposition of the bulk of GE Capital, a feat that will take a few years to undertake. The article below will detail my decision to exit shares of GE.
Share repurchases is the key to the GE story going forward
By selling off the various parts of its capital arm, GE will have a substantial hole in its earnings that will need to be overcome for the shares to continue to rise. GE Capital is expected to provide 60 cents of the parent's expected yearly earnings range of $1.70-$1.80 per share. The earnings of the finance division account for at least a third of GE's overall earnings power; the growth of the underlying industrial groups will not make up for the earnings shortfall by itself.
To smooth over the earnings loss, GE expects to embark on an aggressive share repurchase plan to shrink the outstanding share count from over 10 billion shares to a more reasonable 8-8.5 billion shares outstanding. GE's earnings goal for 2018, when the various moving parts are in place, is for earnings to come in at 2015's range. In 2018, the earnings power of the much smaller GE Capital is expected to contribute 18 cents per share in earnings. If we use the top end of GE's expected earnings range of $1.20 for the industrial division, profits will need to grow 26.7% or roughly 8.5% CAGR (compound annual growth rate). If we use the less optimistic scenario, the numbers become a bit more daunting. Using the low end of the industrial's earnings range of $1.1, growth will need to compound at a bit over 11% annually.
Earnings Conference Call
The following quote can be attributed to Jeffrey Immelt the current CEO of GE. The quote was taken from today's conference call transcript that can be viewed here.
Our businesses executed well in the quarter. Organic revenue growth was up 3%. Geographic growth is balanced. The US was up 2% and growth markets were up 6%. We saw strength in China up 6%, Middle East, up 19%, Africa up 11% and Latin America up 13%.
From a business standpoint, we had organic growth in six or seven segments, and we have forecast organic growth of up 2% to 5% and remain on track for that. Margins continue to be a good story with growth of a 120 basis points. We have targeted 50 basis points of gross margin expansion for the year and we hit 90 basis points in the first quarter.
The industrials remain mired in a bit of a slowdown. Fastenal (NASDAQ:FAST) in its recent earnings report continues to see soft demand from manufacturers as demand is not as robust as expected. A large portion of the lack of demand is the pullback in the energy sector that continues to reverberate through the economy. I admire the team at FAST; they run a good show and have their finger on the pulse of their customer base. I am using FAST as an early tell as to how the industrial sector is progressing. FAST reports monthly sales that should serve as an excellent guide going forward.
The second piece of info revolves around the recent earnings announcement by Precision Castparts (NYSE:PCP).
PCP today announced that following a review of its oil & gas and power pipe end markets and inventories, the Company will recognize fiscal fourth quarter 2015 charges for actions taken to rationalize certain assets and restructure operations. The Company saw continued demand deterioration in its oil & gas and power pipe markets through the fourth quarter of fiscal 2015 and is taking aggressive action to improve its cost and capacity position, including the exit of non-essential investments.
"While we continue to experience momentum in roughly three-quarters of our business represented by aerospace and industrial gas turbine, the uncertainty in our oil & gas and power pipe end markets is driving PCC to take aggressive action to align our cost structure with incoming order levels," said Mark Donegan, chairman and chief executive officer of Precision Castparts Corp. "We have developed strong capabilities in the oil & gas and power pipe markets; however, near-term demand trends remain uncertain.
PCP is extremely well run by Mark Donegan, a former GE employee. PCP's stock performance over the past ten years was quite stellar with earnings growing at a 20% clip per annum over this time frame. PCP generates 18% of its revenue from servicing the energy sector as shown in this link. Interestingly, Alstom and GE Capital are two of PCP's largest customers. GE is very much exposed to this trend with a higher concentration of business in the energy sector. I suspect GE will be quite challenged over the coming 18 months to hit its earnings target.
Selling my shares
I have decided to reduce my exposure here and sold my shares of GE. I made my bullish call on the shares of GE in January with the expectation the shares would trade at $28 by year end. The shares briefly traded above $28, yet quickly met a stiff wave of selling. In light of GE's challenges detailed above, I believe it is prudent to exit with my shares being sold off at $27.30 per share. The trade netted a 12.7% gain for a roughly three-month holding period that is more than acceptable.
At this time, I expect to keep the proceeds in cash and wait for an opportunity to present itself. Earnings season has just begun, which invariably leads to someone panicking over short-term performance. I am quite confident a bargain will appear once again, similar to my recent purchase of Union Pacific (NYSE:UNP) and Phillip Morris (NYSE:PM) as detailed here and here. Ideally, I would favor a wide moat company where the shares could be held over a long period, yet I am not opposed to making a trade such as GE. I would like to thank you for reading, and I look forward to your comments.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation
Seeking Alpha PRO helps fund managers:
- Research new investment ideas
- Reduce risk
Thank you for your interest in Seeking Alpha PRO
We look forward to contacting you shortly for a conversation.
Our PRO subscription service was created for fund managers, and the cost of the product is
prohibitive for most individual investors.
PRO Alerts is our flagship product for individual investors who want to be faster
and smarter about their stocks. To learn more about it, click here.
If you are an investment professional with over $1M AUM and received this message
in error, click here and you will be contacted shortly.
Thank you for your interest in Seeking Alpha PRO
We look forward to contacting you when we have an individual investor product ready!
0 comments:
Post a Comment