We maintain a Neutral rating on General Electric Company (GE), since the shares appear to be fairly valued. While the 10.8 multiple to our earnings estimate for 2011 represents a 37% discount to the peer group, we believe the valuation is justified by GE’s weaker earnings power.
The energy business is expected to drive long-term growth for General Electric, as global demand for alternative energy production will continue to increase. The company had an order growth of 15% in the last reported quarter, primarily driven by demand for energy equipment.
Aviation is another bright spot, with the rebound in commercial air traffic driving demand for GE’s new age jet engines. The jet engines are in high demand among the leading aircraft manufacturers, particularly Boeing (BA). However, the Industrial business and GE Capital’s loan defaults, especially in the commercial real estate area remain a drag on the company’s profits.
Third Quarter Highlights
In the last reported quarter, the company reported modest results, with year-over-year earnings growth of 17%, decline in loan losses for GE Capital and overall order growth of 24%. However, both the top line and margins were under pressure.
Total revenue for the quarter declined 4% year-over-year to $35.6 billion, primarily due to the sale of a majority stake in its NBC Universal business to Comcast Corp. (CMCSA). However, excluding this impact, revenue grew 7% year over year. Revenues were above the Zacks Consensus Estimate of $34.6 million.
Total orders in the quarter increased by 24% year over year, with the total backlog reaching a record level of $189 billion. Equipment orders increased a robust 33% and services orders were up 16%.
The company reported earnings of 34 cents a share, which was above the Zacks Consensus Estimate of 32 cents and up 17% year over year. This was the fifth consecutive quarter in which the company witnessed double-digit growth in earnings. Profits were primarily driven by strong demand internationally for heavy equipment including jet engines and electric turbines.
Margins during the quarter declined due to the pricing pressure in the renewable energy sector. In addition, margins were also impacted by the integration of Energy acquisitions.
During the third quarter, the company increased its R&D investment by 40% compared to the prior year in order to drive strong organic revenue growth and future margin expansion.
Agreement of Analysts
In the last 30 days there was no upward revision in the fourth quarter estimates while 4 of the 12 analysts covering the stock lowered their fourth estimates.
For fiscal 2011 also, only one analyst gave an upside revision to the estimates while four lowered their estimates in the last 30 days.
We believe that such negative sentiments are the result of growing concerns among the analysts about GE Capital’s (33% of the company’s total revenue in fiscal 2010) portfolio and its exposure to the commercial real estate market. This is because the rising defaults on consumer loans, tighter credit markets and declines in real estate values have already impacted the business in fiscal 2010, and therefore may be expected to remain headwinds for GE Capital’s business at least until the first half of fiscal 2012.
The other factor concerning us is the company’s long-cycle industrial business. The analysts believe that the Industrial business division of GE is not performing at par with its peers.
During the latest reported quarter, the Industrial division grew profit by just 1% compared to high single-digit growth at competitors, such as United Technologies (UTX). The Hamilton Sundstrand segment of UTX, which deals in the Industrial business, posted a profit growth of approximately 8% in its third quarter. However, moving forward, the analysts believe that GE’s Industrial business should benefit from growth in emerging markets.
Magnitude of Estimate Revisions
The last 7 days saw no change in the Zacks Consensus Estimate for the upcoming fourth quarter, which remained at 39 cents. The Zacks Consensus Estimate for the first quarter of 2012 also remains unchanged at 35 cents a share.
The Zacks Consensus Estimate for fiscal 2011 and 2012 also remained unchanged in the last 7 days.
GE’s third quarter earnings were in line with the Zacks Estimate, although the surprise percentage over the last four quarters indicates a positive trend. Despite the few downward revisions, the Zacks Consensus Estimates for the upcoming periods remains unchanged, indicating that analysts have confidence in their projections. It is therefore likely that the company will have an in-line fourth quarter.
Although GE’s Industrial business and GE Capital’s loan defaults remain a drag on the company’s performance through fiscal 2011, we believe GE is geared up for a profitable fiscal 2012.
There has been much speculation about a “new golden age for gas power” (“gas bubble”) driven by environmental legislation, cheap shale/unconventional gas, Fukushima, wind power adoption and relatively low capital costs.
Further, the company also sees good growth potential in the Energy sector, as GE Energy supplies the most competent and dependable wind turbine fleet in the world, with average utilization reliability of 98.5%.
The company currently holds a Zacks #3 Rank of #3 which indicates a short term (1-3 months) Hold rating.
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