John Flannery's nine-month tenure as CEO of General Electric (GE) has been a constant exercise in bar-lowering, but the company finally exceeded those diminished expectations Friday with first-quarter earnings that beat analyst projections. But three things I saw in GE's earning release beyond the headline numbers indicate a longer-term turnaround at the ailing industrial giant.
Let's check them out:
Positive Sign No. 1: Services Revenues Exceed Equipment Sales
GE now derives more revenues from services than equipment sales, as this chart shows:
That's good news because services sales generally offer higher margins, lower capital intensity and, of course, more repeat business than equipment sales do.
This transition has been years in the making, but comes with the caveat that GE's equipment sales have been disappointing -- especially in the power division. That makes the services side of the company look bigger on a relative basis.
Still, GE should be less susceptible to whipsaws in performance on a quarter-by-quarter basis as its services business grows as a percentage of the total. That's great, because GE's volatile financial performance has been a main contributor to the stock's lagging fortunes.
Positive Sign No. 2: Less Reliance on North America
North America continues to represent a smaller and smaller portion of GE's total revenues.
As with the move to services, this has been a gradual transition, but GE's first-quarter numbers provide evidence of progress -- along with signs of growth in the key market of Asia:
Non-U.S. economies -- especially Asia -- are growing in terms of population and per capita income. So, major multinationals like GE must position themselves to capture growth in places like China, India, etc.
It seems like that wasn't a priority for former General Electric CEO Jeff Immelt. But hopefully, Flannery will put Asian growth on the front-burner for each of GE's verticals, continuing to expand business in places where the world economy is also expanding.
Positive Sign No. 3: GE Bonds Are Still Investment Grade
General Electric's bond prices rose Friday on the company's earnings release, highlighting the fact that GE's cost of capital is still extremely low.
After all, it's worth noting that for all of the scrutiny that GE's financial performance receives, ratings agencies still view the industrial giant as an investment-grade company. Moody's rates GE debt at "A2" with a stable outlook, while Standard & Poor's lists it as "A," also with a stable outlook.
Such relatively strong ratings allowed General Electric to issue some $9.8 billion of senior unsecured debt in 2017's second quarter at rates between 0.375% and 2.125%. And Baker Hughes (BHGE) -- which General Electric owns 62.5% of -- sold some $4 billion of senior unsecured debt during the fourth quarter for 2.773% to 4.08% despite operating in the notoriously volatile oil-services industry.
All told, GE issued $12.5 billion of debt last year in what was clearly an opportunistic strategy to lock in low interest levels before the Federal Reserve aggressively started raising U.S. short-term rates. As a result, GE Industrial has $62.7 billion in senior notes outstanding at a relatively modest 3.15% average rate, while GE Capital has another $40.8 billion outstanding at 3.11%.
The Bottom Line
I predicted on Thursday that GE shares would hit $15 on Friday following the earnings report and they did (albeit briefly). It certainly helped that GE reiterated guidance of $1.00-$1.07 for 2018 EPS, although I believe that has more to do with financial engineering and accounting legerdemain than actual operational improvements.
Still, the three positives above are all longer-term positive trends. To me, they show that the company founded by Thomas Edison in 1892 finally has some upside potential after 2016 and 2017's dark periods.