Despite GE Capital Sale General Electric Management Remains Misguided by Ben Strubel of Strubel Investment Management
Just a few days ago General Electric announced they were going to sell off their entire financial arm (except for the portions related to their industrial businesses). GE stock shot up 10% on the news and as of this writing trades for around 18 times earnings.
With the financial arm sold GE will operate in 7 segments: Power & Water, Oil & Gas, Energy Management, Aviation, Healthcare, and Transportation, and Lighting (the appliances portion was sold to Electrolux last year).
Energy Management and Lighting make up less than 4% of General Electric’s profits and thus aren’t really worth talking about.
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The Aviation business, primarily manufacturing and servicing jet engines, is a great business and the crown jewel. There are few competitors and margins and returns on capital are high. Barriers to entry are enormous as designing and building a new jet engine requires billions of dollars in upfront costs as well as billions in losses (jet engines are typically sold at a loss) selling the engines until you finally make money from the service contracts on said engines.
Transportation is another good business unit with solid profit margins and high returns on assets. Diesel-electric locomotive sales and service make up 76% of the groups revenue. General Electric has about a 70% share of the locomotive market in the US. The downside is the business unit also has manufactures mining equipment and marine and stationary drilling equipment. The exposure to the volatile mining segment, especially in the midst of a mining bubble (predominately driven by Chinese demand and Wall Street speculation) is the only black mark on this otherwise great industrial business.
Healthcare is a nice business unit as well. In 2014 the Healthcare segment posted 16.6% profit margins and 10.4% return on assets.
Power & Water has the second highest returns on assets and third highest profit margin (for 2014). The business is attractive despite its cyclicality and high reliance on government entities to directly or indirectly fund the capital expenses needed for new power and water infrastructure projects. The business segment benefits from the neoliberal trend towards privatizing state infrastructure assets. Similar to the aviation business this segment generates significant profits from maintenance contracts on installed power generation units. General Electric recently acquired Alstom’s power business for $16.9B in an effort to expand its operations in this business segment.
Now we get to the Oil & Gas segment which GE has devoted billions of dollars to expanding. Out of the five major business units Oil & Gas has the lowest profit margins, 13.8%, and lowest return on assets, 14.55%. Not only that, the business is highly cyclical, with high oil prices spurring oil and gas companies to spend more on GE Oil & Gas services or alternately cutting back extensively when oil prices fall (such as now).
The table below shows the revenue, profit, profit margin, and ROA for each of General Electric’s industrial segments for FY2014 (in millions of dollars).
The problem with General Electric right now isn’t the financial arm, its management’s commitment to investing capital in the Oil & Gas business unit. Instead of focusing on its four high margin, high return business units GE is inexplicably focusing on growing its worst unit.
Until General Electric ends its obsession with destroying shareholder capital in a low return business we believe GE does not present an attractive investment.