By Ben Levisohn
Shares of General Electric (GE) fell 0.6% on Friday, despite what would seem to be good earnings news. Morgan Stanley’s Nigel Coe and team explain why:
Without a shadow of doubt, the number one question on our desk following General Electric’s earnings was why the stock was so weak following headline EPS that matched consensus estimates at 39c – in an earnings season where this has not been a given – with industrial estimates modestly ahead of consensus forecasts on 5% organic growth and 20bps OM expansion. Moreover, General Electric confirmed a major step on the path towards its industrial mix-up goal.
Here are the reasons why the stock had heavy legs, in our view: 1) equipment orders fell 3% with flat to down outcomes across the board, ex-Transportation (on US freight strength). General Electric referenced some project push-outs in wind and subsea that are likely to pull through during 2H 2) cash conversion was very weak due to a decline in customer deposits, related to order weakness, and w/cap build. General Electric maintained its outlook for $14-17bn CFOA; 3) GECC net income matched at $1.85bn ex-preferred, but the underlying quality was weaker on 2-3c tax benefit; 4) A creeping realization that 3Qe of 42c may need to come down in light of normal season flat/down profile vs. 2Q.
JPMorgan’s C. Stephen Tusa and Rajat Gupta are feeling good about their bearish thesis on General Electric:
We come away from the General Electric quarter with reinforced confidence in our thesis. On operations, despite ok margin performance, we think the annual targets are a stretch and mix is a major headwind that is structural, and unlikely to get better, while cost inflation, most notably in corporate, remains a key drag, and a normal cost of doing business that will likely mitigate most above-the-line operating gains from dropping through to EPS. Both items played out in 2Q and should persist in 2H, and the net of it all is another cut to our already below consensus numbers to now show an earnings decline in ’14, the only company in the group to do so, while our estimates in the out years remain materially below consensus. Meanwhile, negative free cash flow and cash to fund Alstom highlights the lack of optionality here, and the end of near term buybacks brings numbers even lower, while the dividend payout ratio on free cash flow remains high. With plenty of portfolio churn providing lots to talk about, the degree of quality improvement (ie – deserved multiple expansion) is debatable, and one way to look at the refreshed SOTP suggests the recent moves don’t help as big ticket power gen valuations remain depressed. Either way, lower numbers, with no change in quality means we see the stock as fairly valued – we remain on the sidelines.
Shares of General Electric have dropped 1.8% to $25.99 at 11:43 a.m. today.