GE Exceeds Our Expectations

 General Electric (GE) delivered strong earnings in the second quarter, exceeding our expectations on the back of better-than-expected performance out of GE Capital but offset by weakness in GE Energy. We are maintaining our fair value estimate share and our long-term thesis remains intact.

While we are encouraged by GE's strong performance, 17% organic order growth in the quarter across the industrial businesses gives us confidence that GE is at the front end of strong growth in its end markets. Renewable energy has been particularly unkind to earnings during the last several quarters as volumes declined materially and pricing evaporated, leaving all firms in the wind and solar supply chain financially weaker. Management noted that renewable markets likely have bottomed, with strong order growth, albeit at lower margins than the last cycle, underscoring the market reversal.

We consider  Boeing's (BA) decision to designate GE's joint venture company CFM as the sole engine manufacturer on its newly re-engined 737 as a major victory for GE and its Leap-X engine. The emergence of old rival Pratt & Whitney in commercial engines gave us pause, since it is never good to see a new competitor enter a wide-moat industry. GE's strong showing at the Paris Air Show in June as well as its winning the Boeing platform reassures us that this business still has solid long-term fundamentals and the industry can support the three major engine suppliers.

GE Capital delivered another strong quarter, earning $1.8 billion ($0.17 per share). Management noted that noncore red assets continue to roll out of the portfolio, helping reduce both the aggregate size of the portfolio and the unwanted exposure to those end markets. Our primary concern for GE Capital going forward is our uncertainty around GE's resolve that GE Capital remain less than 40% of the overall earnings mix. We appreciate the growth provided by GE Capital, but its size was the primary reason management was forced to raise equity three years ago, diluting shareholders. To the extent that management is intent on keeping GE Capital a smaller part of the profit mix, a decision we gladly would embrace, investors should lower earnings expectations for the unit.

All things considered, this quarter's strong performance should be a prelude to a strong showing by General Electric for the next several quarters, as the company has ample liquidity to grow operations and return capital to investors.

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