Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

GE should have known better than to over-promise and under-deliver.

The $256 billion maker of airplane engines, gas turbines and other industrial goods had to lower its 2016 organic sales guidance on Friday after third-quarter revenue at several of its units fell short of some analysts' estimates. The less-sanguine outlook wasn't terribly surprising. In fact, it's been almost a norm this earnings seasons for industrial companies to knock down their guidance. But GE's forecast in particular has long stood out as ambitious -- in hindsight, overly so.

Excluding the impact of acquisitions and currency swings, GE now expects sales this year to be somewhere between flat and up 2 percent from 2015. It had previously estimated organic revenue growth of as much as 4 percent. 

GE's Earnings Update
The company's performance in the third quarter actually was pretty good relative to the challenges many industrials are facing. But the lowered organic revenue guidance stung.
Source: Bloomberg, company statements.

Back when that earlier guidance was introduced last December, it already well outpaced the forecasts of peers such as 3M, Honeywell and United Technologies. It looked all the more aggressive when GE stuck by its call, even as the company's already less-optimistic rivals deflated their outlooks (the exception is United Technologies, but if Honeywell's reduced forecast and weaker aerospace results are any guide, the company may have to make cuts of its own when it reports next week). A continued slide in orders and a 1 percent drop in organic sales in the first half of the year didn't faze GE, with the company insisting that a surge in turbine shipments in the back half of the year would supercharge revenue.

Too Hot
GE's revenue forecast looked aggressive even in December.
Source: Bloomberg, company filings
Data reflects the midpoint of ranges given in 2016 outlooks for organic or core revenue growth. Forecasts are as of December.

Turns out, the division that makes turbines is one of the businesses that came up short. The power unit reported revenue of $6.5 billion for the three months ended Sept. 30, more than 7 percent below the average of four analysts' estimates that I compiled. Orders for GE's industrial products fell about 6 percent on an organic basis, not as bad as the 16 percent drop in the second quarter but still moving in the wrong direction. The decline was in spite of the fact that the Farnborough air show, a pivotal event for aviation orders, took place in the third quarter this year, rather than the second quarter last year.  

GE shares fell as much as 2.6 percent on Friday morning. If the declines hold up, that will make four quarters in a row that the stock declined after the company reported earnings.  

I have to think that GE did genuinely believe in its forecast in December and still believed it was possible when it gave its last quarterly update in July. The industrial economy has undoubtedly been worse as the year has gone on than many people anticipated. But it's not clear why CEO Jeff Immelt didn't give himself an easier goal to begin with. GE has already done a lot for investors: it put the bulk of its financial operations up for sale, successfully unshackled itself from the too-big-to fail label and divested its appliances business. Immelt is also undertaking an ambitious digital revamp of GE. He didn't really need to put another burden on himself.  

Going Backward
GE's stock climbed as the company underwent a massive transformation. But now it has to start delivering in its core industrial business.
Source: Bloomberg

Just for the sake of argument, let's say GE started off calling for organic growth of as much as 2 percent. That would have put it roughly in line with Honeywell's initial forecast. If GE had actually been able to deliver 4 percent growth, it would have looked like a powerhouse. If it met the low bar it set for itself, well, no harm, no foul.

Instead, the company has squandered much of the momentum it had coming off its big realignment. The shares are roughly where they were in February and are now down more than 8 percent for the year. The longer this trend of underperformance continues, the more empowered investors might be to question whether a bigger breakup is necessary. Immelt felt a need to clarify that oil and gas was still a "core" business for the company.

GE may still be too big and too diverse; when one business is doing well, another suffers and it all comes out in the wash. Believers in the conglomerate strategy will tell you that's the point, and I think we can give the company a bit of a breather before mounting calls for another set of divestitures. But GE is going to have to do better to stop those questions from coming.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. I know they are different businesses and their outlooks depend on different underlying financials but this is a hypothetical. 

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net