General Electric (GE, Financial) investors have been a bit concerned over the past few months, particularly after the company gave a conservative oil outlook for 2015 in December. As Brent oil prices slid to about half in a matter of few months, the American conglomerate said that the oil division performance would be flattish to 5% down this year. Currently, oil is trading below $50 per barrel. Apart from this, with the US shale boom and no signs of production cut back from OPEC, there is no clear answer as to when oil prices will start moving north.
GE stock price in the last 6 months, From Finance Yahoo
What’s worrying investors
The fall in the company’s share prices (seen in the chart above) are a reflection of the volatility in oil prices. Out of all the industrial segments, the oil and gas division of the company will get hit the most. This is troubling investors because the segment is the fastest growing industrial segment of the company. The growth of this segment has helped GE overcome the fall in revenue of its consumer facing units where it is divesting. The compounded annual growth rate of the oil segment for the last five years has been more than 11%, which is a very healthy growth rate.
Demand for service and equipment are adversely affected during times of prolonged oil price depression as customers start deferring and reconsidering their mining projects. This automatically reduces the need of new equipment and other related services as unviable and unprofitable projects are dropped.
Strengthening dollar another concern
Other than the oil price depression, a strengthening U.S. dollar against the euro is another challenge that the company is facing. When the dollar appreciates, products made in the domestic market aren't as attractive as those produced in markets outside the U.S. This narrows the margins earned from international markets and also reduces the sales value after converting into U.S. dollars. This is exactly what has happened with GE in the last year, and the effect of appreciating home currency was felt even harder in the third quarter of 2014.
Supporting growth
But there are good reasons to believe that the company is on a growth trajectory with great long term future prospects. GE's management is taking steps to streamline the business process and right size segments. The company has undertaken cost controlling measures to tighten expenses and widen margins. It’s trying to pull down the selling and administrative cost down to 12% of sales from 14% which will save $2 billion that translates to $0.20 per share. These efforts should support margin growth from 16% to 17%.
Besides, GE also targets its industrial segment to contribute around 75% or more towards the total earnings of the company, which is more reliable than the finance arm that suffered a terrible fall during the financial crises. This had hit GE really bad as back then, GE Capital made for more than half of the company’s earnings. Thus, GE planned to shift its core activity in favor of industrials and lessen dependence on its financial wing. Above all, Alstom’s (ALSMY, Financial) assets are going to add great value to the company. The synergies from this arrangement is expected to be highly accretive to the company.
All these things affirm that GE has a bright future and investors need not worry so much about the oil drop. The company is taking several steps that are in its control to lift the overall performance of its business.
