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The Globe and Mail

GE's rally sets bar higher for first quarter

The rally in General Electric shares this month turned the old saying about March on its ear, but now the pressure is on for the company to back up its plus 20-per-cent year-to-date appreciation with its first-quarter numbers due in mid-April.

The stock made a run at $19 (U.S.) last week, and was up 15 per cent this month through Monday's close, a gain that seems to indicate Wall Street believes the company has turned a corner with losses in its finance unit expected to peak this year and cash levels projected to grow enough to eventually justify buyback activity or even a dividend boost. The run-up accompanied surges of a lesser degree for the broad market in March, as both the Dow Jones Industrial Average and S&P 500 were able to turn positive for the year.

GE is scheduled to report its quarterly results on April 16. The current average estimate of analysts polled by Thomson Reuters is for a profit of 16 cents a share on revenue of $36.9-billion for the latest three months. That compares to earnings of 26 cents a share on revenue of $38.4-billion in the same period a year earlier, and earnings of 28 cents a share on revenue of $41.4-billion in the fourth quarter.

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William Blair issued a research note previewing the quarter on Tuesday, and its view is largely in line with Wall Street's current consensus outlook. It also expects earnings of 16 cents a share for the March period, but has revenue coming in at $37.1-billion, slightly above the average analysts' view.

The firm, which has a market perform rating on GE shares, said its short-term outlook on the company is "still cautious." It cited concerns about earnings quality because of the ability for one-time items like restructuring expenses and gains and tax rate fluctuation to skew the bottom line, as well as limited growth in earnings as GE has already said it expects flat profits for 2010.

As for the first quarter, William Blair expects GE's consolidated after-tax margin to fall to 4.8 per cent from 7.4 per cent in last year's equivalent period "as reduced volumes and headwinds from the Olympics offset the benefits of cost reduction and a sales mix shift toward service revenue."

Other projections for the March period include a tax rate of 25 per cent for the company's industrial businesses (along with a tax benefit from the finance side), a $250-million drag on results from the Olympics (smaller than the firm had previously expected), and one-time charges related to Conan O'Brien's departure from NBC. The firm also said it would be keeping an eye on backlog, which remains healthy but has leveled off in recent quarters, hovering between $169-billion and $175-billion since 2008.

Overall, however, William Blair is fairly bullish. Even with the recent run-up, it believes the stock is trading at a "low absolute multiple (roughly 18x the firm's 2010 earnings estimate of $1.03 a share) and with a solid dividend yield (2.2 per cent)" and the expectation, which the market seems to have already embraced, is that improving economic trends will benefit many of the conglomerate's businesses. There could be further upside if GE is able to pull off a few more asset sales or can pare down GE Capital further.

"There is a great deal of discussion around GE re-positioning and de-risking its portfolio of businesses," the firm said, adding later: "We believe the market would view these moves favorably, as they have the potential to reduce GE's complexity, increase its transparency, and improve profitability and returns in the long run" in reference to potential unit divestitures or shrinking GE Capital.

William Blair said it's comfortable with its view for earnings of $1.03 a share in 2010 from GE, a forecast that's a penny above consensus. For 2011, the firm is currently below the average analysts' view as it sees a profit of $1.13 a share on sales of $148-billion vs. the Street's estimate for earnings of $1.22 a share on sales of $154.2-billion, but it said it does have an upward bias to its numbers.

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Recent history points to GE being able to at least meet Wall Street's view, as it's come in ahead of the average analyst estimate for four straight quarters, although the percentage that it's topped consensus by has declined every time, going from a 25-per-cent beat in last year's first quarter (earnings of 26 cents vs. the 21-cent estimate) to a 7-per-cent surprise in the fourth quarter (28 cents vs. 26 cents).

That trend is likely to continue as the company has made a point of telling the market that earnings growth is on hold for this year. Given the long road the stock has traveled to get back above $18 for the first time since December 2008, the shares look vulnerable to a pullback if the first quarter shows even a slight blip in the company's perceived progress.

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