General Electrics, Inc. (GE)
2013 Electrical Products Group Conference Call
May 22, 2013 11:00 AM ET
Jeff Immelt – Chairman and CEO
Deane Dray – Citigroup
If I could ask everybody to take their seats that would be fantastic. So, obviously, Jeff Immelt doesn’t need any introduction. Thrilled, as always, to have you here. Thank you for sponsoring lunch. I also want to remind everybody that even with Jeff, we’ll be accepting buy side questions by BlackBerry, or sell side, if you want to do it that way too anonymously. And I can always be shot on the side. All right. Thanks, Jeff.
Great, Steve. Thanks. Good morning, everybody. It’s great to be back to my favorite resort in Florida. I just want to say that at the offset. I’m thrilled to be here once again. Same themes you’re going to hear from us, portfolio value, industrial growth, smaller GE Capital, good capital allocation, you’re going to hear that through the presentation today.
I’m afraid I’m not going to have a lot of late breaking news on the economy that’s going to be different than what you’ve heard. We see the US getting a little bit better every day. And merchant margins for us continue to be very strong. I would say a good blend of countries, and China is good for us so we see good growth there. Europe and Japan, we’re not counting on much.
I thought I’d give you a little bit more color on Europe. I think we see second quarter being better than first quarter. Places like the Nordic regions continue to be strong, but Western Europe is quite tough. So we’re not counting on anything great out of Europe this year or next, and we’re kind of planning accordingly. So that’s the lay of the land, I’d say, from a global economic standpoint.
We have no real change to the framework that we’ve got for the company from the first quarter call. We adjusted Power & Water after the first quarter, but all the businesses are really performing per expectations. Aviation and Oil & Gas continue to be super strong. Healthcare and Transportation have great strength outside the United States. Energy Management and Home & Business Solutions are going to see margin accretion during the year, and Capital continues to be solid. So that’s kind of the portfolio and how it’s performing.
We don’t have any change to the framework for our earnings or our EPS for the year. We see us getting good solid growth in both of those. No change on cash. We still expect to have a good year in cash. And we said in the first quarter call that our organic growth will be at the low end of the range. No change to that.
We think risks and opportunities are more or less balanced for the year. And the way we try to keep a buffer for ourselves is by running our cost play even harder, and having a lot of cash and being able to do more buyback if that’s a choice we want to make. So that’s kind of the way we look at where the year is.
The strategy of the company is unchanged. We have a big industrial company, a value-creating GE Capital for big imperatives, technology services, globalization, simplification. That’s how we run the place. We laid out five goals for the year. Three of them are in great shape. Right now we’ve got to push harder to achieve better industrial growth, and that’s what we plan to do. But these are the five goals that we’ve got for the leadership team and how we kind of pay people and how we manage it for the year.
I want to spend a little bit of time just going into a little bit more detail on the portfolio itself. We’ve talked about in year-end wanting to get Industrial earnings to 70%, always prioritizing dividends, having a strong payout, at a great dividend payout. We continue to invest in our Industrial growth.
We’ll probably do about $10 billion of acquisitions. Between CapEx and R&D, we spend about $10 billion here in Industrial. On an ongoing basis, we think acquisitions are $3 billion to $5 billion. Our long-term goal is to grow our Industrial earnings 10% and have high returns. Last year our Industrial return was a 16% grow over time.
And in Financial Services, we’ve set a target to get GE Capital down to $300 billion to $350 billion by the end of 2014. And that’s going to create excess cash in GE Capital, and we’re going to use that excess cash to buy back stock. We’d like to get our share count down to 9 billion to 9.5 billion shares by the end of 2015. So that’s kind of the way we think about the portfolio and creating value.
When we were in the crisis, we painted kind of what I would call Phase 1 for GE Capital to get down to $440 billion of ENI. We had some principals. I think what we’re saying to investors today is that we’ve kind of got the next phase outlined getting the portfolio down to – or getting the ENI down to $300 billion to $350 billion of ENI, continue to do one-off of non-core assets to basically look at some staged exits of value-maximizing platforms. So we’re going to do that.
And we’re going to continue to grow the core. We have a great core franchise in GE Capital of kind of midmarket lending, where we have strong number one positions, good returns. And so when you think about Capital over the next few years, it’s going to be smaller, lower ENI, but still high returns. We’ll get gains on sales as we transition these assets. We’ll do staged exits of the assets over time, where a lot of the optionality is in our control.
And GE Capital is super strong financially, right? Our Tier 1 ratios are high. Our liquidity is strong. Our risk management is excellent. So this is the way to think about GE Capital over the next few years, smaller, probably exiting a few of the value maximizing portfolios over that time period and still extremely profitable extremely valuable and extremely strong franchise.
Industrially, we want to continue to grow the Industrial business. Our long-term goals are to grow organically 5% to 10% and expand margins. I think if we think about the next couple years, some of the keys are to continue to grow our Service business, having good positive earnings growth in Power & Water by 2014.
Getting the most out of Aviation and Oil & Gas that have these huge backlogs of higher pricing to manage those, getting some of our underachieving businesses to do a better job from a margin and performance standpoint and to continue to drive costs. So that’s how I think about the Industrial franchise going forward.
Technology is always a big deal for us. We think it’s a core competency. We continue to invest in R&D and launch new products. We use technology as ways to gain and solidify market share in industries like Power & Water and Aviation, fill product gaps organically.
So I think we’ve developed more skill set to be able to fill key product gaps organically versus doing acquisitions. And drive margins, we’ve invested a lot from a research standpoint R&D standpoint, in manufacturing. And we add tremendous value to our acquisitions. I think people that went to the Offshore Oil & Gas Conference last week saw a lot of the technology that we’re applying to the Oil & Gas segment that’s come from other parts of GE.
We’ve got, I think, real scale and capability from a global standpoint. We think our growth market revenues will be up double digits this year. We’ll see double-digit growth both in the resource rich parts of the world and also in Asia, and we continue to invest in capability. We continue to invest in customer relationships and partnerships. We manage risk, and we leverage cost where it’s good places to invest. So, again, we view this as a GE core competency just like we do technology.
I think growth markets, you guys have heard me talk about this for the last decade. We’ve invested a lot in the run rate of the company to be able to run a play in 160 countries around the world. We’ve got a big chunk of the leadership team in these regions.
We’ve got 200 factories and service centers, 15 technology centers. And we’re a partner of choice in most of the countries around the world, and we think this builds competitive advantage for our investors. We think it allows us to diversify our earnings mix in key markets like healthcare and transportation, add acquisition value.
A business like Power Conversion at Converteam had a $50 million run rate in Brazil before we acquired them. We took $500 million of orders last year. When we do a deal like Lufkin, Lufkin has a factory in Romania and one in Argentina. We can blow these places out when we go in and get a new beachhead. So it allows us to do a lot there.
We’re doing a lot in shared services and multi-modality sites to drive our cost structure. And we can innovate in these regions. We have great customer Innovation Centers around the world, three Global Research Centers. So this is about scale, and it’s about really driving good performance in our growth regions.
And Services continues to be a big imperative for the company. We’ve got a massively big backlog. We continue to drive iterations. I’d say we’ve tried to transition our business from a capability standpoint from going from a break-fix model to one that did long-term contractual service agreements. And today, our Service business is all about driving customer outcomes and more productivity for both our customers and for us, and we’ve done a lot on that.
We look at having high capture rate on new products. So when you look at things like GEnx or LEAP-X, the capture rate of long-term service agreements on these engines is extremely high, driving dollars per installed base which we drive and accomplish by driving a lot more installed base value and then driving incremental productivity. So we’ll get $1 billion of productivity in our Service business and we think our margins will continue to grow.
Now we accomplish this because we invest in it and we invest in it consistently. And I’ll talk a little bit about some of the things we’re driving from an analytic standpoint but we’re really trying to enrich our contractual service agreements.
And when I think about investing in analytics, I always think about driving more contractual service agreement productivity and profitability first. So we drive margins back into our installed base. We add more value. If you do a contractual service agreement for 10 or 15 or 20 years, you’ve got to be adding value into that each and every year and that’s what we do.
And we run a $4 billion software company inside GE that’s totally outside our service agreements. And so we think analytics are one of the key ways to do that. If you can improve time-on-wing by doing a better job of modeling how an engine fails or how it’s being run, that’s worth billions of dollars for our customers.
One point of fuel burned on just the GE installed base is worth $2 billion of margin to our airline customers every year. These Advanced Gas Paths we’re putting back into the utility CSA model drives three points of efficiency each year.
So when you think about why Services are valuable through the economic cycles, this is the way we can add value. Now if you look at our business this year, all of our Service businesses will have positive earnings this year and we’re counting on Power & Water being flat but the rest of them will have either double-digit or single-digit earnings. We’ll generate 100 basis points plus of Service margin this year and we’ll grow backlog. So Service is critical to us. We invest in it and we want to continue to grow in the future.
And in simplification, GE is both a cost play and a cultural play. We’re going to get SG&A as a percentage of revenue down to 15% by 2014. We’ll be down 150 basis points this year. We’ll go from 17.5% down to 16%. We’re doing a lot of work in terms of shared services, reducing P&Ls, reducing layers. We’re taking 20% of the structural costs out of Europe.
We’re reducing ERP systems, things like that. So we’re doing a lot on the structure. But at the same time, we’re kind of redoubling our efforts in terms of market intensity and speed inside the company. We’ve got lots of process improvement work that’s going to be at the heart of this. So we think driving long-term costs down and simplification and driving speed in the culture is really critical.
What we try to do at each EPG is kind of go through and single out the things that are of most interest to you in the context, so we, here’s where we went in 2012, kind of an update on where we stand in 2013 and I think the four things that are on your mind as we talk to you, margins, Power & Water cycle, where Oil & Gas is going and capital allocation for the company. So I’m going to go through each one of those in more detail.
Our margin plan this year is backend loaded to get the 70 basis points. This is not an atypical GE pattern. This year looks a lot like 2006 and 2010 in terms of the profile. The second quarter is trending in line with our expectations today in terms of margins.
And I think the way to think about this is we’ve got Power & Water profiled for the second half. We’ve got line of sight on the units we need to accomplish this in the second half. But the other buckets are already in pretty good shape. We’re running a big positive value gap.
Our Service productivity is strong. Our simplification is gaining momentum. So those levers are going to continue to be strong, and we see a good line of sight to the Power & Water units as we look at the second half of the year. And these are probably the six big productivity drivers that we look at in terms of how to think about the company.
Value gap was negative in 2011, was positive in 2012. 2013 will be even more positive from a standpoint of value gap. We’ve got pricing already in the backlog, and a lot of the businesses that we’re in, we’re calling the Power & Water OPI to be about flat. Healthcare down a little bit, but the other ones are very strong. And we just see great improvements in Aviation and Oil & Gas in terms of the backlog. Transportation, we’ve done a lot on our supply chain to drive better value gap, and this is very important for the business.
We’re doing a lot in Manufacturing. I showed the Aviation example, but a lot in terms of new manufacturing devices. So added manufacturing is going to be a big part of the future engines. We talk about a fuel nozzle, but there’ll be other parts, what we call CMCs. So these composites. This is proprietary GE technology. We own the manufacturing. We’re the only guy that’s going to be doing this. And this drives big fuel and capability and a lot of patents around that.
We’ve built lower cost sites in our Aviation business and we’ve captured more of the supply chain. So deals like Avio and some of the other deals, we’re just driving these four things. And the way to think about this from an investor’s standpoint is we’ll probably have 20% more content in the engines that we’re launching in the second half of the decade versus what we’ve had in the past. I think that’s just a way to improve margins and gain more competitive advantage as time goes on.
And we continue to do process improvement. Subsea is a key place where we have to get the margins up vis-à-vis how we run the business. We’ve had a team called Winning in Subsea that’s 50 people, 30 of them from the audit staff, 16 projects, and these are working on deals as quoted, as delivered. And so we think we’ll get, we’ll really double the op profit rate in this business over a couple years and that’s the kind of work that we’ve got to continue to get done.
So that’s margins. On Power & Water, this has been kind of a long cycle that’s playing out but I’ll just give you a couple pieces of context. One is we’ll ship this year more or less the same units we shipped in the late 1990s and we’ll make 10 times more money. So as we’ve built the installed base of a decade ago, we’ve really built out a great Service business. We’ve built out a diversified portfolio. It’s a high return business. And so if you look back, I think we’ve done the right things around the Power & Water business over time.
And then when you look forward, we’re kind of forming, I would say, a bottom. We’re getting the PTC kind of re-normalized into the business and we just think we can run the business without these big spikes in the PTC.
And fundamentally, we’ve built a gas turbine business so that any unit growth in the United States is going to be upside as you think about where we go from here. So right now, we’re thinking about positive earnings in 2014 on a very good base with a high margin business and a high return business, and we don’t have a hangover of a big solar exposure or nuclear exposure or other investments that I think create headwind for the business as we look forward.
Now gas turbines are important. We see that gas, over time, the gas blend continue to increase vis-à-vis the total power generation or the large scale power generation in the world. And the way to think about this is to think about it region by region in terms of where you could see growth. We see demand in the resource-rich regions but you have to hustle for it. The big deal in the resource rich regions this year is in Algeria. We think we’re in the lead position. We believe this is a deal we’re going to win. This is 8 gigawatts, 8.5 gigawatts, guys. This is not small, right? But you’ve got to win the resource-rich regions in the countries that are buying and we’ve done a pretty good job of that.
Asia, I personally think Asia is going to continue to be a solid growth market. You’re going to get demand in Korea and China is converting more coal to gas. We think we can participate in that growth. US, it’s tough to do worse than six units. Maybe that’s the best thing I can say about the US. But you’re going to get a cycle in the US. There’s 60 gigawatts of coal retirements.
Over time the reserve margin is going to go down. We see some orders and some interest right now in some IPPs and other units in the United States. And then we’re just not counting on Europe and Japan for much growth.
So the way you think about this is if you look back a couple years, we’ve averaged about 115 shipments a year. We think if you look out over the next five or six years, the average is going to be more than that. And our product line is quite robust, from 1 megawatt up through 300-plus megawatt. GE is going to have competitive products, efficient products in that entire basket. So that’s kind of how we see it. But look, this is not an easy market, but there’s units out there to be had. And we’re going to win more than our fair share as these take place over time.
And then this is kind of the way we look at the mixture of different drivers, gas turbines we’re not counting on much in the next few years. We think Services, a good backlog profitable backlog will be about flat this year, up a little bit next. PTC, the way that PTC is written is it’ll spread units in 2013 and 2014. 2013 will probably be a little bit better than we thought. 2014 will be probably a good solid year. And then Distributed Power and Nuclear and Water, these will all be reasonably good volumes and opportunities as time goes on. So that’s kind of the way we think about the Power & Water business in the cycle we’re in today.
Oil & Gas is a good story. Oil & Gas we continue to grow. We like investing in. We think we’ve invested in the right segments in the Oil & Gas business, and we like our position in subsea and LNG and measurement and controls. We think we’re in the right places. And we think we’ve got good solid margin headroom, if you look at Oil & Gas in the next few years. So we think just getting more product standardization, building out the service mix, doing a better job of upfront pricing, doing a better job on acquisition integration. We’re going to get a step up in Oil & Gas performance.
The thing that attracted us to Oil & Gas 10 years ago is still the thing that attracts us today. Our customers’ need for technical intensity is growing. We think this opens up more of a competitive position for GE. And when you just walk around the chart, you see subsea integration, some big opportunities there.
A lot on blowout preventers, ways you can do better sensing and better technology around that. LNG, we did an acquisition a couple weeks ago on LNG with a leading company that does mini-LNG. So we think this is a space that could grow as people do fuel conversions or in other countries. So this gives us a window on future technology. And this is the place where the industrial Internet and sensing and technology is really important in terms of where you go in the future. So we think Oil & Gas can be a very positive aspect for us.
And last on capital allocation, we’ve kind of got a core capital allocation case, which reflects the NBC and the CFOA and stuff like that over the next couple years. And then we’ll get – as we continue to reduce the size of GE Capital, you’re going to get special cash on top of that, $20 billion or $30 billion probably on top of that as you think about it.
And kind of the way we think about GE Capital in particular is the GE Capital dividend is going to go towards the GE dividend, but the special dividends we get from GE Capital are going to go into buyback, right? And that’s kind of the way we framed the way we think about the company going forward.
So if you go to the right-hand side, we spent about $4 billion here on CapEx. We’ll continue to do that. Dividends in line with earnings. So we like growing our dividend. We like having a good payout. Buyback, we’ll do $10 billion this year, and our expectation is by the end of 2015 to lower the share count to 9 billion to 9.5 billion shares.
And then bolt-on acquisitions, we’ll probably do about $10 billion this year, and on an ongoing basis, we’ll do $3 billion to $3.5 billion of acquisitions. So this kind of fits the balanced and disciplined capital allocation point that I made earlier, with just maybe a little bit finer edge on what we’ll do as we reduce the size of GE Capital. So that’s kind of the way to think about where we are there.
Acquisitions, we still have a good pipeline of acquisitions. We like our discipline of $1 billion to $4 billion and generating good returns. And we try to do acquisitions where there’s multiple ways to win when we approach the acquisitions that we do. We’ve done or announced two big ones in the last, let’s say, six months. Lufkin in Oil & Gas.
The way we looked at Lufkin is when we acquired the Wood Group, we had a submersible pump, but to be a player in the enhanced oil recovery space there’s more segments than just the submersible pump. So Lufkin was on our game board as being able in one shot to fill in a lot of the other spaces. And then there’s multiple ways to win.
So it opens up our geography. It opens up opportunities to work on supply chain. And Lufkin had a Gear business where GE was already a customer. So we think there’s a supply chain value here as well. So we view this one as kind of a way to invest and have multiple ways to generate a good return for investors.
Similarly, Avio, this was a supplier of ours, where we already had a backlog with the company, we think it gives us complementary skills, allows us to execute on our supply chain strategy. So we like what Avio stands for as well. So these are two deals that ought to add a couple cents to our earnings next year, already in place, but I think they’re typical of the kind of deals that we like to do.
And lastly I just thought, as you think about the company going forward, you’re going to get good solid earnings growth in the Industrial. I think you’re going to get managed from a contextual standpoint, we’re going to be thoughtful about what we do in GE Capital. We’re going to do things in staged exits and things like that, but ENI is going to go down in that place. We’re going to up the buyback, and so the buyback is going to be positive. We’re going to continue to pay good dividends and grow dividends in line with earnings. We’re going to reduce corporate costs, right?
And then when you think about the way the GE leadership team is compensated, our long-term incentive plan, there’s really four key metrics. One is growing EPS. So the EPS has to grow. We have to generate a lot of cash both from operations and doing smart dispositions.
The Industrial earnings percentage has to grow. And ROTC has to grow. So those are the four. EPS has to grow, cash has to grow, industrial percentage has to grow, returns have to grow. And we picked these four because they work together. Let’s say these as metrics work together. So it’s important that we grow EPS while we’re changing the Industrial mix, right? So you want to be thoughtful.
You want to be strategic. You want to have that context so that you’re always doing the right things for investors and things like that. So those two go together. And you want to be able to generate a lot of cash, but you want to do it with high returns, right?
So you want to make sure from an investor’s standpoint that you’re not encouraged to do anything other than disciplined capital allocation vis-à-vis where we go. So we’ll have a lot of cash. We’ll apply it well. Our goal is to grow our earnings while changing the mix at the same time. So there’s no lay-down case that says, gosh, I can do something that’s very disruptive to investors. You do it in a smart and intelligent way.
And in my performance shares, I’ll have a third metric, which is GE’s being in the top quartile on margins and returns versus a basket of 20 industrial companies, including both our competitors and other highly respected industrials, like Honeywell, Emerson, people like that. So we basically – I think we’ve got you covered from a financial standpoint. Our guys will earn money as we’re doing the things that I think are most important to GE investors and that’s how we think about going through this kind of change.
So with that, Steve?
Great. Thanks, Jeff. We have a number of – great. We have a number of buyback questions in. But let’s start with one on the sell side, and then I’ll go to the first buy side.
Thanks, great. So, Jeff, just on the ending target...
I remember the good old days when we had control over our own destiny. We could call on, now you’re just holding us down, Steve.
I’m sorry. We want the real answers coming.
I’ve got to talk to the other members of the CEO union after this meeting to make sure we defend our rights.
Are you trying to say you wouldn’t have chosen me, Jeff?
You can fly us all into a different resort, if you’d like.
Okay. No. No. No. I would admit it’s too much to ever speak.
Okay. So on the ending target, obviously, implies at least one chunky disposition. I think we all know which one we’re talking about. Do you think you can accomplish that kind of disposition in the current M&A environment for financials?
Oh, look. I didn’t come here today to name any one of them. But I think a couple comments. I’d say, look, I think it’s a great – the capital markets are very receptive to IPOs or a lot of different technologies today. So I think you basically have as good a setting as you could possibly have.
And the other comment I’d make is, look, the strength of GE Capital in the end is really secured lending, connected to the core, highly distributed. So I’d say when we think about the portfolio, we think the timing is good to be thinking strategically. We think there’s a lot of techniques to do it. Whatever we decide to do, there’s a lot of techniques to do it in a value-maximizing way.
Jeff, we have a question from the buy side here. You can see why on this one, it’s anonymous. Okay. So, appreciating no formal guidance, lots of estimates around $2.00 in 2015. And given strategic options around PLCC, how do you feel about that? And I would add, obviously, in light of your buy back commentary.
You know, again, I’m not going to predict 2015 guidance. We think EPS is going to continue to grow and we’re going to be able to do it in the context of having a higher Industrial mix and share count being lower.
Jeff, one of the main points of your annual letter this year was admitting that GE has become too complex and really promising shareholders that you could simplify it and such and I think we’ve seen some examples.
But how do you take a company like this that’s inherently complex, continue to think about doing bolt-on acquisitions, which in some ways adds complexity – it doesn’t decrease the size of the company in any way, how do you get there without having major carve-outs, and let’s just say for the sake of argument, another NBC type sale and continuing to get the portfolio down to a very simple, if you will, core? How do you execute on that, I guess, is my question?
Scott, again, I think – just to give you a context in the letter and how I think about it, I think to be successful today you’ve got to be in 150 countries. We’re in markets that are highly regulated, things like that. I think what we have tried to do industrially is shrink the portfolio around things that are – so we sold NBC. We sold Plastics.
We’re basically in a high tech, global sale and service type of model industrially. And then in Financial Services, I think our idea is to be closer to a commercial finance core and then run the company with fewer layers, better IT, no orphans, things like that. I think that’s how we see the simplification initiative working inside the company.
I think we feel like the footprint is pretty close to what’s manageable and we need to continue to benchmark ourselves against peers. It’s not saying I wouldn’t contemplate things like that as time goes on but I think we’ve – with NBC, Plastics, Insurance, we’ve basically sold half the company in a decade. That should show you that we’re willing to take on those things as time goes on.
Jeff, another question from the audience here. Can Power business margins improve in 2013 if the European Service business doesn’t rebound?
So, basically what I’d say, Steve, is what we’re looking at now is more or less margins being roughly flat in Power & Water this year. And I think the way you’ve got to think about that is we’re taking a ton of cost out of the business. So the rest of the Power & Water Service business is quite strong.
We’re not counting on Power & Water Service in Europe necessarily getting remarkably better as the year goes on and we still think we’ll do okay from a margin standpoint. And just the equipment, the number of units first half, second half drives an incredible amount of change between the first and second half.
There’s a follow-up here. So now has the European Power business improved?
So, again, we’re not counting on the European Power business necessarily improving. We think the utilization of power plants is going to stay sluggish this year. We think the demand for new units is maybe only in the distributed power. Not in the big frame units. So we’re really not counting on Europe getting better.
Just to be clear on the EPS outlook or how you’re thinking about it – you did mention in your pitch there will be a lot of gains generated. Are gains part of the earnings construct going forward as you’re looking to replace some of these earnings that would come with divestitures?
I’d say not necessarily, Jeff. Again I think as we get further on the plans, we like to use gains for restructure I’d say industrially, 100% gains will go into restructuring, anything we do industrially; in Capital, it just depends on as time goes on we can use it to offset other things.
So I would count on us basically using the principal offsetting most of the gains with restructuring and I don’t contemplate a lot of that falling through. But it does allow us as we get gains, it does allow us to eliminate headwinds as time goes on. I think that’s important as well.
Just another service question. Are we seeing any weakness in the US? I mean it’s not been a stark but it looks like there’s a little fuel shift back towards coal in the US and is there any tension on Service pricing?
We haven’t seen it yet, Jeff. Our Service business in the US in the first quarter was up a couple percentage points. It was a much better performer. Really the story was Europe and we haven’t seen that yet in the US. And don’t expect it.
Again, we’ve got a pipeline of 52 Advanced Gas Paths, right? So that’s the interplay. It’s just, guys, when you’re in a CSA, an investor shouldn’t expect that these are like static agreements. These are dynamic agreements. Every year – we’ve been working on these every year and the best part about a CSA is your interests and the customer’s interests are aligned. So there’s a lot of levers, there’s a lot of ways to create value inside a CSA. So you got – in the US, you’ve probably got, of the 52 Advanced Gas Paths, you’ve probably got 40 of them in the US, something like that.
Are you thinking of the 30% - 70% mix, which obviously is an intermediate term target? Do you get there firstly by mixing down to $325 billion of ENI at the end of 2014? And are you thinking of that kind of as a long-term place holder? Because as obviously as various cycles kick back up, in theory, unless you actually start to then grow Capital, it’s going to continue to mix down.
Look, Jeff or John, I would say is we like GE Capital. In other words, the GE Capital in the commercial finance space, we have competitively advantaged space. We’re generating new – underwriting new business at 2% ROI or above. You’ve got very strong competitive positions. So we’re going to grow that space. The goal is to have a good and growing Industrial business, a good growing Capital business. I think it’s just a new starting point, if you will.
And to manage the dilution? Because obviously some of the stuff could be a little chunky.
Is your thought process, you’re going to do your best with share repurchase or is there some other sort of lever you, you can pull?
Look, again, the way I would think about it is you’re going to get good solid Industrial earnings growth. You’re going to get staged exits so we can manage the dilution over time. You’re going to get gains that are going to allow you to do offsets and you’re going to be able to buy back a lot more shares.
So you’re going to have a more valuable company that’s still growing its EPS in an effective – in a strong way in a competitive way and you’re going to have a lot of cash optionality. I think that’s the way I look at the company; a more valuable company.
Deane Dray – Citigroup
Hey, Jeff, just following up on that last point you made regarding the ability to dividend up, you said between $20 billion and $30 billion in special dividends out of Capital. Now, we’re trying to do the math here on this in terms of – it would be help on some of the timing of this because you’re now giving up some more insight into share count come in lower than what you had previously guided. So is the $20 billion and $30 billion all predicated on these staged exits or are there additional?
It’s going to happen over time, Deane. In other words, you’re going to continue to be smaller. You’re going to have excess cash and you’re going to have other ways to think about capital allocation as time goes on as part of the IPO process or other processes like that but these are all things that we need to go through with our regulators and these are all things that require us to be in sync with how our regulator looks at the Financial Service business and things like that.
Yeah, Jeff, so in terms of the decision to move forward with staged exits, was that driven by your view of market receptiveness at this point in time or just where you saw GE is in its evolution-wise, sort of put a target on timing?
Again, I think it’s – we never wanted, as we were going through the financial crisis and even today, we never really thought about wanting to do anything we couldn’t complete on our own. And I think when you look at the capital markets today, these are all things we can complete on our own if we need to. And I think on the strategic side, we just like – we think the company has – these are great assets, fantastic, but we believe our commercial finance assets are very strong and very consistent with our competitive advantage so a little bit of both.
In terms of just this – back to the dilution question and your commitment to grow EPS, I mean does this mean you’d like to grow EPS high singles to doubles but in a year where you complete stage 1, that might not be the case, so you’re committing to it still being positive in the year, being better next...?
Again I’d still think about staged exit but my sense is that if you go back to our long-term incentive plan, that has EPS growth consistently every year. That’s kind of what the intent is and we’ve got a lot of optionalities about how we do this and the timeframe that we do it. But again, I think the idea is excess cash applied towards reducing the share count. That’s how we think about it.
When’s the next milestone for the LEAP-X engine?
So we’ve got kind of three iterations of the LEAP-X that are being developed. One for the C919 and one for A320neo and one for the MAX. And so we’re getting, you know, we’re gearing up for the first kind of full frame tests and I think we’re on track and we’re kind of ahead of where we were with the GEnx and so our anticipation is to go to rig test probably by the end of this year. Yeah.
I would like to look at the margin discussion from a slightly different angle. In the presentation, there was the slide of SG&A expense going down by about 100 basis points this year. If you look at the first quarter 10-Q, SG&A expense was up 130 basis points. There is two parts to this question. One is, first of all, how do you see SG&A going down through the year? And are there certain things in the first quarter that maybe made it higher than it should’ve been relative to the year such as restructuring?
The SG&A margins were all the restructuring numbers went and the pension numbers were both in there, so it’s kind of a false – it’s a little bit of an apples and oranges. It’s on the same basis – kind of $200 million.
Okay. And second is that again if you look at 70 basis points in segment operating margin improvement for the year, 100-plus basis points coming out of SG&A, it implies a lower gross margin for GE with a positive value gap – what am I missing? What’s the disconnect?
Again, I don’t know specifically. I think we’ve got probably more Equipment mix in the second half of the year than Service mix in the second half of the year. But I don’t – I think you’re going to get good Service productivity. We ought to be positive on the value gap and we’ll get SG&A, as well. So I’ll have – maybe I’ll have Trevor or somebody get back to you on that.
As we think about nat gas cycle in North America, you know we’re moving towards exporting natural gas, which might have implications for nat gas prices long term. Do you guys care? Where do you make more money? In Oil & Gas, if we export nat gas, does it offset the fact that maybe we get fewer turbines in North America? How should we think about optionality for you guys?
I don’t think we’re that smart, really, to be honest with you. I think, on LNG terminals we make money. On kind of – with like Cheniere and people like that. So we see that as having value content. I don’t think it impacts one way or the other. You know gas pricing is so subdued right now that it’s still a pretty good trade on coal to gas or some of the others.
So I don’t think that the gas price, even if we export, will get so high it will turn off the demand creation for natural gas on that side. So I’d say we’re more or less indifferent on the whole exporting. None of this ever happens as fast as anybody thinks it will, anyhow. So that’s what I think about it.
Jeff, as a follow-up to some of these questions, I mean the plan is pretty clear. The cadence isn’t necessarily as clear, but is there a risk that you’re moving too slow?
And what I mean by that is that we’ve got this big liquidity window that’s open now, if you wanted to spin off appliances and lighting, if you wanted to sell out a major business or exit a bigger portion of the real estate portfolio, for example, the equity stake. I mean is there a chance that you’re moving too slow and you need, and there is a window open now that, that if you miss, it may make it very difficult to hit your $300 billion, $350 billion ENI, and may put you in a tougher situation? Do you think about it...
Well, what I would say, Scott, I think it’s a fair question. You know I would say, if for whatever reason, we miss an opportune window on behalf of investors, that’s my fault. You guys would have every right to say, you made a wrong call. I don’t think we have, because I think, particularly in Financial Services, putting things for sale with the assumption that a bank would buy has been a fool’s journey. So the only way you’ve been able to think about this is by thinking about IPOs. So the market I think is open. If we miss it, that’s on me. Okay? Yeah.
Just on the Services business, I think almost all of your profit in Q1 was Service or all of it. So that’s I guess the main margin driver for the year. Your Services revenues were down in Q1. The orders were down in Q1. So how comfortable do you feel that Services can reaccelerate from here? And which businesses are you seeing that in?
So if you go back to the one page on Service, we’ll have of the six big Service businesses, we’ve got growth in five of them. So very strong, very solid. And again, Power & Water in Europe was the one outlier. You’ve got to remember in Service, we’ve got a massive backlog of Service that sometimes skews where the orders are coming.
Things like spares in aviation are quite strong, right? So our spares order rate is very healthy. Our Oil & Gas orders are good, and will continue to be good in the Service arena. So again, I think we view Service as a mid single digit grower, and – from a revenue standpoint and a good margin enhancement. And I think Europe – run rate in Europe in Power & Water was the negative in the first quarter. But we still think we’ll have a decent year in the Service business.
So unless we have another – we do. Is that a hand up in the back? Yeah. Let’s take one more.
At the December meeting, I got the impression you were leaning in personally on the Energy Management business. What kind of was your take on where to take that business going forward?
Well, look, I think it’s a very fragmented business, segmented business. And one where we have historically underachieved our competitors. And it’s a place where it’s very kind of conducive to linking up with other GE businesses, like Oil & Gas and Power & Water and things like that. So I would say our main priority is power conversion in the business right now to take the asset we’ve got in Converteam and grow it faster.
And we still see good opportunities for margin enhancement in just about every other corner of the business. So there’s no reason why – that’s a place where everybody else in the place does a 10%-plus operating profit. We do 2%. Look, some of the best acquisitions that a company like GE can do are by fixing businesses that don’t work well, and the way I would look at this from an investor’s standpoint is there’s tremendous value that you can create just by running the place a little bit better. And that’s what the intent is.
Jeff, do you want to make any wrap-up comments? And before you do, reminding everybody that Jeff and GE have kindly sponsored a lunch following with management.
You guys, good? I think that’s it, guys.
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