Shares of wide-moat General Electric (GE) slumped April 21 as investors reacted to negative industrial cash flow in the first quarter, which largely overshadowed healthy 7% year-over-year growth in organic sales and a solid 130 basis points of operating margin expansion in the industrial segment. We do not intend to alter our $32 fair value estimate based on the quarter’s operating results.
Industrial cash flow from operating activities was a $1.6 billion use of cash, mostly due to higher-than-anticipated working capital in the quarter and lower cash payments collected from GE’s long-term service contracts. We’re satisfied that these are all largely timing issues and believe the company’s 2017 goal of $12 billion-$14 billion of industrial cash flow from operating activities is still reasonable.
Otherwise, GE reported solid year-over-year gains in industrial revenue after excluding the impact of M&A and foreign exchange. Six out of seven segments achieved positive organic revenue growth, led by the power, renewables, and aviation segments. This was GE’s strongest quarter of organic revenue growth in nearly two years. Orders also showed positive momentum, up 7% organically, with equipment orders increasing 5% and services 9%. This included a 9% organic increase in oil and gas segment orders, which, while off a low base, is a step in the right direction. With broad-based strength in backlog growth, we’re more confident that GE’s near- to medium-term goal of 3%-5% annual organic revenue growth is achievable.
Industrial operating margins expanded 130 basis points to 12.6% in the quarter, with equipment margins increasing 30 basis points and service margins growing 140 basis points year over year. All told, we believe the company is on track, and we urge investors to focus less on quarterly cash flow ebbs and flows and more on the sustainable changes GE has made to its portfolio, which we believe will lead to stronger, higher-quality cash flow over time.
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