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Earnings Preview: Conglomerates GE and PG Report on Friday

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October 19, 2017
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As earnings season kicks into full gear, two major conglomerates are slated to report results at the end of this week. Both General Electric (GE) and Procter & Gamble (PG) report earnings before market open on Friday, October 20.

Both companies have been in the midst of executing turnaround strategies that have attracted the focus of activist investor Trian Fund Management. Below we’ll take a look at what’s been going on at the companies and what might be expected from their results.

General Electric Earnings and Options Trading Activity

This will be the first quarterly report with GE’s new CEO John Flannery at the helm. Over the past several weeks, GE’s management team has experienced a bit of a shakeup. In addition to Flannery taking over the chairman role from Jeffrey Immelt earlier than originally expected on October 2, the company announced its CFO would be leaving, two vice chairs will retire at the end of the year and Trian Fund Management’s Ed Garden would be appointed to the board.

The shakeup comes as GE has continued to refocus on its core industrial operations, part of a plan announced in early 2015 where it would exit a majority of its financial businesses. Now that the GE Capital Exit Plan is “substantially complete”, investors might be anxious to learn what the new CEO’s plans are, but the company has already indicated it’ll provide more details in mid-November that include reframing its look at 2018 and beyond.      

Earlier in the year, GE announced a series of steps it would take, formed with input from Trian, to cut costs and improve profits. The company said it would target industrial operating profit of $17.2 billion for 2017, and target industrial structural cost reductions of $1 billion in 2017 and an additional $1 billion in 2018.

For the third quarter, GE is expected to report earnings of $0.49 per share, up from $0.32 in the prior-year quarter, on revenue of $31.92 billion, a 9.4% year-over-year increase, according to third-party consensus analyst estimates. Over the past eight quarters, the company has beat earnings expectations in seven of them and matched them in one.

On the revenue side, results have been more inconsistent, beating expectations in three of the past eight quarters and missing them in five. Despite consistently beating on the bottom line, shares have dropped following the earnings release in seven of the past eight quarters. 

GE stock's three month performance and implied volatility shown in a thinkorswim chart

FIGURE 1: GE THREE MONTH PERFORMANCE.

General Electric (GE) has declined about 14% since it’s last earnings report. So far this year, the stock is down roughly 27% year-to-date. The bottom chart shows the stock’s implied volatility. Chart source: thinkorswim® by TD Ameritrade.  Data source: Standard & Poor’s. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

With the stock trading around $23, GE’s dividend yield has gotten pushed to just over 4%. A small number of analysts have recently suggested it might be prudent for GE to cut its dividend if challenging business conditions persist in the future. While high dividends might seem attractive in this low interest rate environment, don’t assume companies will always maintain them.

Around the upcoming earnings release, options traders have priced in about a 4% potential stock move in either direction, according to the Market Maker Move indicator on the thinkorswim® platform. In short-term trading at the October 20 expiration, calls have been active at the 23.5 and 24 strike prices, while puts have been active at the 23 strike. As of this morning, the implied volatility is at the 100th percentile.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.

Procter & Gamble Earnings and Options Trading Activity

The proxy contest between Trian Fund Management’s Nelson Peltz and PG recently came to an end with the company announcing preliminary results that shareholders have voted to re-elect all 11 of its directors. Peltz narrowly lost the vote and the final tally has yet to be released. The proxy battle came as PG continues to execute its turnaround strategy that has been focused on divesting non-strategic brands and improving its core brand portfolio.

In addition to divesting brands, in 2012 the company started a $10 billion strategic productivity and cost savings initiative, and management announced plans in 2016 to eliminate another $10 billion in costs by the end of fiscal 2021, with some overlap with the original cost cutting measures. Over the past several years, those cost cutting efforts have pushed PG’s operating margins above the 20% level.

For fiscal 2018, PG has said it is projecting organic sales growth between 2% and 3% and core earnings per share (EPS) growth of 5% to 7%. Management has indicated that it expects EPS growth to be primarily driven by core operating growth and could  be positively impacted through share repurchases, but the negative impact of foreign exchange is likely to  persist. In fiscal 2017, the company repurchased $5.2 billion of its stock. 

Company divisions of Procter & Gamble

FIGURE 2: PROCTER & GAMBLE COMPANY DIVISIONS.

PG has a diverse portfolio of products that are sold in 180 countries around the world. Its Baby & Family Care and Fabric Care & Home Care segments are the largest components of the company and key revenue drivers of the stock. TD Ameritrade clients can analyze a company’s potential revenue drivers on the Fundamentals tab on the thinkorswim® platform. Trefis information and estimates used in Company Profile are provided by Insight Guru, a separate and unaffiliated firm. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

In its fiscal first-quarter results of 2018, PG is expected to report earnings of $1.07 per share, up from $1.03 in the prior-year period, on revenue of $16.64 billion, pretty much flat to last year’s $16.52 billion, according to third-party consensus analyst estimates. Over the past eight quarters, PG has beat earnings expectations in all of them and beat revenue estimates in five of them.  

So far this year, the stock is up a little under 9%, lagging the S&P 500’s (SPX) 13% gain. The stock has dropped in the last several trading days, along with the broader indexes, and closed at $92.77 yesterday. Around the upcoming earnings release, options traders have priced in about a 2.6% potential stock move in either direction, according to the Market Maker Move indicator.

In short-term trading at the October 20 expiration, calls have been active across a wider range of strikes, with heavier trading at the 92.5, 93 and 93.5 strike prices. Puts have been active at the 90 and 90.5 strikes. As of this morning, the implied volatility is at the 52nd percentile.

Looking Ahead

Next week kicks off a particularly busy stretch of earnings releases with several reports from major tech companies. Microsoft (MSFT), Alphabet (GOOG), Intel (INTC) and Amazon (AMZN) all report after market close on Thursday, October 26. If you have time, make sure to check out today’s market update to see what else is happening. 

Good Trading,
JJ
@TDAJJKinahan

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