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Here's What Siemens' Big Power Move Means to GE Investors

Lee Samaha, The Motley Fool

There is no more bitter rivalry in the industrial sector than General Electric (NYSE: GE) and Germany's Siemens (NASDAQOTH: SIEGY), so when one company's management speaks, it's a good idea for followers of the other company to take note. The two compete on a number of fronts, but the focus of investors' attention is likely to be on power -- particularly relevant because an improvement in power is essential for GE to successfully execute its turnaround strategy. That said, let's take a look at what Siemens' latest presentations mean for GE investors.

A declining market

It's no secret that the market for gas turbines has been in decline for the last few years, and this fact lies at the heart of the problems GE and, to a lesser extent, Siemens have had in the last few years -- Siemens stock has underperformed the S&P 500 by around 62% in the last five years, and GE has also by a whopping 114%. As you can see in the chart below, gas turbine orders (in terms of gigawatts of power) have roughly halved in that period.

To that effect, there's been a lot of speculation around what both companies will do to combat pricing pressure and ongoing margin declines that led to Siemens' power and gas segment profit declining 76% to 377 million euros in 2018 and GE power reporting a loss of $808 million and a cash outflow of $2.7 billion in 2018.

Large gas turbine orders by gigawatt.

Data source: General Electric presentations.

GE restructures and Siemens announces big news

GE's CEO Larry Culp has set about restructuring the power segment by separating it into two -- GE Gas Power business and the ongoing GE Power business comprising steam, grid solutions, and nuclear. The more problematic of the two, GE Gas Power, plans to expand margin in its transactional services and equipment sales in the next couple of years.

Meanwhile, Siemens recently announced it would spin off its gas and power business and add to its majority stake (currently 59%) in wind power company Siemens-Gamesa. Moreover, Siemens announced its moves to separate the business would lead to an additional cost savings of 500 million euros on top of the 500 million euros already planned for. In total, Siemens believes it will generate 1 billion euros in cost savings by 2023, with 700 million euros' worth by 2021.

As such, the segment's margin is expected to double to 8% from 2018 to 2021, and adjusted earnings before interest, taxes, and amortization (EBITA) is expected to more than double in the period, with a low-single-digit increase in revenue. Clearly, GE's big rival is shaping up to better compete.

Why GE investors should welcome the news

As counterintuitive as it sounds, it's good news for GE. The fact is that the collapse in gas turbine equipment orders has led to significant overcapacity, and when this happens in an industry, there tends to be significant pricing erosion as competitors fight for orders so they can utilize their assets. This usually leads to a period of margin decline before end markets turn up again and/or capacity is reduced.

These dynamics are particularly relevant to the gas turbine industry, as the only other major player is Mitsubishi Heavy Industries. In other words, the impact of Siemens and GE cutting capacity and becoming more productive is likely to be beneficial to both companies' margins.

A gas-fired power plant.

GE, Siemens, and Mitsubishi compete to win gas turbine orders for electricity generation. Image source: Getty Images.

Pricing won't get significantly better in the near term. For example, Siemens Gas & Power CEO Lisa Davis said she expected a 2% decline in margin from customer price pressure from 2018 to 2021, but consider what pricing pressure there would be if GE and Siemens weren't cutting capacity. In addition, Siemens' message could have been one of determining to win equipment market share at the expense of margin, but instead, Davis is aiming for moderate revenue growth supported by cost-cutting measures in order to raise margin.

Moreover, there's a lot of fat to cut from GE's business. By Culp's own admission, GE power was "slow to embrace market realities, and as a result, we were slow to address our cost structure," and it "has been undermanaged over the last couple of years." In rectifying matters, GE Gas Power CEO Scott Strazik believes the $13 billion revenue business can cut $800 million in base costs by 2020. That would go a long way to helping GE Power recover margin in the coming years. Clearly, both companies are now in full-on cost-cutting mode.

What's changed?

The gas power market is still going to be highly competitive, but both companies are aggressively cutting costs, and the creation of a stand-alone Siemens gas and power business is likely to lead to a more focused approach while management is committed to doubling its cost-cutting efforts.

All told, while Siemens remains a formidable competitor, GE Investors should welcome any sign of stabilization in the power industry, and Siemens' latest presentations and margin guidance suggest it's on the way.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.