What Siemens' Earnings Could Mean for General Electric Investors

General Electric Company's (NYSE: GE) power segment is at the forefront of its 2018 challenges. Since it's hard to make a compelling case for buying the stock unless the power segment stabilizes and/or the Securities and Exchange Commission finishes its investigation into previously booked revenue, particularly as it relates to long-term service agreement contracts in the power segment, it makes sense to analyze what key competitor Siemens (NASDAQOTH: SIEGY) is saying about the power market -- it could prove quite helpful for GE shareholders.

Siemens' commentary

I think there are three key takeaways for GE investors from Siemens' recent presentations:

  • End-market demand continues to deteriorate.
  • Pricing conditions seem to be getting better. GE has been extremely price competitive, raising fears of a low-margin backlog, but Siemens' commentary contains a glimmer of hope for improvement here.
  • Siemens' power services are performing better than GE's -- raising hope that GE can start to turn things around with its services performance.

Let's deal with these three points in turn.

End-market demand

Anyone hoping for some signs of recovery in gas turbine demand would have been disappointed by the commentary from Siemens' management. Earlier in the month, Russell Stokes, CEO of GE Power, said market demand for heavy-duty gas turbines in 2017 of below 35 gigawatts had been lower than he'd anticipated. Furthermore, Stokes declared he was downsizing GE Power to prepare for a market as low as 30 gigawatts in 2018 -- a far cry from the 46 gigawatts recorded in 2016.

Fast-forward to Siemens' first-quarter 2018 earnings call, where CEO Joe Kaeser confirmed that the "structural challenges" in the power market "will continue" and added that "we have initiated and will take decisive steps to adjust" capacity. Furthermore, regarding large gas turbine demand, CFO Ralf Thomas said that "the trough may be even a bit lower than we saw it last year."

It gets worse. Demand for GE's small gas turbines, notably aeroderivatives, fell off a cliff in 2017, and Siemens' commentary suggested that conditions remain tough. "On the small... [gas] turbine side, you mentioned that some of the competitors see a very intense market," Thomas said. "We agree upon that."

GE started 2017 expecting to ship 96 aeroderivatives but ended up with just 40 and expects 30 to 40 in 2018. In short, it's wishful thinking to assume that GE has set the bar low with its power guidance. According to Siemens, end market demand is likely to deteriorate.

Continuing challenges on pricing

According to Thomas, the new power equipment market has "significant price pressure due to aggressive competitive behavior," and given that GE is its key competitor, and the dominant player in power generation, it's safe to assume he's probably referring to GE.

Consequently, it's possible that GE has been winning orders at very low margin, and that could come back to haunt the segment in 2018. However, it's worth noting that end market demand came in much lower than GE planned in 2017, and it may have made economic sense to take on such orders, given that the segment was structured for a higher level of demand.

However, with GE now downsizing and Siemens continuing to reduce capacity, Kaeser's comment that he saw "unnecessary behavior in the marketplace" as being "less intense" is a glimmer of hope that pricing conditions might be getting better.

Siemens' improvement in services

While both companies are suffering from declining end markets and overcapacity, there is a difference with regard to power services. The distinction became abundantly clear in the summer. GE's power services revenue was a lot weaker than management expected it to be in 2017, and former CFO Jeff Bornstein had talked of structural changes in the power services markets -- something Stokes discussed at length during GE's investor update in November.

In comparison, Thomas described Siemens' service business as "a stable contributor" and said it was "holding up very well on top and bottom line." On a comparable basis, Siemens' power and gas orders declined 2% in the most recent quarter, while GE's were down a whopping 25% in its fourth quarter of 2017 -- equipment orders fell 24% and services declined 26%. In a nutshell, Siemens planned and executed a lot better with its power services in 2017 than GE did, and now the latter needs to restructure.

What it all means for GE investors

If you're looking for a quick and easy conclusion, it's probably that conditions look likely to get worse before they get better. However, GE and Siemens are both reducing capacity in an effort to match end-demand conditions. All told, GE continues to face a difficult year in power, so don't be surprised if there's more bad news in the near term. But if GE can demonstrate that its power services outlook is improving, then the segment could be on the long road to recovery.

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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.