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The power segment of General Electric (NYSE: GE) has been front and center among the company's problems over the last couple of years, and Siemens' (NASDAQOTH: SIEGY) gas turbine operation has faced significant issues, too. The key problem for both is the collapse in demand for large gas turbines and the consequent impact on equipment sales and service revenue.
However, there's one reason both companies have some potential upside in the coming years. Let's take a look at what that is.
A GE gas turbine. Image source: General Electric website.
Power industry dynamics
To understand the overarching dynamic in the power industry, you have to look at the deterioration in large gas turbine orders over the past five years. As you can see below, the decline has been pretty dramatic, and GE's estimate of end-market demand in 2019 implies a halving from the demand levels in 2015.
Data source: General Electric presentations.
As a consequence, both companies are now undergoing substantive restructuring in order to reduce capacity and improve margin and cash flow in their power operations. After a 76% drop in its power and gas segment in 2018, Siemens plans for its restructuring to lead to a doubling in the segment's profit margin from 4% to 8% by 2021. In addition, Siemens has decided to spin off its gas and power segment and its majority stake (currently 59%) in wind-power company Siemens-Gamesa into the new company in order to offer a complete range of solutions to the power industry.
At GE, CEO Larry Culp has been quite candid on the subject of how his company was "slow to embrace market realities," and as such, it's been a bit late in joining the cost-cutting party. No matter. GE is now in full-on restructuring mode. The power segment margin of a negative 3% in 2018 is expected to turn into a positive result in 2019, and then the margin is expected to expand in 2020 -- free cash flow from power is still expected to be negative in 2019 and 2020.
What if end demand surprises to the upside?
Now we've come to the key point. Both companies are baking into their guidance a continuation of current market conditions, meaning any improvement in end demand could lead to a substantive pickup in margin and profitability at both companies' segments.
This argument runs contrary to the trends in end demand (see above chart), but here's the thing: It's incredibly hard to predict gas turbine equipment and services demand.
It's fashionable to criticize former CEO Jeff Immelt for his ill-fated purchase of Alstom's energy assets in 2015, a deal completed just as the market was about to begin its slump. However, before casting stones, it's worth remembering that Siemens and Mitsubishi also bid for Alstom's gas turbine and power assets. Given that the three companies dominate the gas turbine market -- and have a finger on the pulse of every significant power deal -- it's fair to say that the best-informed industry leaders failed to see the oncoming decline in end-market demand.