Siemens Is Unlocking Durable Long

Aug 28, 2023

Siemens (OTCPK:SIEGY) (OTCPK:SMAWF), the German conglomerate exploiting power and gas and specialized in energy management, digital solutions, electrification, has become a bit underexposed here on Seeking Alpha. Meanwhile, management continued to pamper shareholders with juicy dividends (no dividend cuts during the latest financial crisis) and share repurchase programs that made sense to lift shares' intrinsic value. Safe payouts and long-term visibility are the driving forces that will unlock additional shareholder value going forward.

Nowadays, Siemens earns its cash flows from a wide variety of business - for instance Power and Gas, Energy Management, Industrials, Healthineers - allowing for EBIT margins of at least 8% on a normalized basis. My investment assumptions are:

In all, Siemens is active in a cyclical industry, but in my opinion the cycle top has not been reached yet, thus the German energy player should be able to grow its revenues and earnings over the coming years, and strong free cash flows allow for juicy dividends and buybacks. Due to a solid growth outlook - which can be determined from Siemens' strategy towards 2020 - and a low valuation, Siemens shares look attractive right now, as shares are trading at the lowest level over the last year.

Siemens is a global powerhouse focusing on the areas of electrification, automation and digitalization. Besides being one of the world’s largest producers of energy-efficient, resource-saving technologies, Siemens remains a leading supplier of systems for power generation and transmission as well as medical diagnosis.

Since both the gas and energy (e.g. wind division Siemens Gamesa) as well as the energy management industry are cyclical, their purchasing patterns are cyclical as well. This, in turn, means that demand from some of Siemens' customers is cyclical, which results in fluctuating revenues, but luckily, thanks to a wide geographical diversification, Siemens has an excellent revenue breakdown in both the emerging markets as well as in mature economies.

(Source: Company presentation)

Siemens sales throughout the last nine months came in at 20.5B EUR, roughly as much as during the same time span 15 years ago including asset divestments and acquisitions, but revenue fell by 4% compared to the prior year. We see that during those ten years, there were steep declines as well as big increases in Siemens' revenues. At first sight, investors often like to purchase shares of companies that grow consistently, whilst revenues of Siemens remained flat compared to 2006.

The fact that Siemens' revenues haven't reached record highs could be easily explained by the numerous divestments the group made to simply its corporate business. Most investors fear the peak of the industrial sector has already been reached, however, nobody knows exactly when an economic downturn could occur, whilst Siemens' management hasn't been spotting order intake slowdowns so far. Throughout this article I'd like to tackle both the short-term doubts that could be outpaced by long-term opportunities.

As mentioned previously, Siemens' revenues fell by almost 4% in Q3, but remained unchanged on a comparable basis. Despite this setback, gross margin jumped from 28.7% to 29.7%, partly offset by increased one-off expenses which rose from 91M EUR to 151M EUR. If that were not bad enough, Siemens' effective tax rate surged from 19.7% to 28.6%, though, that's a shift in overpaid taxes, since over the past nine months we see the opposite. In all, earnings per share rose 9.3%, which was much less than expected due to higher share count (as Siemens re-issued treasury shares in transaction with other owners).

(Source: Company results)

Siemens short-term outlook remained unchanged with a forecasted EPS of 7.7 to 8.0 EUR representing an EPS growth of 5% mid-point. Management continues to anticipate that orders will exceed revenue for a book-to-bill ratio above 1 for the full fiscal year with profit margin of 11.0% to 12.0% for its Industrial Business, excluding severance charges.

Together with a positive outlook, the debt burden is still manageable and doesn't affect the company's dividend policy.

(Source: Company results)

Siemens' business appears to be in good shape right now, which means it should generate tonnes of excess cash flow before any downward pressures from the next economic downturn. Despite the cash flow headwinds from investments into working capital, Siemens still generated 4.2B EUR of operating cash flows through the first nine months of 2018. On an annualized basis this leads to operating cash flows of 5.6B EUR, though, the investments into working capital items hid Siemens' real cash power.

(Source: Company results)

After deducting CapEx, neutralizing working capital changes and adjusting for interest paid and received, dividends paid to non controlling interests and income taxes, free cash flow totaled 4.8B EUR which shows Siemens' strong ability to generate cash. On an annual basis, that would result in 6.4B EUR of pure cash flow that can be used to pay for the dividends and buybacks. In addition, Siemens will certainly mitigate the effects from share re-issuances as it announced a buyback program of 3B EUR, and moreover, its share count has been declining so far:

Siemens' market capitalization is 85.1B EUR, which means that shares trade at a FCF yield of 7.5% if we extrapolate its figures over the past nine months. Note that Siemens' capital expenditures are not overly high (1.6B EUR) and above all, its investment capacity will remain steady despite the execution of its strategy towards 2020. As such, thanks to a relatively high free cash flow yield Siemens can finance attractive shareholder returns.

(Source: Company overview, author's work)

On top of that, it's good to see Siemens has not cut its dividend over the last ten years, despite the cyclicality of the business. The company has hiked its dividend by 2.8% earlier this year, the current dividend yield of 3.7% is quite attractive. Siemens' dividend payout ratio is low (~47% of this year's free cash flows), which makes the dividend very safe. At the same time, the relatively low payout ratio could lead to substantial dividend increases over the coming years.

So, the combination of a positive sales outlook, some operating leverage, and a declining share count could result in attractive free cash flow growth rates over the coming years. Through cash flow growth, juicy dividends, and a justifiably higher valuation, I believe Siemens should be able to deliver compelling total returns over the coming years. This positive outlook is based on short-term growth projections, as mentioned, there's even more: Siemens' strategy towards 2020 and beyond.

In order to support my bullish view on Siemens' long term growth perspectives, I'd like to elaborate on Siemens' renowned strategy towards 2020 on which the group recently provided an intermediary update. The key elements are:

First of all, let's check up on Siemens' progress over the last 5 years.

(Source: Siemens' presentation)

We can easily conclude that Siemens has kept a keen eye on stronger profitability through simplifying the business, and that's paying off. Its order backlog remains rock-solid primarily driven by higher demand for energy management as BP Energy expects total energy consumption will increase by 30% by 2035.

By far, Siemens has already achieved most of its intended financial targets:

According to Siemens' management, long-term windfalls remain intact. First, we should be fully aware of this evolution as the energy mix is shifting, driven by technological improvements and environmental concerns. There's little doubt Siemens will benefit from this trend namely the increased focus on wind energy and natural gas (Siemens Gamesa has an aggregate market share of 59%). Solar and wind generation will increase six-fold until 2050 strongly driven electrification. Market share of renewables is expected to triple during 2017-2035. In its latest report, Siemens reported an increase of 54% in orders for its Power and Gas markets, underpinning the underlying long-term strength of the business.

(Source: BP outlook)

According to a new market report published by Credence Research, Inc., “Building Energy Management System (BEMS) Market, the energy management systems (EMS) market is expected to expand at a CAGR of 14.3% from 2017 to 2025. Siemens' order intake for Energy Management remained robust during the first nine months of this year. Energy management systems are electronic devices that allow consumers to monitor, control, and manage their energy consumption optimally. The global building energy management systems market is currently in the growth stage of development and is expected to offer ample growth opportunities all participants across BEMS value chain. The basic need to save and optimize energy consumption is expected to drive building energy management system market demand. With the ever growing population, rise in urbanization, and rapid growth in industrialization, energy consumption has increased manifolds, widening the energy demand-supply gap. Furthermore, with fast depleting fossil fuels, electricity prices are further expected to hike in the coming years. In view of these futuristic challenges, governments across the globe are enforcing stringent energy standards, guidelines, incentives, and regulations to better manage demand-supply gap.

(Source: Informed Infrastructure)

Second, digitalization and automatization are growing rapidly. Just to give you some headlines, Siemens' digital business have grown from 2.9B EUR in 2014 to 6.5B EUR, and Mendix, which the group acquired for 0.6B EUR, is expected to generate a CAGR in its revenues of more than 40% (!), representing total revenues of 18B EUR by 2022. The icing on the cake: 90% of Mendix' revenues are recurring, which means that Siemens becomes less prone to economic momentum. Compared with Siemens' forecasted total sales of 83B EUR in 2018, its digital factory division will unlock great revenue growth, and with a profit margin of 21% that is already ahead of the 14-20% guidance, it could become the group's crown jewel. Actually, most people forget Siemens does expand its exposure to cloud offerings and digital solutions.

In all, Siemens says it's well-positioned to respond to global megatrends. The biggest game changers are both the demographic change as well as the digital revolution (Internet of Things). By 2050, more than 20% of the world's population will be over 60 years old, and this offers opportunities for the Healthineer business. Digitalization is also a ground-breaking opportunity for technology companies and for Siemens since 50B Internet of Things devices are forecast to be connected by 2020 compared with 9B in 2012 and 23B in 2016. Another element that is shaping Siemens' future is the urbanization. Whereas in 1950 70% of the world's population lived in rural regions, that figure is expected decline to 34% by 2050. In this sense, globalization will continue to gain traction with global trade increasing 4-fold by 2050.

The main question is why Siemens' shares have tanked almost 20% since the beginning of February despite a positive long-term outlook. When Siemens' reported industrial profit came in slightly ahead of expectations in the three months to the end of June, figures were overshadowed by the unveiling of its new Vision 2020+ strategy, which will trim its number of industrial businesses to three from five, giving them more autonomy. On top of that, analysts doubted whether the measures, designed to lift profitability by 2 percentage points from the company’s current 11-12 percent target, were ambitious enough. CEO Kaeser said:

Our aspiration is to create a company that is not only successful today, but well prepared for the decade to come,” said Kaeser, who is due to step down in 2021 from the group that began as a telegraph technology business in the 19th century. We will shift from a one-size-fits all set-up to a purpose-driven and market-focused set-up that can readily create and adapt to disruption and foster consolidation, the 61-year-old told a news conference in Munich. Kaeser, who has hived off Siemens’ wind power and train businesses into joint ventures and listed its medical technology unit on the stock exchange, said there was no plan to float any of the three new operating companies.

The decision to avoid a full break up of the company and continuing problems at the power and gas division - where profit halved - also weighed on the share price, although order intake significantly improved through the third-quarter. The choice of making each division more autonomous remains a good to move to focus and expand digitalization expertise, more individual responsibility of the individual business units, bundle of service activities and reduction of costs and bureaucracy. But it was disappointing that, compared to market expectations, Siemens did not give a clear figure what cost savings and efficiency savings Vision 2020+ will achieve, and nothing about more advanced portfolio restructuring measures, primarily at Power & Gas, has been addressed. In all, investors would like to see Siemens simplifying its businesses, which could unlock easily value. We saw the same thing with Siemens' rivals including Switzerland’s ABB (ABB) have come under pressure from shareholders to separate weaker businesses, while General Electric is spinning off its healthcare business and divesting its stake in oil-services firm Baker Hughes.

Most investors argue it's a bad idea to invest in industrial conglomerates such as Siemens, since the fall in revenues from wind power has been a combination of a sharp market turn, a wayward acquisition and self-inflicted wounds. Energy efficiency programs and renewable sources like solar and wind have both expanded and dropped in price faster than anticipated. And further advances in battery technology could make renewables consistently reliable rather than dependent on the weather. Those forces have prompted utility executives to hold off new orders for gas turbines after years of growth. We could definitely say the market moved much faster than anyone anticipated, but the market is now ignoring the opportunities in its Digital Factory.

It all started with GE's (GE) bid for the electricity generation and distribution operations of France’s Alstom. At first, the deal looked like a good one for GE. Alstom’s base of installed gas turbines, a source of service business, and its combined steam-and-gas generation technology would bode well for the American conglomerate. But integrating Alstom proved to be more difficult than expected, and the acquisition increased GE’s stake in the power business on the cusp of the market’s downturn. GE also said it was sharply writing down the value of its power business. The write-down of US$22 billion was all of the goodwill in the power business, and believe it or not, the largest part of the write-down was on the Alstom acquisition.

And since then, investors have been cautious on buying Siemens shares, though as could be seen in its third-quarter statements, order intake for its Power and Gas business strengthened with a book to bill rate of in excess of 1, indicating there's light at the end of the tunnel. Above all, thanks to a better revenue mix (Digital Factory), share of Power and Gas in Siemens' total revenues declined to 14.5% which is certainly manageable if order intakes would fall. Another reason for Siemens Gamesa’s underperformance is its exposure to the Indian market, which is in transition from a subsidized market to an auction-led one leading to more competition and pressure on wind turbine prices. But in the longer-term, all lights remain green. Global demand for wind is picking up. New installations for wind are likely to hit 58GW this year, up from 52GW last year. This is still far off the 2015 record when over 63GW were installed, but next year is likely to be a record year with most industry participants expecting over 70GW of new installations. The major growth driver is expected to be offshore wind in Europe as well as growing onshore demand in both North and South America. Wind is highly competitive with all other forms of power generation technology The use of highly competitive auctions for the rollout of renewables in many countries has had the impact of pushing wind costs lower which is excellent news for the customer. This year, for instance, we have seen record lows in pricing in India at $34.7/MWh as well as in Brazil and Mexico. Wind generation costs are set to continue to fall in the coming years Turbine manufacturers are increasingly focusing on digital technologies such as from RomoWind which allow the optimization of the output of a wind farm or even a portfolio of assets and thus increasing revenues while decreasing costs of operation and servicing needs. In addition, new manufacturing methods such 3D printing allow the possibility of low cost local production and thus a significant reduction in highly expensive logistics costs. All on all, there is further room for wind to become even cheaper in the coming years. Offshore wind has made major steps forward but will still remain niche market I must admit I was highly skeptical about the ability of manufactures and developers to bring down the cost of offshore wind but players like Siemens and Vattenfall have done a great job, and the result is that offshore wind will become an increasing part of the European energy mix. But I think it will only be in Europe. I don’t see Asia or the US rolling offshore wind in significant amounts. It is just too risky given the amount of hurricanes, tsunamis and volcanoes in these regions. Virtual PPAs are coming. We will probably see all offshore wind tenders in the future done in and around wholesale power prices with no subsidies. This of course makes the financing of these projects more difficult and more expensive, which is why we will likely see them financed by so called power purchase agreements whereby the electricity generator agrees to sell that power at agreed prices to a longterm buyer of that power. However, that power is not likely to be physically delivered to the customer but instead will be done so ‘virtually’ with the power that is generated sold into the wholesale market with any differences to the agreed prices met by payments from one party to another. These so called virtual PPAs will make it increasingly easy for Microsoft and Google to procure the 24/7 renewable power they want as well as giving utilities new revenue streams. Chinese are not coming We are still not seeing the Chinese manufacturers in Europe or any of the major global markets which is a reflection of the technological advantages that players like Vestas and Siemens-Gamesa have.

The biggest risk for Siemens is a destructive trade war that would harm the company, and that would cause a cooling economic growth, though, Siemens is exposed to a wide variety of industries, primarily within the traditional capital goods area. Nevertheless, management has already warned about a trade war. The business world has been unsettled by the probability that exports and imports could be made more expensive by additional costs imposed by countries looking to support their domestic economies, and this will put Siemens' investment strategy at risk. It's good to see Siemens hasn't seen a huge order intake slowdown yet, but its CEO added that the peak may be near.

I consider that the group's healthcare division (Siemens Healthineers) carries the lowest industry risk, closely followed by the Digital Factory, Process Industries and Drives, Building Technologies, and Power and Gas. In my opinion, the Energy Management, Wind Power and Renewables, and Mobility divisions have somewhat higher industry risk. The cyclical character of the Siemens' business could be eased by excellent industry, geographic, and customer diversification, leading market positions as a system provider rather than as a component supplier, and good long-term demand characteristics in most of its business lines. Siemens typically holds a top-three global position and is often the leading player in its markets. In countries where it operates, the group's performance is linked to GDP growth, but the long-term demand for Siemens' products and solutions typically exceeds economic growth. Actually, Siemens' process know-how and technological capabilities provide competitive advantages and should underpin performance over the longer term. Siemens' target to improve productivity by 3%-5% of aggregate functional costs every year, and the already achieved €1 billion of cost savings, are signs of management's commitment to increase the lead in the operating margins over its competitors.

I like to use a WACC of 7% for cyclical companies, as well as a moderate approach that - in Siemens' case - applies a growth rate equal to a GDP growth of 2.5%. This base case scenario doesn't suggest margin expansion, but as I guided, Siemens' current revenue mix offers opportunities to lift operating profitability. My DCF consists of the following aspects:

(Source: Author's calculations)

The calculated price target represents almost 25% upside potential, but I've kept margin expansion zero, whilst management and analyst community are expecting climbing EBIT margins due to a better revenue mix (higher contributions from the Digital Factory) and cost-efficiency programs by making each business more autonomous. However, as I've already mentioned, Siemens' management did not mention the precise amount of future cost-savings after it had completed the previous targeted amounts that were achieved ahead of expectations.

(Source: Marketscreener)

Siemens' business is cyclical, but its future looks bright as the German conglomerate has enough aces up its sleeve to achieve high consistent growth. Siemens has a highly diverse portfolio of leading global operations in industries with growth potential and strong entry barriers, and the company should be seen as a powerhouse with strong technological capabilities and ability to adjust the portfolio toward higher-earning business lines. Siemens' cost-savings plan has reached its targeted amount of 1B EUR, and this should support recovery of profitability. In the short-term, Siemens communicated it sees moderate revenue growth prospects, but a cooling economy may hinder short-term potential, though, in the long run, trends towards higher sustainability will support the company. The business has been shaken up, but now Siemens made a good move by intensifying its focus on divesting non-strategic and barely profitable divisions. The outlook over the coming years is positive, and its exceptional liquidity, with usually sound discretionary cash flow generation through the cycle, is providing very strong financial flexibility. The appealing dividend policy will continue to return a lot of cash to shareholders, making it a considerable buy for DGI.

My price target is €126-€130 for Siemens' main listing is in Germany where it's part of the DAX-30 or USD$143 - USD$147. My price targets are based on moderate growth rates, which outpaces downside risk of around 5% in my opinion.

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