Siemens CEO Joe Kaeser. Source: Time

Siemens (OTCPK:SIEGY) reported solid results for its fiscal Q2. The company reported revenue of EUR 20.94 billion and GAAP EPS of EUR 2.24. Revenue was up 4%, which I found surprising given the company’s past troubles. The company also announced it would spin off its Power And Gas unit amid declining demand for gas turbines. I had the following takeaways on the quarter.

Top-Line Growth Was Solid

The key to a good investment is whether the target can generate consistent revenue growth. Total revenue grew 4% Y/Y, up from low single-digit growth last quarter.

Siemens Q2 2019 revenueThe power generation business, which I would characterize as Power and Gas and Energy Management, represented a combined 28% of total revenue. Its revenue also fell by a combined 1% Y/Y. Power and Gas fell due to weak orders from prior periods. The segment is being disrupted by renewable energy. Siemens has to contend with General Electric (GE) and Mitsubishi (OTCPK:MHVYF) for the gas turbine orders that still remain; Meanwhile, Energy Management benefited from large orders in the transmission products business.

Digital Factory (16% of revenue), which provides industrial software, grew revenue by 4% Y/Y. This segment is expected to fuel future growth as certain industrial processes adopt automation. Siemens Healthineers (17% of revenue) saw its revenue grow in the high single-digits. The segment experienced out-sized growth in its imaging business and strong order growth in China. Healthcare could be key as it has the potential to be more recession-proof vis-a-vis the company’s other operating segments.

Operating Income Ticks Up

Siemens also experienced an increase in its EBITA to 11.4% from 11.04% in the year-earlier period. EBITA for Mobility fell 10% Y/Y; each of Siemens’ other operating segments grew EBITA. EBITA for Power and Gas grew 37% on strong contribution from its service business. The unit’s EBITA margin was 6%, up 200 basis from the year-earlier period. This could be difficult to sustain as Power and Gas continues to be disrupted by alternative energy sources.

Siemens Healthineers and Power Industries and Drives grew EBITA by 16% and 33%, respectively. Healthcare was aided by increases in imaging and advanced therapies. Operational improvements at Power Industries and Drives spurred EBITA growth during the quarter. Margin improvement was a pleasant surprise, but can the company keep it up long term?

Spin-Off Of Power and Gas

Management’s decision to spin off Power and Gas is a bold stroke and has the potential to be transformational. The segment has been in the doldrums for some time now. Its revenue and operating income will likely deteriorate over time. It appears management is shuttering a business that is out of favor. Part of the reason Power and Gas is out of favor is because it is being disrupted by renewable energy.

Secondly, if the economy has peaked then demand for gas turbines could fall anyway due to a decline in industrial activity. Siemens Healthineers could be recession-proof; however, the company’s other segments could face the same recessionary headwinds faced by Power and Gas. Will management shutter other segments that experience revenue and margin erosion? If that is the case, then maybe Siemens no longer wants to be an industrial business.

Lastly, the devil is in the details pursuant to a spin-off. Siemens has debt of EUR 36 billion. How much of its debt will be transferred to Power and Gas? How much debt can the spin-off realistically service given the diminution in its operations? Siemens’ shares could spike initially on a spin-off. However, over the long term, there is no guarantee the sum-of-the-parts will exceed the company’s enterprise value prior to the spin-off. Such financial engineering will garner major media attention as its success (or lack of success) could have implications for General Electric’s Power segment.

Conclusion

Financial engineering may not help Siemens long term. The U.S. is having trouble spurring inflation despite trillions in money-printing from the Fed. That does not bode well for industrial businesses. I do not believe a spin-off of Power and Gas will solve the company’s long-term problems. SIEGY is down by double-digits Y/Y. It will likely fall further on the diminution of Power and Gas or a stagnant global economy.

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Disclosure: I am/we are short GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-05-14