German industrial conglomerate Siemens (NYSE:SI) has gotten a great deal more serious about streamlining its operations around those businesses and markets where management believes they have a long-term edge and appealing growth potential. With that, Nokia Siemens Networks is gone, Osram is about to be spun off, and other businesses like water treatment, baggage handling, and low voltage could be on the way out.
Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.
Siemens actually held pretty good share in these businesses, so the streamlining process doesn't really change the fact that Siemens is typically a leader in its chosen businesses. What still has to be proven is whether the company can significantly improve its execution and margins. Relative to many other global industrial conglomerates, Siemens has an unspectacular track record in margins, returns on capital, and free cash flow generation, and management needs to convince the Street that it can do better before the shares will garner a better multiple.
NSN And Osram On The Way Out, Is There More To Follow?
The question(s) of what Siemens would do about Nokia Siemens Networks and Osram have loomed over the company for some time, but investors have clarity on both now.
Osram, Siemens' lighting business, will list on July 8, with shareholders getting one Osram share for every 10 shares of Siemens that they own. Siemens will still hold a 17% stake, but Osram will otherwise be free to pursue its own path as the second-largest lighting company in the world behind Philips (NYSE:PHG).
Siemens and Nokia (NYSE:NOK) also recently announced that they'd reached an agreement whereby Siemens will sell its 50% stake in the Nokia Siemens Networks joint venture to Nokia for 1.7 billion euros. While it's hard to say that Siemens got full value for this asset, “full value” was always an ambitious goal anyway and this was likely the best option available that Nokia would also find acceptable.
With these two businesses gone, attention now turns to what Siemens management will do with its water treatment, postal automation, and baggage handling businesses – businesses which collectively contribute about 2.5 billion euros in annual revenue. I don't believe selling the water treatment business will be difficult, but Siemens may also be interested in getting rid of its Low Voltage operations.
SEE: A Primer On Investing In The Tech Industry
Siemens Has Good Share In Attractive Markets, But Execution Is Important
Just looking at what Siemens does, there's no reason to believe this business cannot be successful over the long-term. Along with General Electric (NYSE:GE), Siemens is a leader in both fossil fuel power (steam and gas turbines) and wind power. Siemens is also a significant player in automation alongside ABB (NYSE:ABB), Emerson (NYSE:EMR), and Honeywell (NYSE:HON), a leader in healthcare imaging and diagnostics, and a leader in markets like building environmental controls and intracity trains.
The question is whether Siemens can improve its execution and hit its goals for restructuring and cost improvements. Relative to the likes of ABB, Schneider (OTC:SBGSY), GE, and other peer conglomerates, Siemens has had higher labor/employee costs in recent years and unimpressive margins. To that end, I don't necessarily believe that transactions like the Osram spin-off will be “cure-alls”, and I think Siemens management is going to have to deliver actual reported margin improvement before the Street buys into the idea that better margins/returns/cash generation are attainable.
Is it possible? Yes, I believe so. ABB has significantly improved its cost base in recent years and I don't think the two companies are so different that Siemens investors shouldn't take encouragement from what ABB accomplished. That said, fixing European industrial businesses with cost issues is not easy (as Colfax (NYSE:CFX) is learning) and execution risk is significant.
SEE: 5 Must-Have Metrics For Value Investors
The Bottom Line
I'm not sure there's a better correlation in industrial stocks than that between stock price performance and margin improvement. If Siemens management can lift operating margins to the low-to-mid teens levels of peers like ABB, Emerson, and Schneider, these shares could do very well over the next couple of years. At the same time, though, the company will have to deal with strong competition from the likes of GE and ABB, as well as emerging Chinese rivals in several of the company's core markets.
As I'm only willing to give Siemens partial credit today, the shares don't appear to be a tremendous bargain. I'm looking for Siemens to grow its top line at a roughly 3% rate, lower than I project for both ABB and GE, and for free cash flow margin to improve to just under 10% over the next decade. With that, I see fair value at about $107. If I give Siemens the same sort of growth and free cash generation expectations as I do for ABB and GE, the target jumps into the high $130s, so there is definite upside here if Siemens gives cause for optimism on its ability to execute.
At the time of writing, Stephen D. Simpson owned shares of ABB.
Investing BasicsWe all have biases. The key to better investing is to identify those biases and create rules to minimize their effect.
Investing BasicsIrrespective of age, sex and other such factors, no normal investor wants an unsuitable investment. How much people really understand about their investments depends on various factors, including ...
Investing BasicsHere are 10 financial services books that are informative and useful.
InvestingWhile stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
ProfessionalsObtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
InvestingThere are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
EconomicsAfter the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
Stock AnalysisLearn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
Stock AnalysisA summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
Technical IndicatorsLearn one of the most common methods of finding support and resistance levels.
When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>