Europe Won't Kill Siemens

By Stephen D. Simpson, CFA | January 11, 2012 AAA

It's not easy to garner much investor interest in European companies these days, and that's especially true in the industrial/capital goods sector. While it is true that Siemens (NYSE:SI) gets a significant amount of its revenue from Europe, it's also true that this is a globally diversified conglomerate, with numerous opportunities to improve both top line growth and margins. With the CFO of Siemens recently admitting that the company's recent guidance for 2012 may be challenging to achieve, long-term investors may want to keep a close eye on these shares. (For more, see Earning Forecasts: A Primer.)
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"Challenging" Doesn't Mean Impossible
Investors are already inclined towards a "shoot first" mindset when it comes to European capital goods companies, certain that the ongoing sovereign debt/banking malaise has to kill the economy there sooner or later. Siemens did itself no favors when the CFO Joe Kaeser admitted in a Wall Street Journal interview that the company's guidance (which it gave in November) was "very ambitious" and that conditions had gotten worse.

That's alarming. Even though the CFO did add some nuance to those comments in explaining that the company expected a weaker first half and a strong second half rebound, that's not going to be the story that most investors take away.

Short Term Vs. Long Term
Even if Siemens is in for a tricky 2012, investors may yet want to dive into this name and add it to their watch list. Siemens is not only a huge company operating in diverse markets, but it is also generally one of the top three companies in every market it addresses.

The company's industrial division continues to do well on the basis of factory automation, and Siemens only currently addresses about one-third of the potential market for process automation (businesses that operate continuous processes, like beverage companies or pulp/paper). Moreover, while rivals like ABB (NYSE:ABB), Emerson Electric (NYSE:EMR) and Schneider Electric (OTCBB:SBGSY) have been building up their own offerings, Siemens has plenty of greenfield growth prospects.

Energy could be a more challenging market in the short term. There's still activity in natural gas-fired generation, but coal and nuclear are dormant and green power has withered in the wake of major government funding cutbacks.

Healthcare is an area where Siemens needs to get better. The company has been losing share to rivals like Varian Medical Systems (NYSE:VAR), in radiation oncology, and sits in the number three slot in diagnostics, but with little momentum. Siemens is weak in the growth areas of diagnostics (like molecular diagnostics) and may be supplanted by Danaher (NYSE:DHR), before long.

Time to Improve Internal Ops
Siemens has a relatively clean balance sheet, good cash generation and a willingness to do deals to shore up weak points. That may be the company's best opportunity to fix its healthcare operations and it should also be a significant part of maintaining market leverage in its industrial, power and infrastructure markets.

In the meantime, there are other operating challenges for management to tackle. Siemens is relatively under-exposed to China, although not as bad as General Electric (NYSE:GE). At its roughly 3% exposure to China, Siemens does significantly lag ABB, Emerso and Schneider in a market where automation, infrastructure, power and healthcare are major growth opportunities.

Siemens also could do better on margins. Siemens has long had relatively high employee costs, typically spending about 4% more of its revenue on this item than its European capital goods peers. While the nature of the respective businesses can make comparisons misleading (Siemens' products don't necessarily lend themselves to the same cost structure as other European companies, like Volvo (OTCBB:VOLVY) or MAN), better operating performance is still a worthy goal here.

The Bottom Line
Unless the bottom falls out on the global economy in 2012/2013, Siemens shares just look too cheap. Granted, they don't seem as cheap as ABB, but Siemens is a more diversified business with incrementally better industry exposures.

The big key to Siemens realizing that potential, though, is in improving its cash flow generation. If Siemens cannot improve its free cash flow margin over historical trends, the stock is arguably over-priced. Recent developments have been encouraging, though, and if Siemens management delivers on the company's potential, long-term shareholders will be pleased. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)


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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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