GCTAY - Siemens Energy: No Quick Turnaround For The Renewable Business In Sight Sell

Summary

• More bad news from the Siemens Gamesa subsidiary of Siemens Energy AG.
• Siemens Energy reduced profit guidance and now expects a loss similar to last fiscal year.
• Siemens Energy overpaid to get full control of Gamesa.
• The Siemens Gamesa timeline for a turnaround stretches until 2025.
• Downgrade from Hold to Sell as the stock is up almost 80% since October.

Investment thesis

(Note: all amounts in the article are in EUR. At the current exchange rate this is almost equivalent to USD.)

In a recent Seeking Alpha article , I made the argument that Siemens Energy ([[SMEGF]], [[SMNEY]]) is in an outstanding position to benefit from the ongoing energy transition, but is not a Buy because it is suffering from chronically low profit margins and is dragged down by problems in its Siemens Gamesa ([[GCTAF]], [[GCTAY]]) subsidiary.

On February 7, the company announced Q1 results (Siemens Energy's fiscal year starts in October). Preliminary numbers had already been released mid of January, maybe to prepare the market for the bad news. The numbers were certainly not encouraging. Repeating the ugly surprises of the past year, there is again unexpected bad news from Siemens Gamesa, and Siemens Energy had to reduce its earnings forecast for the current fiscal year. Management expects to lose money this year again. The losses in the first quarter of the fiscal year actually doubled YoY instead of reducing.

To me, it looks like Siemens Energy overpaid to get full control of Gamesa. It paid 3.15bn euro to acquire a 25.6 percent stake, valuing the company at over 12bn euro. This is almost 90 percent of the current Siemens Energy market capitalization, which stands at 13.8bn, and in addition Siemens Gamesa carries a net debt of 1.9bn euro. This is a lot of money for a company that lost nearly 1bn last fiscal year (October 2021 to September 2022) and another 760mn in the first quarter of the current fiscal year.

More bad news from Siemens Gamesa

The troubles at Siemens Gamesa regularly masked progress in other Siemens Energy businesses, and this pattern continued in the last quarter.

Once again the business with renewable energies is responsible for the problems, while the other sectors were doing slightly better than expected. Siemens Gamesa reported an operating loss before special items of EUR 760 million for the first quarter of its 2022/2023 fiscal year (also ending September 30) due to quality problems. An inventory of the existing installed base resulted in higher cost for guarantees and maintenance service due to unexpectedly (!) high failure rates for certain components. The quarter ended with a net loss of 884mn.

Siemens Gamesa has been in crisis for years. Again and again, the wind power group surprised its parent company with forecasts, revised downwards and new burdens. In the past fiscal year, Siemens Gamesa had made a net loss of almost one billion euros. To be able to take better action, Siemens Energy decided to fully integrate the subsidiary. With the help of a multi-billion takeover bid, Siemens Energy secured 93 percent of the shares and will take the company private. But as I have said in my previous article, I do not expect a quick turn-around from Gamesa. The Q1 results unfortunately confirmed this view.

Gamesa turnaround plan is not ambitious

In the results presentation for the previous quarter (probably the last one as a public company), the new Gamesa CEO Jochen Eickholt said that new orders signed have much greater protection against volatility in product costs and logistics disruptions than those signed in the past. Eickholt was sent from Siemens Energy last year to manage the manage a turn-around at Gamesa.

Positives are a new organizational structure within Siemens Gamesa, effective from January 1, 2023. The new structure integrates onshore and offshore manufacturing and technology activities. Siemens Energy says that this will result in cost and quality improvements. Progress has also been made with the restructuring of the workforce, and a pre-agreement has been reached with employee representatives in Spain. With the new organizational setup, Siemens Gamesa should also see cost synergies through the integration with Siemens Energy.

The company is not very transparent though when we will see those improvements in the numbers. The "official" Siemens Gamesa timeline for a turnaround is 2025. This does not look ambitious to me.

It is not unusual for Gamesa, but also for other companies in the wind industry, to sign long running contracts (10 years seems to be something like a sweet spot) for installations including maintenance and service. You can see this in the relation between annual revenue, order intake and order backlog. Last fiscal year , Gamesa had annual revenue of 10.2bn an order book of 32.5bn. Of the total installed capacity of 118 GW, 79 GW were under maintenance. (Siemens Gamesa does maintenance and service for installations from other manufacturers too, but does not break this out in numbers. I assume this is a quite small part.)

I guess you can have an optimistic or pessimistic approach here. The optimistic approach says that things have gone wrong now for so many times with Siemens Gamesa, eventually it must go right, especially as Siemens Energy is taking control now. The pessimistic approach says that if a company has failed so many times, it will more likely fail again. I am in the negative camp after the company has disappointed over and over. Sure, things can work out. My understanding is that the provisions are for future maintenance and service; maybe the new CEO wanted to clean-up and get all negatives out on the table so that things will look better going forward. But I do not think there is enough evidence yet and holding or buying shares is to some extent based on hope.

Siemens Energy overpaid for Siemens Gamesa

Another concern for me is that I think Siemens Energy overpaid for Siemens Gamesa - and I mean by a lot. The company paid 3.15bn euro to acquire a 25.6 percent stake, valuing the Gamesa at over 12bn euro. This is around 1.5x sales (based on the recent Q1 quarter) and almost 90 percent of the current Siemens Energy market capitalisation which stands at 13.8bn, for a business that lost almost 1bn last fiscal year (October 2021 to September 2022) ) and another 760mn last quarter (Q4 2022). In addition, Siemens Gamesa also carries a net debt of 1.9bn euro.

Siemens Energy will either carry a significant goodwill on its balance sheet or, if things do not work out, write down billions of euro over the next years. It is notable that Siemens Gamesa itself had around 4.6bn euro goodwill on the balance sheet per December 31, 2022 .

In total Siemens Energy will need to spend up to 3.7bn euro (in cash) on the transaction. The CFO said that up to 2.5bn will be funded through new equity or equity-like instruments. The current Siemens Energy market cap is around 13bn. Therefore shareholders can expect a comparable dilution.

Other business segments did better

The general reception from analysts to the Q1 numbers was that, while things are bad with Gamesa, the rest of Siemens Energy has been doing quite well. Accordingly, out of the 11 analyst covering the stock ( to my knowledge), 7 are positive, 2 neutral and only 1 is negative.

There were notable operational and profit improvements at the three other segments - Gas Services, Grid Technologies, and Transformation of Industry. I especially like that all three segments increased their profit margins, as Siemens Energy has been plagued by low profit margins for years. Across all three segments the profit margin increased from 5.4% to 9.1% YoY.

Low profit margins were the reason why Siemens ( OTCPK:SMAWF ) ( OTCPK:SIEGY ) spun off the energy business in the first place. Siemens still holds a 35% percent stake, but has made it clear that it wants to exit completely if it has an opportunity to sell.

Impact on Siemens Energy

Siemens Energy reduced its earnings forecast for the current fiscal year. Instead of a significant loss reduction, a net loss at the previous year's level (where it lost 647mn euro) is now expected.

Driven by the negative development at Gamesa, Siemens Energy reported a net loss of 598mn million euros after the recent quarter, reflecting a negative margin of -5.4% (analyst consensus was -0.5%). The net loss in Q1 FY 2022/2023 was 246m, so the loss more than doubled. EPS was -0.60. Siemens Energy has already cancelled the dividend for the last fiscal year. It looks like there will be no dividend for the current year either.

There were some positive surprises too: Revenue came in at 7.06bn (analyst consensus was 6.6mmn) and order intake was 12.72bn (analyst consensus: 9.45bn). Pre-tax free cash flow ("FCF") was -58mn, and the company now expects FCF to be positive for the fiscal year. Previous guidance was for FCF to be in a negative range of low- to mid-triple-digit millions. The change is due to advance payments from customers related to new orders, so maybe not permanent.

Conclusion - Sell recommendation

My recommendation is Sell Siemens Energy AG, a downgrade from Hold in my previous article.

Siemens Energy is up almost 80 percent since the low near 10 euros in October 2022. Investors should realize the gains. The risk/reward ratio is not good (in my opinion) for hanging on now to see whether a Siemens Gamesa turnaround will come over the next one or two years. There is a fair chance that a lower entry point will come again.

I realize that this is not in line with the general analyst thinking. So please be diligent and make your own opinion. A recent (December last year) article from Wolf Report on Seeking Alpha is also more positive regarding Siemens Energy. It is probably a good idea to check this one out too before you make up your mind.

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