Stagnation fears

Siemens’ Moment of Truth

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Joe Kaeser is facing an uncomfortable year.
  • Why it matters

    Why it matters

    Despite Mr. Kaeser’s massive restructuring plan, only half of Siemens’ eight divisions reached their margin goals in 2015. Alarm bells are now ringing among shareholders.

  • Facts

    Facts

    • Siemen’s net profit increased by 34 percent to €7.4 billion ($8 billion) in 2015, but mainly becasue of asset sales.
    • Adjusted sales increased six percent in 2015.
    • Siemens increased its dividend from €3.30 to €3.50.
  • Audio

    Audio

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It was the first really big purchase for Joe Kaeser as Siemens’ boss: In September 2014, the firm acquired Dresser Rand, American specialists for oil-producing equipment. Currently Mr. Kaeser, who has been in post for two years, can’t be too happy with the $7.6 billion (€7 billion) acquisition, because the business of oil production equipment is suffering greatly due to the decline in oil prices.

The market leader, Schlumberger, is cutting 10,000 jobs, while rival General Electric reported a decline in profits in the fourth quarter of 2015. According to analyst estimates, Siemens also felt the oil price decline in the past three months.

Already in the 2014/15 financial year (to the end of September), profits at the Munich-based company decreased in the power plant sector and in the “process industry and drives” division. These divisions represent many of Siemens’ customers in the oil industry. The expensive acquisition of Dresser-Rand increased Siemens’ dependence on the oil sector even further. The volume of direct trades increased from 8 percent to about 11 percent as a result, according to a Handelsblatt balance sheet analysis.

The analysis coincided with rumours that Siemens is about to buy U.S. software firm CD-adapco for close to $1 billion (€9.2 billion) in cash. Sources told Reuters that the engine-simulation software produced by the York-based company would complement Siemens work in the area. The German giant has been criticized for having too few in-house software engineers. Carmaker Renault has used CD-adapco software to improve its Formual 1 racing engines.

“An improvement over competitors such as GE, ABB and Schneider Electric is the least of what we expect in the coming fiscal year.”

Christoph Niesel, Union Investment

The 2014/15 balance sheet shows a picture of stagnation at Siemens and now investors want to see growth. The grace period is over for Mr. Kaeser. According to analysts, he’s started off well, despite the oil price issue. The figures for the first quarter, which he will submit to the shareholders on Tuesday, are predicted to turn out well. Progress in other areas offset the weak demand from the oil sector.

The balance sheet for 2016 is expected to be presented by Mr. Kaeser in the new headquarters in Munich. By then the company’s internal overhaul should be largely completed. Mr. Kaeser had demanded a lot of patience of his investors. Although he managed the restructuring without major slumps or billions in depreciation, the numbers aren’t much better than the results of his hapless predecessor Peter Löscher. “But we are well on our way,” Mr. Kaeser promised.

In 2016, the investors should be able to measure Mr. Kaeser’s performance against his promises: The overhaul should show its first concrete results in the form of growth. Anything else is likely to disappoint investors. “An improvement over competitors such as GE, ABB and Schneider Electric is the least of what we expect in the coming fiscal year,” Union Investment fund manager Christoph Niesel, a representative of many investors, said.

 

Siemens Key Figures 1-01

 

For Mr. Kaeser the moment of truth will come in late fall of 2016. He calls 2016 the “year of optimization.” The 2014/15 fiscal year was dubbed a “year of operational consolidation” by Mr. Kaeser. One might also have described the year with the word “stagnation.” Siemens managed to achieve the not very ambitious goal of an operationally stable turnover. If one includes currency effects and acquisitions, group sales increased by 6 percent to €75.6 billion.

Siemens has had weak economic growth for years; little changed in 2015. Some operations ran properly, others poorly. Of the eight industrial divisions, half were able to increase revenues while the rest saw losses on a comparable basis.

The biggest problem child is the power plant division “Power and Gas.” Adjusted revenue fell by 11 percent to €13.2 billion. Order intake also declined slightly. So it seems that a quick turnaround is not in sight. Siemens made no great leaps in any division. The biggest increase was a growth of 5 percent in energy management. Medical technology and building technology segments grew, but as a whole, the company saw more bad news than good.

Mr. Kaeser now wants to switch to growth as part of the company’s Vision 2020. That’s gone badly before. With Mr. Kaeser as chief financial officer, Mr. Löscher had successfully reduced bureaucracy and increased profitability. At the height of his tenure the former chief reached margins on par with archrival General Electric. But then Mr. Löscher switched to growth and built up massively in sales and distribution, among other things. As a result, Siemens invested right into the economic downturn. Margins crumbled and the promised growth failed to materialize. After several profit warnings Mr. Löscher had to go.

Mr. Kaeser wants to fix the weak growth with investment in research and development, with leaner structures and improved customer access. But so far these initiatives have only impacted cost with spending on research and sales up sharply.

 

Siemens Order Intakes-01

 

The Siemens’ chief knows that he must not lose sight of profitability. To date, he has held to his forecasts, even if they weren’t overly ambitious. The aim of increasing the net profit by at least 15 percent was easily achieved – it rose by 34 percent to €7.4 billion. But Mr. Kaeser only achieved this by selling the conglomerate’s stake in Bosch Siemens household appliances and the sale of a hearing aids division. This was also the main reason that the return on investment soared upwards from 17.2 percent to 19.6 percent.

Adjusted for these one-off revenues, 2015 was the picture of stagnation. The operating profit of Siemens’ core industrial business grew only 1 percent to €7.75 billion. The profit margin of the industrial business was 10.1 percent, down from the previous year’s figure of 10.6 percent. Mr. Kaeser had promised a value of 10 to 11 percent – and did his utmost to achieve this goal. He called for stricter cost discipline, cutting back even on small things, according to some inside the company. For nine months the rate of return was still in the single digits. In the fourth quarter of the fiscal year, Siemens managed 10.9 percent.

The company’s eight divisions showed a very mixed performance. Only four were on target and reached the predefined margin ranges: Medical, digital factory, railways and building technology. In the fields of power plant equipment, wind and renewable energy, process industry and drives as well as in energy management, profitability targets were missed.

Mr. Kaeser proved he had a knack for implementing an austerity program. In fiscal 2015, costs were reduced by €400 million – twice as much as planned. From a financial perspective, Siemens is doing well, since so much effort was put into improving the operational working capital in some divisions and the reduction of inventory, particularly in the fourth quarter. Siemens still managed a free cash flow of €4.7 billion for the full year, despite a negative value in the first half of the year.

Free cash flow is one of the key performance indicators for Siemens. Free cash flow indicates how much cash a company moved from its operating business in order – after deduction of the investment – to service its debts and be able to distribute money to its shareholders. €4.7 billion should be enough for Siemens to do both. Net debt, however, has risen significantly because of acquisitions. But the ratio of the debt in the industrial sector to the operating profit still lies in Siemens’ desired range of between zero and one.

Siemens’ free cash flow, however, is trending downwards. In 2013 the company generated more than €5.3 billion in cash, in 2014 it was €5.2 billion. The Siemens boss puts more emphasis on shareholders’ interests. The dividend payment was increased from €3.30 to €3.50. The current dividend yield of around 4.4 percent is impressive – Siemens is in the top third of DAX companies for this metric.

It’s still unclear whether Siemen’s fourth quarter progress is sustainable – or just a brief reprieve. Mr. Kaeser promises further improvements in earnings. He can’t rely on favorable economic conditions outside the company. The first half of the year has seen little economic tailwind. Once again he is promising a return of 10 percent to 11 percent in industrial business.

He’s hoping it won’t be quite so close as it was in 2015. “We expect that the margin will expand with the growth,” said Mr. Kaeser. Here all departments are “on or within” the margins. The overhaul should finally show an effect in the numbers. For Mr. Kaeser it will be a moment of truth.

 

Axel Höpner is bureau chief in Handelsblatt’s Munich office. Bert-Friedrich Fröndhoff leads a team of reporters covering the chemicals, healthcare and services industries. To contact the authors: hoepner@handelsblatt.com and froendhoff@handelsblatt.com

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