By Stephen D. Simpson, CFA
In a market already looking for trouble in Europe, Siemens (SI) managed to step on quite a few different landmines with its fiscal first-quarter earnings. Although management continues to expect a second-half rebound in Europe, there are more than enough questions raised by this report to give investors something to chew on for a while.
Disappointing Results From Top To Bottom
Siemens reported 3% organic sales growth for the quarter, missing the average analyst guess by about 3% (landmine #1). Energy was the leader in reported sales (up about 8%), while industrial sales rose about 5%, healthcare climbed less than 1%, and infrastructure sales fell more than 3%.
Profitability was an absolute mess. Taking reported segment/operating profits at face value, Siemens missed expectations by about 20%. Even backing out numerous charges and items only shaved the disappointment to about 10%-13% relative to expectations. Clearly, then, margins are becoming a cause for concern (landmine #2).
Orders were also disappointing; book-to-bill was still well above one, but organic orders fell 4% (landmine #3). Orders were quite solid in automation, but energy was weak on tough year-ago comps and diminishing orders in renewables. Healthcare orders were surprisingly strong - they were only up a few percentage points, but that is still better than the results from General Electric (GE) and Philips (PHG).
Guidance And Cash Flow A Concern
With the first quarter coming in light on sales and with margins quite weak, it's not a huge surprise that cash flow was weak. Still, it was quite a bit weaker than it should have been (landmine #4). Judging a company on one quarter's cash flow is tricky, but it seems reasonable to lower expectations for 2012 and perhaps consider a longer runway for the expected improvement in free cash flow conversion.
Guidance will be another concern to take from the quarter (landmine #5). Management reiterated its expectation that second-half results would be stronger, but there seemed to be quite a bit more hedging and a lot of "body language" that suggested that the outlook was slipping. To the point, management highlighted that the U.S. was the only place the company saw sales and order growth.
Plenty Of Siemens Implications
Being involved in so many businesses means that Siemens regularly provides a lot of potential signals for other companies. Sluggish performance in transmission is not great news for ABB, nor is softness in emerging markets, but relative strength in automation is encouraging for both ABB and Emerson (EMR). Weakness in Siemens' renewables business suggests that investors in solar and wind power companies had better be braced for more difficulties, as this market continues to soften.
Weakness in the infrastructure business certainly bears watching as well. Not only are companies like Alstom, GE, Invensys (OTCQX:IVNYY), and Schneider (GM:SBGSF) more directly exposed, but there's a an entire foodchain of companies like Eaton (ETN), Illinois Tool Works (ITW), and Honeywell (HON) that feed into many of these markets.
The Bottom Line
Siemens is an underrated industrial conglomerate, but investors probably want to think about names like ABB or Atlas Copco (GM:ATLKF), as better trades today. Simply put, these companies have smaller relative exposures to the weakest areas of Europe and better exposure to healthier markets.
That said, there are a lot of factors still in play for Siemens as a long-term name. Siemens gets about one-third of its revenue from emerging markets, even though China is less than a 10% contributor. Siemens also has relatively high employee expenses and reducing these costs is an explicit long-term goal of management; success here will drive better operating leverage.
With Siemens triggering so many investor landmines this quarter, it will not be altogether surprising if the stock trades lower in the short term. Even with lower expectations, though, the stock is undervalued enough to merit a spot on a watch list. Forward free cash flow growth of 10% may sound aggressive for a company of this size and maturity, but Siemens has quite a bit of "slack" to take up in its operations and only partial success on that mission may be well enough to drive double-digit growth over the decade.