GE Part III: Energy Management Segment Analysis

| About: General Electric (GE)
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Summary

This article offers up a deep analysis into the Energy Management segment of General Electric.

GE's energy management segment is compared to ABB and parts of EMR and JCI.

This analysis derives a value of $4.28 billion for the energy management segment of GE.

GE's energy management segment will be adversely affected by the drop in price of crude oil.

Company Background

General Electric (NYSE:GE) is a massive corporation that is more or less eight individual companies operating under one roof. In Part I of this series, I investigated the Power and Water segment of GE. In Part II of this series I investigated the Oil and Gas segment of GE. Please take a look at Part I for more background and overall breakdown of GE.

Company Breakdown

This is Part Three of diving deeper into each of the eight individual operating units of GE. One method of analysis is to look at each segment individually. The analysis in this article will focus on revenues, profits, growth and opportunities for the energy management segment. All GE segment revenue and profit numbers for 2010 through 2013 were collected from the 2013 annual report. Data for 2014 was collected from the 2014 third-quarter report.

GE's Energy Management

According to GE the energy management segment is a unit using technology for management, conversion, delivery and optimization of electrical power across industrial applications. In 2013, the energy management segment had revenues of $7.6 billion and profits of $110 million. Compared to 2012, revenues increased 2.12% and profits decreased 16%. The increase in revenue from 2012 to 2013 was primarily driven through acquisition, increased volume and increased prices. The profit decrease was a result of a stronger U.S dollar and lower productivity. Profit margin decreased from 1.8% in 2012 to 1.5% in 2013. The small and shrinking profit margin is a little alarming to an investor as this segment of GE appears to supply minimal profit to the overall company. I offer up some suggestions later as to why GE is continuing to invest in this low margin segment.

Estimating future revenue for each segment can easily be accomplished as GE outlines their order backlog for each segment. GE reported increased orders for the energy management segment in 2013 of $8.8 billion. The segment's backlog stood at $4.6 billion at the end of 2013. The $4.6 billion breaks down to $3.6 billion in equipment and $1.0 billion in services. The backlog at the close of 2012 stood at $3.2 billion for equipment and $0.6 billion for services. Total backlog increased 21.1% from 2012 to 2013, with a 12.5% increase in equipment and a 66.7% increase in the services backlog.

Through the first nine months of 2014, the energy management segment generated revenues of $5.341 billion and profits of $133 million. Revenues for 2014 decreased 3.9% while profits more than doubled, increasing 107.8% through the first nine months. The chart below shows the growth through the first three quarters of 2013 compared to the first three quarters of 2014. One area I like to keep an eye on is the profit margin, from the information below, the profit margin more than doubled. This increase in profit margin is nice to see as the profit margin for this segment is alarmingly low.

Q3 YTD 2013

Q3 YTD 2014

Growth

Revenue

5.557

5.341

-3.9%

Profit

0.064

0.133

107.8%

Profit Margin

1.2%

2.5%

116.2%

In 2014, this segment of GE did not see any acquisitions, so any revenue changes were organic. In 2013, the energy management segment benefited from $1.0 billion in new revenue through acquisition. The spike in profit margin could be related to integration of the newly acquired business. Additionally, the spike in profit margin could be a result of operational savings by combining like businesses and streamlining costs. Going further, GE noted in their 2014 third quarter report that overall backlog increased 21% year over year and services climbed 10%. GE does not break down the backlog to operating segments quarterly, only offering this information in the annual reports. Below is a chart showing revenue, profit and profit margin from 2010 through 2013, all values are in billions.

2010

2011

2012

2013

Δ '10-'11

Δ '11-'12

Δ '12-'13

Ave '10-'13

Revenue

5.161

6.422

7.412

7.569

24.43%

15.42%

2.12%

13.99%

Profit

0.156

0.078

0.131

0.11

-50.00%

67.95%

-16.03%

0.64%

Profit Margin

3.0%

1.2%

1.8%

1.5%

-59.82%

45.52%

-17.77%

-10.69%

Similar to previous segments, GE has grown the energy management segment through acquisition. These acquisitions include Lineage Power Holdings and Converteam. These acquisitions have established GE as a leader in the energy management support industry. While this segment of GE is not generating a significant profit currently, I view this as some of the secret sauce which makes GE great. The energy management segment complements the rest of GE extremely well and can bring in additional business. Working with one company versus multiple companies is often preferable for customers. This can lead to cross selling for other segments within GE and creates a sticky experience for customers, once you enter the web of GE, it is hard to get out.

The Competition

Let's take a look at how GE compares to the competition. The three competitors I selected were ABB (NYSE:ABB), the network power segment of EMR (NYSE:EMR) and the power solutions segment of Johnson Controls (NYSE:JCI). In order to get a more pure evaluation, I had to use segments of both EMR and JCI. These companies offer different components of energy management, but are close competitors the energy management segment of GE. All of the values below were gathered from the company's 2013 annual reports and revenue/profit numbers are in billions.

GE Energy Management

2011

2012

2013

Δ '11-'12

Δ '12-'13

Ave '11-'13

Revenue

6.422

7.412

7.569

15.42%

2.12%

8.77%

Profit

0.078

0.131

0.11

67.95%

-16.03%

25.96%

Profit Margin

1.2%

1.8%

1.5%

45.52%

-17.77%

13.87%

ABB

2011

2012

2013

Δ '11-'12

Δ '12-'13

Ave '11-'13

Revenue

37.99

40.232

38.896

5.90%

-3.32%

1.29%

Profit

3.168

2.704

2.824

-14.65%

4.44%

-5.10%

Profit Margin

8.3%

6.7%

7.3%

-19.40%

8.03%

-5.69%

EMR Network Power

2011

2012

2013

Δ '11-'12

Δ '12-'13

Ave '11-'13

Revenue

6.811

6.399

6.155

-6.05%

-3.81%

-4.93%

Profit

0.756

0.624

0.554

-17.46%

-11.22%

-14.34%

Profit Margin

11.1%

9.8%

9.0%

-12.15%

-7.70%

-9.92%

JCI Power Solutions

2011

2012

2013

Δ '11-'12

Δ '12-'13

Ave '11-'13

Revenue

5.875

5.906

6.358

0.53%

7.65%

4.09%

Profit

0.822

0.784

1.006

-4.62%

28.32%

11.85%

Profit Margin

14.0%

13.3%

15.8%

-5.12%

19.19%

7.04%

GE's energy management segment has the strongest revenue growth over the time frame evaluated. GE's revenue growth is more than double that of JCI, with JCI being the nearest competitor. This is more than likely due to the fact that GE has made several acquisitions in this segment over the last three years in an effort to boost this segment. GE also saw the strongest profit growth over the time frame evaluated, again doubling JCI, the nearest competitor. GE is by far the worst of the companies evaluated when comparing the ability to create a return from the revenue generated. GE has a profit margin between 1% and 2% while the competition has a range of 6.7% to 15.8%. When comparing the energy management segment of GE to the competition, some generalizations can be made:

  1. The energy management industry is highly inconsistent from year to year
  2. The profit margin across the industry is generally low
  3. As customers continue looking for ways to decrease energy usage, the need for energy management companies will grow

None of the companies in this analysis were able to generate positive revenue and profit growth through all three years analyzed. While GE and JCI were able to generate positive average revenue and profit growth, this was a result of one very strong year and one weak year. As previously mentioned, the only consistency appears to be inconsistency.

One thing to keep in mind is the energy management segment is only a small piece of GE's total P/E. Based on 2013 revenues, the energy management segment is only 5% of the overall company. Below is each company's P/E ratio from Google Finance at the time of this analysis.

P/E Ratio

GE

18.19

ABB

21.08

EMR

20.91

JCI

23.48

Considering the analysis above, GE and JCI should garner the largest P/E, ABB in third and EMR in fourth. What I am taking away from this analysis is that this segment is not the primary profit center for GE, JCI or EMR. ABB has made a business out of being an energy management company and has the low margins to prove it. As previously mentioned, the benefit of having this segment available in larger companies such as GE, EMR and JCI is that this creates cross selling opportunities and can create new sources of revenue for other segments.

The Price of Oil

The energy management segment of GE is highly tied to the price of energy, primarily crude oil. As outlined in Part II of this series, the oil and gas sector has been in a strong growth phase over the last couple of years as the price of oil has been consistent and strong. Below is a chart showing the price of West Texas Intermediate (WTI) Crude Oil over the last six months.

As is clearly seen in the graph, the price of WTI has dropped from a peak over $100 to less than $70/barrel as of today. This greater than 30% haircut changes the economics of the energy management segment. I would anticipate this drop in price to adversely affect GE's energy management segment. Companies are less concerned about energy efficiency when the cost of energy is low. Additionally, the energy industry will slow investments waiting for higher oil prices to offer a higher return on investment. I would expect this to take a couple of quarters to catch up as the majority of these projects are already underway or funded to start soon. GE will more than likely see a drop in energy segment backlogs going forward rather than a drop in current quarter revenue as a result of locking in orders.

Valuing the Energy management Segment

As done in my initial article, GE: The Sum of All of the Parts, I just took the average of the competition and estimated the value of this segment. According to FactSheet, the earnings expected in 2014 for the S&P 500 are $128.57, giving the market a multiple of 16.09 as of market close on Monday, November 24, 2014. Utilizing these numbers, an average stock should trade at the market multiple. I feel that based on the average growth rate over the last several years that the energy management segment of GE should trade at a premium. For valuing growth stocks I like to apply a value of 1.5x the growth rate. Multiplying the growth rate from 2010 through 2013 of 25.96% by 1.5, I feel a fair multiple would be 38.94. Applying the calculated P/E of 38.94 to GE's 2013 segment profit of $110 million, the energy management segment can be estimated to a value of $4.28 billion. This is $2.18 billion higher than the original estimation in my initial article.

Conclusion

GE is a very complex company operating in eight different segments. An overall estimate for GE can be made by evaluating each individual segment as a standalone company. Comparing GE to the competition, we see that GE is showing similar growth as the competition. Based on the financials for GE's energy management segment, I feel this segment should be trading at a premium to the market. We are able to estimate that the energy management segment is contributing $4.28 billion of the overall $271 billion value of the total company. Part I: Power and Water and Part II: Oil and Gas are available on Seeking Alpha and please continue watching Seeking Alpha for Part IV through Part VIII of this series.

Disclosure: The author is long GE.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.