Energy Management: A Key Growth Driver Within General Electric

Summary

  • Energy Management (EM), one of General Electric's smallest industrial business segments, will double in size (to $13 billion in revenues) with the acquisition of Alstom Grid.
  • EM will partner with other GE businesses to capture more Electrical Balance of Plant (EBoP) sales by selling more generators (with gas turbines) and converters (with wind turbines) (GE4GE).
  • By increasing the insourcing of parts and components, EM also expects to sell more to other GE businesses (GE2GE).
  • Consequently, GE anticipates significant growth in EM’s revenues and earnings over the next few years.

General Electric's (NYSE:GE) Energy Management makes transformers, motors and related products that allow utilities and industrial firms to manage electricity efficiently from generation to consumption. Its products are used to distribute, protect and control electricity, modernize the grid, enable micro-grids and convert electricity into power (or power into electricity). Roughly half of its 2014 revenues of $7.3 billion came from the U.S. The Alstom grid acquisition will double EM's revenues, especially outside the U.S.

Overall growth in electricity demand is expected to be modest. According to IEA estimates, the demand for power will grow 2.3% annually to 2040, net of annual efficiency gains of 1.2%. Even so, the growing use of distributed power, the drive to modernize electric grids, the growth of emerging market economies and the quest to improve efficiency will ensure ready markets for EM's products and services.

EM believes that its addressable market exceeds $150 billion. It expects solid growth in marine, technology (e.g. data centers), commercial & industrial, power & utility and military applications over the next three years. EM is currently small compared with industry leaders like ABB, Siemens and Schneider Electric, but the Alstom acquisition will bring it to within striking distance. More importantly, EM's 2015 operating profit margin of about 3% is far below the 10%-20% margins of the market leaders. Consequently, EM sees significant opportunity to expand revenues and profit over the next several years.

There are three businesses under the EM umbrella: Industrial Solutions ($4 billion in 2014 revenues and orders) provides low and medium voltage equipment, controls, critical power products and related products and services to a broad range of industrial customers.

Power Conversion's machines, drives and automation and control equipment helps transform motion into electricity (e.g. generators), electricity into electricity (e.g. railway microgrids) and electricity into motion (e.g. marine propulsion). This business, formed around the 2011 acquisition of France's Converteam, had $3 billion of orders and $2 billion of revenues in 2014. GE thinks that it has a competitive advantage in Converteam's variable speed drive technology. Since the acquisition, Converteam's sales have doubled, mostly outside of its core European market. GE views Power Conversion as a global growth business.

GE has made a significant investment in improving Converteam's operating efficiency. Since the 2011 acquisition, Converteam's on-time delivery rate has improved from 25% to the low 90s and is on a path to reach the high 90s. GE has also reduced Converteam's manufacturing costs, for example, by cutting the number of design tools that it utilizes from 300 to 30 (and eventually to less than 10).

Digital Energy ($1.5 billion of orders, $1.4 billion of revenue in 2014) help utilities deliver power to end users, automate the grid and manage and control their assets. It will become EM's largest business with pro forma revenues of $6.5 billion, when it is combined with Alstom Grid. The merger will also round out EM's transmission and distribution product offering, giving it strong positions across the full product range, from low voltage through to ultrahigh voltage applications. It will give EM scale in key businesses and a strong global footprint, with project capabilities. It will also provide significant opportunities for cost synergies and growth within the GE ecosystem.

EM is using all aspects of the GE playbook to grow sales and revenues. It is making significant investments - $300 million annually in 2014 and 2015 or roughly 4% of sales - to upgrade key product lines, such as switchgear, grid control software, breakers and industrial controls. It is using the FastWorks framework to speed new product introductions. For example, the design cycle on its GuardEon breakers has been reduced to two years (compared with the industry average of 5-6 years). This best in class breaker technology will have a simpler design (24% fewer parts), be manufactured in fewer plants (7 vs. 16) and cost 20% less to make than GE's legacy breaker products.

EM expects to partner more with GE businesses to capture more sales on power plant projects. This process, known within GE as GE4GE, is geared toward enabling GE to capture more Electrical Balance of Plant (EBoP) sales. It involves including more of EM's equipment and components in turnkey (or near-turnkey) solutions (e.g. selling power conversion generators with gas turbines, converters with wind turbines and inverters with solar panels). GE sees significant opportunities for growth in EBoP sales in thermal, distributed power and oil & gas applications.

The segment also expects to expand EM content within GE's entire product line-up (GE2GE), replacing competing products and components in GE products and capturing new opportunities for parts and services sales. This will help to boost EM's operating scale and manufacturing plant utilization, which will help drive unit production costs lower. EM sees GE2GE as a potential double-digit growth opportunity over the next several years.

Energy Management has often found it tough to compete for attention within GE against big ticket products like gas turbines and jet engines. In some sense, therefore, it has been a neglected business. By carving it out as a separate segment, GE is now focusing on opportunities to grow these businesses by boosting sales and improving operating efficiency. Over the past two years, EM has been slimming down by reducing headcount, closing manufacturing plants, consolidating back office systems and paring its supplier base. It has lowered its SG&A expense ratio by 200 basis points to 19% and seeks another 300 basis point reduction by 2018. It has also used lean process improvements to lift gross margins. Overall, EM has improved its operating margin by 250 basis points, but still sees opportunity ahead for significant margin expansion.

Thus, through the Alston Grid acquisition, internal GE4GE and GE2GE opportunities, product investments and a focus on simplifying operations and reducing costs, EM expects to grow revenues and margins at very high rates going forward. It plays a key role in GE's overall growth objectives for its industrial businesses.

Author's Note: The Alstom acquisition still awaits approval from EU regulators, who have raised some concerns recently about potential concentration in the gas turbine market.

Most of the content for this article was derived from recent presentations made by EM management at the GE Technology Investor Meeting on March 11, 2015 and at the Bank of America/Merrill Lynch Global Industrials & EU Autos Conference on March 19, 2015.

This article was written by

Steve Percoco founded Lark Research, an independent provider of investment research, in 1991. He published the Income Builder newsletter from 2001 to 2018. He is a generalist, but focuses on several key sectors, including housing, real estate, utilities (electric, water and gas), telecommunications, energy and technology. Lark Research also offers institutional research services, including company and sector research reports.Steve chaired the CFA Institute New York's Committee for Improved Corporate Reporting from 1994-2004 and served on its Board of Directors from 1996-2002. He received the Society’s Volunteer-of-the-Year award in 1995, 1996, 2001 and 2002.Prior to founding Lark Research, Steve was Vice President in the High Yield Corporate Bond Research Department at Salomon Brothers (1987-1990) and investment officer at Bank of Boston (1983-1987).From 1994 to 2010, Steve chaired the Springfield NJ Investor Education Group of the American Association of Individual Investors (AAII). He served as a member of the FASB’s User Advisory Council from 2004 to 2006.Steve is a graduate of Bowdoin College and Harvard Business School.
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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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