Morningstar | SIEGY Updated Forecasts and Estimates from 20 Jun 2019
We are maintaining our EUR 128 fair value estimate for narrow-moat Siemens following the solid second-quarter performance and announcement of the power and gas business spin-off, which is a modest positive on valuation but more material in terms of the company's changing strategy. We see Siemens as the leading European industrial automation supplier because of its more advanced software offerings and believe its shift to focus more on products supporting electrification (for example, autos) and industrial automation will be supportive of longer-term returns. The shares look attractively valued at current levels.Siemens' second-quarter revenue was in line with expectations. The underlying demand trends from previous quarters looked unchanged, with organic orders and revenue up 2% and 4%, respectively. EBITA margin expanded 40 basis points to 11.4% due in part to power and gas segment margin rebounding from previously low levels.
In 2020, Siemens plans to spin out the power and gas division into a new listed entity that will also hold Siemens' 59% stake in wind turbine supplier Gamesa. The spin-off announcement was not very surprising news, but it is still good news. Siemens follows in the footsteps of other diversified industrials in deconsolidating a troublesome business to focus on markets with brighter longer-term demand prospects. The power and gas business has been floundering in a market with overcapacity and severe pricing pressure with no end in sight. To that end, it serves as a distraction for management and a drag on valuation.
The growth outlook for Siemens' other industrial business (excluding Healthineers) is much more promising. Siemens has a lead on software innovation in industrial automation through earlier acquisitions, including Mentor, and returns would benefit from the company focusing on and leveraging that lead over peers like Schneider and ABB.
Looking at Siemens post spin, the new entity should have improved return prospects, given the weak profitability of the power and gas division. The division deserves a higher valuation discount, but as it only accounts for about 7% of the total group value, the spin-off would only offer modest upside potential on valuation.
However, strategically, we think move gives management more time to further curate its product offering from next-generation solutions in industrial automation. As a result, we expect to see some acquisitions in the software or even robotics space.
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