Power plants like this one are a big source of revenue for GE Power. Image source: Getty Images.
Things have been looking up lately for General Electric's (GE 0.22%) power unit. The company has announced successful installations in Italy and the Netherlands in the last week alone. It's also been one of the company's most successful industrial units, with revenue up 4% in 2015 compared to overall revenue declines for the conglomerate.
But GE Power CEO Steve Bolze has some concerns about what the future may hold. He sees a looming issue that could cause big problems not just for GE Power, but also for rivals like Siemens and Honeywell.
Big business
The problem, according to Bolze, isn't one of demand. Quite the opposite: Bolze sees demand for power skyrocketing over the next 20 years. And he's not alone. According to the International Energy Agency's World Energy Outlook, global energy demand will increase by one-third by 2040.Bolze himself is even more bullish, predicting a 50% increase in the next 20 years.
Of course, increasing demand should be good for power companies like GE, Siemens, and Honeywell. More demand means a bigger market for GE's and Siemens' turbines, and for Honeywell's smart grid and power management systems. But the problem Bolze sees isn't demand for these big-ticket machines and systems; it's paying for them.
Big bucks
Anyone with an electric bill knows that power ain't cheap. Power infrastructure, though, is incredibly expensive. As an example, last year the Saudi Electric Company signed a $1 billion deal with GE for a single power plant to support local mining operations. And there's more demand where that came from. "We continue to strengthen the Kingdom's power infrastructure to meet the growing demand for electricity and to accelerate all-round growth," said Ziyad Al Shiha, CEO of Saudi Electricity Company, in a press release.
But such massive expenses require huge amounts of capital to pay for them. Capital that's currently in short supply. Many developing nations, particularly in the Middle East, have been crippled by persistently low commodity and energy prices, leading power companies there to seek private financing to bring energy infrastructure projects to fruition. "Financing is a big deal on a lot of transactions happening in the world," Bolze said in an interview with Bloomberg.
For American firms like GE and Honeywell, the U.S. Export-Import bank could have been a potential source of this financing. But even though Congress reauthorized the Bank last year, a key vacancy on its Board remains unfilled. That means the Bank can't approve loans of more than $10 million, which is tying up more than $30 billion in funding for various projects until the vacancy is filled. A nominee has been proposed, but is currently stalled in a congressional committee.
Bolze's concern is surprising given that GE has an entire business unit -- GE Capital -- devoted to providing financing for big-ticket purchases. Even after the bulk of GE Capital's businesses are divested in the coming months, the company will retain its industrial financing arm. However, GE Capital only has about $16 billion committed for energy projects, and while that could conceivably be increased to meet demand, the company's pockets aren't infinite.
Big problem?
Bolze thinks that as much as $8 billion worth of GE Power sales opportunities could be delayed due to financing problems. That may not sound like much in this world of billion-dollar projects, but it represents a sizable chunk of potential revenue to a unit whose 2015 revenue totaled $21.5 billion (including revenue from the Alstom acquisition), less than half of which came from equipment sales
Luckily, GE already has a sizable backlog of industrial orders that it's working through -- $315 billion as of the end of last year. While the company hasn't broken out that number by business segment, the power unit is no exception, working on a current backlog of 33 turbines. So it's not as though GE Power is hurting for business. That said, if financing isn't available, delays in signing new contracts will inevitably result, leading to shrinking backlogs, which will be of concern to investors and could affect the company's stock price.
But Bolze wisely points out that building an expensive new power plant or buying costly new turbines aren't the only ways to increase energy production. Maximizing the efficiency of existing energy infrastructure can also increase capacity. With its investments in digital and software technology, GE is poised to use the global cash crunch to its advantage by offering cash-strapped utilities tools and solutions that can improve capacity without breaking the bank.
While it's true that a new software package isn't going to generate as much revenue as a new power plant or turbine, the software packages and service contracts GE offers are far more profitable for the company. In fact, GE's CEO Jeff Immelt revealed in 2014 that services were about twice as profitable as equipment sales for the company. GE Power derived more than 60% of its 2015 revenue from services as opposed to equipment sales. Another good thing about service revenue is that it helps GE maintain long-term relationships with major players in the industry and secure future equipment business.
Foolish takeaway
Even if access to capital becomes an issue for potential GE customers, the company is unlikely to be seriously affected. Power is an essential service to a growing population, and even a cash-strapped government has an interest in ensuring uninterrupted power generation for its citizens and businesses.
GE already has a sizable backlog, and while a shrinking of that backlog might worry investors and hurt the stock in the short term, unless it continues over several quarters, it's unlikely to cause major long-term problems. That said, wise investors will want to keep an eye on the backlog over the next several quarters and pay attention to management's explanation for any significant declines, which might be indicative of a long-term negative trend.
