General Electric (NYSE:GE) is in the midst of transforming its business for the second time in a decade. After shifting away from finance in the wake of the financial crisis -- and the heavier regulation on banks it spawned -- GE is now separating its transportation, healthcare, and oil and gas units from its core operations.
This will leave General Electric its aviation (primarily aircraft engines), power products, and renewable energy units. Aviation is growing and profitable, so that's a great business for GE to stay in. But the power products and renewable businesses compete directly against one another, and that dynamic is one reason GE may have a long-term energy problem.
The power business is in decline
GE is one of the biggest suppliers of power plants and turbines for the power sector. Plant construction and the provision of services to existing coal and natural gas power plants account for the majority of the power business.
In 2017, GE's power unit was a $35 billion business, making it nearly as large as aviation ($27 billion) and renewables ($9 billion) combined. The problem is that it's in structural decline. In the second quarter of 2018, power revenue was down 19% year over year ago to $7.6 billion, and segment profit was down 58% to $421 million, or a 5.6% profit margin.
The coal power plant business has essentially ground to a halt both in the U.S. and in mature markets like Europe. Natural gas has filled some of the void over the last decade, but now that's under heavy pressure from renewable energy -- another business that GE has a significant presence in.
Renewables are fighting for their place in the world
Wind turbines accounted for $8.0 billion of GE's $9.2 billion renewable energy revenue in 2017. Costs for wind turbines have come down so far and so fast that wind has started to replace coal and natural gas in the power grid. According to investment bank Lazard, new, unsubsidized wind power plants can produce electricity for 3 cents to 6 cents per kWh, compared to 4.2 cents to 7.8 cents per kWh for new natural gas power plants. It's no wonder renewable energy accounted for more then half of all new capacity deployed from 2014 to 2017.
Despite the fact that total installations for renewable energy are growing, and that wind is displacing some of GE's legacy power sales, the renewable business is volatile, and hasn't proven to be very profitable long term. Revenue was down 29% to $1.6 billion in Q2, and segment profit was down 48% to $82 million, for a margin of 5%.
That weak profitability profile is consistent across renewable energy. As the costs of installation come down, volumes go up, which increases renewable energy's share of the electricity market. But manufacturers like GE often see revenue decline when that occurs, because the volume doesn't rise enough to offset the falling sale prices per watt of renewable energy. As a result, revenue stagnates, and margins remain under constant pressure.
Renewable energy is killing GE's traditional power business, but it isn't a particularly profitable replacement, and overall, its energy business appears to be in structural decline as a result.
Energy is tough for GE
GE has bet big on energy now that it's spinning off or otherwise divesting itself of its transportation, oil and gas, and healthcare units. But the electric power business is a tough market for its industrial suppliers right now. Ironically, GE is part of the problem, because it produces low-margin wind turbines that are taking market share from the coal and natural gas plants it has profited from for decades. This a big and long-term power problem for GE because it likely means profitability will remain low in the power business for the foreseeable future. The only potential turnaround I could see is if wind sales and margins rise, leading to a growth path in power long-term. But that's unlikely given competitive pressures in the market.
For investors in GE, this is notable because power plants or wind aren't what's going to drive the stock going forward. GE is becoming more dependent on aviation to drive revenue and earnings growth. That's good while more aircraft are taking to the skies, but if aviation demand goes south there isn't a lot of operational help coming from the power business long-term.