Probably the most important single clue that General Electric Company (NYSE:GE) would miss its full-year earnings and cash flow guidance didn't actually come from GE. It came from Germany's Siemens (NASDAQOTH:SIEGY). Back in August, GE's key rival served notice that margin for its Power and Gas segment would decline in 2019. Meanwhile, GE management's Power segment guidance was implying a significant increase in margin -- no prizes for guessing that it didn't happen. With this in mind, let's look at what Siemens' recent fourth-quarter earnings can tell about GE Power's prospects in 2019.

Where Siemens leads, GE will follow

It's not uncommon for two companies in industries with only a few leading players to have similar profit margins. Indeed, a quick look at recent margin performance of GE and Siemens confirms this.

As you can see below, outside of GE's fourth quarter of 2017 and third quarter of this year (both quarters saw GE taking substantial charges), the two companies' margin performance tends to be similar.

Siemens and GE power segment margin.

Data source: Company presentations. Siemens quarters are adjusted to the nearest GE quarter. Chart by author.

With this in mind, when Siemens management warned in August that its 2019 margin for its Power and Gas segment would decline to the low- to mid-single-digits from the mid-single-digits in its fiscal 2018, it called into question GE's rosy implied guidance for GE Power's margin to expand to something near 8% in the back half of 2018.

Adjusted power profit was positive

The two companies' most recent power results are shown below. 

Company/Segment

Profit

Reported Margin

Charges

Adjusted Profit

Adjusted Margin

Siemens Power and Gas

(139 million euro)

(4.1%)

(301 million euro)

162 million euro

4.9%

GE Power

($631 million)

(11%)

($790 million)*

$159 million*

2.8%*

Data source: Company presentations and author's analysis. *Author's estimate/assumption.

In common with GE, charges in the quarter took Siemens' power profit and margin into negative territory. Siemens took a 301 million euro ($343.6 million) severance charge as the company laid off workers as part of its restructuring efforts.

Meanwhile GE, according to CFO Jamie Miller, when asked about one-time charges in the quarter: "had $240 million of charges, on the blade issue, with respect to warranty and maintenance reserves. We saw about $400 million of project reserves and other execution issues and about $150 million of just some other execution issues."

GE can be forgiven for the blade turbine issue, even though Miller expects "a similar incremental amount of cost over time related to the blades as we perform planned outages in our services contracts." And if the "other execution issues" really are one-time charges, then GE, in common with Siemens, looks capable of low- to mid-single-digit margin in 2019. 

In fact, Siemens CFO Ralf Thomas claimed the adjusted power margin of 4.9% was "somewhat better than expected."

What Siemens management said

The underlying results from Siemens suggest the possibility of positive earnings next year, and new CEO Larry Culp is taking immediate action to improve matters at GE. However, it's clear from Thomas' commentary that end-market conditions are not getting better anytime soon. He referred to "declining power generation markets" and noted "negative pricing impact is expected to be around 2% to 3% of revenue with stability in the short cycle and ongoing pricing pressure in power generation businesses." https://seekingalpha.com/article/4220134-siemens-ag-adr-siegy-ceo-joe-kaeser-q4-2018-results-earnings-call-transcript?part=single

In the context of what GE reported, it should be taken as a positive that Siemens reiterated guidance for low- to mid-single-digit Power and Gas segment margin in 2019.

Why power matters so much to GE

Unfortunately, Siemens' outlook suggests more problems ahead for GE. There are two things to focus on.

First, as Culp noted recently, one of GE's problems in 2018 was that management held on too long to a revenue outlook for GE Power that was highly unlikely to be met. This was problematic for GE because not only did it make its 2018 guidance look untenable, but it also cast doubt on its plan to strengthen its balance sheet and reduce debt-to-earnings levels. 

Indeed, according to GE's recent quarterly Securities and Exchange Commission (SEC) filing: "market factors such as increasing energy efficiency and renewable energy penetration continue to impact our view of long-term demand. These conditions have resulted in downward revisions of our forecasts on current and future projected earnings and cash flows at these businesses."

This being the case, then the plan to 2020 will surely be negatively impacted -- not least because Miller previously said that a "significant improvement at Power" was an integral part of the 2020 plan.

A gas turbine being serviced.

GE and Siemens are hoping power services will offset weak equipment services. Image source: Getty Images.

Second, the ongoing SEC investigation involves looking at long-term service agreements (LTSA) in GE Power. Given the SEC filing referenced above, management's admission that it previously overestimated Power demand, and the disconnect between GE's earnings and cash flow in recent years, it's possible that the SEC will find that GE booked more earnings on LTSA than will come  -- more charges/fines to come for GE?

Where next for GE Power

Culp recently argued that GE was close to a bottoming in Power. While that's good news, it's also a possible indication that more pain/charges will come in the fourth quarter. Meanwhile, the weakening in Power puts GE's 2020 plan in doubt.

Unfortunately, Siemens' recent results suggests power markets won't get better for GE anytime soon, and it's not surprising to see GE accelerate plans to raise cash. Ultimately, there is a pathway to profitability for GE Power -- Siemens' earnings show that. It's just that GE has to go through an uncertain period with SEC investigations, raising cash, and strategic adjustments before it can get there.

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.