Better Buy: GE vs. Siemens

Industrial giants General Electric (GE +2.10%) and Siemens (SIEGY +2.97%) are fierce competitors across a number of industries. But despite having exposure to many of the same industries, the two stocks make for very different investments. Here's why.

The case for buying General Electric

GE investors are hoping for two things in the next few years. First, and most importantly, the commercial aviation market needs to recover from the devastation brought on by the COVID-19 pandemic, because that market is GE's key earnings and free cash flow, or FCF, generator. That extends to GE Capital as well, as its most important business is an aircraft leasing business, GE Capital Aviation Services. 

Second, CEO Larry Culp needs to oversee a margin improvement in the power and renewable-energy segments. Notably, the mid-single-digit margins at Siemens' power and renewables businesses are a target for GE to aim for -- more on that in a moment.

GE and Siemens are fierce competitors in the gas turbine market. Image source: Getty Images.

In a sense, GE's margin issues in power and renewable energy -- caused partly by previous management's dash for growth -- are both a curse and an opportunity. If Culp can turn around these businesses and aviation can get back to 2019 levels of FCF in a few years, then GE could be a good value stock. But there are a lot of "ifs" in the scenario GE finds itself in, and GE also needs help from its end markets.

Data source: General Electric presentations. *GE divested its biopharma business to Danaher in 2020, a business responsible for $1.3 billion of healthcare's $2.5 billion in free cash flow in 2019.

The case for Siemens

The investment thesis for Siemens is based on the idea that its digital industries (factory and process automation, industrial software, and motion control) and smart infrastructure (control products, electrification products, building products, and grid solutions) have a bright future.

There's no shortage of interest in automation at the moment, not least because of the difficulties some companies have had with their supply chains during the pandemic. Automation will help make reshoring production more commercially viable, and the growth of the industrial Internet of Things and digital technologies in general will increase the efficacy of automation.

As for smart infrastructure, the idea is that Siemens can benefit from a move toward digitizing the power grid and expanding the use of electrified building control products. There may be a margin expansion opportunity here, too. For example, management is aiming for a 10% to 15% margin on the basis of earnings before interest, tax, and amortization (EBITA). That target looks achievable, considering peer  ABB's electrification segment EBITA margin was 12% in the first half of 2020. 

As for the other parts of Siemens, the company can rely on its 72% stake in Siemens Healthineers to produce a steady stream of cash flow, and the mobility segment -- which consists of rail rolling stock, rail infrastructure, traffic systems, and rail customer services -- is a stable low-growth business that tends to convert its earnings into FCF.

Finally, Siemens recently combined its 67% stake in renewable-energy business Siemens Gamesa with its gas and power segment to spin it off as Siemens Energy. Siemens retains a 35.1% stake in Siemens Energy but plans to significantly reduce that amount within 12 to 18 months of the spinoff.

All told, the major swing factor in Siemens' future earnings will be its digital industries and smart infrastructure segments -- and they look to be pretty well placed for earnings growth.

Data source: Siemens presentations. *Siemens will own a 72% stake after the purchase of Varian . **The 67% stake in Siemens Gamesa is now combined with the gas and power segment within Siemens Energy, a company Siemens currently has a 35.1% stake in. 

Siemens or General Electric?

On a risk/reward basis, Siemens looks like the better buy. But that doesn't mean you can't buy both stocks.

GE has more potential to dramatically increase its earnings and FCF in the future, but a lot of things need to go right for GE in the next few years, and the recovery in FCF generation -- Wall Street analysts are expecting an outflow of $3.6 billion in 2020 -- could get pushed out if the commercial aviation industry doesn't improve as hoped. In contrast, Siemens is expected to generate 4.3 billion euros of FCF in its fiscal 2020 and 5.4 billion euros in fiscal 2021.

In a nutshell, you can think of GE as having the higher risk-reward option and Siemens as the lower, so the decision somewhat comes down to your risk tolerance. However, a lot of the risk with GE is concentrated in the commercial aviation sector, while Siemens has a lot more diversity in its FCF streams. On that basis, Siemens is the better buy.