Investors in international conglomerate General Electric Company (GE 1.08%) will want to pay attention to a few key industries and trends in the years to come. I laid these out in 2012 and still believe these growth-drivers are of utmost importance when thinking about GE's future prospects:
- First, the rise of megacities will increase demand for better infrastructure around the world. All of those fast-growing economies still lack the robust electrical grid, for example, of the U.S. or Western Europe.
- Second, countries with plentiful resources -- especially in energy -- will become the new emerging markets.
- Third, natural gas will continue to steal the spotlight as a price-competitive and cleaner-burning fossil fuel source.
When you think about General Electric's diverse portfolio of businesses -- from transportation to aviation to healthcare to energy -- only one segment sits squarely in the overlap of those three emerging trends: GE's power and water business. To be more specific, the power generation unit within power and water is at the red-hot epicenter of a significant transition toward natural gas power.
For perspective, power generation produced $12 billion in revenue for GE in 2013, nearly 50% of power and water's overall $25 billion in revenue. Thus far in 2014, the power and water segment has grown more than 10% while the unit builds out a lucrative services business to accompany the sale of highly complex natural gas turbines.
According to the CEO of GE's power generation products segment, Vic Abate, the future looks bright for the industry as a whole. But GE still must prove that it can build incredibly sophisticated machinery at a price point that is attractive for customers and profitable when pitted against an array of different fuel options. That's no easy feat.
I spoke with Abate recently to get a close-up view of power generation, discuss the tailwinds behind natural gas, and understand how GE is quietly building a competitive advantage through its blockbuster $13.5 billion acquisition of Alstom's energy business. Here's what he had to say:
Isaac Pino: Looking at GE's power and water segment overall, revenue was down 13% in 2013, but it's growing at a double-digit clip in 2014. What's behind this shift?
Vic Abate: Production tax credits play a role, as does the lumpiness of power plant orders. But while regulatory pressure in wind can change in both directions, electricity demand is more predictable. The amount of electricity needed correlates with GDP and population growth. The things that fend it off are demand-side efficiency, like energy-saving refrigerators. Overall, net of efficiency, we still see 3% growth in energy and 4.3% in capacity [over the next decade].
Isaac: What's most compelling about the natural-gas power-generation business today?
Abate: Really, the business we're in is infrastructure. We can help make the total cost of electrical power production cheaper for the customer. The metrics to think about are up-front capital cost, service cost, and fuel cost. Gas is different from renewables in that fuel is free in renewables.
For us, the beauty of the gas turbine is that it's very hard to do because it's so technically sophisticated. If you put in a BTU of natural gas, how many kWH come out? The gas turbine determines that. For customers, fuel is the largest expense over lifetime of products. When you make the product itself more efficient, you reduce fuel and you reduce carbon emissions.
Isaac: You mentioned in a presentation that GE needs to become [a] "power plant system design company." Can you elaborate on how Alstom's assets take you a step closer to that goal?
Abate: Alstom gives us more control over the conversion process. The conversion of natural gas to heat to electrical energy is thermodynamic. And it's a complex process. We think of our turbines like an Intel computer chip -- the brain or the engine of the whole process. I can have the world's best chip but I can have lousy everything else.
So we need to do the whole conversion. Like General Motors: the whole car, not just the engine. Alstom does more of the car, and we do the engine. This is putting those two together.
Abate was particularly bullish on GE's new air-cooled H-class turbine, which the company says is the world's largest and most efficient combined-cycle turbine. So far, GE has received orders for 13 H-class units during the first year of production: four for a U.S. utility and nine heading abroad.
Of course, production of complex machinery such as a gas turbine can present challenges for manufacturers, especially for new products. Look no further than Boeing's Dreamliner for an example of the hurdles a company can face. For investors in GE, this will be an important rollout to watch, especially as the conglomerate looks to build long-term services relationships with its customers. Overall, GE's power-generation game plan looks solid; now it's all about the execution.