When GE Vernova (NYSE:GEV) was formally spun off from GE in March of this year, I believed that the former GE Power business was in recovery. The company was set to benefit from the energy transition and population growth across the globe with its all-round energy solutions across power, wind and electrification.
Despite the rosy long-term prospects, which were seen for the business in the ownership of GE as well, the businesses have been struggling in recent years. This year, real momentum is seen, driving incremental improvements driven by freedom to operate and strong end markets, and frankly enthusiasm with investors.
I understand this, to a large extent, but at the current valuation, the proof lies with management to deliver on further anticipated improvements, as expectations have been raised significantly.
Focusing On Electrification And Decarbonization
GE Vernova focuses on serving the energy transition across the globe, with trillions to be invested to decarbonize and electrify power across the global economy. In fact, the total addressable market is set to nearly double to half a trillion by 2030.
GE Vernova is a powerhouse, employing 80,000 workers across more than 100 countries, with activities including 7,000 installed gas turbines, 55,000 wind turbines, as well as hardware and software to manage production, storage electricity, and alike.
The largest of these activities is the power business. This was a $17 billion business in 2023 which focuses on gas, steam, hydro and even nuclear, with a backlog of more than 4 years. New technologies play a role as well, including a switch to natural gas, increased usage of hydrogen, as well as the rise of carbon capture technologies and small modular reactors. Segment EBITDA margins came in at around 10% last year, being the backbone of GE Vernova.
The wind business generated $10 billion in sales from onshore and offshore wind solutions, with a backlog of nearly three years. Like many peers, the business is challenged, and in fact posted an EBITDA loss of around a billion in 2023, expected to break-even in 2024.
There is a third segment as well, being the electrification segment, which provides grid solution, power conversion, solar storage, and related services. With a $6 billion sales number, this is the smallest segment, posting very modest profits in 2023.
Zooming into the details, it was very clear that a $33 billion business has been far from on fire, and nor has it fired on all cylinders. With some 272 million shares outstanding, a $145 stock was valued at $39.5 billion at the time of the spin-off, as the balance sheet actually included $2 billion in net cash.
For 2024, the company guided for sales to be largely flattish between $34-35 billion, with EBITDA margins seen in the high single digits, suggesting $2-3 billion in EBITDA. Moreover, the company guided for double-digit EBITDA margins in 2025 and better free cash flow conversion, as this provided support to the shares since day one.
With the assets clearly having to transform itself, and being mismanaged within GE, I saw appeal at modest sales multiple, amidst a strong balance sheet, yet noted that execution was needed as some (wind) peers were struggling as well.
On Fire
Since the spin-off, shares of GE Vernova quickly rose to the $150 mark in early summer, broke the $200 mark late in August, and have rallied to $225 per share here.
Besides the numerous positive updates which flood the news release section of the website, GE Vernova posted second quarter results in July, the first earnings report post the spin-off.
Second quarter adjusted sales rose by 2% to $8.1 billion, as the real achievement was a near 400 basis point improvement in EBITDA margins to 6.4% of sales. These achievements were driven by the Power segment. Revenues rose by 8% to nearly $4.5 billion, amidst a near $5.0 billion order intake. Already solid segment EBITDA margins improved by another 250 basis points to 13.8% of sales.
The wind business saw sales down 21% to nearly $2.1 billion. Even as the order intake was cut nearly in half, orders of nearly $2.2 billion were still, resulting in a growing backlog. Segment EBITDA losses were more than cut in half, towards 5.7% of sales, encouraging given the pressure on the topline.
Electrification sales were up 19% to $1.8 billion, as the order intake of $4.8 billion remains incredibly strong. Segment EBITDA margins improved by more than 5 points towards 7.2% of sales.
All this means that the business now sees sales towards the higher end of the $34-35 billion sales guidance issued for the year. More important is that EBITDA margins are now seen at 5-7%, with the free cash flow guidance hiked by six hundred million to $1.3-$1.7 billion.
What Now?
The 278 million shares of GE Vernova now value the business at $62 billion and change. The balance sheet remains in pristine shape, with no (bank) debt and over $5 billion in cash being apparent, yet the company has huge contract and equipment liabilities. An equity position of around $10 billion is somewhat modest in relation to a near $50 billion balance sheet.
If the company can deliver on its promises towards the high end of the guidance, both in terms of sales and margin, EBITDA of $2.5 billion might be in the works, for a 25 times valuation multiple. This is however a bit too shortsighted, as the business is far from on fire. The pace of improvements is huge here, as second quarter EBITDA of $524 million trends at $2.1 billion per annum already, but moreover was up some three hundred million on the quarter (on a sequential basis).
In September, the company reaffirmed the full-year guidance, which was quite comforting. It guided for a $300 million EBITDA loss for the wind segment, which actually posted a loss of “just” $117 million in the second quarter. With the company sticking to the full-year guidance, this shows the momentum in the other parts of the business, and frankly is based on the expectation that the business is expected to post profits in the wind segment in the fourth quarter.
Not that the issues with recent turbine blades are not attributed to design or quality issues, but frankly by too high winds, at least as claimed by GE Vernova.
If the company can really move towards 10% margins, another billion in EBITDA might be in the works next year, needed at current valuations as a $3.5 billion EBITDA number translates into an 18 times multiple on this front. This shows that more needs to be done, yet this is realistically to be expected.
If the company can grow towards $50 billion in sales in the coming years, amidst the huge backlog, and can grow EBITDA margins to let’s say 12%, appeal is seen. Assuming a 10% EBIT margin in such a case, and unleveraged business could post profits of $3.5-$4.0 billion, which can justify the current valuation.
I guess what I am trying to say is that while the long-term prospects look good, there is still relatively little current earnings power to justify this, as frankly, not long ago, the entire business was valued at zero, or even negative, within the gates of GE. I wonder if the market is somewhat getting ahead of itself here. The company certainly has the potential to grow into the valuation, but it is now up to management to execute on this.
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