Improving fundamentals, course correction add power to Siemens stock

Sharper business focus, relatively favourable valuations also augur well for the firm

A stock hitting fresh highs in successive trading days is usually a signal to investors to pull some money out of the table. And that too if the stock is of a capital equipment maker, given the backdrop of a slowing economy.

However, for Siemens, which hit an all-time high again on Monday (Rs 1,604) and gained over 30 per cent in three months, the need to turn cautious aren’t visible yet. While it may be a good idea to book profit, at least partially, it appears that there is more steam left in the rally, thanks to the improving fundamentals. 

The Street is hoping that reduction in corporation tax rates will not only benefit Siemens but should also lead to a revival in capital expansion (capex), at least for private players.

“Siemens is a highly cyclical stock and there is strong correlation between revenue growth for the company and gross fixed capital formation,” analysts at Antique Stock Broking said. 

“We believe Siemens is in a sweet spot to benefit out of an uptick in private capex and that its high cyclicality should aid disproportionate growth once the investment cycle revives,” they add in a recent note where they reiterate optimism on the Siemens stock. Apart from improved sentiment, what should also work well for the company in the coming months is the course correction that it underwent at the behest of Siemens AG, its German parent – a move which is turning out to be quite rewarding even for the Indian subsidiary.

While work is under way at the parent level to spin off the power and gas vertical and list it as a separate entity globally, other businesses such as mechanical drives, health care and telecommunications have in the past been carved out of the Indian listed entity. Due to such initiatives, in the past year, Siemens’ operating margins have increased from 10.2 per cent a year-ago to 11.2 per cent in the June quarter. Siemens follows the October to September financial year reporting.

With digitally-enabled services taking the centre-stage in the engineering industry, globally and in India, Siemens’ decision to focus more on such contracts is also working well and is partially responsible for improvement in operating margins.

Therefore, instead of focusing on large power generation and transmission contracts, Siemens decided to focus more on smaller orders from sectors such as food and beverages, cement, automobiles and steel plants. 

The orders could be to enhance existing plant productivity, improve output or even facilitate setting up new manufacturing units. Given the nature of work, which is a combination of product and service delivery, the quantum of these orders may not be very sizeable. Hence, this strategy is more a play on the volume. Nonetheless, it does increase the overall utilisation of assets even for Siemens and these positives are reflecting in its financials in the form of better productivity and higher net profit.

While the new strategy is working well for Siemens, what needs to be monitored is the order book growth that hasn’t been too steady as in the past (see chart).

With these positives playing out in favour of Siemens, analysts at Macquarie Capital also reiterated their ‘outperform’ recommendation on the stock, while raising their target price from Rs 1,298 a share to Rs 1,730.  

Interestingly, ABB India, its domestic rival, has also taken to a similar trajectory and its financials are also looking much better than before. However, from a stock market perspective, Siemens’ 33x FY20 estimated price-to-earnings valuations gives it an edge over ABB trading at 37x FY20 estimated earnings. Investors could hence latch on to their position in Siemens and any meaningful correction could be used to take fresh entry into the stock.