GE Vernova

GE Vernova had yet another strong second quarter, with power and electrification propelling results higher. Second-quarter orders surged a resounding 88% organically, implying a book/bill of roughly 2.2 times, while gas power equipment backlog and slot reservation agreements grew to 116 GW.

Why it matters: We believe the market debate for GE Vernova has largely moved from near- to medium-term results to long-term runway into the next decade. So, slot reservation agreements, which are binding pre-orders in the power industry, will be a leading indicator that investors focus on. Manufacturing capacity will also continue to be a key focus item. We think this is what matters most as the company has multiyear visibility, and earnings will come down to how fast it can fill the accelerating demand for turbine and grid equipment orders. We surmise the stock declined on the trading day partly on a valuation that carries very high expectations and partly due to hopes for new manufacturing capacity. We think Vernova is taking a prudent approach under CEO Scott Strazik and is adding capacity through lean initiatives.

The bottom line: We bump our fair value estimate to $1,050 from $1,000 for narrow-moat-rated GE Vernova to account for higher full-year free cash flow guidance and time value of money. We also move our Uncertainty Rating to Very High from High to account for less certainty around upside risk. We think a higher book/bill gives GE Vernova the ability to continue to raise prices given the outsize demand from data centers powering the artificial intelligence boom. Vernova's turbines benefit intangible assets given their high degree of engineering in an oligopolistic industry. Investors may be hoping for new manufacturing capacity to accelerate the delivery of critical equipment, but we like the lean initiatives like using incremental machinery in existing footprint, expanding shop visit capacity, and using robotics and AI given lessons learned from history.

We bump our fair value estimate a bit higher to $1,050 from $1,000 for narrow-moat-rated GE Vernova to account for higher full-year free cash flow guidance and time value of money. In our updated outlook, we think GE Vernova stands to disproportionately benefit from this multigenerational electrical supercycle. While asking investors to pay 40 times 2026 EBITDA bakes in a lot of future expectation, we think the visibility from backlog and potential new orders justifies the valuation.

The key drivers of our valuation are revenue growth, EBITDA margins, and free cash flow conversion. We model compound annual revenue growth of nearly 16% during the next five years, over and above the firm's low-double-digit target, which we think is too conservative. We assume the electrification segment achieves the fastest revenue growth, while the wind segment experiences revenue contraction.

We assume improving margins during our forecast as GE Vernova executes its self-help initiatives and benefits from rising demand. We forecast EBITDA margin to climb to between 23% and 24% by the end of the decade based on an assumed incremental margin of roughly 40%. The improved profitability is broad-based across the gas power and electrification segments.

Our long-term free cash flow conversion assumption is approximately 90% of adjusted net income. This is in line with the company’s long-term conversion target of 90%-100% of adjusted net income by 2028. This outlook assumes that GE Vernova continues to make modest improvements in its working capital efficiency and that capital expenditures remain approximately 2% of sales.

We assign GE Vernova a Narrow Morningstar Economic Moat Rating that is underpinned by intangible assets and switching costs. The company has leading share in oligopolistic markets such as gas turbines, wind turbines, and high-voltage equipment. While historical returns on invested capital have been underwhelming, we see a strong line of sight to sharply improved results over the long term.

GE Vernova’s power segment consists largely of its gas power business. The market for gas turbines is concentrated in the hands of three global players: GE Vernova, Siemens Energy, and Mitsubishi. GE Vernova has a long history in gas turbines and the largest installed fleet of gas turbines globally. We think its gas turbine business has a narrow moat, supported by intangible assets and switching costs.

The gas power segment’s moat is underpinned by switching costs. Roughly 70% of gas power revenue is service, consisting of a combination of long-term service agreements and aftermarket equipment. The financial model for gas turbines is similar to other razor/blade business models. GE Vernova makes little money on the upfront equipment sale and expects service—both via LTSAs and aftermarket equipment—to generate healthy profits. For instance, a new H- or HA-class turbine sale is almost always accompanied by a 15- to 20-year LTSA with GE Vernova.

As turbines age and initial LTSAs roll off, customers have the option of switching to an independent service provider to handle routine maintenance. GE Vernova has active service contracts on roughly 25% of its installed fleet. However, in instances where the company does not have a service agreement, it still often receives the aftermarket equipment revenue. In general, we view GE Vernova’s gas power moat as strongest in its newest class of technologies, with its moat weakening as turbine technology ages.

Gas turbines are highly engineered equipment with long development cycles, supporting an intangible asset moat source. The gas turbine market can be separated based on technology, such as E class (oldest), F class, H class, and HA class (newest technology). Developing new technology requires years of research and development. GE benefits from its long history and expertise. New product development cycles are long. There has been roughly 15 years between introductions of new class technology. The robust technical requirements contribute to a consolidated gas turbine market.

GE Vernova’s wind segment consists of its onshore and offshore wind turbine business. The company’s onshore wind market share (excluding China) has historically been second globally behind Vestas but the leader in the US. Broadly, we view the wind turbine business as more moaty than solar panels but less moaty than gas turbines due to less ongoing service opportunity. While wind’s moat characteristics are relatively more attractive than solar, we award the segment a no-moat rating, consistent with our moat rating on Vestas.

Wind turbines account for approximately half of the levelized cost of energy for an onshore wind project and 25% for an offshore wind project. Given this large share of project cost, wind turbine suppliers face consistent pressure to keep prices low and perform regular product innovation to improve their capacity factors. However, limited product differentiation and product innovations are not groundbreaking enough to avoid replication and limit pricing power of manufacturers.

Relative to gas turbines, wind turbines offer less of a lifecycle service opportunity, resulting in lower switching costs. Unlike other razor/blade business models, such as the elevator and aerospace engine businesses, spare parts of other brands are sold by multiple service providers. In addition, oftentimes customers (asset owners) will perform operating and maintenance themselves rather than relying on turbine original equipment manufacturers.

We expect GE Vernova’s wind segment profitability to improve in coming years as it shifts its strategic focus to fewer markets and fewer product variations. In particular, the company is increasingly focused on the US onshore wind segment, where it has historically held top market share. We think the retrenchment to the US will improve profitability but also increase policy risks. Wind installations in the US have been sensitive to changes in US tax credits, which have led to past boom and bust cycles. While the Inflation Reduction Act should stimulate healthy wind demand by providing long-term tax credit certainty, there remains the risk of changes in the legislation with election cycles.

GE Vernova’s electrification segment consists of grid equipment, including power conversion, switchgear, transformers, and grid automation offerings. Much of the segment focuses on medium- and high-voltage applications, which we broadly view as less moaty compared with low-voltage equipment. Markets for certain product offerings, such as high-voltage direct current, are oligopolies, but many of GE Vernova's remaining offerings, such as transformers, are more fragmented. Unlike gas power, electrification does not benefit from a large aftermarket service opportunity, with less than 30% of segment revenue tied to service. The segment has some competitive advantages, such as long lead times and a degree of customization for specific projects, but we don’t believe the segment as a whole warrants a moat.

GE Vernova enjoys leading positions in oligopolistic markets, including gas turbines.

GE Vernova’s products and services stand to benefit from the ongoing electrification and decarbonization of the global economy.

GE Vernova’s balance sheet is in a strong position, with an investment-grade rating.

GE Vernova's historical margin and profitability record has been inconsistent.

The company’s onshore wind business is focused on the US market, which is sensitive to changes in tax policy.

GE Vernova is susceptible to changes in AI power demand expectations.