META - Opportunities For Vestas Wind Systems

2023-08-30 12:03:47 ET

Summary

• It is a challenging time for investors in emerging technologies, but this also means opportunity.
• The wind turbine industry is challenged but not all players are equally affected. Siemens Energy is challenged by quality and pricing, while Vestas has largely avoided these problems.
• There are industry-wide issues concerning permitting and supply, although these are being addressed.
• The scale of expected offshore wind developments is massive and the industry is beginning to gear up for huge expansion.
• While Vestas share price has been marooned in 2023, change is in the air and it is a good time for wind industry investors to pay attention.

We live in interesting times when 7 companies (Microsoft ( MSFT ), Alphabet ( GOOG ), Nvidia ( NVDA ), Meta ( META ), Tesla ( TSLA ), Amazon ( AMZN ) and Apple ( AAPL )) command a big share of good times on the US markets this year. For investors in companies which address emerging technologies, the story is very mixed. For the wind industry the picture is challenging with the First Trust Global Wind Energy ETF ( FAN ) down 5.6% in 2023.

Readers who follow me will be aware that I think the wind industry (especially offshore) has a big future and I’ve focused on leading turbine maker Vestas Wind Systems ( OTCPK:VWDRY ). Wolf Report has recently published a sanguine overview of the recent history of Vestas Wind Systems which emphasizes recent pricing and supply challenges of its turbine business, while indicating that its service business is robust and profitable. This provides investors a good insight into Vestas' current business. I find it interesting to see how different authors position a business. My focus is mostly qualitative so I look closely at where a company is headed in making investment decisions. My take, which I develop here, is that offshore wind is about to become huge and that Vestas is well positioned to benefit. The Wolf Report article did not even mention offshore wind. While noting Wolf Report’s “hold” call, I conclude that this is a good time to think about including Vestas in your energy portfolio.

What is up with the wind industry?

It is a curious time for the wind industry as opportunities are opening up everywhere as the push to decarbonize the electricity system begins to bite (think fires in Canada and Greece, floods in California, heat in Europe, hurricane in Florida etc). Does this create opportunity? The scale of expected expansion, especially for the offshore wind industry (expected to be up 10 fold by 2030), is staggering but this is not reflected in the share price of major wind companies. Vestas Wind Systems share price has fallen 13% this year. There are various reasons for this fall and, while there are major logistical and regulatory changes needed, none of these seem to be of long term significance. The industry-wide impediments are being addressed in most global markets now.

The wind industry faces challenges to implement massive scale up

The latest IEA report concerning the wind industry makes 4 major recommendations to get the scale up of wind power in line for renewable power needed for net zero by 2050. These involve i) streamlining permitting procedures; ii) supporting development of floating wind turbines to tap into deeper (more than 50-60 meters) offshore resources; iii) supporting advanced wind power grid integration solutions; iv) improving resource assessment and spatial planning.

Whereas the early stages of solar PV and wind projects involved focus on site assessment and construction, a missing link was how the new power sources would integrate with grids. It is interesting to see that new offshore wind projects often involve planned closure of existing fossil fuel assets and accessing the existing grid infrastructure.

What is holding back offshore wind developments?

There are many reasons why companies fail to thrive. It can be that technology is not adequate to deliver the required products, or a shortage of skilled staff, or that the business environment is immature.

In the case of the offshore wind industry my take is that while the above issues are significant they are not what is holding progress back. I think it involves several key issues. Of significance is the immaturity of the permitting system combined with failure to adequately provide a suitable environment for the offshore turbines to be integrated with power grids. And then there are challenges facing a key competitor, Siemens Energy, which absorbed Siemens Gamesa Renewable Energy earlier this year.

Siemens Energy

The Wolf Report made a big deal of Vestas pricing issues but I think that Vestas has not been affected in the way that another major wind turbine supplier Siemens Energy has. Vestas has been very focused on these issues for some time, while the chickens have only recently come home to roost for Siemens Energy.

It is clear that a number of issues were crystallised with the full acquisition of Siemens Gamesa Renewable Energy. In a recent press release Siemens Energy sought to draw a line under several issues. Firstly the full cost of several problems with its onshore turbines has now been determined. The expected cost to remedy the quality problems amounts to Euro 1.6 billion, most of which will occur in fiscal 2024 and 2025. The problems at Siemens Energy don’t stop with its onshore turbine fleet as there are also higher than expected production costs for offshore projects which amount to Euro 600 million to be spread over several years. This is not just about already committed projects as Siemens Energy needs to substantially ramp up various factories and also increase the size of offshore turbines. Vestas has hinted at problems being experienced in the industry for some time. Vestas management suggests that these issues have been largely avoided by careful attention to quality and pricing issues. In other words a significant negative issue for wind turbine manufacturers is not evenly experienced in the industry, although of course the Siemens issues have led to concern throughout the industry.

There is more to investment in Siemens Energy as this company has recently split off from the Siemens parent and there are many unresolved issues as far as I can see with the new business. This is no focused wind business, although it is a wind business with a lot of problems being sorted out. The bigger issues for me involve the power turbine business (gas market) and also what it plans to do with the nuclear business. This is a bigger story around the exit from fossil fuels and strategy for decarbonization, which is another story. I prefer the focus of Vestas for my exposure to the wind industry.

Vestas and offshore wind

Vestas has identified Australia, the US and Brazil as key areas of likely rapid growth for its offshore wind business.

I follow closely activities in Australia and the Australian story is a good example of what is happening elsewhere in the world. It is interesting because it includes many of the features that are going to be needed for successful offshore wind development.

There are 3 regions which seem to have key features for success of offshore wind in Australia. These include connection to areas where there is major coal infrastructure that is beyond its use by date (Hunter area, Illawarra, East Gippsland) yet with good grid interconnectivity. For each of these areas ports are being identified for repurposing to support major offshore wind developments. Notable is Newcastle which is currently the world’s largest coal export port.

Offshore wind complements solar PV as it has a different time-of-day profile. It is clear that overall planning for exit from fossil fuels will be successful by managing intermittency , and reliable offshore wind with high capacity factors is a key part of the solution. Of course there are other elements to this overall solution, including extensive big battery projects, the possibility of West Australian solar PV connected to Eastern Australia via HVDC (High Voltage Direct Current) cabling to address early evening peak load, and electrified transport (large source of battery storage).

Vestas Q2 2023 reporting makes clear why the going is tough

Those who follow me will be aware that I am a fan of quarterly earnings calls because this is a chance to hear from management about the current situation and for management to respond to issues that analysts raise. The high level takeaway for Q2 is that the service business (approximately half of Vestas business) is performing extremely well (EUR32 billion backlog, revenue up 29% year on year, 150 GW active service contracts, duration of service average 11 years!) but the turbine business still has challenges. There was discussion of pricing and warranty issues, but the nature of this discussion by Vestas was quite different to the recent Siemens Energy coverage of the same issues. Vestas management has been saying for a long time that it pays a lot of attention to pricing and warranty issues.

The Q2 2023 earnings call gave a good insight into some issues that don’t quite yet give offshore wind clear air. Permitting and uncertain regulations remain issues of concern, with agreement between four key players (governments, developers, owners and OEM providers (including Vestas)) still unresolved. For governments it isn’t just about permitting but also following through and accelerating targets.

Vestas has the biggest offshore wind turbine (V236-15MW) being implemented and the preferred supplier agreements amount to 12 GW. Note that new technology implementation is complex and takes time, so the first of the new turbines won’t be delivered until 2025.

What the market thinks about Vestas

Over the past 12 months the share price of Vestas has gone nowhere (up 0.4% year on year). Vestas is the world’s biggest turbine manufacturer yet its coverage is almost non-existent on Seeking Alpha, with just 1 Seeking Alpha author covering the stock in the past 90 days, with a “hold” rating. Wall Street has just 1 rating (“strong buy”) in the past 90 days. Seeking Alpha’s Quant rating, which usually has a dim view of companies in changing technology spaces, has a “hold” rating, with Vestas scoring badly on Revisions, Profitability and Momentum, but highly on Valuation and Growth. This lack of interest in wind companies by US investors is likely due to the fact that Europe and especially Scandinavia is the key driver of wind developments. Note however that Chinese companies are beginning to dominate recent growth.

Conclusion

It is important for investors to form their own opinions about investment opportunities, but an often neglected feature of this decision process is to develop a sense of where an investment area is going at a time of great change. Big, influential investment advisors can be helpful, but it is important to understand the context of their investment commentary. When commentary comes with a clear view of the investment environment that does not align with reality, I find it important to be cautious. A good example is a recent report from Wood Mackenzie “ Five themes for energy and natural resources in 2023” which starts out acknowledging dramatic expansion of renewable energy, and then continues as if these huge transitions are going to have no impact on energy needs, which Wood Mackenzie posits as a continuing oil & gas story, meaning more oil and gas and higher oil prices. Seeking Alpha author The Long View Investor has recently published the contra view for the oil (& gas) industry in which he suggests that this is a dangerous decade for Exxon Mobil ( XOM ). Every time a new solar or wind project comes on line, that means (when combined with the electrification of wheeled transport) less oil and gas needed. My take is that, as the scale of renewables investment already exceeds that for fossil fuels, the exit from fossil fuels is getting closer. It is in this context that I conclude that the future for Vestas is increasingly bright, especially since offshore wind offers less licensing approval issues than onshore wind, and the capacity factor for offshore wind is large. I like the conservatism of Vestas management and focus of Vestas as a pure wind play.

Whether now is the right time to buy Vestas is a personal choice. Given the uncertainty in global markets I chose to exit my Vestas stake earlier this year after doubling the value of a 2018 investment in Vestas. Today I’m considering when will be a suitable time for new purchase of Vestas shares. I’m thinking that the bottom is close.

I am not a financial advisor but I follow closely massive changes happening as the world begins to decarbonize and electrify power and transport. I hope that my commentary is of some value to you and your financial advisor as you consider your investments in the energy space.

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