Vestas Heads Off Tailwinds From Chinese Competitors
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Believe it or not, there is an upside to Chinese low-cost producers stealing your market share.
Before China made a strong entrance into the wind market, leading wind turbine maker Vestas (NASDAQOTH: VWSYF) enjoyed a comfortable lead over a usual lineup of competitors. Now that the low-cost Chinese producers have blown in on a gale wind, displacing half of the top 10 wind turbine makers, the economics of the wind industry are changing. They have also swept in a lower cost structure. While a more competitive wind market is putting strain on Vesta's cash flow, it is emerging a more scalable competitor.
A more scalable Vestas is quickly growing market share in new hemispheres while diversifying beyond Western markets where it has had a dominant position. Notably, its sales are becoming less dependent on the volatile US wind market. Driven by government subsidies, US wind turbine demand has been prone to wide swings. Revenues soar when subsidies are strong, but swing low when subsidies are withdrawn. Vestas has been riding this roller coaster for decades. In a lower cost environment, however, margins have less room to ride out the low swings. Margins were lower than expected in key markets in the third quarter, notably for some projects in the US and Germany.
As the US Congress quibbles over renewing wind subsidies, Vestas and its competitors are enjoying stronger growth in non-Western markets. Ahead of the expiration of the US Production Tax Credit (PTC), wind turbine sales typically increase to benefit from the 2 cents per megawatt subsidy. Likewise, Vestas sold a record 1,800 megawatts (MWs) in the US in 2011 following sales of 1,883 MWs of North American turbine orders in 2010. It is now facing a sharp slowdown in US sales while also grappling with a decline in Asian sales growth. Vestas remains the leader in global wind turbine market share at 12.7%, with a little over 50 gigawatts installed, down from 27% in 2007. Four Chinese companies now make up the top 10, or about 29% of the market, with Sinovel and Xingiang Goldwind Science and Technology (XJNGF) second and third.
The withdrawal of renewable energy subsidies worldwide is affecting investments in wind power. Germany's Enercon, with 7.2% of the global wind turbine market, has canceled plans for a wind farm in Spain following the withdrawal of feed-in tariffs. Vestas' bigger push into South America and Latin America is helping to offset slower growth elsewhere. In the first nine months of 2011, orders from new markets equaled 58% of new orders, up from 23% in 2010. Revenues are now around 31% for the Americas, 59% Europe and Africa and 10% for the Asia-Pacific. Service revenues are another key growth frontier, having grown to over $700 million this year from $298 million in 2007. Offshore wind is third growth market. Vestas has installed 1.4 MWs of offshore capacity in Europe and Japan.
The Danish wind gear maker is now at a critical growth stage. While it builds out its international business, margins are feeling the pressure. Admittedly, Vestas is working in a more challenging operating environment and will continue to do so into 2013, says CEO Ditlev Engel. There is no reason to doubt that, as Engel states, Vestas is becoming more scalable and flexible to meet the challenge.
Its biggest challenge is lowering costs and freeing up cash flow while two major growth markets retrench. As they have nine times since 2005, US wind sales will rebound in 2013 when wind subsidies are restored. Furthemore, wind sales in China will start to pick up with GDP in 2013, an increasingly important market for Vestas. After the United States at close to 10 MWs, and Germany at 7.8 MWs, Vestas has installed 3.5 MWs of capacity in China.
The need for international expansion to grow earnings is starting to shift the market in favor of incumbent players like Vestas over the Chinese players The lower sales growth has highlighted increases in costs. Vestas' cost of sales have been steadily rising. For the first nine months of 2012, the cost of sales was $2.3 billion up 45% over the year-ago period. Part of the cost increase is associated with higher production costs for its newest turbine the V112 and GridStream technology. These costs are expected to decline in the coming year. Additional cost reductions may come from new blade technology, which is expected to be less capital intensive.
Vestas is producing further cost benefits from restructuring. In 2012, 2,335 positions were eliminated, and another 2,000 will be eliminated in 2013. The company is increasing productivity 24% in 2012 to 6,300 megawatts, up from 5,100 in 2011 while operating with 10% fewer employees in manufacturing. Its workforce is planned around an installation of 5,000 megawatts in 2013. More downsizing is planned. A total of $517 million in total employee cost reductions are expected by the end of 2013. Capital expenditures have been more than halved to $452 million, from $982 million in 2011. To further tackle costs, Vestas plans to bring down working capital and improve inventory management.
Vestas capital structure overall is strong enough to withstand a few market dips. The company that has powered the world's largest wind economies – Denmark, Sweden, Germany, UK, US – is looking out over the five-to-seven year wind industry business cycle. Vestas has a debt-to-equity ratio of .69, in line with the industry average. Its current ratio is 1.13. Vestas' operating margins have improved, stretching to 7% in the third quarter from -6.9% in the year-ago period
With manageable liquidity, alongside Vestas, the industry's largest players are assertively shoring up their balance sheets. Incumbent Spanish wind player Gamesa (NASDAQOTH: GCTAF) has joined other wind power companies in announcing layoffs as part of its plans to cut global staff by 20%. The $2.52 billion company is focusing on wind farm development to offset slower sales in China and Europe. It has just completed the sale of an 8-megawatt wind farm in France to London's Impax Asset Management. Gamesa has a current ratio of 1.52 and a debt-to-equity ratio of .73.
The Chinese wind turbine makers have not been insulated from the downturn. As less mature players they have more expenses related to international expansion, such as setting up local production and supply chains. Goldwind considers the US a key market but has put a US factory on hold pending renewal of the wind production tax credits. International expansion is likely to put more pressure on its low-cost model, which has contributed to a high return on invested capital (ROIC). Goldwind has an operating margin of 3.54%, a current ratio of 2.01, and a debt-to-equity ratio of .70.
With cash flow declining, the Chinese companies are likely to take on more debt to fund international expansion. Goldwind's cash flow has fallen to a negative $755 million. The lack of diversification is showing up in larger losses for Chinese wind firms. Sinovel experienced an 82% decline in profits in the third quarter, primarily related to the slower economy and grid constraints in China.
The Chinese companies are also feeling pressure from the declining prices for wind power gear that their low cost models have produced. Guodian Technology, whose market is largely still concentrated in China, has seen its gross margins shrink from 17.4% to 14.6% in the first half of the year. A unit of power company China Guodian, in the first six months of the year its sales were up 66% to $906 million over the year-ago period. It has a high Chinese government approval rate for its projects, support which will help it fund global expansion. It recently announced its first US wind installation in Texas.
Vestas has a large backlog of orders and as projects under development reach completion working capital is expected to decrease and cash flow improve. Deliveries were up 49% in the third quarter and there are 8.3 gigawatts in back orders. An increase in turbine prices will help. The average price is up 10% to just over $1 million per megawatt in 2012. The low cost service business will be an increasingly important profit center. Service revenues were up 46% and it is benefiting from an expansion in length to six to seven years.
Vestas' restructuring into a more scalable player is on track. In the fourth quarter, net debt is expected to be lower and revenue and earnings growth positive.
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