Sour grapes for green transformation amid COP26 talks
Head of Equity Strategy
Summary: Vestas delivered its third straight quarter of disappointing operating income due to unhedged steel prices impacting costs, but rising transportation costs and supply constraints are also impacting Vestas negatively and the wind turbine maker does not expect the headwinds to ease until late 2022. Orsted, the world's largest developer of offshore wind farms, delivered on earnings but investors are sending share down as short-term risks have increased and Orsted's equity valuation is still richer than Apple. Finally, we also take a look at the solar industry which is also under pressure this year from rising polysilicon prices.
At the COP26 meeting the political class and industry talk about goals for the future to limit the impact from climate change, but on the ground some the more mature technologies applied to solve the issues are experiencing a setback.
Vestas will face headwinds into late 2022
Vestas has reported Q3 revenue at €5.5bn vs est. €5.1bn and EBIT excluding one-off items of €325mn vs est. €387mn, and maintains revenue outlook for the fiscal year but lowers the EBIT margin to 4% from previously 5-7%. This is an somewhat embarrassing downgrade as this is the third weak quarterly earnings from Vestas driven by unhedged commodity input prices on steel and other materials. The world’s largest wind turbine maker is guilty of trying to smooth things with investors instead of acknowledging the enormous pressure from commodities and transportation costs. Vestas shares are down 14% today and down 18% over two trading session as investors were preemptively dumping the shares yesterday despite a positive session in global equities.
Rising commodity prices including steel which is the dominant part of a wind turbine are slowing down orders and wind projects, but at the same time higher energy prices are making wind power more affordable. But many wind turbine farms are based on negotiated electricity prices and if Vestas passes on all the cost increases then these projects may no longer be profitable for the operator. So the volatility in steel prices is making planning more difficult and Vestas may suffer from this conundrum for a while. The long-term outlook for wind turbines does still long strong as governments and COP26 talks show huge support for the transition to renewable energy sources. The question is whether investors will look past the next year and keep Vestas at these high equity valuations (valued at 30x FY22 earnings).
Sentiment sours on Orsted despite earnings beat
Orsted reported earlier Q3 EBITDA of DKK 3bn vs est. DKK 2.8bn and revenue of DKK 14.5bn vs est. DKK 9.8bn, driven by the centralized heating and power business offsetting weakness in its offshore wind power business that has been hit by historically low wind speeds this year costing the company DKK 2.5bn compared to the first nine months of 2020. The company announced that it is divesting 50% of its Greater Changhua 1 wind farm and earlier this year it sold a portion in a zero-subsidy German wind farm underscoring the investor demand for these wind farm projects. Shares are nevertheless down 5% in today’s session as investors might be questioning the valuation relative to the growth in the business.
The company guidance DKK 15-16bn in EBITDA excluding new partnerships which using DKK 401bn in enterprise value gives you an operating earnings yield of 3.9%. For comparison Apple is valued at 5% with a stronger business model, less volatility, and much lower CAPEX needed and thus higher return on invested capital. But Orsted’s valuation and investor appetite is held up by extraordinary forecasts for wind turbine capacity (18% p.a. towards 2035) on a global scale over the coming decades (see figure).
The green transformation is more than wind of course, and solar had a good October offsetting a disappointing year. Polysilicon prices are surging as a function of higher energy prices. The majority of the world’s solar modules are produced in Northern China which primarily uses coal as the fuel source for electricity generation, and with coal prices galloping higher this year prices on solar modules are also rising. After a strong 2020, solar stocks are down 5% for the year (chart), but as with wind the growth outlook is strong and last year 40% of total new net addition of power generation came from solar and Bloomberg New Energy Finance expects that it could increase again this year. The problem with solar is that the producers are facing the deflationary forces of rapid technological development just like personal computers in the 1990s, which however will normalize in the future when the marginal gains slow down. In the meantime, the gains on solar are likely best obtained on the asset side (utility companies owning utility-scaled solar farms) instead of the manufacturers.