Thesis: Long Vestas Wind Systems (VWS GY). VWS is the world's #1 wind turbine manufacturer. Renewable energy companies were historically economic boondoggles and creatures of subsidy - that attitude has persisted such that growing concern about the economics of wind turbines at the end of a subsidy period starting now through 2020 has caused the Western publicly traded turbine companies to trade down as much as 40% - 60% off of their highs. In fact, we believe that wind turbine manufacturing today is a much better, more orderly capital goods market than the bears give it credit for and VWS is competitively advantaged in this post-subsidy world. Furthermore, we believe that VWS’ service business is an underappreciated gem that will swiftly grow both its proportion of VWS’ total EBIT as well as its EBIT in absolute terms and ultimately prompt a rerate given the profitability and stickiness. At 10x - 12x consensus forward earnings including net cash or 7x - 8x EV/Fwd EBIT, we don't think our more optimistic view is even close to being priced into the stock and the stock looks to have a high-teens IRR just on these factors. However, we are also structurally optimistic about renewable energy (wind in particular) and, in our bull case, believe that this could become a coveted business as its strategic importance and future business prospects become clear.
Instead of being an economic boondoggle, VWS is an excellent business with a pristine balance sheet, strong returns and FCF generation and the leading position in an emerging oligopoly. VWS is even a buyer of its own shares and we can’t think of many renewables companies that are in a position to do that, much less do it repeatedly!
Some Background: 5 to 10 years ago, this author focused a material amount of his workday on the energy sector. At the time, renewables were seen - at best - as a nice gesture towards the environment and - at worst - as cynical greenwashing and an uncommercial waste of money fueled by political fancies. This author fell somewhere in the middle of that spectrum but, whatever, at the time renewables were viewed within almost all quarters as economically nonviable and, at the time, that view was correct.
However - 8-12 months ago - this author STILL held the belief that renewables were nonviable on an economic basis. That view had been overtaken by human progress and had become incorrect.
In fact today, on anUNSUBSIDIZED basis, the cheapest incremental MW of power generation is provided by wind:
This is Lazard’s most-recent version of this analysis but it has been corroborated by other research efforts as well as the fact that energy companies are continuing to bid for renewable projects on an unsubsidized basis. You don’t have to believe research projections, market participants are speaking for themselves. Some companies like NextEra even believe that new renewables plus storage already make sense as a replacement to baseload power”
We aren’t willing to go that far yet, but consider it food for thought as we wouldn’t find it shocking if many VIC participants had similarly skeptical attitudes to this author’s from not that long ago. It’s an important tipping point that we have just recently reached:
[Note: LCOE stands for ‘Levelized Cost of Energy’, a measure of the cost of building and producing a MWh of energy]
Hopefully this inclines otherwise-skeptical readers to be less skeptical. And the LCOE of wind looks to keep dropping further for many years. The world has changed.
Company Background: VWS is a Danish company. Founded in 1945, VWS began making turbines in 1979. As the market matured has matured, VWS has emerged as the #1 OEM in the world and now has over 85 GW of installed capacity globally. As with many other capital goods companies, VWS has a servicing business that has grown in importance and now does a significant amount of 3rd-party turbine servicing after acquiring the largest independents in Europe and the US in 2016. In total, VWS services ~75GW globally today and has by far the largest turbine servicing business.
Key Thesis Points
Excess pessimism around the extent to which turbine prices could go down: We think this is likely to be an orderly market and the recent large price declines are more of a reset to a post-subsidy world than representative of a new price decline cadence.
Confidence in future wind turbine prices has been roiled in recent months as the US Production Tax Credit (PTC) which incentivized the construction of renewable energy moves towards expiry in 2020 (and was threatened by the recent US tax bill along the way) and many other markets, especially in Europe, move towards an auction model. The concern is that wind turbine manufacturers, unaccustomed to this new commercial reality, will get involved in a messy price war. To wit, all the major Western turbine OEMs have disclosed HSD to low-DD px/MWh declines in the most recent quarter.
The bears seem to be inclined to assume these price declines are the new normal but we think that’s not correct. While price declines will be a part of this business as incremental efficiencies are realized, this is not the feisty, diffuse industry of a decade ago when wind power really took off globally:
China has been a big part of those capacity additions but, as you’ll see in the following exhibits, it tends to be separate:
Globally, there are clear leaders but VWS is the only truly global player:
[Note that Siemens recently acquired Gamesa]
In the US, a number of entrants flooded the market as installs took off before becoming consolidated. In CY16, VWS and GE made up >80% of the entire US wind turbine market: