Vestas Wind Systems A/S
CSE:VWS
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Vestas Wind Systems A/S
Earnings Call Analysis
Q2-2024 Analysis
Vestas Wind Systems A/S
For the second quarter, the company reported revenue of EUR 3.3 billion, reflecting a decrease of 4% year-on-year. This drop was primarily due to issues in the Service segment, partly offset by higher delivery average selling prices in the Power Solutions segment.
The Service segment faced significant challenges this quarter, generating a negative EBIT of EUR 107 million. This was largely due to a EUR 300 million negative adjustment caused by changes in planned costs. The adjustment had no cash flow impact but led to a 26% decline in Service revenue.
Order intake for the quarter was positive, growing by 54% year-on-year to reach 3.6 gigawatts. This growth was mainly driven by onshore projects in Europe and Asia-Pacific. The company's adjusted free cash flow was EUR 0.5 billion, helping to reduce leverage to 0.7 times net interest-bearing debt to EBITDA.
Based on the quarter's performance, the company has updated its financial outlook. The revenue for the full year is now expected to be between EUR 16.5 billion and EUR 17.5 billion, narrowed from the previous range of EUR 16 billion to EUR 18 billion. The EBIT margin is also revised to be between 4% and 5%, down from the previous guidance of 4% to 6%.
Despite the issues in the Service segment, the Power Solutions segment made significant improvements. The EBIT margin for this segment improved by almost 8 percentage points compared to the second quarter of the previous year. This strong performance allowed the company to offset some of the negative impacts from the Service segment.
The company has maintained its investment outlook, with total investments expected to be around EUR 1.2 billion for the full year. They highlighted that they aim to keep building on the robust performance in the Power Solutions segment while addressing the challenges in the Service segment.
The leadership emphasized their commitment to resolving the issues in the Service segment and leveraging the improvements in Power Solutions. They also mentioned an upcoming investor call to discuss further details, indicating transparency and active communication with stakeholders.
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Thank you, operator. With this, I would like to welcome to this extra investor call triggered by our announcement a little earlier this afternoon. So first of all, let me take you through a couple of highlights. I'll then pass to Hans to go through the Service overview before I conclude with the updated and narrowed outlook for the year. So operator, if I could have the first slide with the key highlights.
So the key highlights for our Q2 revenue of EUR 3.3 billion. That's a revenue decrease of 4% year-on-year affected negatively from Service and offset by higher delivery ASP from the Power Solutions. We have had Service impacted by adjustments to planned costs, that means the Service EBIT negative of net EUR 107 million in Q2 due to approximately EUR 300 million in negative adjustment and has no cash flow effect. The underlying earnings progressing as expected, the turnaround in Power Solutions is on track and has improved EBIT margin almost 8 percentage points compared to the second quarter of 2023.
The order intake in the quarter was 3.6 gigawatts. The order intake grew 54% year-on-year, driven mainly by onshore projects in Europe and Asia-Pacific. We also have seen a strong cash flow. The adjusted free cash flow in the quarter was EUR 0.5 billion that drives leverage down to 0.7x net interest-bearing debt to EBITDA. And then as a reflection as all of the above, of course, we have made the announcement because we are changing the outlook.
So the outlook narrowed the turnover is now between EUR 16.5 million and EUR 17.5 billion and the EBIT margin is between 4% and 5%.
With that, I will hand over to Hans and also for the next slide and the Service overview.
Thank you so much, Henrik. And as you mentioned, we are seeing our profitability being impacted by adjustments to our planned costs. In the quarter, Service generated a negative EBIT of EUR 107 million. And this is a consequence of the adjustments that we are doing to our planned costs which is due to the percentage of completion method of accounting that we're using affects EBIT in the quarter. This adjustment has had a negative accounting effect of about EUR 300 million on the Service EBIT in Q2, I should say, and you pointed to that also that in the quarter, there is no cash flow effect from this adjustment. And disregarding the impact of the adjustments, the earnings would have been that flat year-on-year.
The revenue and Service declined 26%, again, driven by the impact of the adjustment that I mentioned before. And I should also point to the fact that transactional sales increased in the quarter, and we had a currency headwind of about 1%. And all in all, that is, as you see on the right-hand side, what then takes us to a revenue level of EUR 671 million and a negative margin of 15.9%.
Thank you for that, and then we'll go to the next slide and Henrik will talk a bit about the outlook.
Thank you so much, Hans. And the therefore, narrowed outlook for the year, we're that far now in August. So we see the revenue for the full year sitting in the range of EUR 16.5 billion to EUR 17.5 billion. The previous was EUR 16 billion to EUR 18 billion. The EBIT margin before special items, two changes here, the outlook for Service now sits around EUR 500 million in EBIT. Previously, it was between EUR 800 million to EUR 880 million and the total outlook for Vestas is, from an EBIT point, between 4% to 5% versus the previous outlook, 4% to 6%.
Total investments, no change there, approximately EUR 1.2 billion for the full year.
So I will say in conclusion, we continue to see the steep progress in Power Solutions and in this quarter, offset by an adjustment in Service I'll also say here, let me also say that we still look forward to the full pack release on Wednesday. I know we have scheduled to call and set an investor call on Wednesday, where we can also have the full details of the full report. And of course, we look forward to discuss a lot more of the business in details on Wednesday.
With that, I would like to turn to the operator where we can then have a short, and I encourage people, to a related Q&A on the Service part today, and then we can continue the exchanges over the remaining part of the week.
[Operator Instructions] And the first question comes from Claus Almer from Nordea.
Two questions from my side. The first goes to this EUR 300 million adjustment, is this a adjusted compared to what you have done in the past? Or is it adjustment compared to what you were otherwise going to recognize as revenue profit going forward? That would be the first one.
So if I understand you correctly, you're asking where the EUR 300 million comes from and -- it's an effect of the POC accounting. So effectively, the way that it works is that when you adjust the planned cost, then you also need to go in and of course, adjust exactly what is the expected future cost levels of the contract, right? And so you get to this adjustment by simply realizing that the percentage of completion you have a right to is different. And what you thought it would be this is where it gets a bit technical [indiscernible] but effectively, as you realize that, you will then go in and also do an adjustment of the revenue levels and then the profitability levels that you've have achieved and that you will then be doing that, you can argue at a later stage, so to say. So that's how it works.
Sorry, Hans, I might be slow. So I really didn't understand that reply. So the EUR 300 million profit, if you haven't made this announcement today, would that have been a profit going forward? Or would you have EUR 300 million less profit in the past? Or is it a combination?
If it's a planned cost change we are making, right? So when you think about it like that, we're seeing a higher cost level in the contract in the future. And the way that it then works is that you then go in and rebase your contracts to the levels that you expect for that margin level to be at. And as part of that process, of course, when your planned costs go up you lower the expected profits that you would be seeing on that contract. And as a consequence of that, your -- say profitability level will, of course, be coming down as a consequence of that. At the same time, you can go in and make this adjustment.
So you have not been front-loading profitability to be clear?
So the way, again, it works is you go in and update your expected costs on the contract. And as you do that, when you update your planned costs as a consequence of that, of course.
Then my second question, if I want to look at Vestas' underlying performance, would you say it would be fair to say we should add back this EUR 300 million to 2024, i.e., if I use the midrange of your guidance, I should add EUR 300 million, i.e. in the EBIT margin above 6%. Is that the right way to do it?
I think there's a multitude of other things that comes into play when you add it all up and instead of looking at it from the perspective of the Vestas Group and there are lots of dimensions also and what we're going to be sending out in a few days' time. So perhaps when we're talking to Vestas Group [indiscernible] and what you should think about that perhaps you can take that discussion when you have a chance to look at that, Claus. But it's too mechanical calculation to make just like that.
And the next question comes from John Kim from DB.
Just to clarify and build on Claus' question, the EUR 300 million charge in the period was simply affected the accounting policies, i.e., there were no voluntary adjustments on the cost accounting going forward. Do you see the EUR 300 million [indiscernible] catch up? Or is this an ongoing charge or effect we should think about in the high cost or high inflation environment?
I think it's a bit hard to hear what you're saying, but if I infer a bit from what I could hear, I think you're asking -- say how to think about this from the perspective of what has kind of happened here? And so I said this is a combination really of the sustained inflation that we're seeing, in particular within specific inflation components that we are faced with and it's also linked to, say, effects we are seeing from the ongoing repair and upgrade campaigns that links in turn to the quality and LPF issues that we've also been talking to.
And then finally, also, what we're seeing is that we are also unfortunately seeing some of operational initiatives that say we take the efficiency up off the service business not manifesting itself as what we would have hoped. And for those reasons, we are expecting that the cost levels of the contracts that we're looking at before they hit end of the line before they get to the end of completion. But they have increased. And as a consequence of that, we are then updating the numbers, and that's why you get the easy [ one-off ] is what adjustment that we've seen here, which is part of the continuous cost planning process that we do as a part of our business.
Maybe if I phrase it differently, is this -- is there a significant amount of impairment in the number?
So I wouldn't think about it like this. It's continuous cost planning we are doing. And where we have been looking at the aforementioned factors and also have been doing performance revenues in our Service business. And as part of those continuous reviews, we are seeing that we need to make this adjustment. So we think it's prudent to do that now at this point in time.
Any color you can give us on that contract assets.
Yes, of course, there's a linkage to some extent to this because if you're looking at it from the perspective that you're seeing higher costs than what you would potentially have anticipated. In turn, that drives revenue and the [ billing ] plan stays the same. So from that perspective, of course, there's a linkage in that when you have that kind of effect then you will see that there is a build on the contract asset. And so there will also be an adjustment to that as part of what we are looking at here.
The next question comes from Deepa Venkateswaran from Bernstein.
Sir, I think, my other question is, how are you looking at Service margins going forward for next year and so on. And I know you've talked about it being around last quarter, so around in the 20%, 21%. Are you still maintaining 20%, 21% going to 25% over some period? Or should we be thinking about the new normal being more in the early 20s?
And secondly, for clarification, so EUR 300 million, will you be adopting the contract assets in the balance sheet by the EUR 300 million? Or is this more a provision that some service contracts are probably loss-making for the future, so you've taken those provisions now. So it doesn't change the contract asset. I wasn't very clear on your answer to the previous question.
So first of all, Deepa, thank you for that. And let me -- on the underlying business, it is performing and will be continue performing around the previous quarters and the levels we have seen there, nothing really changing, which means it is in the indication of the around the [ 2020 ] level.
I think also here, we don't change the target for the business. The business is sound, the business is good. In that sense, some of these changes, as Hans is referring to comes from the macro changes we are seeing in certain areas of the world. So therefore, target is still to invest and keep also developing the business towards EBIT '25. And I think on the contract asset, Hans, you want to comment on that one?
So in rough numbers, the contract asset will, of course, be impacted in rough terms by the same amount. That's what we're looking at here. So I hope that answers the question.
So eventually, this is reverting some revenues you already booked because of the POC and then now because of the cost adjustment you are writing that back?
We are adjusting the contract assets as mentioned, down by about the same amount as you're looking at in the [ 300 ] products that we're looking at. That's going to be the effect on the balance sheet.
So then it pertains to already recognize revenues rather than future, right? Because the assets will only be recognized -- would only be created because you recognize that revenue ahead of the [indiscernible]?
It's a very bad line. It's -- it cuts, Deepa, I can't hear what you're saying. Speak again.
Yes, sorry, I was just saying out loud that doesn't -- the fact that you're reversing the contract asset means that this pertains to revenues already recognized, which is why this unbilled revenue was even created in the first place.
So if I understand your question correctly, then the contract adds will increase less than what it otherwise would have. It's not a reversal in itself. But of course, there is a reduction in it as a consequence of this.
And the next question comes from Kristian Tornøe from SEB.
So first of all, I'm still struggling a bit to understand that if planned cost is higher than expected and then not fully compensated by inflation indexation why this will not impact margins going forward?
Of course, the margins are impacted by this in how it works in the [indiscernible] had a higher planning cost level than what you had anticipated. I think that's evident. But we still see a business that works well in many ways. And hence, with what Henrik said before, we are expecting to perform to the levels of what we've seen.
Of course, there is an adjustment to the cost levels that we have seen in the backlog. But let me remind you also that you're looking at a very significant size of the backlog. Just to put that into perspective, it's a multibillion -- very large backlog. And hence, when you put what we're looking at into that perspective, it gives you kind of a sense of what we are facing here. But to understand your question correctly again, it's not that we are seeing a Service business that doesn't perform at all. But what we are seeing is that due to these changed cost levels, we are now, say, expecting to see a profitability level, et cetera, around the levels that we mentioned before, which is on par with what we had in prior quarters.
So maybe the EUR 300 million is a reflection of overstated margins historically. For how many quarters does this reflect? So I mean, what's -- get a sense on what the effect on a quarterly basis in [ insulation ] because I guess this reflects a longer period of [indiscernible].
Kristian, but the way it works as you go in and then you look at what is the level of cost that you're expecting and what we are doing now is changing the expected future costs that we are seeing on the entirety of the contract. And on average, it's an 11-year type contract backlog that we are looking at and hence, even smaller adjustments to the numbers gets to have, let's say, an accumulated effect and when we're then looking at the combination of factors that we have been facing, sustained inflation rates, the upgrade in [indiscernible] campaigns that has gotten more expensive than we thought, operational inefficiencies also. Then when you combine all that, then you get to something like this in totality.
And the next question comes from Vlad Sergievskii from Barclays.
It's just a quick question on the wording of the release. If I understand it correctly, you're basically saying that the impact of this higher cost was partially offset by expected future efficiency achievements and cost-out actions. Would you be able to give us an idea how big the charge would have been if you wouldn't have factored in these future initiatives and cost-out actions?
I don't think that's a number that we have been communicating, no. But of course, you're seeing ups and downs in what goes into it. And the net effect of what we're looking at is what brings us in to the EUR 300 million that we are taking here. And of course, also, as we highlight our say, efficiencies and our, say, challenges on those initiatives that we have been working on, they come through with a net negative also as a consequence of this. So of course, this is something that net does not work in our favor. I think that's what we're saying.
Of course, in a business like this one, you are constantly working with improvements and you're working with the office so to say -- and managing improvement, so to say, and if those improvements does not come through as you would have hoped, then you have a net negative consequence of that, and that's what we have been seeing now as part of this.
And the next question comes from William Mackie from Kepler Cheuvreux.
The first question would be around why now what catalyzed this event as you went into the quarter end? Is it an annual review? Or was there something else? I mean a number of the issues relating to inflation, for example, have been with us now for many quarters and could have been reviewed at the end of last year. So the first question is why now?
Yes. So what we do here is part of our continuous cost planning. And as I said, it's a multitude of different things that really come together in a way that brings it to the level we're looking at now. I think I've mentioned them already, the factors. And unfortunately, we are seeing now at this point in time that they all do not really work in our favor. As I pointed to before, it's a fairly sizable backlog that we're having. And that also means it's a fairly sizable cost backlog that we are having. And when you combine the effects of what we're seeing, and this is something we continuously do, then we get to the conclusion that this is something we had to adjust at this point in time. So it's really just part of a revenue we go through.
Of course, you don't do it every minute, but it is say, a continuous work that we do in the company. And again, as I like to point to, the underlying business is performing well in many ways, but you have seen the combination of these factors where we are seeing now that we need to make certain adjustments to that. And that is what we are now doing.
And the second question, if you'll excuse my simple mathematics. But basically at the midpoint of your revised guidance, you've lowered the midpoint -- well, less than EUR 100 million implied in what you're saying. But you're guiding to a EUR 300 million impact on Service profits for the year. Should we take away from that? Or what should we take away from that? Do you see that the Power Solutions business performing ahead of expectation. Is there any other message you could give beneath the Service commentary?
I think, first of all, thanks, but we will keep quite a lot of the details. You know why we've done this when you change your outlook, you come out with it in a different timing, which we have done today. but your assumption is right. We couldn't lower the outlook to that and narrow the outlook in that range if Power Solutions was not performing better, and we see that in general terms, we will do the comparisons when we sit with the full report. But you're right, we are almost 8 percentage points better in Power Solutions year -- quarter-on-quarter from the 23-year comparison. And we are generally seeing improvements in that also for the year -- for the second half of the year.
And the next question comes from Vivek Midha from Citi.
So my question is a follow-up regarding the drivers of the update. You cited both cost inflation and the impact of increased repairs and upgrades. Is there any way you can quantify the relative importance of the cost inflation and then the repair activity. Have you made any changes to your views on expected lost production factor, failure rates and so on?
Thank you for the question. I think you're touching on the two factors here. Both of them for us in our books becomes more sticky. We can see that the inflation and especially also the gap in between the CPI and the wage inflation has become something we see and experience become more sticky. Number two is, as you've seen also in the previous quarters, we're trending in the right direction on LPF. We're still having an LPF that is touching around 3%. And of course, the triggers, as we also said, a lot of the upgrade and repairs would also create a task backlog, we have to deal with for the general Service business. And that is predominantly where we are seeing this is in Americas and in Europe or EMEA, as Hans was mentioning.
So that's where we are, and that's what we are doing right now. But besides that, there is nothing that we have seen in there that significantly changes. We can just see that the two points there are sticky. And as we said, that's the third one, when you start looking deep in the details, there are also a couple of operational inefficiencies in our own operations here, but that is to a lesser extent.
As a very quick follow-up. With those site differences in the Americas and Europe, are you seeing this more on legacy turbine platforms or newer turbine platform. Is there any color you can give around that?
I don't think there is a separate split, we have seen it both in terms of legacy and newer platforms. We're also seeing, of course, in maturity to end of contracts so we have been through most of it in that sense. And so I think here, when you talk about that, it is much more about how do you get [ people ] components and other things in and around on the upgrade and repair, it is what it is and it's what it has been for now some time. And that doesn't sit in and around particularly one turbine or one platform.
And the next question comes from Togo Jensen Dan from Carnegie Bank.
Just to understand and to be clear. Is there any impact on this on the revenue new line? Or is this just a cost issue for this year? So the percentage of completion is sort of say where you expect it to be it's just become a bit more expensive, so to deliver on the revenue. That's the first question.
So technically speaking, again, the way that it works, then is that the revenues will be impacted by this to the tune of EUR 300 million. That is what we have done. Also, when you look at the revenues on the slide that I presented before, EUR 671 million they are impacted by EUR 300 million from this. So you have this effect that revenues are impacted by this. It's basically a mathematical calculation you do as a consequence effect when you say percentage of completion is at a different place than where it was before you made the adjustment. So that's what you're doing, and that's how it works. And that's why you see an impact on the revenue line of about EUR 300 million.
And then just also, again, to be clear, the EUR 300 million, does that cater only for what you have so to say guided for this year? Or does it cater for potential, so to say, lower margin for the whole backlog. So it's not just an issue for this year, it caters for future, so to say, revenues as well.
So this is for the backlog. That's by definition how it works right. When you go in and do the adjustment for the planning costs then it impacts the backlog that we are looking at because this is exactly how this has been technically calculated that when you get to see that this impacts the remaining part of the life of the backlog. So that's how you should think about it.
Technically, we should see what you can call it normal Service margin going forward in a few years?
As we were referring to before, we are expecting to see a Service margin as I also said earlier on, I think that is around the level we have seen in the last two quarters. And in many ways, the Service business is performing well, and there are many things to say about it.
And then maybe, sorry, can you elaborate just a little bit on this underlying lift you're actually doing to the Power Solution part? Is that because some of these lower-margin orders are now out of the order or the backlog for -- and you so to say, not being delivered in the second half?
I think you've seen announcing orders also after 30th of June and other things. Could we save most of that to Wednesday. You can see in here, it's working well in Power Solutions, and we have had to issue this today. So I think it's better that we take some of those more related other areas of Vestas, save them for Wednesday.
And the next question comes from Akash Gupta from JPMorgan.
So if I look at last few years, a higher share of your Service orders are coming with risk where you basically share risk and reward with customers. The question I have today is that can you say on record that secure turbine performance in these performance-related contract is not the reason behind this service adjustment to profitability in second quarter.
No. We can say that for your record, No, that's not part of it and that's not specifically related to this issue. So the 3 points -- we are pointing to here has the three reasons for it.
Could we maybe have one last question or last person on questions, operator?
The last question today comes from Klaus Kehl from NYkredit.
Just another follow-up question to this service change. If we kind of look through all the technical issues and we look through this percentage of completion, wouldn't it be fair to say that this is kind of a provision? And if you have done it correctly, then you won't see any changes to your profitability in the service business going forward, let's say, in '25, '26 and '27. And in other words, it's in one-off or am I missing the point?
Of course, by definition, when you do a planned cost of date, then you cater for what you think is now the cost level you're at and that is your best estimate at the point in time you're at. Of course, you then adjust to the margin levels that we're expecting to see on the backlog. But as we have been talking to now around in different shapes and forms, what we're looking at here now reflects that this is how we see the business performing. And as you also hinted to me by saying that we're expecting to see these margin levels based on prior quarter performances so that gives you also an indication of where we expect to see the services business tracking. So as I said, this is a continuous cost planning update that we have been doing. But now that reflects the margin levels that we're looking.
Thank you Hans. Thank you again to everyone who participated with short notice. You know the rules, and we know everyone would like to have a longer lead time and a lot of stuff in these cases, you can't. So I apologize for that. Otherwise, we look forward to speaking again on Wednesday, I'm sure there will be exchanges as always, the Investor Relations and Daniel will be available to that. Otherwise, look forward to speaking again on Wednesday with the full presentation and also the full details and also to see many of you in the remaining part of this week.
So with that, thank you. Have a nice afternoon and evening. This conclude the extraordinary call.