Vestas Wind Systems A/S

SIX:VWS

Earnings Call Transcript 2021-Q1

[Henrik Andersen, Group President & CEO]

Thank you, and good morning, and welcome to this Vestas presentation of our Q1 results. And with me, as always, Marika is here. And therefore, let's go through the presentation and also have the following Q&A.If we go to the key highlights first, we finished Q1 2021 with an all-time high order backlog. The combined order backlog now is EUR 45 billion, and that comes despite the lower order intake in Q1 2021. And we are working very hard to integrate the offshore business, so a little bit more than 3,000 new colleagues have been welcomed into Vestas also to capture the future value of the offshore market, and not least also create the structure for how we operate the combined businesses going forward. Revenue of EUR 2 billion in Q1, slightly lower than Q1 2020 due to lower activity levels and especially impact from the supply chain constraints, which we will talk more about. EBIT margin ended at minus 3.6%. That is slightly down from Q1 2020. It is impacted by the lower turnover and also some of the logistical challenges. We have continued our annual displacement of CO2 and now reached 192 million tonnes. And of course, that also illustrates the progress in still establishing further capacity worldwide.So if we then go into a bit more details and, first of all, the global business environment. I think it is fair saying and we talk about the longevity of the pandemic here and also how that continues and also gives ripple effects and, to some extent, also entails further challenges into the supply chain. I think we have also seen in the quarter that it has created some fragile conditions in and around the supply chain, which probably is best illustrated when we saw the ship being stuck in the Suez canal because it immediately comes back to almost the whole supply chain. Throughout this, since Q1 last year where the pandemic started, we have to say again here that our focus on the business continuity has been primary together with our health and safety for our colleagues working around in our more than 80 countries. That still continues to be the case, and that still continues also to be the prevailing guidance when we operate across the world.We've also seen here the logistical challenges and supply chain bottlenecks. They are only now amplified by the COVID-19 restrictions. I also think it's fair saying here for most of our colleagues around the world, a lot of those and a lot of us can potentially start seeing a bit of light in the tunnel of coming out of the pandemic situation, but we also have a lot of our thoughts with some of our colleagues that are still in some of the hardest hit areas, not least mentioning here, India, as we speak. We have also seen in this quarter there is a reduced mobility for service technicians, the construction workers, and there are also goods and components that are being held in and around our borders. And some of the service technicians and construction workers are therefore in quarantine waiting to enter or even waiting to come back. But here, I will also just take the opportunity to thank you, our external partners, not least our colleagues across the world. It's absolutely impressive to see both the spirit and also the resilience that it has been created and also demonstrated in a Q like this. And so that is also what we are building further on when we come in to the remaining 3 quarters of the year.If we then do a short overview of the time of the year where we have the market shares being released. We have sustained our global leadership position. So if we take the global onshore installation in total, it's gone from 57 gigawatt to 94 gigawatts from '19 to '20. Our market share gone from 21% to 15.3%. And if we exclude China, the global market went from 33 gigawatt to 39 gigawatt and our market share from 35% to 33.7%. In this, we have used Wood Mackenzie, one of the leading agencies for releasing these market share data every year.Then into the business. And when we look at the business in Power Solutions, we have had a Q1 order intake of a bit more than 2 gigawatt. That is down 39% compared to Q1 2020. You can see from the chart here that it's across the 3 areas and 3 regions we normally show. Our ASP in the quarter was EUR 0.8 million, which is up compared to Q1 '20 and also at a positive level compared to the previous 4 quarters. I think the highlights within Power Solutions, if we start with, first of all, the high level in terms of the mega trend, I think all fundamentals and the mega trends have, of course, again, in this quarter been very supportive. We have seen strong new ambition levels communicated from EU, U.S. certainly targeting a CO2 reduction of more than either, respectively, 55% and 50% already now in 2030. Of course, that will drive both mechanisms and also active actions from countries and areas and customers in so.When we look at it also, we have seen and we are participating in a strong tender activity in the offshore market, which, of course, will lay the foundation, as we presented now a number of times, in the market beyond 2025. What we have seen in the quarter, we have seen a lower order intake primarily driven by U.S. and China, but the underlying pricing environment remains stable. We finished this quarter with a strong order backlog of EUR 19.4 billion, both across the onshore and offshore, and we remain strong focused on the project profitability. That also gave us some cautious thinking in Q1 as we have seen some of the components and especially also the commodity of steel quite an increase throughout the quarter.If we then look at the Service business, again, a very good quarter for the Service business. We ended with an order backlog in the Service business of EUR 25.3 billion. We operate 118 gigawatt of turbines with active service contracts split between 114 in onshore and 4 gigawatt in offshore. And in the combined backlog, we have more than 10 years of average duration in the backlog, which, of course, is again testament to strengths of the business. When we look at the highlights, I will say here it is only mentioned in a one liner, and I think it doesn't deserve just having a one liner by integrating an offshore business into the combined Vestas family. We are right now doing that. I know a lot of colleagues are working very hard to get together and create that operating model across the world. And therefore, we are right now leveraging our global supply chain and scale within the Service organization when we combine on an offshore.When we look at also the previous quarter, we have had long-term service contracts. They continue to be long term, and we have seen them in the Nordics and Ukraine. And we, of course, continue prioritizing that also going forward. Below, we have just shown in the service fleet, how the split is from the regions. And again, here, I will also just take away, again, growth in all regions and a priority to the Service business across all regions.We also just want to share what has happened in this sustainability strategy. Nothing really changed but progress overall and a couple of observations to you when you follow us. So first of all, the displaced CO2 emissions that we do from our turbines has gone up with 14% from Q1 '20 to Q1 '21. And it's an amount we, of course, are proud of and will continue to follow and show and share with you. When we look at the carbon emission, meaning our own emissions that have come out in Scope 1 and 2, it has gone up. It has gone up from a Q1 '20 to a Q1 '21 specifically through the integration and also the inclusion of our offshore activities. That one, we will now create a baseline in 2021, and work on some of the tools, some of the structures and also some of the solutions we already were successfully implementing in the onshore Vestas parts before.When we look at the Service, I think this is, again, a quarter we have managed to reduce the total recordable injuries in the quarter with 9%, quite impressive especially considering the conditions that are around in a lot of our markets. So we're really positive that people and colleagues are taking good care of each other.When we look at the increase of the carbon emission related to the offshore, you've also seen in the quarter, we have done an investment into the bio-composite specialist Modvion in Sweden to investigate further how we can use wood into the towers either completely or as a combination with steel and concrete. It's also here, it's very well positioned in saying thanks to both treasury and finance for working diligently through the new credit facility and combining that with sustainability targets in it. So therefore, we now have a new EUR 2 billion facility with our Baa1 credit rating that relates to how we also have the journey in sustainability ahead of us.So therefore, over that, I will hand over to Marika.

[Marika Fredriksson, Executive VP & CFO]

Thank you, Henrik.So if we start as usual with the income statement, I think you see very well here that the activity level is low here in Q1 as it was as well last year, but you see a declining 12% here year-over-year. Worth highlighting is also the gross profit where we see an improvement in the underlying, so you -- we are up 2.6 percentage points. And that is primarily driven by improved project profitability, which obviously has been a very high focus from our side. But to be very specific also is what Henrik mentioned earlier, that the COVID-19 challenges continues, and that has a very big impact on the overall logistical situation for us both from supplier side as well as us getting to customers. I will get back to the SG&A because you see an increase here, and that is primarily related to the integration of offshore. EBIT margin before special items decreased mainly driven again by the SG&A increase due to the offshore piece.So coming back again to the SG&A cost. You see here from a percentage point of view, we are down to 5.7%, so very good performance, which also shows that we are leveraging the SG&A cost. And the depreciation and amortization, excluding impairments here, increased EUR 56 million year-over-year, and that is primarily related to offshore. And we see, as I said at the beginning, a decrease down to 5.7 in percentage points.Service business, strong Service performance. So you see an increase of 11% here on the revenue. And that is compared to Q1 of last year, and that is obviously higher activity level and also integration of the offshore business. Profitability is down compared to Q1 in percentage points, so down from 26.2% to 22.2%. That is primarily the external factors that we have been talking about as well as the integration of the offshore business. I think everyone understands that is not free of charge.Change in net working capital. Inventory is increasing. But again, as planned for, I think it's also a good proof that we are expecting higher activity levels here in the coming quarters of this year, so nothing we are surprised with but really planned for. It's somewhat compensated by down and milestone payment, so the usual profile.Cash flow statement. Cash flow from operating activities is slightly better compared to Q1 of last year. That is eaten up by the change in net working capital, in this case primarily the inventory. And the cash discipline has obviously not changed. It continues to be a high focus from our side. And you see free cash flow is improving slightly but more or less in line with last year. You also see investments in JVs, and it's the EUR 186 million, and it's primarily the CIP transaction.Total investments is very stable year-over-year, a slight decrease but very slight. And the methodology has not changed. We continue to invest in technology as well as capacity and primarily the modes and localization.Warranty provision. Here, you can see that we continue to provide. We are 3.2% here in the quarter but expecting the 3% for the full year. And you see that the profile is changing, so we are definitely starting to consume more than what we provide for. And that is, again, expected that we will see that trend here during 2021. LPF as a consequence of the extraordinary repair, which I think you are fully aware of, is materializing, so again, not a surprise but a consequence.Capital structure. Net EBITDA to -- net debt to EBITDA remains low, although worsening a bit compared to Q4 of last year. And I also want to highlight it is still well below the thresholds that we have put up, but this is obviously a consequence of the net working capital that we continue to consume. We also have, as Henrik mentioned, a new EUR 2 billion credit facility to support both onshore and offshore wind project and primarily for an increasing demand for guarantees in the offshore segment.By that, I hand over to you, Henrik.

[Henrik Andersen, Group President & CEO]

Thank you, Marika.And then for the outlook and guidance for the year. Revenue continued to be EUR 16 billion to EUR 17 billion. Service is expected to grow approximately 15%. EBIT margin is expected to be 6% to 8%, and the Service margin in there is expected to be approximately 24%. Our total investment for the year is expected to be around EUR 1 billion. And I think here, it's also worth highlighting in 2021 our warranty provision are expected still to be around 3% of revenue, including both on and offshore. We have a note of special items that are expected to be around EUR 100 million when it relates to the integration of the offshore business. And not least, that, of course, the guidance comes with a degree of uncertainty compared to normal still with the COVID ongoing.So with that unchanged guidance and then over to the Q&A, and happy to pass back to the operator and start the Q&A. Thank you.

[Operator]

[Operator Instructions] And our first question comes from Claus Almer from Nordea.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

Yes. A few questions from my side. The first question goes to the Q1 loss. I fully understand that you don't want to split the profit between on and offshore, but maybe in more round numbers, you could help us to understand the dynamics behind the Q1 loss within the Power division. That will be the first question.

[Marika Fredriksson, Executive VP & CFO]

Okay. I thought you would take the 2 at the 1 time, Claus. Sorry for that. And obviously, I think it's fair to say here in Q1, we have a low activity level. It is slightly lower than what we anticipated when we did the budget. But the vast majority of the loss that you see or the impact is really on the onshore side here in the quarter. And I think it -- what you see is obviously, from an EBIT point of view, it is the impact from the EUR 56 million that I mentioned. In a small quarter as such, it has a big impact when it comes to the SG&A. And I think you understand also that the observation is maybe not a super eye, if I put it that way, without being specific. But it's we continue on the journey of improving the overall business and the execution of the projects and also the overall profitability level. And I think from that perspective, even though it's a low activity level here in Q1, you see an improvement year-over-year on the gross profit. So it's, I think, a very good proof that what we have put in place is getting traction.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

Okay. So just to be sure, so offshore is likely breakeven, the loss comes from onshore. Is there any on the contribution margin? Is that a -- compared to last year, it must be way better given the miss you had last year. But maybe you could put some color on your contribution margin in what you delivered this quarter.

[Marika Fredriksson, Executive VP & CFO]

And obviously, on the contribution side which is relating to how we execute the projects, that is clearly improving on the execution side. I think you all heard me say pre and post calc, and that is getting more and more in line. Then obviously, what you see here is the logistical challenges that Henrik was also alluding to and some of the rerouting and even lack of containers, stoppage in the Suez canal. So it's -- all of the above is obviously impacting the gross profit. But despite that, we see an improvement in the gross profit. So underlying, clearly, the actions that we have taken to minimize the discrepancy between pre and post calc for the contribution margin is getting traction.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

Okay. And then the second question, the loss production factor, that continues to increase. And yes, you have these provisions, but do you also have a negative impact from this in the P&L in addition to the provisions?

[Henrik Andersen, Group President & CEO]

The answer to that, Claus, is no. But of course, we look at the LPF. And I think it's not -- as Marika said, it's not a surprise because, as we said, the consumption of our NG will increase in '21 because that's how we address the warranty and also the repair and upgrades we talked so much about in second half of 2020.

[Operator]

Our next question comes from Kristian Johansen from Danske Bank.

[Kristian Tornøe Johansen, Senior Analyst]

So my first question is on this slower-than-expected start to the year and just sort of understanding whether this is entirely driven by the logistical challenges side that you haven't been able to get turbine to sites to the degree which you were originally planning for? Or whether there is an element of customers also deciding to delay projects and, along that, why you're stating that you're comfortable that you're doing catch-up in the following quarters.

[Marika Fredriksson, Executive VP & CFO]

Yes. And to be fair, it is -- I think we said at the beginning of -- or on the guidance for this year that we expected a slow start, so a very normal distribution between quarters. So when I say it's slightly -- or it's slower than what the budget was indicating it is not huge numbers, Kristian. So obviously, that is why we feel comfortable keeping the guidance for the full year. So again, it is low activity level, but it's not a big deviation from what we expected.

[Kristian Tornøe Johansen, Senior Analyst]

Understood. Then my second question is on orders. So you say that the decline year-on-year in orders is primarily U.S. and China, yet EMEA is down 22% year-on-year as well. At the same time, obviously, you report quite a high order ASP. So I'm just sort of wondering whether you have sort of gone out and raised prices to a degree where some customers are stepping away. Is that part of the explanation as well?

[Henrik Andersen, Group President & CEO]

No.

[Marika Fredriksson, Executive VP & CFO]

No. No. Okay, we're debating here. So no, what we see, Kristian, is, yes, we see an improved profitability level or an improvement in the ASP, but that is not causing any customers to step away from us offering to them. But we are equally, and we have been for the last couple of years, more selective in what our expectations are on profitability. Then we've had execution challenges. I think that's no secret. So that's why we have -- from an EBIT perspective, have had an impact. But it's not -- and if you -- also, if you look at the lumpiness of the order intake, and you see only this week, we have taken in 600 megawatts of orders. So we don't see customers stepping away at all. What we see and that I have highlighted before is more that there are less and less numbers of competitors when we have an offer out is not that many. And therefore, we also see a different discipline because everyone has a need to make money.

[Operator]

Our next question comes from Gael de-Bray from Deutsche Bank.

[Gael de-Bray]

There is one thing that struck me this quarter is that your order intake was below that of some of your peers, Siemens Gamesa, to not to name it. And I think that was the first time in many years it happened. And at the same time, I can see that your ASP is actually going up while their ASP is going down. So if you try to adjust for the mix effect in terms of geographies and power ratings, do you see some of your competitors, generally speaking, becoming a bit more aggressive and more successful in tenders at the moment? So that's question number one.Question number two is about the Chinese market. Obviously, last year was very strong with the Russian installations, in particular, towards the end of the year. So my question is how does it look like now for the remaining part of this year because I'm hearing about potentially significant catch-down effect in China in coming quarters. So if you could give us a bit more, well, details, of what's your view about this, please?

[Henrik Andersen, Group President & CEO]

Thank you, Gael, and I will just sort of start with the order intake, again, put that a bit in perspective. I think it's actually a testament to also the process we have spoken quite transparent about. We have a robust process when we do our sign-off of projects globally. And we also have robust targets when it comes not least to profitability signing off some of these orders. So therefore, when we have quarters, like Q1 here, where we have seen some of the underlying components and not least also steel deviating or increasing substantially, and we're not talking about a few percentages, we're talking about steel increases that in some markets in the last 6 months have been more than 60%, 70%. So for that reason, there is changes and variable to pricing of the technology we deliver to the solutions. That, of course, can either delay the discussions. It can also be that we have to go back with the customer and look at the whole project and how that can be reshaped as such, and we do that. I won't comment on how competition are addressing it. But I think here, at least accordingly to how we make our solutions, it contains many of the same components and also some of the same commodities. So I think we will have the same cost structure in that sense, and we deal with it in a transparent customer-by-customer basis. So as Marika alluded to, we are robust, and we know also the process and the target we are having. So I will leave that with that. When we look then at China, I think it is where China probably finished the year, and I will always ask for a little bit of understanding when you are able to put that much gigawatt up in a year because there is probably a backlog of things in China. So let China and China customers find their feet a little bit in evaluating that. We know that's ongoing. I can't put a quarter and we don't do a quarterly guidance on order intake. So let's see how the Chinese customers and not least the Vestas China team gets together and find each other in some of the new projects. I don't think the ambition level has in China nor in other countries around the world gone down in terms of renewable entity. So therefore, China will still have a priority to renewable both from a wind and a solar and also a combination leading towards the P2X as well. So still good market in China, but we need to find a little bit the coming out of the feed-in tariff in.

[Operator]

Our next question comes from Supriya Subramanian from UBS.

[Supriya Subramanian, Equity Research Analyst of Industrials]

Yes. I just have 2. One is on the onshore business and your market. And of course, you've maintained the guidance of EUR 16 billion to EUR 17 billion, which, if I back calculate on what you have guided for offshore and service, implies that onshore equipment is expected to decline about 5% to 6% year-on-year. Given what you've seen in momentum in orders in the first quarter, how confident are you for -- on catching up on this to meet the full year onshore guidance? Or rather if I put it, how much of this guidance is dependent on the backlog itself and how much in-for-out orders would we need in 2021 to meet the onshore guidance? And my second question is related to the inflationary trends, of course. And I guess, to some extent, I think reflected in your ASPs but just wanted to get your thoughts on how willing customers are to take price hikes to -- in every sort of -- in the new orders that you're negotiating to offset the inflationary pressure that you've seen on the cost side.

[Henrik Andersen, Group President & CEO]

Okay. If I should just comment on your questions related to guidance, you are right in assuming there are some deviations and minor changes in onshore versus that, and that has been the whole plan for the whole year ever since we issued the guidance in February. The guidance that sits with right now is, of course, a guidance we are fully aware of. It's the planning of what we did when we issued the guidance in February. We still see that planning holding well. There will be some movements and, as Marika described it, minor movements out of Q1 towards some of the later quarters. But the ramp-up and the split has always been skewed towards second half of the year but then a busy 3 quarters ahead of us. There will be some in for out risk still sitting in that guidance, but that is still a minor part of the EUR 16 billion to EUR 17 billion in there. But you, of course, will wait and see when we get to some of these orders later in the year. When it comes to your ASP and putting equation between ASP and the willingness for customers to pay for it, I don't -- maybe I should say it differently, but I'm pretty sure supplier, I'm not talking out of terms, I don't think any customers call you and ask for a price increase. And I don't think in our partnership and our relationship with customers that we underestimate the hassle and the discussion and also potentially the negative effect when some of the components changes. But the art of this technology is that it contains quite heavily commodity and underlying components. When that goes up in price, there isn't a magic thing that can just take that price increase away. So that is, I think, generally for all of the conversations we have had customer to customer, is a mature conversation around how to plan on the site and how to plan the project and then being transparent in it. If we have had success in that, looks like it, but I also think you should read something in here that there are some delays when some of these things, it's not a few percentages, it is high percentages change. And of course, that gives some variables and some challenges to everyone in the value chain.

[Operator]

Our next question comes from Dan Togo from Carnegie.

[Dan Togo Jensen, Financial Analyst]

I'm curious to know these logistical challenges, how far do you see them stretching to the coming quarters? And so to say, in order to get some sort of sense of what you expect into guidance, that would be the first question. And the second question also relates to the guidance. In which scenario is the EUR 17 billion in revenue and 8% EBIT margin still feasible?

[Marika Fredriksson, Executive VP & CFO]

If I start with the logistical challenges and how we view them, Dan, obviously, we've given a guidance and then both on the revenue as well as on the EBIT. And that is reflecting where we will end up. Then having the crystal ball, I don't think anyone has at this point in time because the market and the challenges are changing, if not on a daily basis, enormous lift frequently. So this is something we work with and, I think, we're managing. And are we perfect? Probably not. But we are in a situation where there's both a lack of -- or a lack of availability, both land transport and the sea transport. And on top of it, the logistical companies are very good at when you need something ad hoc, they certainly charge for it. So -- and then on top of it, you have the challenge of moving people, training people. So it's everything that it's impacting. And the market that have severe challenges are changing as well. And right now, I think the biggest hurdle is India as we speak.

[Dan Togo Jensen, Financial Analyst]

We are right now well into Q2 and then things have been improved basically. We are heading into a peak season, so to say, in the container market. So I mean standing from where we are now, I mean, you might be a bit optimistic to think that things will improve the next 1, 2, 3 months. So I'm just curious to know how you see this and what is baked in. I mean if things do not improve, where should we see, so to say, EBIT end up? Or where is it -- is there a risk, so to say, for that to -- that we are any more at the lower end of the guidance range if things do not improve? Is that sort of say how we should interpret it?

[Marika Fredriksson, Executive VP & CFO]

I mean we're keeping the guidance, and obviously, we feel comfortable with taking hit for the challenges or the more severe challenges, which obviously represent the lower end. And the higher end represent that things are going better than the low end. So I mean I think we have taken a hit, otherwise, we would give you a different guidance at this point in time.

[Operator]

Our next question comes from Martin Wilkie from Citi.

[Martin Wilkie, Managing Director]

Yes. It's Martin from Citi. So the first question was just on the onshore outlook. I mean you've booked fewer orders in the quarter than people might have thought a few months ago. But obviously, the backdrop particularly when we think of the U.S. has gotten better when we think of decarbonization and so forth. Has that fed into conversations with you yet? Or is it too early to tell as to what that means in terms of the tendering process on onshore? That was the first question. And the second question was just on the timing of what we can expect in offshore. I think in the past, you've said that this year, it's probably more preferred bidder status if there is to be anything happening on the new 50-megawatt platform. But just perhaps if you can give us some sort of sense as to the timing we should think about for preferred bidder and then ultimately orders for the 50 megawatts.

[Henrik Andersen, Group President & CEO]

Thank you. On the onshore order intake, I think it is always, as we also said, don't judge it necessarily on a 90-day period especially not in the quarter where you have that many variables hitting not only the pricing of the technology but also potentially the external factors. And as you would appreciate, in the U.S., if we just take the last 90 days, the last 90 days in Q1 includes a reentry into the Paris Agreement, a target of 50% reduction in CO2 in 2030 and still an ongoing discussion of how should that potentially influence either the ongoing current PTC structure or potentially elements that would relate to either localization and others in the U.S. So I think this is simply too early to basically put again a connection between a heading politically and a statement political towards that transition and then a direct order intake. And I think you and I will appreciate that if you are a customer right now, you could actually say goodbye to a potential upside if you do certain things before you know all of the details in that. So we see still there's a lot of activity. We also see some of those coming out probably later on. It will come out later in the year. But the big influence of going 50% CO2 reduction is not going to come in, in the coming couple of quarters. That's like when you see the EU Green Deal being announced, but it will drop into the country auctions doing either latter part of this year or '22 or '23. When we then look at the offshore, we will ask for a bit more patience, as you already implied in your question, so to say, because patience here comes with that we are participating in the commercial discussions around the world with customers right now. When the outcomes comes out positively for us, then, of course, we will make those announcements that are triggered by that. And then you will also appreciate that the offshore cycle of both projects and products as such are just longer, and therefore, you have to allow us a little bit more patience on that one. Right now, real focus here is get the business proper settle in. So we run both on and offshore in our operating model and, of course, then also give the evidence to customers that, that will work wherever they have the need for our technology.

[Operator]

Our next question comes from Akash Gupta from JPMorgan.

[Akash Gupta, Research Analyst]

My first question is on hedging of your backlog. So Marika, I mean in the past, you have said you try to hedge as much as possible in your backlog. And I wanted to ask if you can help us understand the backlog policy -- hedging policy in backlog, like how much of backlog you can hedge, and what are the elements which are not possible to add. Like can you hedge polymer raising exposure given their price have also gone quite significantly? And if you can also tell us how far out you can hedge your raw material exposure. So that's question number one.

[Marika Fredriksson, Executive VP & CFO]

So the hedging profile has not changed. So when it comes to raw material, for example, we have a 36-month view. And in that view is obviously the firm order intake that goes into the order. It's also conditional orders, and it is what we are negotiating as we speak. And for the firm order intake, we plan for everything, including either hedging or we have pre-bought steel. And we also have indexation in the contract. And that is also when we secure currency if we have an exposure or we have a natural discrepancy. So the quality of the firm order intake is high by default because that is how we're planning. When we talk about external factors is when we need to change from that planning. That's when it's starting to cost us. But in this case, it is primarily on the transport. So when the tariffs were coming or, in this case, when we have a COVID situation, so we have to change anything from the given planning, that's when we see additional cost. But the firm order intake is hedged by default. That is what we do when we consider something firm.

[Akash Gupta, Research Analyst]

And my follow-up is are you continuing to hedge at these high levels or are you waiting for some of the raw materials to come down when it comes to forward-looking hedging.

[Marika Fredriksson, Executive VP & CFO]

I mean we are not raw material traders, so we -- our job is to sort of secure what is best for Vestas and for the customers. So we are securing every time we see that we have a firm order intake, we start securing what could have an impact on the profitability.

[Operator]

Our next question comes from Casper Blom from ABG.

[Casper Blom, Lead Analyst]

Actually, just one follow-up on the ASP. For me, a positive surprise that it came in at 0.8 and up some 11% year-on-year, a pretty big price increase. First, is this sort of representative for a normalized level as things are today, i.e., is this also a level that we could expect in the coming quarters? And secondly, with this increase here, do you feel that you have sort of covered it as much as is realistic in terms of the higher input cost because it really is a big impact on the margin when prices go up 10%?

[Henrik Andersen, Group President & CEO]

Okay. First of all, Casper, you cannot just put and do that percentage calculation because there will, as always, be a change of order intake both in terms of geography and scope and mix of it. So please don't do those percentage calculation in that way. Having said that, I think it is fair, as you've heard us speak to now a number of times, I think it's only reasonable and it will actually be almost question mark to what we have also been communicating, the discipline of how we run project by project and also how we sign it off when you have such a quarter where components are moving. And as Marika just answered the previous one, our hedging strategy and orders haven't changed, so therefore, we have a good insight in the costing of the technology and the solution we are providing to our customers, and we will adjust accordingly. So that's where we are. And I wouldn't necessarily put your exact percentage calculation as you've just done between order intake. So we will continue doing that quarter-on-quarter.

[Casper Blom, Lead Analyst]

That's absolutely fair, Henrik. But then if I can -- may rephrase a little bit, it is an increase, all else equal. And is this sort of an unusual high level that you've seen this quarter? Has there been any some specific tailwinds? Or is this sort of just -- I mean, again, is this a fair level to assume for the coming quarters?

[Henrik Andersen, Group President & CEO]

Casper, it's another way. It is a positive. It is an increase, and it should be for everyone because there is not in 90 days 1 single component or 1 single part of your logistic or transport that has gone down. So therefore, it's all going one way, and therefore, it is going up. And it's, by the way, going up for everyone.

[Operator]

Our next question comes from Katie Self from Morgan Stanley.

[Katherine L. Self, Equity Analyst]

Just the first one, my line got cut, apologies if I missed this, but I'm just trying to understand particularly on the Service margin. How much of that 4 percentage points decline year-on-year was related to the integration of offshore and how much of that was the logistics challenge? So if you could give us any indication of the kind of underlying onshore service margin or offshore, that would be helpful. And then just the second question was there were some articles out a few weeks ago around a COVID outbreak at one of your plants in Western Denmark. I was just wondering if you could update us there. Is that back to normal operations now?

[Marika Fredriksson, Executive VP & CFO]

Katie, if I start with the Service, and you see good development on the revenue side and the logistical challenges as well as the integration, I would say, it's a mix. And that is what causes the discrepancy. But also remember that it's a smaller business, so I mean not enormous numbers have a big impact on the Service margin. But if you look at the logistical challenges, it is very, very difficult to move people in between countries. It's costing us. It causes delays because people could be in quarantine for a couple of weeks before they can actually enter into sites, so we see a lot of extra costs simply because of COVID. And as it looks, it's going to continue for a while, but we're continuing to manage that situation. And then the integration, as I said earlier, obviously, that is not free of charge either.

[Henrik Andersen, Group President & CEO]

And Katie, in relation to your question on one of the factories is right, we had an outbreak of COVID in our night shift related to our factory in Denmark. And I will just say here, yes, it's back to partly operating normal. It is what we have also seen in some other factories where we have had some of these. I think the one thing we have learned of this one is also when you have protocols and you maybe either relax the protocols or you take them easier in a period of time, that is where you have an outbreak like that. So I think actually, in this quarter, it has served us a little bit well to have one of these things to also been able to discuss how we avoid and how we learn from that first and foremost. I think we all feel the fatigue about it. But as I said, now it's just another good way of highlighting the need for sticking to the discipline and the protocols.

[Operator]

Our next question comes from Sean McLoughlin from HSBC.

[Sean D. McLoughlin, Associate Director of Clean Technology]

If I can just build on a couple of previous questions, firstly, on ASP, could you quantify how much of that ASP increase is from better scope? And secondly, In service, can you quantify how much is the integration charge related to offshore?

[Henrik Andersen, Group President & CEO]

I can -- Sean, thanks for that. On the ASP, we don't split the ASP down to your question in terms of either scope or geographies, so we don't do that. And as I said here, you can -- as our previous answers, you can assume that the main part of it also relates to what has happened with the underlying components of our technology solutions. In terms of the integration costs, we don't have that as a separate line. And therefore, we run and we integrate the business. And there has been quite an attention for us throughout basically end of Q4 and also coming into Q1. So there are some of that, but that will be ongoing throughout this year as also part of the P&L. Only when we get to a larger part, we'll come back with a potentially special items, as we have said in the guidance.

[Sean D. McLoughlin, Associate Director of Clean Technology]

Understood. And just a brief follow-up, if I may, regarding that service. I mean you said earlier that these extra costs related to the difficulty challenges of moving people will continue for a while, so we could expect also a depressed margin in Q2. I mean that obviously assumes very strong profitability in service in the second half to make that guidance. Is that how you're thinking about the Service piece?

[Marika Fredriksson, Executive VP & CFO]

We haven't changed anything on the guidance. So obviously, we think we have a good overview where we land. And if we see it differently, you will know.

[Henrik Andersen, Group President & CEO]

And I always also say, when you focus on the percentages here, it is a business that contains more than 12,000 service technicians globally. So when you have that effect of that scope and magnitude of people, also be aware a 4% deviation or comparison is actually somewhere around EUR 20 million in a business of that scope and magnitude. It's just focus on the percentages, we do the same, but I'm also saying here in the deviation of integrating that number of people and getting it up running globally, EUR 20 million is not big deviations to focus on.

[Operator]

Our next question comes from Deepa Venkateswaran from Bernstein.

[Deepa Venkateswaran, Senior Analyst]

I had a couple of questions. So first one for Marika on the working capital. Could you perhaps explain how you expect the trend to change and evolve during the rest of the year and how much of the inventory built up is because of the logistical challenges? So that's question number one. And then my second question is coming back to the raw materials inflation point, and this is obviously more of a long-term equilibrium question, is that, obviously, when there are sleep changes, perhaps you're not able to fully pass through. But 2 years down the line, is there any reason why the supply chain absorbs more of this and your customers don't fully -- and you don't pass this on fully? And they themselves don't fully reflected in the tenders that they're participating in? So those are my 2 questions. And if I can ask the third one is just that you highlighted on the offshore side, you are participating in tendering activities with your customers. So how has the reception to your new model being with customers? And is the technology of gearbox presenting any challenges as you're proceeding in these discussions?

[Marika Fredriksson, Executive VP & CFO]

Okay. If I start with your inventory question or the working capital, we're following a pretty normal profile. We have been very clear that we utilize this -- the strength of the balance sheet instead of investing in capacity, so we are keeping inventory. And the profile that you see now, you see an increase here in Q1 of this year, and that is to accommodate for the activity level we have ahead of us. Then how it pans out obviously depends on how active Q1 of next year will be. So I mean we will not disclose how the end of the year will look like, but it's following the normal profiling that we have for the buildup and support the overall activity level. When it comes to raw material, I think I answered pretty much in detail. We have a 36-months overview or anticipation how the raw material will pan out. Then how we secure depends on the backlog, so the firm order intake that we have. If we have conditional orders, how we anticipate that, that will pan out in time. And obviously, when we negotiate a new contract, then we have to take height for the cost that we have or that we see at this point in time. But when we have a firm order intake, then we have secured steel, which is the biggest exposure that we have, but any raw material, either by hedging, either by indexation in the contract or -- and obviously, the indexation, the longer profile you have of the contracts, the more indexation you have to be sure that you can accommodate for increases. Then we -- our profile is not to make money on hedging. Our profile is to secure that we have the profitability that we anticipated when we accepted the order.

[Henrik Andersen, Group President & CEO]

And for our customer, it's about having the transparency to be able to bid with that 2 or 3 years forward in onshore and, of course, in offshore even longer. When you come to your -- Deepa, on your question to offshore, we have had a good dialogue with most of the players in offshore. And I think it's fair saying here there is -- when you come out with a technology and a new product road map ahead, there will always be those discussions. And I think that's probably what we should say right now in and around the commercial journey ahead for offshore. And as we said, we will say more when we have more concrete to say in as such. You would appreciate we are a few players from an OEM side, and we are also a few more players from a customer side. But it is still a market that is building and developing from a relatively small 5, 6 gigawatt market towards a 25, 30-gigawatt market in the second half of this decade.

[Operator]

Our next question comes from Ajay Patel from Goldman Sachs.

[Ajay Patel, Executive Director]

I have a couple of questions. One around pricing again. So just on the onshore order intake, Is there anything that you can give us in terms of the step-up quarter-on-quarter what proportion of this is actually just cost and therefore shouldn't reflect in margin and what portion could actually be better pricing and therefore better margin? I'm just trying to get a sense for how much it is ultimately just passed through and there's no impact to the margin or not. And then same thing but just from the offshore perspective, one of the sort of themes at least from the utility side has been the perception that maybe competitive pressures are rising in offshore on the developer side, especially with some of the recent auctions in the U.K. where we saw quite heavily bidded prices for seabed licenses. I'm just wondering from your perspective, are you seeing any of that potential pressure in the auctions that we're seeing this year, maybe highlighting that, that competitive pressure maybe being exported up and potentially have any implications for margins? And then just carry on from that last point, this year and next year, obviously some sizable amounts of auctions on the offshore side are definitely more painting the picture for you guys -- beginning to paint the picture for you guys from 2025 onwards. I'm just wondering what proportion of the auctions are you actually are participating in? Is there -- or are you potentially able to bid into everything, well, alongside, obviously, the developer? Just some color there would be great.

[Henrik Andersen, Group President & CEO]

Ajay, thank you so much. I think here, as we have not only a few people on an audience like this, I think on your split in the ASP, we don't give you the breakdown of what we believe is related to an underlying cost change because it absolutely comes down to individual customer discussion project by project. So we have our super robust process here for sign-off. We are disciplined in that. And that basically has to come through here and has a yes or a no if we are working on some of those threshold areas. So that we are confident of providing to you, Ajay, but we won't give neither to the market or to the public in how we are dealing and how we are mitigating some of that. You can see some of it actually works. And as Marika said, some of the internal investors things we have been working on, the handles works well for us, and we have seen the progress in our gross margin. But there are also still things we can do better at. When it comes, I will just say, to the offshore, I fully share your excitement and fully share your passion with it. You also appreciate that right now, I think the biggest upside for us is that we now have one team, and that is the team investors to sit with some of the same customers. And of course, that gives us an upside in, first of all, expanding and strengthening the relationship with the individual customers. We know what we are participating in, and we also know that is definitely leaning from end of '24, '25 and onwards into second half of the '20s, so this decade. And we have to be patient. And I'm sure you will allow me to say, be patient because we have to work through diligently those auctions, and we are able to participate with the customers and the auctions we, together with the customer, make a priority to participate in. The easiest thing we'll try to give you a percentage here, and that will most likely be wrong anyway because if 1 or 2 of the auctions comes either our way or away from us, then we will either be successful with that percentage. We said all along a leading position in offshore and that we still believe in.

[Operator]

The next question comes from Ben Heelan from Bank of America.

[Benjamin Michael Heelan, Analyst]

Can I ask, sorry, another one on hedging? I just want to -- it sounds as though you're pretty well hedged through the forward hedging you get when you book a firm order and the indexation that you said you had in some of the contracts. So we really shouldn't be thinking about raw materials as a headwind for profitability over the next couple of years. Or is there any other way that we can see raw mat starting to weigh on margins as we move into '22 or '23? That would be the first question. And then secondly, obviously, a decent improvement in gross margin in Q1. Is there a way to understand what the impact of the logistical challenges and the supply chain constraints were on that margin in Q1?

[Marika Fredriksson, Executive VP & CFO]

If we start with the hedging, as I said, we have a 36-month view. And obviously, with offshore now being part of it, you have an even longer-term view on the -- on any raw material, I would say. So when we have a firm order intake, then we start the hedging, then we start planning basically everything. Whether it's currency, whether it's sourcing, whether it's transport, everything is booked. Where we could have in a given year an exposure on this deal,is on the conditional orders. So if we have a conditional order that we have negotiated, the scope of contract pricing, what have you, then it's a negotiation with the customers. And then obviously, we, as everyone else, could be successful or less successful. But that would be the exposure I see. If we have an in for out orders, I think Henrik was also pretty clear on that is when we have are in the negotiation of an in for out, then we take high for the actual prices we see in the market. So from that point of view, we are sort of securing. The conditional orders are, if anything, the question mark. But that can be mitigated with having an indexation clause in the contract or that we have pre-bought steel because we see that we can allocate it into other contracts. So it is a difference. But in the whole scheme of things, and we were also pretty clear of that in the beginning -- at the beginning of the year, is that we see a bigger risk with the transport and the logistical challenges. That just continues. We've had tariffs, and now we've had COVID for a year, so it's sort of an ongoing. And that is because we, in a given year, have to change location or we see that we have supply constraints somewhere, then we relocate. And then you're sitting with a payment for a transport that you planned for, plus you're having an additional one. What I think is important when you look at the low activity level in the quarter and you look at the gross profit improvement, obviously, that supports what we have said that we have the threshold for the contracts. And the biggest and most important thing for us is the execution of the contract, that they live up to sort of the overall expectation on the contribution margin for a given contract. Then again, what I said on the logistical challenges, that will be a headwind. But underlying, I see that is clearly an improvement in how we execute on contracts. And that is a consequence on also how we have been negotiating. It's a long answer to your question but...

[Operator]

Our next question from Klaus Kehl from Nykredit.

[Klaus Kehl, Chief Analyst]

Yes. First of all, a follow-up question to integration costs and special items related to the offshore business. Was it correctly understood that here in Q1, there is integration costs which you have not quantified? And then for the rest of the year, we should expect special items in the range of EUR 100 million. Was that correct?

[Marika Fredriksson, Executive VP & CFO]

That's correctly understood.

[Klaus Kehl, Chief Analyst]

Okay. And then secondly, all these logistical issues that you have here in Q1, did you say that they added up to EUR 56 million. Or if not, would you try to quantify them a little bit because I think, to be honest, there's a lot of one-off costs in this quarter.

[Marika Fredriksson, Executive VP & CFO]

I think what I was referring to, and I hope you understood, is that it was integration cost that impacted the SG&A. That was EUR 56 million. If you look at the line of SG&A costs, you see an increase in the quarter. And that's obviously with a low activity level and a low revenue. It has an impact on the EBIT number. So it's EUR 56 million, but that's integration altogether. So it's now special items or integration costs. It's simply that we have increased the SG&A.

[Klaus Kehl, Chief Analyst]

Got it. And could you, on top of this, try to quantify for what the Suez issue, potentially, what impact that has?

[Marika Fredriksson, Executive VP & CFO]

I didn't hear your question.

[Klaus Kehl, Chief Analyst]

I guess there's been a lot of extra costs due to the Suez issue. Could you just try to quantify what these costs could be?

[Henrik Andersen, Group President & CEO]

I think in here, when we go in and I know everyone right now are trying to slice up every part of the logistic challenge, you can't. Because what is it that comes and you will say I book that towards the Suez Canal issue, and that is also a little bit why we this quarter have said this about having a box of COVID cost, What is then COVID cost and what is Suez. So therefore, we just said we mitigate and every time we have a single asset component, whether it's in a container or it's in a single asset of the turbine, we try to mitigate any sort of either delay or blockage. It can have a cost, but we also have super good partners to work with, so sometimes, we're able to mitigate it. So we won't go into just putting and Suez has that cost to it because you can't divide it that way right now in the supply chain. Cause of delay can come not in Suez, but it probably comes at arrival in the port, and that might give you a delay on the road or the rail transport in the other end. So what is then Suez and what is the rail and road? So we don't do that. We know it's booked towards the project cost, and that's where we have to get better.

[Operator]

Our next question comes from Lars Heindorff from SEB.

[Lars Heindorff, Analyst]

The first one is also on the transportation cost. You've already been indicating that supply chain/transport cost in total is around about 15% to 20% of your input costs. Now in order to avoid all those nitty gritty parts that you don't want to answer anyway, I don't know if you can give us some indication of what kind of level we are looking at here given the problems that you have been talking about.

[Marika Fredriksson, Executive VP & CFO]

We -- yes, that's the first one. I understand your question. And obviously, the best answer I can give you, Lars, is if you look at the guidance, we have taken height for that in the 6% scenario and, obviously, a more beneficial situation in the 8% scenario. And as we speak with the COVID situation and rerouting and supplier constraints, the container constraints that we have, it's very hard to sort of say exactly where we will land. But it is definitely in the 6% to 8% on the EBIT. And that is, unfortunately, the best answer I can give you.

[Henrik Andersen, Group President & CEO]

As also, you say sort of we don't want to comment on nitty gritty, also allow us just to say here we don't give away how we run transport when it's that magnitude of our projects. So if we have a locked transport or locked cost, which is also possible that we have, therefore, allow us also to not comment on exactly that part of it.

[Lars Heindorff, Analyst]

I'll do that. Sorry. The second one is on the outlook because you stated a little bit about your ambitions for the 3 business areas. And for the onshore, you talk about stable or slight growth in the next couple or maybe 1, 2, 3 years ahead. And I noticed that you also used WoodMac for these market share calculations. But if you look into both WoodMac and Bloomberg Energy Finance, both of them forecast actually considerably decline in onshore installations into '22, '23, '24 mainly driven by U.S. and China. So I'm just wondering, I mean are you seeing anything different? Or they -- have they just not updated their numbers? Or I'm just curious to find out what are you basing the growth on there.

[Henrik Andersen, Group President & CEO]

I think here, there will always be individual quarters. There can also be individual years of that, that will have variations to the theme. And you will appreciate right now, our earlier comments about the U.S. and the U.S. market could be changing depending on what happens from a political side in that. On the other hand, when we look at it right now, it is fair saying over the last 6 months, Lars, that we haven't seen any policymaker anywhere in the world going the opposite away. So the mega trend and the underlying trend, whether it's in on onshore or in offshore, it's pointing in the same direction. And if you're not, then on top of that, also include now some of the planning that's being done when it comes to P2X or hydrogen, which is actually scalable, will require even bigger onshore or offshore installations. Then I think it is fair saying that we see it in Europe right now, individual countries. You saw the German auction coming out most recently here, bigger amount, still with a gap on the permitting side. So we still believe and we still see that countries are still catching momentum also on the onshore side.

[Operator]

The last question comes from Rajesh Singla from Societe Generale.

[Rajesh Kumar Singla, Equity Analyst]

A couple of questions on the business. So one is, like yesterday, you had received a very big order of 400 megawatt, and you had EPC contract as well in that particular project. So given your recent investment in CIP, can we assume that you would be doing more and more of EPC work going forward? And second question would be on basically offshore business. Like what kind of traction you are getting from the customers with respect to your new turbine and if you can share any time line when we can expect any order in the offshore business.

[Henrik Andersen, Group President & CEO]

I think if I start on the offshore side first, as we said here, It's a big audience, so we don't give away our progressing and our status under discussion with neither the customers or the auctions that we are participating with customers. It's -- first of all, it's 2 big lots in the offshore, and that also makes the success or not. So when we have something to share, we will share it. But as I said, I hope it comes clearly through from both Marika and me in terms of the passion and the excitement about having both the offshore and onshore together investors. So I think that I will leave it with that. I think on the EPC and the investment into Copenhagen Infrastructure Partners, it is actually total 2 unrelated topics. So EPC, about how we run the projects around the world; and Copenhagen Infrastructure Partner is about investing into projects around the world from the fundraising they do. So I will just say that's not related at all, and it's down to us how we consider EPC, and that has nothing influenced from an investment in Copenhagen Infrastructure Partners.

[Marika Fredriksson, Executive VP & CFO]

And Rajesh, if I can add to the scope of contracts, I mean, I think our strength is that we can do any type of contract anywhere in the world. And that is what this is representing. And an EPC contract when it comes to execution is one of the bigger risks that we have. So the supply and install and will continue to be the biggest part of our portfolio.

[Henrik Andersen, Group President & CEO]

Okay. With that, I thank you very much for your active participation, and we look forward to see and speak with many of you in the coming days. So thank you for this.