Investors didn't want to hear (or think) about it back in 2006-2008, but the renewable energy “revolution” has followed a pattern that is pretty familiar to most experienced investors, and left a great deal of debris in its wake. Wind turbine manufacturer Vestas (OTC:VWDRY) has found itself one of the worst-hit companies to still be in business, as the stock is down more than 90% from its 2008 highs.
Growing global capacity and shrinking government subsidies have hammered this company, as margins have plunged. The company has tried to respond - changing management, cutting costs, and streamlining operations – but the ultimate outcome is still very much in doubt. While Vestas seems undervalued if the company can in fact survive this winnowing process, survival is far from certain at this point.
SEE: Clean Or Green Technology Investing.
Mixed News In The Fourth Quarter
When Vestas reported earnings back in March, there was a little something for bull and bear alike. The 23% growth in revenue was encouraging, as was the ex-items operating profit, positive cash flow, and increase in deliveries (by megawatt or MW). On the other hand, orders plunged by two-thirds and the company's unit profitability (euro/MW) is still quite low.
Smaller And More Focused Seems Like The Way To Go
In response to the challenging order and price environment, Vestas has looked to streamline its operations. The board installed new management about a year ago, and since the fourth quarter of 2011 the company has cut its employee headcount by about 5,000 (or about 20%). Another 10% cut from here seems probable.
Management has also curtailed excess capacity and streamlined operations. Vestas now focuses on three core turbine platforms and management seems to be still evaluating whether Vestas needs to be a “soup to nuts” player in components – while manufacturing blades, controls, and turbines makes sense, rivals like ABB (NYSE:ABB) and Siemens (NYSE:SI) have definitely had better success with their generator operations.
It's also worth noting that Vestas has seen its share decline significantly over the last eight or nine years. While Vestas is still a strong player in the European and North American markets, a host of Chinese rivals have grabbed share both in Asia and abroad. At the same time, large players like General Electric (NYSE:GE) and Siemens continue to build their presence and position their wind power offerings as parts of larger, diversified utility and power franchises.
Survive To Parity
One of the fundamental problems with wind power is that without subsidies it is still more expensive than conventional electricity. That gap is shrinking (and may be gone entirely by 2015-2016 in markets like Germany), but the wind power industry has been hammered by the shrinkage of government subsidies in the wake of the global financial crisis.
The question for Vestas is whether it can stay in the game until parity arrives. The long-term outlook for wind power is still relatively attractive; it's not flawless, but countries like Germany and Japan want to move away from nuclear and coal generation, and likely do not want to put all of their chips on natural gas-fired generation.
In the meantime, Vestas is looking at low margins tied in large part to significant global overcapacity (as much as 40-50% by some estimates). Making matters worse, the company's debt obligations are likely to lead to a dilutive equity offering, as I don't see the company generating enough cash between today and the maturation date of its debt (though the company could perhaps restructure its debt obligations).
Longer term, it's also worth asking if Vestas makes sense as a go-it-alone company. While the quality of Vestas' turbines has never really been a problem, would-be buyers like GE and Siemens have done fine on their own, and it's not clear to me that a company like ABB (or, say, Honeywell (NYSE:HON) or Eaton (NYSE:ETN)) would want to get into this business. I'm not ruling out an acquisition per se, but rather I don't know that Vestas will attract a bid that would please shareholders and look like full value.
SEE: Analyzing An Acquisition Announcement
The Bottom Line
The curious thing about Vestas today is that the sell-side doesn't appear to believe its own models. While most analysts believe the next couple of years will be challenging, the implied value of the longer-term projected cash flows suggests a fair value well ahead of the analysts' own price targets. Of course, these models can be wrong and sell-side price targets are notoriously useless, but my point is that the numbers don't match – sell-side analysts should either raise their fair value estimates or lower their modeled revenues and cash flows.
Certainly there is a risk that long-term estimates are moot, and that Vestas won't survive to see what the post-parity wind power market even looks like. Along those lines, another serious global recession or stubbornly low industry margins (below the cost of capital) could wreck this story.
At this point, though, I find myself asking the infamous question “how much worse can it get?” It would seem that management has figured out how to eke out survival even in tough times. I'm certainly worried by the expected decline in shipments for 2013 (20% or more) and whether management can maintain positive cash flow, but very aggressive investors may want to freshen up their due diligence on Vestas as a potential deep turnaround story for 2014.
Disclosure: Author owns shares of ABB.
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