Bloomberg News

Vestas Apes Rolls-Royce to Salvage Wind Turbine Profit

August 23, 2012

Vestas Wind Systems A/S CEO Ditlev Engel

“In 96 percent of the cases when we announce new orders it comes with a service contract, so that’s going to be a very important part of our business,” Chief Executive Officer Ditlev Engel said in a phone interview yesterday as Vestas reported its loss widened in the first half. Photographer: Simon Dawson/Bloomberg

Vestas Wind Systems A/S (VWS) is copying strategies used by mobile phone operators and Rolls-Royce Holding Plc (RR/), boosting its maintenance and spare parts business to a record to salvage flagging profit from manufacturing.

The world’s biggest producer of wind turbines forecasts revenue from servicing windmills to climb 21 percent this year to 850 million euros ($1 billion). The Danish company yesterday increased guidance for the unit’s margin this year to 17 percent, offsetting unprofitable sales of the machines that can weigh upwards of 200 tons each.

“In 96 percent of the cases when we announce new orders it comes with a service contract, so that’s going to be a very important part of our business,” Chief Executive Officer Ditlev Engel said in a phone interview yesterday as Vestas reported its loss widened in the first half. “On an annualized basis it’s growing around 25 percent year-on-year.”

Intensified competition from Chinese companies gutted turbine prices and forced Vestas to increase its reliance on maintenance. The move mimics how mobile phone operators give away handsets and Rolls-Royce sells aircraft engines, signing clients to service agreements that provide steady revenue, said Sean McLoughlin, a clean energy analyst at HSBC Holdings Plc. (HSBA)

‘Critical Mass’

The move signals the wind industry is maturing, with an installed base that can provide “the volume and critical mass” needed for a servicing business, said Jacob Pedersen, an analyst at Sydbank A/S. (SYDB) “Every seller of large equipment -- the mining industry, the cement industry -- makes money from services.”

Vestas is scaling back manufacturing to contain widening losses, and forecast a decline in turbine shipments in 2013. The shares, which gained 16 percent in the week before earnings, and were up 3.5 percent at 3:54 p.m. in Copenhagen today, after tumbling 6.4 percent yesterday. Vestas shares have now lost 67 percent in the past year, underperforming the 16 percent decline of the Bloomberg Wind Energy Index (BWIND) as the company slashes its workforce to curb its widening loss.

Turbine makers including General Electric Co. (GE:US), Siemens AG (SIE) and Enercon GmbH are also beefing up their service offerings, said Pedersen of Sydbank, which is based in Aabenraa, Denmark. Vestas is leading the industry in developing maintenance as a way to offset declining profit from turbine sales.

“I can’t grasp why they’re not all doing it in a big manner,” Pedersen said. “If you sell some hardware, you’ve got to make your bucks on the servicing afterwards.”

Turnaround Plan

For Vestas, the services business is a cornerstone of a turnaround plan announced in January. Yesterday, Engel gave the most detailed forecast yet of the expectation for the unit.

Vestas in 2011 posted a margin on earnings before interest and tax of minus 0.7, which included a positive margin of 16 percent for its service business. Yesterday it kept guidance for an overall Ebit margin of zero to 4 percent, and increased the services margin guidance to 17 percent from 14 percent.

The global market for maintaining wind turbines more than doubled to 8.3 billion euros since 2007, according to Bloomberg New Energy Finance. Vestas is vying with its rivals including GE and Nordex SE (NDX1) for a bigger share of the business.

Depending on services is nothing new for established manufacturers. Rolls-Royce, the London-based maker of aircraft engines, had revenue of 3 billion pounds ($4.7 billion) from servicing in the first half of 2012, about 53 percent of its sales, according to its earnings report on July 26. Mobile phone providers from Vodafone Group Plc (VOD) to AT&T Inc. (T:US) routinely sell handsets below cost, recouping profit through service contracts.

Wider Margins

“If you look at jet turbine companies like Rolls-Royce, they would tend to make more revenue on after-sales servicing than on the original sales of their engines,” Robert Clover, research director at Aarhus, Denmark-based Make Consulting, said in an interview. “If you’re making zero percent margins on your manufacturing business, you’ll take a mid-teen margin on a smaller side of your business.”

Gamesa Corp. (GAM) Tecnologica SA is also ramping up its services offering in a reversal of policy after the Zamudio, Spain-based company sold the unit performing that function in 2006 for 170 million euros to 3i Group Plc. (III) Gamesa On April 13 said it started a new unit to service components such as gearboxes, generators and blades.

As part of a reorganization this year, Vestas on Feb. 1 set up a dedicated services unit to capitalize on what it described as its “fastest-growing business area.”

‘Locks Them In’

“They don’t just make it and sell it,” McLoughlin said. “They make it, lease it out to the customer, which ensures they get the upgrades and Rolls-Royce locks them into the servicing and the maintenance. This is higher margins than the manufacturing.”

Germany’s Nordex, another of Europe’s three traded turbine makers, said in its annual report that it wants to widen the share of services from a 10th of revenue. GE, with more than half of installed wind turbines in the U.S., expects a rising share of sales from services rather than equipment, said Stephen Tusa, an analyst at JP Morgan Chase & Co. (JPM:US) in New York.

“With a slower growth equipment market, GE is refocusing toward a broader service offering,” Tusa said in a July 17 note to clients. He estimates that services now represent less than 10 percent of GE’s wind revenue.

Vestas got 12 percent of its sales from services last year and may boost that level to 13 percent this year. It has a backlog of work from the unit of 4.8 billion euros, half of its turbine order book. That helped boost Vestas’s total order backlog to a record 14.4 billion euros in the first half.

The 850 million euros expected from services would be about 13 percent of 6.5 billion euros, which is the low end of the company’s forecast for revenue in 2012.

Chinese Rivals

That income would soften the blow from declining orders for turbines as governments from the U.S. to Europe scale back subsides and competitors such as Nordex and Xinjiang Goldwind Science & Technology Co. Ltd. (2208) of China siphon away orders.

Engel said in a conference call yesterday that the company has a manufacturing capacity of about 9 gigawatts of turbines. It expects shipments to decline to 5 gigawatts in 2013 from 6.3 gigawatts this year.

“Service is not as capex-intensive as the regular business,” Engel, the CEO, said in the interview. “We have 2 revenue streams going forward: turbines and services.”

To contact the reporter on this story: Alex Morales in London at amorales2@bloomberg.net

To contact the editor responsible for this story: Reed Landberg at landberg@bloomberg.net


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