It's been a miserable year for renewable-energy investors, particularly those who invested in wind power. Not only have stocks in wind power companies Siemens Gamesa(OTC: GCTAY) and Vestas Wind Systems(OTC: VWDRY) slumped, but General Electric's(NYSE: GE) renewable-energy business has been at the heart of that industrial giant's difficulties this year.
Nevertheless, there are clear and recent signs of a concerted effort to improve matters, and the building blocks of recovery are in place. So it's time for investors to start looking at the sector again.
A challenging 2022 for renewable energy
The chart below shows the stock performance of all three leading wind energy companies in the West. Vestas and Siemens Gamesa are focused on wind power. GE Renewable Energy is a small part of GE's overall operations currently. However, when it's combined with GE Power and spun off as GE Vernova in 2024, it will be a vital part of the new company's prospects.
Data by YCharts
The reasons for the underperformance can be put into three interrelated categories:
- Ongoing supply chain issues and raw material cost inflation impact the industrial sector. These issues are particularly problematic for wind turbine companies due to the extensive logistical operations needed to manufacture and transport turbines and components across the globe.
- Political uncertainty around the extension of production tax credits (PTC) for wind power in the U.S. impacted investment decisions, notably in GE Renewable Energy's core U.S. onshore wind market.
- The industry is characterized by ultra-competitive pricing as the leading players fight to establish market share. Competitive pricing is a complicated issue for the wind power industry because it tends to rely more on equipment revenue rather than services revenue. For example, aircraft engines are often sold with a negative profit margin because the real money is made over a couple of decades worth of service revenue. In comparison, GE Aviation's equipment revenue was $3.4 billion in the first half compared to $8.3 billion from services. Contrast this with GE Renewable Energy's equipment revenue of $4.8 billion and services revenue of just $1.4 billion.
As such, the management teams of Vestas, Siemens Gamesa, and GE Renewable Energy all lowered their full-year guidance and now expect to lose money this year. It's all a far cry from the high single-digit profit margins that Vestas and Siemens Gamesa were generating before the pandemic struck -- a level of profitability that GE Renewable Energy was aiming for.
A chart of GE Renewable Energy's profit margin below demonstrates just how badly the industry was hit in 2022.
Data source: General Electric presentations.
Why the industry could be over the worst
While it's been an extremely challenging year for the industry, there are two signs of a possible recovery to come. First, there's wide-scale restructuring. For example, Vestas is accelerating its investment in digital solutions to improve its service offering. Siemens Gamesa is implementing a new operating model, focusing on its key markets, and cutting 2,900 positions globally, with "further reductions" planned.
GE Renewable Energy is already taking action. Management is resizing the company in response to a smaller market while refocusing on its most profitable geographies. While GE Renewable Energy is still working through less profitable legacy contracts, its management focuses on increasing pricing. GE CEO Larry Culp declared on the company's last earnings call that "our pricing has substantially improved in onshore while continuing our focus on deal selectivity."
Second, deflationary forces are gathering in the industry. Transportation costs declined in the global economy alongside raw materials like steel and copper prices.
Time to invest in the industry?
The actions taken by Vestas, Siemens Gamesa, and GE are tangible and designed to deal with the new reality in the marketplace. As such, the industry can begin to work its way back to pre-pandemic profit margins achieved by Siemens Gamesa and Vestas. As for GE Renewable Energy, it's worth noting that GE Power faced a similar problem a few years ago, and it's already a high single-digit margin business again.
It will take time for all these companies to turn around, but the groundwork is being laid now, and 2022 might mark the low point in margin performance for all three.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
