It wasn't supposed to be like this for wind power equipment providers. Since the start of 2021, many of the leading players in the industry, including Vestas Wind Systems(OTC: VWDRY), Siemens Gamesa(OTC: GCTAY), and General Electric's (NYSE: GE) renewable energy business, have all had a disappointing performance. That said, it's still an industry with a big future, and the slump in stock prices could be an excellent entry point.
Investing in wind power stocks
If you invest in the sector, you will need to look into what's gone wrong over the last 15 months. The industry started 2021 on a high, with investors feeling confident about long-term prospects for wind power. The cost of electricity generation from renewable energy continues to fall, and policymakers are increasingly favoring its use for environmental reasons. As such, the long-term demand situation looks favorable.
However, the performance of leading wind energy equipment providers has been very disappointing.
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What went wrong
There are three things to focus on.
First, GE Renewable Energy, Siemens Gamesa, and Vestas significantly missed their initial earnings guidance in 2021. General Electric's management believes its renewable energy business (including onshore and offshore wind power) is capable of a high-single-digit profit margin over the long term. That's a figure in line with what Vestas and Siemens Gamesa reported in 2019 -- the year before the COVID-19 pandemic hit. Unfortunately, all three companies were nowhere near that figure in 2021. Siemens Gamesa and GE Renewable Energy's earnings margin was negative. Vestas' adjusted earnings before interest and taxation margin of 3% was significantly lower than the 6% to 8% management expected at the start of the year.
Second, part of the revenue and margin shortfalls come down to a combination of highly competitive pricing and the impact of the extension of production tax credits (PTC) in the U.S. The extension tends to create conditions where demand is pulled forward (as wind farms try to buy in ahead of its potential expiry) and companies relax on orders after the extension takes place. It was a significant issue for GE, particularly given its heavy exposure to the U.S. onshore wind power market.
GE's revenue shortfall in the fourth quarter largely came down to its renewable energy segment.
Third, profit margins were negatively impacted by surging raw material costs and ongoing supply chain issues. Manufacturing, assembling, and transporting massive wind turbines is a logistical feat in itself at the best of times, let alone when transportation costs are soaring, and many companies are facing issues getting critical product supplies.
Putting it all together, the industry faces a challenging set of conditions. End demand is falling, notably in the U.S., as customers move through a cyclical downturn after heavy investment in previous years. At the same time, the rush to get orders is pressuring profit margins from a pricing perspective, while rising costs are pressuring margins from the other side.
Image source: Getty Images.
Over the worst?
So, the industry has faced a lot of pressure leading to collapsing margins, but surely it's all in the price by now, right? There's reason to believe that question is valid because GE is improving margins by being more selective over contracts and emphasizing lean management techniques to cut costs. Similarly, after an extended period of poor operational performance, Siemens Gamesa appointed a new CEO to reduce cost overruns and project delays.
Meanwhile, many industrial CEOs, including GE's, believe supply chain issues will ease in the second half of this year. As such, all the three leading players expect to start to build a margin recovery, and with two of the three (GE and Siemens Gamesa) taking aggressive actions to improve margin, the industry may have passed the low point.
Image source: Getty Images.
Time to buy?
There are some positives developing, but there's reason for caution here on balance. Frankly, many things need to go right for the industry to get back to high single-digit margins. Indeed, GE Renewable Energy expects to reach breakeven in 2023, while the midpoint of Siemens Gamesa's 2022 profit margin outlook is negative 1.5%, and Vestas' management is calling for 0% to 4%.
Margins are likely to be wafer-thin for a while yet. The uncertainty around the economy created by the conflict in Ukraine is yet another item in a list of risks to factor in. Unfortunately, it's almost impossible to predict what impact it will have on the costs for an industry with such slim margins. All told, the industry remains attractive over the long term, but now might not be the best time to go looking for specific exposure to it.
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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.
