Siemens Gamesa Renewable Energy SA (OTCPK:GCTAY) Q2 2018 Earnings Conference Call May 4, 2018 3:00 AM ET
Cristina Perea Sáenz de Buruaga - IR
Markus Tacke - CEO & Executive Director
Miguel Ángel López - CFO
Peter Testa - One Investments
Akash Gupta - JPMorgan Chase & Co.
Pinaki Das - Bank of America Merrill Lynch
Juan Cánovas - Fidentiis
Michael Rae - Redburn
Alok Katre - Societe Generale
Fernando Lafuente - Alantra
Sean McLoughlin - HSBC
Gurpreet Gujral - Macquarie Research
Cristina Perea Sáenz de Buruaga
Hi. Good morning, everybody. Thank you for joining us in our Second Quarter 2018 Results Presentation. Before we start with the call, please have a look to our legal disclaimer in Page 2. After the presentation, we will move to a Q&A session. Given the time restrictions, as you have one of our competitor's results after this conference call, please restrict to 1 question per analyst.
And with this, let me hand over the call to our CEO, Markus Tacke. Markus?
Thank you, Cristina. Good morning, ladies and gentlemen. Thank you for joining us. Today, I'll take this call with our CFO, Miguel Angel Lopez, to present Siemens Gamesa's results for the second quarter of fiscal year 2018. Before giving Miguel the floor go into details of our second quarter performance, I would like to provide you with an overview of where we stand today.
It has been a little bit more than 1 year since we merged and created Siemens Gamesa. Since April 2017, we have achieved a lot in terms of developing our business and in terms of integrating our organization. However, I must admit I would like to have liked integration process to be even faster in some areas.
Our second quarter results demonstrate that we are on track and that both our customers as well as investors can rely on us. Looking at the development of our business, I'm pleased to state this quarter's performance was better than that of the preceding one.
A particular highlight was the strength of our commercial activity continuing the strong performance since quarter 4 of 2017. After achieving €3 billion in firm orders between January and March, our order backlog climbed to €22 billion at the end of the quarter, practically in line with the order book in March 2017, which marked the peak of the previous cycle in the mid-market. This order book enabled us to reach full coverage of the low end of our revenue guidance for the current year, set to €9 billion to €9.6 billion as announced while we expect additional a book to bill still to come.
All segments performed well and our turbine order intake was 29% higher than in the same period in 2017. Onshore had its best quarter ever with orders for 2.5 gigawatts. This represents an increase of 54% year-over-year, mainly driven by India and the U.S. In Offshore, we entered into an exclusivity agreement with Ørsted to supply turbines for the world's large offshore wind farm, the project for 1.4 gigawatts. The service segment had a strong start into the year and ended the quarter with a 2% year-on-year increase in its backlog.
I'm also practically - I'm also particularly pleased that our financial performance in the second quarter and in the first half of 2018 is in line with our guidance for the fiscal year. This good performance was partially driven by onetime effects and timing effects.
In the second quarter, revenue amounted to €2,242 million, which was less than our pro forma figure for the second quarter of 2017. This was caused by lower wind turbine revenues, driven by lower volumes and prices in the onshore market. As a result, EBIT pre-PPA, integration and restructuring cost amounted to €189 million, equivalent to a margin of 84%, in line with the profit target of 2018.
In the first half of the year, revenues were €4,369 million, and EBIT pre-PPA, integration and restructuring costs amounted to €322 million with an EBIT margin of 7.4%. The reported net income was €35 million for the quarter, resulting in 0 overall for the first half year.
Net debt position at end of March was €112 million due to working capital seasonality. We expect to regain positive cash flow in the second half of the year.
The L3AD2020 program is the key company initiative to further drive the success. Within it, Siemens Gamesa has continued to intensively work on the integration and transformation of the company. We've launched the L3AD2020 program at the Capital Market Day on the 15th of February aiming at industry leadership. By now, the program has been fully rolled out and shows traction. As part of the initiative, the workforce adjustment launched to address challenging market conditions and synergies is well underway and on track.
Let me give the floor to Miguel Ángel for more detailed explanations. Miguel?
Miguel Ángel López
Thank you very much, Markus, and good morning to all of you. We have been returning in quarter 2 2018 to the order backlog peak levels of 2017. In onshore, the order backlog, there, we have seen a recovery after growing 3 quarters in a row with 20% of the overall order backlog. In offshore, the evolution reflects the expected order intake volatility with 32% of the total. And in service, because of the long visibility, the 48% of the total reflects a level of around €10 billion. So overall, €22 billion as of quarter 2 in '18.
With this order backlog, we have already secured the revenue in fiscal '18 and beyond. With the actual revenue of €4.4 billion, we see €4.6 billion already in the backlog so that the €9 billion of our revenue is secured. And of course, beyond that, with €17.4 billion, the backlog for the years after '18 is consistently high.
So 100% coverage of 2018 revenue guidance achieved. We have in offshore and service high level and duration of the backlog and a solid development in onshore of the order book fiscal '18 and good progress for 2019.
The order intake has been strong. We moved above the book-to-bill ratio above 1, and this means overall order intake of €3,043,000,000 for second quarter of fiscal year '18. The book-to-bill ratio has been 1.4 and the last 12 months, 1.1. So we are moving into the right direction for achieving all our overall goals. We have been strong in onshore order intake, there at 26% growth year-over-year. We did see the expected volatility in the offshore order intake. Nevertheless, there, as already communicated, we have the preferred supply agreement for the largest offshore wind farm signed with Ørsted in Q2 '18 in the U.K.
We have seen also the expected volatility in the service order intake. And of course, this annual comparison is impacted by the strength of the order intake signed in quarter 2 '17. In onshore, we have seen the highest ever order intake, 2.5 gigawatts at a stable average selling price quarter-over-quarter. We have seen a continuous recovery of onshore order intake following the normalization of auction systems in the major markets. The last 12 months order intake is 7.5 gigawatts, up from 7.2 gigawatts in March '17. And the distribution has been quite substantial over the geographies: India with 25%; U.S. with 22%; Norway, 12%; Spain, 10%; and Australia, 8%, have been the main contributors to the order intake in quarter 2 '18.
It's the second quarter of stable average selling price of the order intake. And we have been speaking in the first quarter of '18 about one data point which has been the 0.72, and we were not able to determine whether this is already a trend. We have now the second data point, and this is confirming the development of what we have seen in quarter 1 '18. However, the year-over-year evolution with minus 18% in Q2 was clearly impacted by pricing and by FX. We have also seen an intense offshore quarterly activity, but with the expected volatility. So 328 megawatt in firm orders in quarter 2, already mentioned, the Ørsted negotiation exclusivity, and we have seen a reinforced presence in Asia. A licensing of the 8-megawatt technology to Shanghai Electric, the offshore leader in China and an MOU with Yeong Guan Energy to support the offshore wind development in Taiwan.
Offshore order backlog provides strong visibility of future revenues. As you can see here, we have a substantial piece of the revenues of 2019 and beyond already in our order backlog.
Let's come now to the results and our KPIs. In the second quarter in '18, with the group revenues of €2.242 billion, we have been achieving an EBIT pre-PPA I&R of €189 million with a margin of 8.4%. The reported net income is €35 million. It does mean for the first half of the year, €4.369 billion in revenues and €322 million EBIT pre-PPA I&R for the bottom line, which represents a 7.4% in the first half of the year, we come with this to a 0 reported net income after the minus 35 in quarter 1.
What is the main impacts that we need to report here? So we have the lower on pricing and this remained the most important drivers of the decline in group revenues and EBIT. Two important onetime effects and timing effects: one is to early reversal of inventory impairments on the back of positive market developments, impacting in our EBIT €25 million in quarter 2. We expected this effect in the second half of the year. If we take this into account, the EBIT margin, would be - would have been 5.3%.
Second onetime effect is a positive FX-driven impact of €19 million in the service EBIT. Taking this onetime effect out, service EBIT would have been 15.3%. So overall, taking these to effects into consideration, instead of the 8.4%, we would have been at the level of 6.5% on EBIT margin pre-PPA and I&R.
Our Q2 reported net income includes net financial expenses of €10 million and a tax expense of €11 million.
Let's come now to the revenues. As mentioned before, the onshore revenues have been impacted mainly by the lower sales volumes. Offshore revenues are according to schedule activity for 2018.
Service revenues are 7% down year-on-year, impacted by the volatility of value-added services. And taking this out, this would have been at a flat level. The fleet under maintenance in service is 55.5 gigawatts, plus 4% year-on-year, driven by the offshore growth.
In onshore, we have seen close to 1.4 gigawatts in quarter 2 '18, and this has been impacted, of course, also by the record activity in Q2 last year, where we delivered 100% safe harbor orders and some of the regulatory changes in India we anticipated. That's the reason for the strong decline year-on-year. In quarter 2 '18, U.S., Mexico and India are the main contributors to onshore revenue.
The EBIT margin is aligned with fiscal year '18 guidance. The guidance for the year is 7% to 8%. We have been achieving the 8.4%. If we go then to the next level, 6.5% on WTG and 22.3% on service. However, and again very important to remember the 2 impacts that positively were in Q2, which is the inventory impairment reversal, €25 million and the FX, positive impact, €19 million in service. If we exclude those impacts, again, it - the EBIT margin pre-PPA and pre-I&R amounts to 6.5%: 5.3% in WTG; and 15.3% in service.
Lower pricing and volume are the main drivers of the decline in profitability. As you can see from the overview, the volume decline is the largest and most important impact beside pricing, and we, of course, drive cost optimization to get positive impact into the bottom line.
With the sound balance sheet, taking into account that we already mentioned several times that we will see a weaker half year 1 and a stronger half year 2 also in this chapter, we have seen working capital impacted by seasonality, especially related to offshore project execution, resulting in a net debt of €112 million, largely impacted by the seasonality of the working capital. However, cash flow generation, working capital and net debt trends will be reverted in half year 2 '18. And Adwen provision stands at €904 million after provision use of €12 million in quarter 2 '18.
Working capital is in line with the fiscal year '18 guidance and again, is impacted by project seasonality. We are focusing on the working capital and closely monitor receivables inventories but also payment terms. And with all the measures that have already been taken, we will revert the situation in half year 2.
In terms of capital expenditure, we are, as announced in the CMD, having a stringent control of the planned and actual spending. This resulted for the first half of the year in €166 million CapEx development. Going forward, we will - as announced, we will go for the 2020 target to be below 5% in this arena and also target a reinvestment rate of 1. However, half year 2 '18 is expected to be more capital intense. And nevertheless, we will go for achieving the targets.
In terms of cash development, we achieved the gross operating cash flow of €135 million. We have been already talking about the working capital variation. This is because of the seasonality. Adwen payments, reduction trade payables days are the main drivers of the net debt evolution Q2 '18. The provision usage of Adwen has been at €12 million in Q2 and to date, €61 million. And again, we will be back to a net cash position in half year 2 '18.
Overall, quarter 2 '18 performance is within the fiscal year '18 guidance. As mentioned already, €9 billion to €9.6 billion in revenues for fiscal year '18. The EBIT margin pre-PPA, pre-I&R, 7% to 8%. Working capital, minus 3% to plus 3%. So a low end of the revenue guidance is fully covered by the order backlog as of March 2018. Synergies of 1.5% of revenues are targeted by year-end 2018 and this is included in margin expectations.
The estimated impact of PPA is €321 million for the fiscal year. €158 million have been already in half year 1 '18 and thereof €75 million in Q2.
Our integration and restructuring cost of €160 million were recorded as €75 million half year 1 and in Q2, have been €61 million.
We will see a stronger half year 2 driven by project timing, by the cost optimization programs and the expected synergy delivery in the second half of the year.
And with this, Markus?
Thank you, Miguel, for your analysis and explanations. Looking at recent results as well as the outlook for the year, I'm confident we are on the right path to address the weak market challenges and to seize the opportunities the wind business offers in the short, medium and long term.
The merger has put us in a great position in the market. On top of that, we have a very strong team that has developed a sound strategic plan for the next 3 years. This strategy, combined with the launch of the L3AD2020 program, is key to achieve industry leadership. In this context, we focus on 4 areas: Growth, you want to grow faster than the market; transformation, we've announced the cost-reduction program of €2 billion and a focus on cash generation, and you see the results of first traction of this program; digitalization, turning data into value; and change management, establishing a joint company DNA.
Our commercial strengths underlines the sound competitive position in all segments. In this context, the highest ever onshore order entry and an important exclusivity agreement in offshore stand out. In addition, the commercial performance, Siemens Gamesa's financial performance is in line with the 2018 guidance. Our strong order book covers the low end of revenue guidance for the current year, €9 billion to €9.6 billion. And the EBIT margin pre-PPA integration and restructuring cost stands at 8.4% in the second quarter and 7.4% in the first half of the year, also in line with the 2018 guidance which is 7% to 8%. All this is accompanied by a strong outlook for the wind power sector with a long-term growth rate in all segments.
Concluding with this, I would like to thank for your attention and open the floor for your questions. Thank you very much.
Cristina Perea Sáenz de Buruaga
Thank you, Markus.
[Operator Instructions]. Our first question comes in from the line of Peter Testa calling from One Investments.
I had a couple of - I had a question on the working capital, please. Inside the working capital table you have on Page 18, there's a significant move in contract assets and contract liabilities, which seems to account for the positive movement working capital. I was wondering if you could explain those and maybe how they link into project recognition?
Miguel Ángel López
Thank you, Peter. So overall, in addition to the expected seasonality of the offshore projects, as you mentioned, the main driver in Q2 has been trade payables and contract liabilities that we needed to bring into more normalized levels. In the coming quarters, we will see there an improvement in trade receivables as well and the contract assets, and inventories will continue to come down. So we will see then the opposite trend to what we have seen in half year 1. And as mentioned before, we will move back then to the net cash position.
Okay, but the substantial drop in contract liabilities, how does that relate to project execution, please?
There's no change in the overall policy.
Next question comes in from the line of Akash Gupta.
My question is on onshore profitability and especially the margin profile in order intake. Because if I look at your ASP, it is stable sequentially, while the cost of steel has gone up. And obviously, we are also seeing increased labor inflation in many of the markets. So maybe if you can talk about gross margin that you see in Q2 order intake compared to Q1 in onshore?
Akash, this is Markus speaking. Profitability in onshore, you reflect to the ASP that we have shown. You see a stable ASP of orders coming in for onshore. You need to also look at the - some mix and scope effects that we have in that. Overall, we see a stable development in market prices. Certainly, there is an adverse effect out of the market. You mentioned the steel pricing. We are well covered with contracts for fiscal year '18. We feel rather solid for fiscal year '18. In fiscal year '19 looking forward, we are currently reviewing possible impacts out of pricing. At the same time, we have launched the L3AD2020 program with a significant cost-reduction effort in order to bring down our costs, so we have some time to deal with the situation and prepare for the - these changes in the market so they're anticipated. For '18, we see negligible impact out of steel pricing. Commodity pricing changes, we see in the market.
The next question comes in from the line of Pinaki Das calling from Bank of America.
I have a question around the order levels in onshore. You've had a pretty good quarter in terms of total orders. If we're to understand if you feel this run rate could be maintained in coming quarters, or it's probably an exceptionally high quarter and then you still go back to the sort of normal run rate of between 1.5 and 2 gigawatts? How should we think about the coming quarters?
Certainly, thanks for the question first, Pinaki Das. Certainly, there is a volatility, seasonal volatility in order entry. You've seen now 3 quarters above 2 gigawatts. And now we have in quarter 2 an especially good order entry. Certainly, order entry is focus of the company. But by no means, we take every order we can take in order to also protect our bottom line. So we do a balance between order volume and order quality in a good way. I would see quarter 2 as an exceptional high order intake for onshore, but at the same time, looking at the 3 quarters, we've seen above 2 gigawatts is a reasonable indication where it could go forward.
Your next question comes in from the line of Juan Canovas calling from Fidentiis.
My question is about pricing. I've seen pricing was stable but I wonder whether you could make comments on specific markets. For example, your peer, General Electric, made comments about price weakness in the U.S. I wonder whether you are seeing similar trends in the specific markets.
Thanks for the question. I will not comment what others communicate to the market. I can comment what we have communicated to the market. We have been early in discussing significant changes, pricing changes in the market. We have been quite transparent on what is going on there. With the pricing trend, we have anticipated it early. We have put it into our guidance for this fiscal year '18, the impact we see out of this. For time being, I can refer to the numbers that we have provided within the document that we see now over 3 quarters what I would call stable pricing environment. Taking into account scope and mix and FX impacts, they're certainly within that pricing. But the 0.74 we have seen for the second quarter, for me, is an indication that after a significant change, we have communicated early on double-digit. Now the prices seem to have stabilized in the periods. A leading indicator I'll take for that is auctions, result of auctions that confirm the development in the market. So overall, we stick to what we have said before. Significant change, but now, a stabilizing element within the market going forward.
The next question comes in from the line of Michael Rae.
Can you provide an update on the major work streams that are underway around the integration? And is there any way of benchmarking just how far progressed you are on the delivery of L3AD2020?
The integration program works on the number of work streams. Some of the work streams are concluded, and the integration has been completed. Some of the work streams will continue for quite some time. The one that concluded early is, for instance, one on technology decisions and implementation of technology decisions. An example for work stream that would go for quite some time is an IT work stream, for example, integrating IT into a structure. Everybody knows that it is an exercise. It will take some time if you do it diligently is what we do. So in that regard, the integration is going ahead. What certainly I can report is that the major decisions have been taken. We're now moving into an implementation phase in our work streams and moving forward. With the L3AD2020 program, that is a program focused on transformation of the company while having an aspect on growth. So we have the elements I've mentioned earlier: the growth elements where we focus on market growth and growing faster than the market; then we have the transformation element, which is within its core, it's the €2 billion cost reduction, €400 million out of these synergies coming out of the integration; and then we have the technology element to move us forward into the technology space where I think it's of equal importance to the other 2. All this is well-balanced. It's a change management program to make sure we keep the company - one company approach.
We developed the one company approach in the developing joint DNA for Siemens Gamesa. We will report on the L3AD2020 program, including also how far we have come with the integration on top of what I have just said by end of September 2018 with the conclusion of the fiscal year in much more detail as do this right now.
Your next question comes in from the line of Alok Katre calling from Societe Generale.
Alok Katre from SocGen. Just one. I was wondering if you could shed some light on the offshore blade repair issue that we had seen in March. Should we sort of see that as a one-off? Or is it something more recurring that you have been expecting already? And do we have any cost estimates for that repair and how well it's covered by the existing provisions?
Thanks for the question. What you mentioned is leading-edge erosion that specifically offshore turbines experience. Also in heavy rain areas, for onshore, you can see that effect, so it's an industry topic. It is not a Siemens Gamesa specific topic; it's an industry topic with higher tip speeds, technology is evolving, these effects occur. It's a topic that has been addressed in 2014 quite early in terms of dealing in the financial wave of it and in providing, in an adequate way, for those activities that need to follow out of the observation of those erosion effects. Siemens Gamesa has developed an upgrade package for our customers that are affected by that phenomena. So we offer and beyond a repair, which is also possible, what others might do, we often an upgrade package. So while going at the blades, we also improve turbines' performance, a business will be offered to the market. So - and this is what you have seen in March in the press with the [indiscernible] activities with the summer campaign have been kicked off in order to go after these blades and first, of course, deal with the erosion effect, but at the same time, help our customers to upgrade their plant performance. From a financial perspective, that had been taken care of early on in the respective provisions that have been built. And I'm confident that the amount of provisions is sufficient.
Your next question comes in from the line of Fernando Lafuente calling from Alantra.
Just one question on the positive one-offs that you are booking in the EBIT in Q2. I basically understand the €25 million reversal into the inventories. I wanted to have a more clear view of the positive impact of FX in the service business. Where does it come from? And in both cases, I think I understood Miguel saying that you were expecting them in H2. And the question is whether - if they are included in the guidance or if we should consider these 2 effects on top of the 7% to 8% EBIT margin that you guided for this year?
Miguel Ángel López
Thank you, Fernando, for the question. First of all, the expected impact in terms of the inventories, the €25 million, it was expected to have this in half year 2. And of course, as some of the events happened before, so we recorded them in Q2. So this was included, of course, in the overall guidance for the year. Related to the FX impact, this is - because of a currency clause in a long-term service contract, and this has been determined as an embedded derivative. And the impact is a fair value adjustment of this embedded derivative. The contract overall is going over a term of 15 years. So this was not foreseen, but still, no reason to change the guidance and it is an impact that will be also within the guidance of the 7% to 8% for the full year.
Your next question comes in from the line of Sean McLaughlin calling from HSBC.
It's on services. I understand that there was this contribution from value-added service in Q1. Yet in the service backlog, you're saying you have contracts with higher margin. I just wondered how you see the profitability outlook for services compared to your historical numbers and how important the scale is and operational gearing.
Thank you for the question. So the long-term view in service profitability is that we will be in the area of 20-ish. So we don't see the revenue growth then also resulting in additional scale in the result over the next years. In our L3AD2020, we have been communicating the growth that we will have in service over the 3 years. And this growth will not result in increasing margins. Because of the price pressure that we see also in this arena, we see a margin around the 20s also in the next years to come.
The next question comes in from the line of Gurpreet Gujral calling from Macquarie.
Just one question from me. I know it's only been a few months since your CMD, but at the time, there was a lot of focus on the bill of materials. Can you give us an update here and whether you can share with us the early wins in terms of perhaps new supplier agreements or pricing for some of your components that you order in?
The focus on simplification of our product portfolio certainly is high, and it will continue to be high as we communicated at the Capital Market Day. The 25 to 9 program has been implemented. It is part of the L3AD2020 program where we have a submodule, specifically focusing on our products, product affordability and product simplification. And as I said before, we will give details on the progress of the L3AD2020 program, including also how we move forward with the products and product simplification streaming our technology pipeline, streamlining our technology pipeline by the end of the fiscal year. At that point in time, we have substantial achievements that are worthwhile to discuss and present to you.
The next question comes in from the line of Peter Test calling from One Investments.
It was just to try to understand some other things in the guidance. You're guiding for around €120 million of cost effects to happen in the year. I was wondering how much happened in H1. And then on the provision use, there was €114 million, I guess, €12 million with Adwen and so I was wondering whether you had any views on how that would be used through the year as well regarding I guess the blade thing that was talked about earlier.
Thank you for the question. We expect the 2 things to increase activity in the second half of the year. It is the ramp-up of synergies and productivity improvements at the same time that we see an increasing cost on I&R as predicted. As we have said, €160 million of expected integration restructuring cost for the full fiscal year. And in half year 1, we are around the €75 million. There you see that, again, this will ramp up in the second half of the year as well as the cost reduction and, respectively, the impact in the bottom line.
We have no further questions coming through on the line.
Cristina Perea Sáenz de Buruaga
Thank you. Markus, do you want to close?
So thank you very much for the - your attendance to our earnings release for the second quarter of Siemens Gamesa in fiscal year '18. I think we have presented to you a consistent quarter in line with the guidance that we have given before. Thank you for your valuable questions and looking forward to continue the discussion with you in any other point in time. Thank you very much.