Siemens Gamesa Renewable Energy SA (OTCPK:GCTAY) Q3 2019 Earnings Conference Call July 30, 2019 2:30 AM ET
Cristina de Buruaga - Director, Financial Markets
Markus Tacke - CEO
David Mesonero - CFO
Conference Call Participants
Akash Gupta - JPMorgan
Ji Cheong - Citi
Fernando Lafuente - Alantra Equities
Sean McLoughlin - HSBC
Alok Katre - Societe Generale
Akash Gupta - JPMorgan
Casper Blom - ABG Sundal Collier
[Call Starts Abruptly] …that corresponds today, pre-June quarter. Before we start, let me turn your attention to our disclaimer in Page 2. Our CEO, Markus Tacke, will explain the period highlights, the outlook for the company and this sector, and will make the closing comments. Our CFO, David Mesonero, will conduct the rest of the presentation. We will finish with the Q&A session. [Operator Instructions]
And with this, let me hand over to our CEO, Markus Tacke. Markus?
Thank you, Christina, and good morning, ladies and gentlemen. Thank you for joining us. Today, I'll have, I'll take this call with our CFO, David Mesonero, to present Siemens Gamesa's results for the third quarter and the first 9 months of fiscal year 2019. Before giving David the floor to go into the details of our third quarter performance, I would like to provide you with an overview of where we stand today. First, let's look at our ESG principles and our sustainable development. I would like to start this presentation with an overview of our goals and achievements in integrating environmental, social and governance factors into our decision-making.
Since Gamesa is fully committed to sustainable development and to stricter ESG principles, we truly believe that who cares, wins. We are not the only one, investors do, too. So our inclusion in major sustainability and corporate indices not only makes us proud, but is also good for our business. And because of our main aspiration to accelerate the transition to a sustainable power supply, it is important to us that starting next year, our customers will be able to save more than 250 million tonnes of carbon dioxide's equivalent every year.
We pioneered the energy transition, so it is to be expected that we make the same effort to reduce our own environmental footprint. By 2025, we expect to have achieved carbon neutrality, with a 10% increase in energy and waste efficiency and a 10% reduction of waste to landfill and hazardous waste. We also expect our partners to adhere to the same standards, its supply chain submitted to scrutiny. Therefore, we expect that by 2020, 80% of our annual procurement volume from our main suppliers will comply with our code of conduct.
So let's look at the highlights of the period. While the energy transition keeps developing positively, along with higher demand for renewables, some headwinds are having an impact on the immediate horizon, the more competitive market, the trade war among 2 of the largest exporting countries of the world, and uncertainties in emerging markets are putting pressure on the wind turbine manufacturing industry, in particular, in the short-cycle Onshore business. These challenges are transitory in nature. We are now seeing signs of recurring pricing and are having an impact on our bottom line, but only in the short-term as the shift towards the adoption to renewable energy is driven by its cost competitiveness and productivity gains. And that is where Siemens Gamesa is right now.
In the new reality that we will soon overcome, thanks to the transformation we are undertaking with our L3AD2020 strategic program, our product portfolio and our recent additions. To prove my point, look at the strong performance in our commercial activity, not only in volume, but also in euros. As you can see, we achieved a new order record, with a backlog of €25.1 billion at June 30, with order intake of €12.3 billion in the last 12 months, up 2.2% year-on-year and a record amount of €4.6 billion in quarter 3, with a book-to-bill of 1.8% for this 3-month period. Those numbers represent our best performance since the same period in 2017 for the 9-month period and is our best order intake for the quarter since the merger. And despite of the headwinds I just mentioned, particularly in the Onshore business, our financial performance in the third quarter was in line with the guidance. Our EBIT margin pre-PPA and I&R costs was 6.1% in quarter 3 2019, while revenues increased 23% year-on-year to €2.632 million. We anticipate a strong performance in quarter 4. We confirm to end the fiscal year in the guidance range.
I would also like to take advantage of today's financial results presentation to introduce our new Onshore CEO, Alfonso Faubel. With his addition, we will have completed our reorganization of the company's senior management team. Alfonso Faubel looks back on more than 30 years of experience in the automotive and energy industry. He has a deep knowledge of the wind industry after years of senior management in areas related to onshore and offshore business, and I'm very confident that he is perfectly suited to lead the Onshore business in the described environment.
As for the announcement in May of the planned transfer of Siemens AG's shares into Siemens Gamesa -- in Siemens Gamesa into Gas and Power NewCo, we are accessing the potential implications this might have on Siemens Gamesa in order to be well prepared for any steps intended by Siemens AG.
Before I give the floor to David for more detailed explanations, let me tell you some of today's successes that will secure our future growth. This quarter has many success stories to tell about commercial activity in our 3 business areas. Starting with Onshore, we landed the largest repowering order to date in the U.S. history. With this last contract of 429 megawatt, we reached a total of 1.9 gigawatt of repowering projects in the U.S. Repowering of aged onshore wind farms has become a strong business, and we are positioned to take advantage of that trend. According to the energy consultancy of group -- of Wood Mackenzie, 8 gigawatt of the existing wind fleet is expected to be subject to repowering in U.S. by 2025, out of 16 gigawatt expected globally.
We're also moving quickly towards manufacturing the most powerful wind turbines on the market that will contribute to further reducing the levelized cost of electricity. Here, we'd like to highlight the commercial success of the Siemens Gamesa 4.5 megawatt class turbine, which is on its way to becoming one of the fastest selling wind turbine models in the company's history. In addition, we launched our new platform, the 5.8-155 earlier this year. It is a benchmark in power output and rotor size that can be tailored to the needs of each site, and we're advancing rapidly in industrializing this next-generation technology.
In the Offshore business, we are making good progress with new contracts in areas and countries where we already have had a foothold, like Taiwan, and we're also opening new markets with good prospects, like Japan and the U.S. In Taiwan, we received a firm order to supply 640 megawatt to Yunlin offshore power plant, located approximately 6 kilometers off the shore in the Taiwan Strait. With this contract, we're introducing the offshore turbine Siemens Gamesa 8.0-167 in the Asian market, a region with an increasing number of sizable opportunities.
In June, we received our first preferred supplier nomination for an offshore wind project in Japan. It includes using Siemens Gamesa 8.0-167 offshore wind turbines for the Northern Akita offshore wind farm project, which has a capacity of up to 455 megawatts. Service remains an attractive market. We signed important contracts, like the one in Texas where, we got a 4-year multi-brand O&M and Diagnostics, analytics contract. In Poland, we secured our first full scope multi-brand contract that includes availability and component warranty for 29 Vestas V90 turbines. There's increased diversity of fleet composition, as most wind farm owners expand their fleets beyond a single turbine manufacturer, due to economic performance or because of integrating fleets from M&A activities.
After this overview of our quarter 3 highlights, let me hand over to David for more detailed explanations.
Thank you, Markus, and thank you to all the investors and analysts joining us today. We know it's a busy day for all of you. As Markus just explained, this quarter combines some strong results, our success stories that considered a solid base to build our future growth with some challenges that are impacting our short-term financial delivery.
Starting with Slide 8. We have some of these strong results. We are very proud of 2 new records achieved in Q3: A record order intake at group level and a record backlog. We signed €4.7 billion of new orders in the quarter, 42% more than in the same quarter last year and reached a book-to-bill ratio of 1.8x on a quarterly sales, 0.3x more than our book-to-bill ratio in Q3 '18. The growth in order intake was well spread throughout the different areas. Onshore orders grew by 44% to €1.7 billion, Offshore orders grew by 33% to €2 billion, and Service orders grew by 58% to close to €1 billion. As we will talk in the coming page about Onshore and Offshore, let me now focus here in services.
We started the year with a relative short order intake, €346 million in Q1 '19. And if you remember, we said that we were expecting a positive progression, and that is what we have delivered, €749 million in Q2 and now €931 million. Two things worth highlighting: Taiwan and multi-brand. In Taiwan, both orders, Yunlin and Greater Changhua came with service contracts. In the case of multi-brand, Markus has already gone throughout our success in the U.S. and Poland, with nearly 300 megawatts of third-party technology service contracts gained in the quarter.
Looking now into the group order intake in the last 12 months, we reached €12.3 billion, up 2% year-on-year and a book-to-bill of 1.2x our last 12 months' revenue. Onshore, with last 12 months order up 8% year-on-year to €6.7 billion, is the main source of this increase at group level.
Moving into our order backlog, €25 billion, up 8% year-on-year. This backlog gives us good visibility of future growth and provides a coverage of 98% of the midpoint of our revenue guidance for the year. Back in March, we had already covered 100% of our low end and now, we are in the midpoint of the first half of the range.
Our backlog is also well balanced. €11.5 billion, or 46% of the total, belongs to service, has a duration of close to 8 years, and this means higher profitability, faster cash conversion and a more recurring nature. But let's not forget that with our WTG division, there are now high-quality Service revenues. €6.4 billion of order backlog in Onshore, 36% up year-on-year, representing 25% of our group order backlog. And €7.2 billion in offshore, 8% down year-on-year, driven by the extraordinary growth in Offshore revenue this year, and representing 29% of the total order backlog. Geographically speaking, our backlog is also very well balanced.
Now let's move to the onshore order intake in Slide number9. Sound commercial performance in Onshore, too. The U.S. market has been the driver of growth for the industry in the last 12 months. And this quarter, Siemens Gamesa has not been an exception. 8.9 gigawatts intake orders were signed in Onshore in the last 12 months, up 4% year-on-year, with more than 50% coming from Americas and 38% coming from the U.S., 3.4 gigawatts. 2.1 gigawatts was signed in Q3 '19, up 28% year-on-year, with 82% coming from Americas and 62% coming from the U.S.
In the U.S., it is worth highlighting, as Markus did, the repowering contract with Mid-America, as we see good potential in repowering in the U.S. Also thanks to the U.S., we have reached our first gigawatt of sales with our new onshore 4.5-145 onshore wind turbine. Beyond the Americas, we have seen the reduction in EMEA, both in the last 12 months and in the quarter. Nothing to be worried here. This is largely driven by Spain and South Africa, where we were very successful in Q3 last year, when both markets reactivated after a longer relative end pace. Both markets have now ambitious targets, and after last year's reactivations, we are expecting new renewables option to come.
In Spain, the draft energy plan proposed to cover 42% of consumption with renewables by 2030 and 100% by 2050, and the yet discoveredfor wind will require a bit over 2 gigawatts of new installations per annum between 2021 and 2030. It is true that we do not have yet a government, but all Europe is increasing their renewable commitment, and we do not expect Spain to be different. Perhaps, we might see delays, but no structural difference.
In South Africa, the draft of the integration resource plan also targets a predominantly renewable model, with 1.6 gigawatts of annual wind installations between 2022 and 2030. We are well positioned to capture market share when both plans are becoming a reality in the coming years.
We can see a decline in APAC, too. This has been largely driven by the volatility that the India market has experienced since the beginning of calendar year '19. In this regard, the last 2 SECI auctions have been undersubscribed. Several things might have impacted.
First, it has been an election year, and that creates some disruption. Market players delayed investment decisions to see the result of elections. We have seen the impact that government change have had in market developments, both in Brazil and Mexico. There have been also some issues with the connection to the grid, payments delayed to renewable producers, scarcity of land and auction prices, although higher than before, are still relatively low, so here, we are also starting to see some price discipline among market players that is welcome.
All these might have generated the volatility we have seen, volatility that has clearly impacted our commercial activity in the last 6 months and now our top line delivery and margin delivery this year because, as you know, India is one of those markets where delivery times are shorter, and we will continue with 13 orders to move to the upper part of the revenue guidance range. The good news is that we signed a sizable order in the last week of June in India, 450 megawatts. The down payment money did not reach us until the 1st of July, and hence, the order has been booked in Q4, very strict accounting rules that we fully comply with.
Beyond the short-term volatility, India remains a very attractive economy and a very attractive wind market, probably the second to China beyond 2021. And to preempt some questions later, I'm going to add some additional about our commercial strategy. We are not trying to be bigger and gain market share at any cost. And that means that in the short-term, we will continue to walk away from certain tenders. And that is okay for us because profitability levels in onshore market are already much lower than we were expecting back in our Capital Markets Day presented in February 2018, and we need to bring profit profitability back to acceptable levels not only through technology, productivity, execution and focus but also pricing discipline. And if we lose market share temporarily in the process, we will assume it.
Moving to pricing. You can see an upward trend, from a stability to increase in the ASP, but again, a cautionary remark. There are many factors behind the ASP. Last quarter were China affecting a negative way. This quarter, we have a positive impact from roads, taller towers and larger rotors and scope, where powering has been slightly positive for the ASP. Looking to the underlying pricing, we can see a small increment, but it is mainly driven by some tensions in the supply chain, including the import duties to Chinese components that we are passing through the extent possible.
Moving to Slide 10. Great commercial success in offshore this quarter with the confirmation of 2 large contracts in Taiwan 1, and both contracts are the results of our early engagement with developers and our stakeholders, as Markus has explained. Order intake, up 12% year-on-year to 1.5 gigawatts with the confirmation of Yunlin, 640 megawatts with WPD and Greater Changhua, 900 megawatts with Orsted. Last year, Q3 was also quite successful. We signed Hornsea 2 and Formosa 1. The quarter has also been a success in terms of conditional orders, Vattenfall won in Holland, the project HKZ 3 and 4, and we have a conditional order from them with our new Tamil platform. And in the U.S., we have been conditionally awarded 1.7 gigawatts from Orsted and Eversource to develop the 3 offshore wind projects in the Northeastern U.S. The 880 megawatt Sunrise Wind power, the 704 megawatt Revolution Wind and the 130 megawatt South Fork project, all American pipeline with our 8-megawatt platform. So great success in 2 of the new markets, U.S. and Taiwan, that will help drive great growth in wind offshore installation in the next decade.
In total, we have a conditional pipeline of more than 7 gigawatts in France, Poland, U.S. and other countries like Japan. Together with our backlog of 5.4 gigawatts, we have built a solid base to support our future offshore performance.
Moving now to our financial delivery in the quarter. In Page 12, we have a summary of the financial metrics, both P&L and balance sheet. Moving fast, as we will see later in more detail what is more important, group revenues up 23% in the quarter and 12% in the 9 months. While 9 months' growth is mainly driven by Offshore and Services, growth in the quarter is also driven by Onshore, not perhaps as much as we were initially expecting, because of volatility in some emerging markets, but good growth. EBIT pre-PPA and I&R cost is lining up in the quarter to €159 million, but flat in the 9 months with margins down, both in the quarter and in the 9 months to 6.1% and 6.5%, respectively. We will explain in detail, but lower pricing in our backlog remains the main driver of lower profitability.
The decline in reported net income in the quarter to €21 million is driven by taxes. Last year, we had a positive impact from taxes, and we adjusted our Q1 '18 impact from the U.S. tax reform. This year, we had a tax expense. In the 9 months, reported net income, up €88 million, up nearly 100%, and this has been driven by lower impact from PPA and depreciation of the intangibles and lower integration and restructuring costs. The underlying net income in the quarter amounted to €96 million and in the 9 months to €297 million.
Moving to the balance sheet metrics, only one comment on the provisions as we will see more details on net debt and working capital later. Provisions are down year-on-year to €186 million, €147 million on the back of Adwen, and the rest are ordinary releases driven by product platform improvements and service productivity, as were already discussed in the Q2 '19. This quarter, provisions have remained relatively stable, €42 million down, largely driven by Adwen outflows, €35 million. And a comment on CapEx, €127 million, 4.8% of revenue and in line with guidance.
Looking into our top line in more details, let's move to Slide number 13. As we said at the beginning of the year, we will have a stronger growth in the second half, and this is what we see here. Good growth from all 3 areas. In Onshore, with revenues up 17% to €1.3 billion, we are not yet seeing higher activity. But we see a top line that grows on the back of better geographic mix, with a strong contribution from EMEA and a strong installation activity. In Q3 '19, we have installed more than 2 times what we installed in Q3 '18, 1.7 gigawatts versus 839 megawatts. As you can see in the revenue volume chart on the bottom, flat volume year-on-year in the quarter, 1.7 gigawatts and 4% growth in the 9 months.
EMEA is the main driver of volumes. On a country basis, Norway is the largest contribution, with 23% on the Onshore volume. U.S. is the second largest, with 21% and Spain is the third, with 17%. At a distance, India with 9% and Sweden with 8%.
Offshore revenues up 31% year-on-year to €1 billion, an extraordinary level of activity. The right execution and skills are very relevant for our clients from a CapEx perspective. We have already discussed our 25, 24/1/99 program but in July, we reached a new execution record. We installed 32 range of 7 megawatts plus in 14 days, great achievement. More than 100 megawatts installed in a week and a strong congratulations to our Offshore team.
In Service, 26% revenue growth in the quarter to €390 million, driven by growth in maintenance contracts and value-added solutions. We ended the quarter with 59 gigawatts under maintenance, 2 gigawatts more than in Q3 '18, 48 gigawatts in Onshore and 11 gigawatts in Offshore. So most of the growth in the fleet under maintenance continues to be by Offshore. But as we have explained earlier, we are not trying to capture megawatts, we are trying to capture profitable business. And this is what we are doing in Onshore service. A final comment regarding our top line for Q4. We do expect to see a strong growth in Onshore next quarter, but not in the other 2 divisions.
As I said at the beginning, we ended the quarter with 98% of the midpoint of revenue guidance or around €10.3 billion. So barring some book and bill, we should be executing €3 billion of revenues in Q3 '19. Now from revenues to profitability in Page 14 and 15. In Slide 14, our EBIT bridge. Pricing continues to have the largest negative impact on group profitability, but there are some other things to highlight in this slide. In this quarter, the benefits of the transformation program have compensated the impact from lower pricing. It has not happened before. It is just a quarter, and a quarter is not a trend, and we cannot relax, so we need to continue pushing for productivity improvements.
On pricing, 70% comes from Onshore. It has come down from Q2 '19, and we can ensure that the impact will be much lower next quarter. 30% comes from Service and Offshore, 50/50. Service has seen pricing pressure for many years now. We are all over. Here, productivity, digitalization and technology play a very relevant role compensating pricing pressure. Offshore, we see some pricing impact on margins now we did not see in the previous quarter, and that explains the largest size of the pricing bar. It has been more than compensated by the Offshore productivity gains. Two important things that we need to keep in mind about Offshore. 2019 has been an extraordinary year for Offshore in 2 fronts.
First, big volumes that are not going to be repeated next year, when we expect a decline in above-normal profitability driven by the price war execution and the same peak volumes that help reel in, in the fixed cost absorption. Second, Offshore will go through a transition into a much more competitive market, driven by the auctions we are seeing today. That means that we will move from above-normal to normal profitability, but we do not expect the rational behavior we have seen in Onshore. And hence, the very lower profitability of offshore projects in Offshore. And our clear leadership in the market makes us confident on the large value creation potential in this market, much larger than what we would have expected back in February 2018.
Mix and scope, negative, this is Offshore. With executing projects that are slightly less profitable than what we executed this same quarter last year, an order that we are going to discuss in the next page, because it has been quite unexpected.
We see year-on-year a sequential reduction in profitability in Q3 '19, and we were not value delineated. And we are obviously disappointed. We see at group level, and we can say that it's largely driven by Onshore business. It has been driven by execution challenges that we have faced, both in Northern Europe and in India. All the challenges have led to same additional costs, and to a lower-than-expected profitable levels. If we were to exclude those, the EBIT margin this quarter will have increased both year-on-year and sequentially.
Moving to the balance sheet and cash flow metrics now. Slide 16, working capital, with €238 million of working capital, or 2.4% of revenues. Year-to-date, working capital increase has been driven by the back-end loaded planning of the projects and especially in Onshore planning. But you can see that working capital to revenues is down year-on-year from 3% to 2.4%, which tell about a strict management.
Nothing here new. Year-on-year, the increasing trade receivables and inventory to cope with Q4 '19 deliverables have been fully compensated by the increase in trade payables as part of the working capital management, and we can see a very small valuation of net contract assets and net contract assets in opposite directions, but none of them relevant. We should see a favorable movement in working capital in Q4. We expect to move back to negative working capital in Q4.
And finally, moving to Slide 17 to our net debt position. We have ended the quarter with a net debt position of €191 million after generating €146 million in gross operating cash flow in the quarter and €287 million year-to-date. Also, it's worth to highlight that we have received a BBB credit rating from Fitch, reflecting our industry leadership and strict financial management, a strong liquidity and low leverage.
We have seen a positive trend in gross operating cash flow generation in the last 9 months, from €57 million in Q1 to €84 million in Q2 and €146 million in Q3. This gross free cash flow generation has been compensated year-to-date by working capital and in the last quarter by CapEx. So quarter-on-quarter, the net debt increase have been driven by CapEx, €127 million spent in tooling, blade molds and product R&D, with a small increase in working capital. Year-to-date, the reduction in net cash moving to net debt is totally driven by working capital, and we should see a move in the opposite direction in Q4 as we expect to meet our target of positive free cash flow generation after our payments. Regarding Adwen outflows, €35 million in Q3 and €119 million in the 9 months.
And with this, I will hand over the floor to our CEO, Markus Tacke, who will share with you our future prospects.
Thank you, David. As I said before, Siemens Gamesa's performance during the first 9 months of fiscal year 2019 is in line with the guidance range. Revenues amount to €7.283 million in the 9 months of fiscal year 2019. For the whole fiscal year, we expect revenues to be in the first half of the guidance range. Our EBIT margin PPA and I&R cost was 6.5% for the 9-month period, but we maintain our prediction for the full fiscal year at the low end of the range of 7% to 8.5%. The EBIT margin for fiscal year 2019 is affected by short-term headwinds, such as lower sales in emerging markets, the trade war impact on commodity pricing and the delays in project execution in Northern Europe and India. We anticipate those headwinds to continue in quarter 4. The impact is expected to be compensated by revenue execution and the speed of the L3AD2020 transformation program, including annual synergies of 1.2% of revenues by the end of fiscal year '19.
Let me briefly elaborate on the state of the wind market in general in our business, specifically. Trends that have impacted performance during the first 9 months beyond the known price pressure will still be present to burden in the short-term, but do not impact the potential and attractiveness of our industry or group in the medium and long term. We have anticipated a number of regulatory changes and expect to see more. The pressure of trade war, the discussion on a potential no-deal Brexit, the slowdown in the growth of the world economy, macroeconomic volatility in emerging markets, such as India, Mexico, Argentina or Brazil, will continue to impact Onshore volumes and margins on the most immediate horizon.
As Offshore, the delay in the construction of 2 Danish projects impact the performance in the short term. In addition, the Offshore business also continue to see price pressure, which needs to be challenged and compensated by cost-out and further performance improvement measures. In this competitive environment, the continued trend in the Service business for larger operators to self-perform will continue. As described, the wind market is facing several short-term headwinds. However, in light of the comparable good performance compared to our competition of Siemens Gamesa in recent months, I'm confident we will succeed in further strengthening our position, and actions have been taken to offset those short-term mentioned challenges.
We implemented optimization measures in the Onshore product portfolio. We are increasing productivity on existing products and diminishing complexity in our supply chain as well as the manufacturing footprint. We are launching platforms, like the 5.8-megawatt platform, which will be ready for the market by end of 2020. We are, therefore, putting our efforts into further reducing the levelized cost of energy in our industry. And there are signs of rationalization in the market as we saw the first price increases this past quarter and continue to observe an ongoing market consolidation.
In the Offshore area, we will still expect solid growth, with double-digit installation growth and market volumes to increase from 7 gigawatt by 2019 to 16 gigawatt by 2025. With a €7.2 billion backlog and more than 7 gigawatts in the pipeline, we maintain our leadership in this business area, and we will continue to lead the market in the foreseeable future, thanks to our track record of execution and with products, like the one just launched this year, the new Siemens Gamesa 10.0-193. And as for the service market and our own Service business area, we expect performance in line with the business plan 2018 to 2020, despite the challenges described before. To explain our vision for the near- and long-term future, we plan to hold a Capital Market Day towards the second half of 2020.
So with the event of more reliable and efficient wind turbines and the shift towards the adoption of renewable resources and with the need to drive sustainable development, we expect average annual wind installations to roughly double by 2040, with investments up to $5.3 trillion through 2050. Growth will increasingly be driven by offshore, with a compound annual growth rate of around 21% from 2018 to 2025. We expect ex China onshore installations to increase significantly in the next years and then plateau. In this scenario, Siemens Gamesa is positioned to lead as offshore and onshore marking markets -- onshore emerging markets, which will continue to drive growth in wind installations.
So to conclude, and before we start the Q&A session, let me sum up the main results. Our well-balanced order of backlog reached a record €25 billion, with a year-on-year increase of 8.2%, driven by sound order intake of €12.3 million in the last 12 months. And this record order backlog gives us visibility for the remainder of the fiscal year, with 98% of revenue covered at the 9-month mark. Nonetheless, there are short-term headwinds, trade wars, pricing pressure and some market volatility all weigh on margins. But those adverse effects, regulatory changes will have a limited time and only short-term impact. A strong market outlook and company prospects remain unchanged. We are, therefore, in a position to confirm our 2019 guidance for revenue and EBIT margin pre-PPA and I&R cost.
Thank you very much for your time, and I'm ready for your questions.
Good morning ladies and gentlemen. The Q&A session starts now. [Operator Instructions]. The first question comes from Akash Gupta from JPMorgan. Please go ahead.
Good morning Markus, David and Cristina. I have a question on bridge that you presented on Slide number 14. The first one is on pricing, if you can give us some indication how that splits between Onshore, Offshore and Services segment. And second one is on volumes. I mean, and then particularly, if you can talk about profitability of Onshore business there compared to what you had in Q3 last year. So that's question number one. Thank you.
Good morning Akash. Thank you for your question. Regarding in the Page 14, regarding pricing, negative bar, as I explained, 70% comes from Onshore. It has come down from the Q2 '19, and we can assure that the impact will be much lower next quarter. And the other 3% comes from Service and Offshore, 50%, 50%. Regarding your second question about Onshore profitability, as you know, preferably, we do not disclose the Onshore margins. What we can say is that it has been affected, as Markus has previously explained, by 2 execution issue that we have had in Northern Europe and EMEA.
The next question comes from Ji Cheong from Citi.
Yes. Ji from Citi. Just one. So just on the 7 gigawatts of your Offshore expected pipeline, just wondering if we can get some further clarity on that, please.
Yes. This is Markus speaking. Happy to give you a view on that one. If you go on Page 10, you have the 7 gigawatt, which is, the pipeline is made up of the preferred supplier agreements that we have in France; the conditional orders we have in Holland HKZ 1 to 4; the pipeline, we recently announced in the U.S. of around 1.7 gigawatts; and others, 1.2 gigawatt across the other jurisdictions, most of that is Taiwan. Those pipeline is either preferred supply agreements or conditional orders, where we wait for the financial close of the projects.
The next question comes from Fernando Lafuente from Alantra Equities.
Just one question on the 2019 guidance and on the outlook headwinds for 2020. Assuming that you are expected to end the year at this 7% more or less range in terms of EBIT margin and considering the headwinds, temporary headwinds that you have for next year, like the slowdown in Offshore, probably the house market in Mexico or the slower expected recovery in India, what are your views at this point on the EBIT for 2020? Are you still comfortable with this 8% to 10% EBIT margin that you guided for in the last Capital Markets Day? Or considering these headwinds, we could face some slowdown still in the progression of the margin?
And my second question is on the performance of the Service division. You were vocal in previous quarters that services should normalize growth at some point in the second half of the year, but it's still growing at 20-plus percent every quarter. First question is why is growth, and I guess the growth is more price-driven or average income per megawatt, whatever you want to call it, I mean, look at it. And secondly, what should we expect for, I mean, David, you said for Q4, there should be lower growth, but not even for Q4, for next year. What are your better views on this margin, on this business?
To answer the first one, we are currently focusing to secure the good performance of fiscal year '19. And I have been explicit, as you mentioned, on a number of headwinds we anticipate in the current environment, short-term headwinds coming out of regulatory changes, we anticipate it, like the trade discussion, we'll still need to digest what potential and no-deal Brexit with our footprint and Offshore business in the UK means for us. At the same time, we see also a number of opportunities, the new products we bring to the market, the L3AD2020 cost-out, price stabilization that has been mentioned by David. So we are currently in the process to complete the assessment of the impact of those factors on the next fiscal year and the years to come. So we look at this with caution, but it is too early to take a judgment -- a final judgment on next year and years to come at this time, given the high dynamics we see in that environment.
On the Service topic, we see Service growing, with around 10% on a yearly basis. Service will continue the growth with the margins we have seen in the past. So in Service, and as I stated earlier, is well in line with the assumptions we've taken before. Of course, Service needs to modify the business model in a way that we need to anticipate the trend to self-performing large fleet operators. We found a solution, and you've seen the good results in quarter 3, winning other OEMs' business in 2 significant countries. We've seen some of that has been won because of our digital capabilities that we bring to those aged wind farms. So this will be the new growth fields to allow continuous growth of Service going forward as anticipated before.
Thank you. Sorry. And if I may, a follow-up, Markus, on my first question on the 2020 guidance. I'm sorry to be a bit insistent on this. I understand that you are in the process of planning or budgeting in the next year, but I mean, I understand that the 8% to 10% is still valid. I mean, it could 150 basis points up or down, depending on this headwind, or these headwinds are so material that the 8% to 10% is under review?
As I said, we see some challenges, some headwinds. We have -- I have mentioned, we see some opportunities. We look at this with caution. We are still completing the assessment of what it means for us. As for instance, as I also mentioned, the Brexit, a non-deal Brexit would have a significant impact, so we need to have a judgment on this one. As you see other potential regulatory changes, uncertainties in governments that have not yet been formed, we need to put our judgment to it, and we will come back with that to the market when we have a firm opinion on this one. And that is the reason why I also announced a Capital Market Day in the first year of next year to be very clear on what that means for the company going forward.
Cristina de Buruaga
Thank you Markus, thank you Fernando. Next question, please.
Thank you. The next question comes from Sean McLoughlin from HSBC. Please go ahead.
Thank you. Good morning. You mentioned that there's a transition in Offshore, the next 1 to 2 years from, let's say, a higher-than-average profitability to a normal profitability. I just wanted to understand a little bit these dynamics. It's a high-growth market. There are only really 2 suppliers in this rapidly growing market. What is driving this lower profitability? And also, can you give us a clue as to what you consider to be normal profitability?
Sean, I think that you probably read in the current way, we are suffering a transition in Offshore. It doesn't mean that we will see the rational behavior that we have suffered in Onshore. As you were saying, we see ourselves as the leader, clear inner leaders of the offshore industry. But also what we cannot ignore is that we are coming into an auction system in which the LCRE pressure is, of course, becoming more and more important. Regarding where we see our profitability of Offshore, as I have repeated several times, we see our Offshore business being accretive for the company profitability.
The next question comes from Alok Katre from Societe Generale.
This is Alok Katre from SocGen. Just probably 2 questions from my side, please. Firstly, if you could elaborate a bit on your comments about the execution issues in Northern Europe and India as well, since these are expected to persist in fourth quarter. And then how should we think about that versus the, let's say, the margin guidance, which still implies 8% margins in the fourth quarter, because you talked about a lot of headwinds on pricing and tariffs and so on. So that's question number one.
Second, if you could also detail a bit more on India and why we are probably to do, if we are suddenly seeing the return of the issues, such as grid connections, is there a freeze on execution by developers? And what is the state of your pipeline, especially, I think you have a 660 megawatt hybrid project in Andhra Pradesh, which is, Andhra Pradesh state, which is where most of the issues seem to originate?
Markus speaking. To discuss the execution issues we had in Northern Europe, that is fully understood. That is contained. It's a contained topic. In fact, in quarter 3, you have seen that where we transferred in the profit bridge that was discussed by David. If you go to the root cause, what it has been, it has been issues in logistics, the accessibility of bridges for transportation and the accessibility of harbors that needed to be reviewed and different routes need to be selected because of those bridges, but this is fully understand. It is not a continuing topic. It is a current topic. It is contained in quarter 3.
So quarter 4 will not be impacted by those execution topics in Northern Europe. On India, we have short-term topics in terms of market volatility. As also mentioned by David, we could secure a significant order, 543 megawatts in the last week of the quarter. We didn't recognize that order entry, but certainly for us as indication, the market is moving. We are taking our very fair share out of that market. We are very well positioned. However, given the short-term uncertainties, it's election year. There are some topics on land scarcity. It is not so much a good connection. We have mentioned, I think, that is -- it has been discussed earlier, that is not what I see as it's limit on land scarcity. These things have slowed down somewhat, the award process of some orders. And as you know, and as also mentioned by David, the Indian market is a very fast-turning market from a book-to-bill perspective. That might slow down somewhat the revenue giving those orders as those turn somewhat above 6 months already.
Cristina de Buruaga
Thank you Markus thank you a lot. Can we take the next question.
Thank you. [Operator Instructions].The next question comes from [Alex Garcia] from shareholder. Please go ahead.
Good morning. Have you seen how EBIT margins with pre-PPA and I&R costs have not fallen this third quarter? I would know if why is the company could give more details of why they expect that the early margins will improve in the last quarter to fulfill the 2019 guidance?
Alex, so first of all, as Markus has just explained, we see extraordinary negative impact coming from execution issues that we have contained. So that's -- if you see the EBIT bridge and if you -- in the Page 14 and you exclude the other aspects that there is certainly that, we should be above the -- even the last quarter. So it's affecting us negatively in a quarter, and that is not going to be repeated in the Q4. And also, what makes us confident is that the strong activity that we expect and that we are seeing right now in the Q4. So we expect, as we were saying, sales of around €3 billion, slightly above €3 billion, that will help us to be absolutely within the range of the EBIT pre-PPA and I&R cost.
Cristina de Buruaga
Thank you, Alex, thank you David. Can we take the next question
The next question comes from Akash Gupta from JPMorgan. Please go ahead.
Hi, thanks for taking my follow up. It's on Offshore business where you have announced conditional order in the U.S. for deliveries in 2022 to '24. I'm wondering if you can talk about how do you hedge your exposure to raw material in such long lead times project and also, perhaps you can elaborate whether you need to invest in a local manufacturing for executing this project. Thank you.
Akash, course, this is part of our commercial strategy that we cannot disclose in a so open manner. Of course, as we said, first of all, in terms of currency, in terms of translation effect in our -- sorry, transaction effect in our P&L, we are more or less fully covered in the euro-dollar. So in that sense, from the just exchange ratio currency, we should not expect any major impact. Regarding raw material, of course, this is something that we cannot hedge with 4, 5 years in advance. Of course, there is something that we will consider. But of course, nothing to be done yet.
Finally, regarding the potential impact from import duties, we are talking about 4, 5 years from now, so let's see what is the new government in the U.S., what is the new policy in terms of import duties. But of course, the majority of the production is going to come from Europe. So in that sense, we do not see any major impact from the trade war perspective in our Offshore pipeline.
The next question comes from Casper Blom from ABG Sundal Collier.
Casper Blom from ABG Sundal Collier here. Just a follow-up [indiscernible] the lower end of your EBIT margin guidance. You mentioned these different factors, the execution challenges, import duties and market volatility. If you were to sort of weigh those different factors a bit, could you try and put some weight on it, what really matters the most here?
Casper, I assume that the question is, if we can quantify what is affecting us in the short term. As I was previously explained in several results, I think that from the U.S. trade war, we should expect in the year a kind of around €15 million of EBIT, so low double-digit EBIT impact. This is coming from around 2%, moving from 2% to 4% of our sales in the U.S. pipeline. As you can see also, the U.S. is becoming more important this year and next year, so this is sadly what is affecting us in a more negative way. Regarding Brexit, also is something that we are analyzing, even on a weekly basis. Indeed, in the Executive Committee yesterday, we reviewed the potential impact from Brexit. But as you know, there is still uncertainty on that aspect. But we could quantify also at the range of a low double-digit EBIT. So all these aspects are, of course, affecting our EBIT profitability this year and next year.
The next question comes from Alok Katre from Societe General.
Perhaps if you could help me a bit with the Offshore sort of mix issues and the margin comments over there. The Offshore mix issue, is it really just about the 2 Danish projects, I think, which were flagged sort of earlier? And is that got to do with the short, relatively shorter lead time on those? Or is there a bit more structural that we should be thinking about, also given your comments about moving from above average, above group average margins to a bit more normal margins, which I would read as being in line with the group targets?
About the impacts on the mix effects on Offshore, I have mentioned volume-wise, it is on dimension projects that have been shifted out of still open permitting questions that have appeared in those projects, where those projects needed to be shifted. So these projects are certainly still in our backlog. We're preparing for them, so it is secured order entry. However, the timing shifts somewhat, it is those projects. Overall, the growth story in Offshore, as I also said, remains intact. The growth potential is above 20% CAGR going forward. So these project shifts we have seen before in the offshore market. It is simply very large projects. And if those projects shift, it's a quite visible impact.
From overall, the competitive situation in offshore. Offshore, certainly, we're seeing that in the recent auctions, is seeing the trend down to lower L2Es. The beneficial position of Offshore, and I've explained it before, is that given the very low turnaround times compared to Onshore, there is significant time to compensate those effects from product cost-out and product improvement measures. So having said that, going forward, I see offshore to continue to operate above group average margins.
Cristina de Buruaga
Thank you Markus, thank you Alok. We are going to take the last question.
Thank you. The next question comes from Sean McLoughlin from HSBC. Please go ahead.
Thank you. Just a follow-up on your Onshore strategy, about how you can be selective. Are there specific regions or countries where projects are more profitable? Is this done on a case-by-case basis? I noticed the U.S. has figured heavily in your Q3 Onshore order intake. Just a little bit more clarity about your thinking there and potentially, what could be the risk of lower capacity utilization of your Onshore factories actually negatively impacting margins with this strategy?
Thank you Sean for the follow question. Sean, so regarding Onshore, I think that in that -- the pricing negative effect from the backlog signed around 18 to 24 months ago is still impacting us in a negative way. As you can see in the slide of the EBIT bridge, the 70% of that negative pricing bar is affecting Onshore, and we have been very vocal saying that, that negative effect isn't going to happen in Q4. Regarding our strategy, regarding volume or prices, I have been very vocal also saying that we are not going to take any contract at any price. Indeed, what we will do is probably be more selective on the auctions that we want to attend. I don't want to be specific on the regions as we see, and we have also discussed several times, this is a global industry, and in general terms, we see similar margins in the most of the regions. Of course, it could be dropped because of the potential issues on execution, so that's why we have been also very vocal that execution focus is going to be one of our main priorities in the next quarters. So in that sense, making or ramping up our strategy, price discipline and a global reach.
Cristina de Buruaga
Thank you, everybody. Markus, do you want to conclude?
Thanks for all those that participated in the call and looking forward to your questions during the roadshow. Thanks a lot.