Renewable energy stock TPI Composites (NASDAQ:TPIC) has made a lot of investors happy in 2020. The stock has more than doubled this year, and its move comes down to a lot more than just investor interest in wind energy and/or speculation over a U.S. policy shift with regard to renewable energy. Simply put, there's evidence to suggest a favorable structural shift in the industry for TPI. Here's what happened and why.
First, some background on TPI. The company is the largest independent manufacturer of composite wind blades for the wind energy market. While the blades are the most prominent part of a wind turbine, they only contribute 22% of total installed turbine costs. As such, wind turbine manufacturers can focus on generating margin on the non-blade components like turbines, while still outsourcing blade manufacturing to TPI.
Its customers have 52% of the global onshore wind market and 88% of the global market excluding China, so TPI is a key supplier to all the leading Western players in the industry, including General Electric (NYSE:GE) and Vestas Wind Systems (OTC:VWDRY) -- more to come on them in a moment.
The investment case for TPI Composites rests on the idea that the wind power industry will grow and that TPI will win market share within it. Focusing on the latter, investors in TPI will be hoping for the following:
- Wind power companies will continue to outsource blade manufacturing as opposed to manufacturing in-house.
- The movement toward larger blades will continue, as it favors the larger blades that TPI manufactures.
- TPI's regional footprint (manufacturing facilities in the U.S., Mexico, Turkey, India, and China) will position it to benefit from regional industry demand.
Putting it all together, it seems TPI is in a very favorable position to benefit from continued growth. However, high growth markets rarely operate in still waters, and wind energy is no different. In fact, something happened in 2017 that raised significant questions around TPI's future prospects.
General Electric buys LM Wind Power
The deal to buy TPI's largest competitor, LM Wind Power, threw the cat among the pigeons within the wind power industry. By purchasing LM Wind Power, GE added significant in-house manufacturing capability in its efforts to build scale in the industry.
However, the deal was seen as problematic for TPI for two main reasons:
- GE is a major customer of TPI (see chart above) and it might, and may, decide to reduce its business with TPI or terminate supply agreements in favor of using LM Wind Power -- a risk cited in TPI's filings at the SEC.
- The deal might have marked a shift in the trend in the industry toward insourcing production rather than outsourcing to companies like TPI.
These two concerns represent a significant threat to TPI's business. However, events have continued to move in favor of TPI, and there's real evidence to suggest that they will not prove as big as an issue as many initially feared.
Events moving in TPI's favor in 2020
Starting with GE, the good news is that, since the LM Wind Power acquisition, GE has been expanding its supply agreements with TPI. For example, in 2018, GE extended its supply agreement for another two years (to 2022) for one of TP's Mexico facilities. In 2019, GE agreed to shift toward a larger blade model in TPI's Iowa facility.
Moreover, on TPI's second-quarter earnings release in August, management announced that "we extended two supply agreements with GE: one in Iowa through 2021 with an option to extend through 2022 and one in Juarez, Mexico through 2022. We will also be adding another production line in Mexico to provide for GE's wind turbine technologies in North America."
Clearly, the LM Wind Power deal hasn't, as yet, diminished GE's relationship with TPI. Turning to the issue of insourcing versus outsourcing, there's evidence to suggest the trend toward outsourcing (good for TPI) is still in place.
Hexcel (NYSE:HXL) is a manufacturer of composites for the aerospace and wind power industries. In common with TPI, Hexcel's primary customer is Denmark's Vestas. However, Hexcel sells directly to Vestas by way of the latter's in-house manufacturing operations, whereas TPI benefits from Vestas' spending on outsourcing.
Unfortunately, during its third-quarter earnings call in October, Hexcel's CEO Nick Stanage announced that its "major wind energy customers shifted their U.S. blade operation to an outsourced model rather than using Hexcel's glass fiber composite material to manufacture the blades in-house for the Americas region." As such, Hexcel will be closing a facility in Colorado. Moreover, Vestas recently announced it would be cutting 185 jobs in its own blade production facility in Colorado.
Why TPI Composites soared in 2020
The rise in TPI's stock this year comes as a consequence of its own operational execution and because some of the risk around the stock appears to be dissipating. The GE deal to buy LM Wind Power in 2017 hasn't slowed down its relationship with TPI, and the industry trend continues to be toward outsourcing blade production. That's good news for TPI, and a large part of the reason why the stock has soared in 2020.