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There's Still Value in the Renewable Energy Sector

By Lee Samaha - Mar 13, 2021 at 6:43AM

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A look at the industry dynamics in the wind power sector, and a few stocks investors might be tempted into.

The recent dramatic slump in wind blade manufacturer TPI Composites (TPIC 4.54%) serves as a stark reminder that growth markets, and the stocks within them, rarely move up in straight lines. That said, how should investors react? Does the crash in such a high-profile wind power stock suggest investors should exit the sector and TPI Composites -- and if so, what is the best way to invest now? Let's take a closer look at what's going on.

TPI Composites

The wind blade manufacturer has contracts with all the leading Western manufacturers. Vestas (VWDRY -0.37%) represents around 42% of its sales, with General Electric (GE 0.01%) contributing 30%, followed by Nordex at 14% and Siemens Gamesa (GCTAY -0.53%) at 10%.

Wind turbines.

Image source: Getty Images.

In addition to the potential for its customers to increase orders and production, TPI has a growth opportunity from the ongoing shift toward outsourcing blade production. Moreover, the increasing length of blades will also play to TPI's strengths as a manufacturer. It all comes together to make a compelling case for the stock, particularly as the Biden Administration is seen as being more favorable to renewable energy investment.

Also, the ongoing reductions in the cost of using wind power as a source of electricity generation are seen as driving long-term growth in wind power on a global scale. 

What went wrong

Unfortunately, the company has hit some growth hiccups in 2021, and TPI has joined Siemens Gamesa and Vestas in declining 19%-28% on a year-to-date basis. Although it's still important to note that they have all significantly outperformed the market since the start of 2020 as investors have warmed to the sector.

TPIC Chart

Data by YCharts

TPI's issues relate to a combination of what management described during the earnings call as "short-term overcapacity issue with a few of our customers" and "certain of our customers shifting production away from China to mitigate geopolitical risk and increasing costs associated with doing business in China."

As such, TPI has removed five production lines in China, and expects the other 10 lines in China to be operating at a lower utilization rate in the second half of 2021. Also, "several" other production lines in other regions are expected to operate at lower capacity in the fourth quarter. 

Not straight-line growth

TPI management's commentary on "short-term overcapacity" issues rings true given the recent announcement that Vestas is consolidating its operations in Colorado. The actions will come at the cost of 450 jobs, and are to "reflect lower near-term market demand," according to the company.

Moreover, Vestas' medium-term outlook highlights the uneven nature of growth in the industry. For example, Vestas expects the onshore wind market to grow "slightly from the current high level the next two-to-three years," after which a new phase of growth will begin. Meanwhile, the offshore market is expected to grow in activity until 2023 followed by a two-year decline, and then grow strongly thereafter.

Wind turbines.

Image source: Getty Images.

Another issue is that near-term profitability in the industry has taken a hit due to a combination of the pandemic and fierce price competition. For example, here's a comparison of earnings before interest and taxation (EBIT) margins for Vestas and Siemens Gamesa with that of GE Renewable Energy over the last few years.

All three companies are aiming for margin improvement, with Vestas targeting 6%-8% in 2021, and Siemens Gamesa aiming for 3%-5%. Meanwhile, GE is aiming to get to the kind of high-single-digit margins recently enjoyed by its peers while developing its offshore wind business at the same time. 

Earnings Before Interest and Taxation Margin

2018

2019

2020

Vestas

9.5%

8.3%

5.1%

Siemens Gamesa

7.6%

7.1%

(2.5%)

GE Renewable Energy*

1%

5.2%

(4.6%)

Data source: Company presentations. *Segment margin

What it all means to investors

TPI's issues in 2021 highlight the variability in the industry's growth, as does Vestas' guidance. Meanwhile, the 2020 performances of Siemens Gamesa, GE Renewable Energy, and Vestas are reminders that the industry still operates on slim underlying margins.

On the other hand, all three companies believe in the long-term growth prospects of the industry, and investors shouldn't lose sight of the potential here.

There are probably two good ways to invest in such an environment. The first is to take advantage of the fall in TPI's share price and buy into the long-term growth story. This argument is based on the assumption that the company will continue to win contracts and ride out some potential volatility as industry capacity catches up with near-term demand shifts.

The second is to buy GE stock in the hopes that its renewable energy business will catch up with its peers when it comes to margin. That could help the investment case for the stock significantly. 

In both cases, patience will be needed to ride out the inevitable volatility and lumpiness of orders in the industry.

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Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
GE
$74.53 (0.01%) $0.01
Vestas Wind Systems Stock Quote
Vestas Wind Systems
VWDRY
$8.04 (-0.37%) $0.03
Nordex SE Stock Quote
Nordex SE
NRDX.F
$10.99 (-8.80%) $-1.06
TPI Composites Stock Quote
TPI Composites
TPIC
$13.83 (4.54%) $0.60
Siemens Gamesa Renewable Energy, S.A. Stock Quote
Siemens Gamesa Renewable Energy, S.A.
GCTAY
$3.78 (-0.53%) $0.02

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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