It's no secret that renewable energy, in this case, wind power, is a long-term growth industry. Indeed, leading energy industry bodies such as the U.S. Energy Information Administration (EIA) believe that, on average and without tax credits, onshore wind power will make more financial sense than combined cycle (gas and steam) power within the next 20 years. However, the industry's growth will be lumpy at best, and investors will need to be stock selective because end-market conditions will vary over the next decade. Here's why.
Three arguments about renewable energy
I want to flesh out the following points:
- Wind power has long-term growth prospects, but global onshore wind power installations will be flat in the medium term, while global offshore installations will likely only take off in 2025 and afterward.
- Reports of the death of gas power have been greatly exaggerated, and combined cycle plants still have a future.
- Given this combination, it makes sense to invest in companies like General Electric (GE -1.75%) and Siemens Energy (SMEG.F 0.03%).
Image source: Getty Images.
Medium-term wind power installations
All the leading wind power companies, including GE, Siemens Gamesa (GCTAY), and Vestas (VWDRY -0.84%), cite research from consultancy Wood Mackenzie when making forecasts, so it's no surprise that they are all saying a similar thing about medium-term demand. The critical number to follow in the power industry is installations measured in gigawatts (GW).
I've added trend lines in the chart below so readers can get an idea of the medium-term situation. Overall new installations will grow between 2020 and 2025, but this is because of offshore wind power growth. On top of new installations, wind power companies have an opportunity to grow revenue through repowering aging turbines. That's part of the reason why GE is taking action to recycle repurposed wind blades -- it will encourage more repowering activity.
Data source: Wood Mackenzie. Chart by author.
In this environment, I think Siemens Energy (a company that comprises a 67% share of Siemens Gamesa and the former gas and power business of Siemens) and the renewable energy business of GE are more exciting businesses than Vestas and others.
Focusing on Vestas is illustrative. Wall Street analysts have the company's revenue peaking at 16.7 billion euros in 2021, only to decline for the next couple of years. Furthermore, Vestas' management expects its offshore power business to peak in 2021-2022 at around 2 billion euros to 2.5 billion euros, before declining to 1 billion euros to 2 billion euros in 2023-2024 and then finally rising to 3 billion euros in 2025. In a nutshell, if you buy Vestas, you should be ready to wait until 2025 for a significant pickup in revenue.
Siemens Energy and GE
The name of the game for Vestas is margin expansion, but in this regard, it might make sense to buy Siemens Energy or GE instead. The difference is that Vestas already has a decent profit margin, but GE Renewable Energy and Siemens Gamesa (remember that Siemens Energy owns 67% of Siemens Gamesa) have more potential to grow their margin and, therefore, profitability.
Wall Street analysts expect Siemens Gamesa to grow revenue at a mid-to-high-single-digit rate in a couple of years after 2021, and profit margin is forecast to get back to high single digits by 2022. Meanwhile, GE's management expects GE Renewable Energy to grow revenue at a mid-single-digit rate and turn margin positive in 2022 while aiming to reach the high-single-digit rate in the future.
|
Company |
2019 Profit Margin |
2020 Profit Margin |
2021 Estimated Profit Margin |
2022 Estimated Profit Margin |
|---|---|---|---|---|
|
Siemens Gamesa |
7.1% |
(2.5%) |
4.4% |
6.7% |
|
Vestas |
8.3% |
5.1% |
7.2% |
8.3% |
|
GE Renewable Energy* |
(5.2%) |
(4.6%) |
"Better" |
"Positive" |
Data source: marketscreener.com, Siemens Gamesa, and Vestas are analyst consensus. *GE management guidance for segment margin.
One key difference with GE Renewable Energy is that it's growing its offshore business from a low base. Management expects to grow its offshore revenue from just $200 million in 2020 to $3 billion by 2024. Simply put, GE is growing in the right area of the market.
Image source: Getty Images.
Gas power isn't dead
The second reason to favor Siemens Energy and GE (GE also owns a substantive power business) comes from two ideas suggesting that gas power and gas turbines still will play a significant role in energy production.
First, if gas prices fall over the long term, it will become relatively cheaper to use gas turbines to generate electricity. Renewable energy is substantially more expensive in terms of upfront costs, but its fuel source is essentially free. Lower gas prices would reduce that advantage.
Second, renewable being cheaper only makes more sense now, on average, because of tax credits. Moreover, renewable energy won't be the best option worldwide. Even if the average cost of renewable energy is less than a combined cycle plant, it won't be the case everywhere. There are plenty of geographic, political, and environmental factors at play here.
What it means for investors
All told, renewable energy investors can expect a bright future but need to be ready for some varied conditions in the next few years. It makes sense to look at the companies that can grow their earnings significantly through margin expansion (GE Renewable Energy and Siemens Gamesa).
Also, don't be surprised if gas power makes a comeback after a half-decade slump in orders. Some exposure to gas turbine demand (GE and Siemens Energy) when onshore wind power is set for a flat period makes sense, too.
