By Victor Reklaitis, MarketWatch
BP/Marc Morrision/Amer. Wind Energy Assoc.
The U.S. market, a trophy for Vestas Wind Systems, is at risk of turning into a turkey, depending on how Washington’s tax-reform push pans out.
Shares in the world’s biggest manufacturer of wind turbines have tumbled more than 20% in November, whacked in part by worries about a potential hit to a production tax credit that has helped drive construction of U.S. wind farms.
Weaker-than-expected quarterly results have sparked concerns about the Danish company’s pricing power and also weighed on Vestas’ stock /zigman2/quotes/205019303/delayed DK:VWS -1.03% .
While bulls say the selloff appears overdone, those taking a cautious stance have a compelling story to tell.
“If the U.S. were to go from hero to zero, that would mean a lot for Vestas’ global position in this industry,” warns Jacob Pedersen, head of equity analysis at Denmark’s Sydbank. His bank has cut its rating on the shares to Hold from Buy this month, citing uncertainty around the production tax credit, or PTC, and the pricing pressures.
Aarhus-based Vestas climbed to the top of the heap in the U.S. wind market last year, topping General Electric /zigman2/quotes/208495069/composite GE +0.57% in newly installed capacity. The U.S. provides about 38% of the company’s revenue, according to FactSet data. Germany delivers 14% of revenue, and several countries contribute from about 3% to 4% each, including the United Kingdom, China, and Brazil.
Vestas has become the leader in its industry, ahead of rival wind-turbine makers such as GE and Siemens Gamesa Renewable Energy /zigman2/quotes/205820667/delayed ES:SGRE +0.43% , thanks in part to making strong inroads in the U.S. market, Pedersen tells Barron’s. That’s why the PTC pickle is particularly troubling. Vestas’ executives and many analysts say the most likely outcome is no change to the subsidy regime, and the Senate tax-reform plan hasn’t taken aim at it. But concerns persist around a House of Representatives proposal to reportedly cut credits to suppliers to 1.5 cents per kilowatt hour, down from 2.4 cents.
“As long as it’s part of what’s being negotiated, I’m quite worried that project developers in the U.S. will sit on their hands,” Pedersen says. “They do not know what type of regime will exist when tax reform is done, if it’s ever done.”
As Vestas CEO Anders Runevad put it on the company’s earnings call this month: “The House tax legislation creates uncertainty.” Many investors didn’t see this headache coming, as the PTC is already being wound down. The subsidies have been slated to decrease over three years and disappear altogether after 2019.
U.S. lawmakers “created what I regard as an extremely efficient tool for phasing out the subsidy for the wind industry, with the aim, of course, that the industry should be able to stand on its own over a period of four to six years,” Pedersen says. “I’m very surprised that it’s on the table to change this very successful phaseout.”
Even if the PTC stays intact, Vestas isn’t necessarily set for smooth sailing in the event, he adds.
“We might see a big order intake from the U.S. in December, but I think a lot of investors might ask themselves, ‘OK, but what’s the profitability on these orders?’” the Sydbank analyst says. He expects high volatility in shares until the company gives more guidance on its profit margins, and that may come only in February.
Manufacturers of wind turbines have been dealing with a drop in subsidies globally and increasingly competitive auctions. “Pricing pressure has increased a lot over the past three months,” Pedersen says. “It’s actually a positive for the long-term well-being of this industry—that prices are coming down—because that is exactly what is important: to make wind energy fully competitive.”
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Analysts have flipped to a more-cautious view on Vestas, with their average price target dropping to 542 Danish kroner ($86) this month, down from DKK632 in October, according to FactSet data. (Pedersen says Sydbank doesn’t disclose price targets, but theirs is “not far” from the stock’s recent price.) The new consensus target still implies a rally—a gain of about 28% from the stock’s recent DKK422. Roughly two-thirds of the analyst teams covering Vestas have the equivalent of a Buy rating on it, about the same as last month.
“We see value here,” wrote a JPMorgan team led by Akash Gupta in a recent note, as they maintained their Overweight rating but cut their price target to DKK510 from DKK700. Vestas’ valuation isn’t off-putting, with the stock trading at 12.9 times forward-year estimated earnings, versus 13.5 for Siemens Gamesa and 19.5 for German rival Nordex /zigman2/quotes/203935859/delayed DE:NDX1 +0.06% .
Nonetheless, investors may want to wait for a better entry point, which could come when we get a clearer read on the U.S. tax overhaul and Vestas’ outlook.