How to analyse: Wind energy

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Non-polluting, renewable energy has become a fad these days. With the Paris climate agreement, the global movement towards non-polluting energy has become much stronger. This has made the case for investing in wind and solar power companies. High expectations are pushing up solar/wind power company valuations through the roof. So, it is imperative that investors understand what these businesses are really worth, and what to look for in a company.

Let’s discuss about Wind Turbine Generators (WTG).

So, what do they do actually?

Wind Turbine Generators supply equipment to power producers, to set up wind farms. Some companies do hybrid projects, combining wind with solar power.

They supply all the parts of a wind turbine – rotor blades, gearboxes, generators, towers. Hence, Wind Turbine Generators are classified as ‘Capital Goods’ companies.

With that introduction, lets think about some of the key characteristics of the Wind Turbine Generator industry:

Characteristics of the sector

  • Source of revenues: New installations, and re-powering (fresh installations in old wind sites to replace ageing turbines) form the primary source of revenues. Additionally, companies earn money from maintenance of wind farms. (See ‘How do they make money’ below).
  • Working capital intensive: 1MW wind farm typically requires INR40m of working capital. This means that, companies need to bridge the funding gap using debt. So you will see high receivables on asset side, and high borrowings on the liability side. Remember, the asset side bears no interest while the liability side does. See the trend of  ‘number of days receivables’ or ‘net working capital days’ for the company in question. If the number of days are trending down, then it is a good sign – the company is making efforts to bridge the cash flow gap.
  • Land intensive: 1MW wind farm typically requires 10-15 acres of land. Further, these lands have to be viable wind sites, which makes it a challenge to procure land.
  • Government-driven: Government support is required in the form of subsidies, as well as provision of adequate power grids. Also, financial ability of State-Government owned electricity boards (SEBs) to procure wind power at higher-than-conventional rates complicates the situation.

How do they make money?

Basically, WTG companies make money by:

  • Supplying wind turbine generators (WTG)
  • Turnkey projects – the entire spectrum of activities from supply, installation and commission of a wind farm
  • Maintenance of WTG

But, there are a complete range of other related activities that bring in service revenues:

  • Wind site identification – to determine feasibility
  • Power evacuation – to transfer power generated at the wind farm to the power grid
  • Site infrastructure development
  • Support for all government approvals
  • Engineering, Procurement and Construction (EPC) of wind farms – especially important in catering to smaller customers who do not have the capability to execute such projects.
  • Operation and Maintenance of wind farms
  • Post commissioning Support – includes support for registration for renewable energy certificates (REC), generation based incentives (GBI) and clean development mechanism (CDM)

Who are their Customers?

  • IPPs (Independent Power Producers): who own the wind facility and sell power to utilities. They constitute the majority of demand. Hence, relationships with IPPs is key to gaining market share.
  • Large corporates
  • Financial investors who own wind farms (think Private Equity guys)

They get plenty of Government support

  • Feed-in-tarrifs / Preferred rates: higher per-unit electricity rates compared to conventional power
  • Subsidies: to developers who ultimately own the wind farms
  • GBI (Generation based incentives): per-unit incentive provided to power producers based on units produced, rather than on installed capacity.
  • AD (Accelerated depreciation): High  depreciation (for computing income-tax) for equipments, allowed in the initial year of installation. This is a capacity-based incentive, rather than generation-based as is the case with GBI.
  • CSR: Spending on renewable energy qualifies as CSR activity under Indian Companies Act
  • RPO (Renewable Purchase Obligation): Distribution companies are required to procure a percentage of all electricity from renewables. India aims for 15% sourcing by 2020.
  • REC (Renewable energy certificates):  Non-solar RECs are issued for generation of electricity based on non-solar renewable energy sources.
  • Wheeling and power banking: Wheeling facility (feed power into grid and access it from another location) and power banking (feed power into the grid and use it later) are provided by some governments as additional benefit.

Key metrics you should look for in a WTG company

Revenues
  • Revenues are volatile – especially for younger companies with lower installed base. Companies with higher installed base will be able to make a steady stream of income from maintenance.
  • Relationship with IPPs is key – Good quality wind site inventory and timely project execution is key to the relationship. Good relationship with IPPs as preferred partner is a success
  • Order book shows revenue visibility
    • Supply and/or erection of WTGs: Represented in terms of MW
    • Wind site inventory – Wind sites are the most scarce resource in the industry. Wind site is the most important criterion for choosing a supplier. This metric is represented in terms of potential capacity of wind energy (in MW) that can be generated from the sites at hand.
  • Realisation per megawatt
    • For new installations and supply of WTG: Wind turbine sales realisation per MW. This is currently ~INR 50 million (in 2015)
    • For maintenance of installed base: Maintenance realisation per MW. This is currently ~ INR 10 million ( in 2015)
Costs
  • Royalty for WTG technology: if technology is sourced from other WTG manufacturers
  • R&D expenses: if WTG is designed in-house
  • Warranty-related costs: due to maintenance costs withing warranty period. Also, companies make provisions based on expected rate of warranty claims.
  • Location of manufacturing facilities and proximity to major potential wind sites: is key to reducing costs of transporting WTG to customer sites.

Future growth opportunities

India has a dearth of wind sites. Onshore sites are very few. Hence, in the long-term, new installations will need to be in offshore (sea) sites. Look for the untapped wind energy potential in the country to have an idea of the long-term prospects for the industry. Re-powering will provide a consistent demand, as installed base increases.

See here for India’s wind energy potential: C-WET

Valuation

Nothing much special here. Usual stuff..

Fundamental: DCF

Relative: EV/EBITDA, P/E

Bottom line

Wind Turbine Generator industry is driven by the trend in moving towards non-polluting renewable energy generation. Falling per-unit power costs, and government support will drive the industry in the long-term. Revenue opportunities will come from new installations (onshore in medium-term, offshore in the long-term), and re-powering.


Major listed ‘Wind Energy (Capital Goods)’ stocks in India:

Inox Wind, Suzlon Energy


Note: This post is part of “How to analyse” series. I will continue to update the post, as I learn new stuff about the sector.

Feedback: Your feedback is important to me. It helps me correct my mistakes and lets me learn new things. Please leave your feedback in comments.

Image Source: Pixabay


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