We hosted a Q&A-based mid-quarter call with our President & CEO Håkan Agnevall on Monday 22 August 2022. The recording of the call is available here. Håkan started the call with a quick summary of the business and market environment.
Firstly, Håkan pointed out that, as was seen in Q2, the service business both in marine and energy continues to grow. We talk about moving up the service value ladder, which starts from spare parts and field service hours, moving on to service agreements and retrofit projects, and finally to performance-based agreements. We are growing in all these categories in both marine and energy, which is a concrete proof point that our strategy is coming into action and delivering results. Running hours in Energy are going up, despite the share of balancing power increasing, which is of course very beneficial for the service business. We see high utilisation rates also on the marine side across segments – for instance, above 90% in the cruise segment. Furthermore, we have launched decarbonisation services in the energy market. The concept is still at an early stage, but we are having some very interesting discussions with customers.
Secondly, Håkan touched upon the equipment business and noted that we see a lot of activities in the energy market. Demand for energy storage is clearly back after a subdued first quarter. On the thermal side, there is also a lot of activity. We see increasing interest in balancing power, and the recent Inflation Reduction Act in the US should have a positive impact on our energy business there in the mid- to long-term. On the marine side, demand for equipment is going in the right direction. We see a lot of activities in the LNG segment, clearly driven by the current energy and gas price situation. Ship contracting overall is a bit down this year, but it is expected to come back next year.
Thirdly, Håkan talked about cost inflation, which is still high. While our order backlog comprises some contracts for which rising costs can compensated, in the far majority of contracts the prices are locked. Price realization is strong on the service side.
Finally, Håkan reminded the audience about the recent footprint adjustments. We are planning to take measures to ramp down our manufacturing in Trieste, Italy, which was not an easy decision to take. By doing this, we will have a footprint in Europe that is competitive and also scalable for future growth. We have now also left Russia and built capabilities elsewhere. This change has of course delayed the turnaround of Voyage.
Some highlights from the Q&A session:
When do you see the mix that is now weighed towards equipment eventually turning back again?
This year is still a year of equipment, because we had a very high order intake particularly in Energy last year, and we are delivering that backlog this year. Even though we are growing in services, we have been growing even more in equipment. It takes about 12 to 18 months to deliver these orders. However, I would also like to highlight that the energy storage business had a fairly slow start to the year, but it’s picking up. So, it's a bit too early to say when we will see a more normal balance, as it will depend a lot on the storage order intake going forward.
How should we think about FX rate volatility in terms of competitive dynamics? Do you see what's happening to the euro largely as a benefit or as a bottleneck?
We see a strong dollar, and that in general has a positive effect on us, because when we sell in dollars, we have our cost base to large extent in euros. Typically, around 25% of our net sales is USD denominated.
Wouldn't it make sense for you to monetise the value of your storage business, considering that Fluence is today roughly 1/4 of your market cap, and that thermal power is more profitable?
You’re right that the thermal side is more profitable both from an equipment but also from a lifecycle perspective. However, energy storage is an integral part of our Energy business, as these two technical solutions, thermal power and storage, are complementary. The profitability of storage is lower, but we are working on that by scaling up and improving the profitability step by step. One element in energy storage where our customers tell us that we have an edge is power system optimisation, as we are fundamentally a power system company. We bring different generating assets and storage together and integrate those with the GEMS platform to ensure the lowest energy cost and best uptime reliability. With decarbonisation services and performance-based contracts, we aim to unlock additional value for both our customers and ourselves, combining storage and digital solutions.
Are you able to say if your storage orders will be higher this year compared to last year?
We see positive development in energy storage order intake, but you have seen how fast things can change. It seems like the market has adapted to a new price level and is moving ahead, but there are a lot of uncertainties regarding raw material prices. It's very hard to predict how lithium-ion prices develop. But right now, we clearly see that there is positive traction in the market.
We've been seeing stories about Chinese lithium production struggling and industrial power cuts. How do you see this impacting the energy storage business?
We have very strong supplier relationships, so in terms of having adequate capacity, I think we have a good situation.
Has the gas situation in Germany had any impact on Wärtsilä?
In the short term, we clearly see that not only in Europe, but also in other markets power generation based on coal is increasing. We also see some of our multi-fuel engines running on HFO. So, the world is going back to the cheapest and readily available energy sources. In Europe, there is a strong focus on gas availability, and in many countries there are LNG projects coming along. The situation will also accelerate the renewable journey, because it becomes a question not only of sustainability and the Paris Agreement, but also a question of national security. But these things take years. I think in Europe the key challenge now is not capital but permits. This is a political process that will take time.
How should we think about your dependency on the European supply chain and your own production, if we're going to see this extreme energy price movements? Is this something that you have been sufficiently pricing in, or is there a fear that there will be another wave of inflation hitting your supply chain over the winter?
If you look at our supply chain, we have a significant share of it in Europe, so inflation there will have an impact. In some areas, we have introduced price indices, so I think there is a higher level of preparedness and focus on this going forward.
Is there a reason to be fearful of availability of some components, if the energy price is so high that it leads to shutdowns among European suppliers?
We haven't seen anything like that so far. What we have seen since the beginning of the war and China lockdown is the impact on commodities like electronics. We continue to monitor the situation very closely.
Is there a cyclical element in your recent service growth – have you seen your clients hoarding parts and increasing inventories because of these supply chain issue?
We don't see hoarding of spare parts as a significant driver of the recent service growth. The major drivers are agreements and the utilisation of equipment. You are right in a sense that there are some cyclical elements in the service business that relate to maintenance cycles both on the energy and on the marine side, and they are rather favourable right now. But that is not the major driver of growth, but rather a contributor. What has been holding us back in the retrofit business is the shortage of electronics. When we move into a situation with less electronics constraints, there is even further business potential in that area.
In this environment where German power prices have just gone through 700 EUR/MWh, do your customers run their engines more, or do they have to turn them off because they can't afford the fuel? Do you see service demand higher or lower in this environment?
It's a mixed picture. If I take a global perspective, I see many of our global customers going back to HFO, so they switch from gas to diesel, and they run their plants a lot. Germany is not our biggest market for thermal power, but the plants that we have in operation there are running. The fuel as such doesn't impact service intensity, but we can clearly say that utilisation is high overall at a global level. It's a little bit hard for us to delineate to what extent this is related to high gas prices.
Looking at your orders historically, there seems to be a correlation between currency turmoil and demand in the emerging markets – are you seeing major orders, such as the one from Mexico last year, in the pipeline there today?
I don't see a strong correlation between the FX situation and our order intake. I think there are a lot of opportunities and a solid pipeline in the emerging markets for thermal power – there are a lot of things happening for example in Brazil, Mexico and Indonesia. But please also note that the order intake in Q4 2021 was all-time high in the history of Wärtsilä.
The price of gas is likely to be structurally higher in the future, if European countries import it with LNG carriers instead of getting it from Russia. What does this mean for your competitiveness compared to gas turbines in the European landscape in the longer term?
In the longer term, as the share of renewables grows, there will be more balancing power needed in order to have a stable power system. Right now, the most interesting market for balancing power is the US, because there are a lot of things happening there both on the storage side and on the thermal side. The system in Europe is more integrated, so it might take longer before balancing power is needed, but the day will come. Then it's about which technologies will be used to provide the balancing power – we have battery storage and thermal power solutions. Our engines ramp up and down fast and can do it frequently, which is an intrinsic benefit of our technology. Customers in the US have compared different technologies and see this as well.
What needs to happen for your margin to become double-digit again?
Some major items holding us back are cost inflation and factory capacity under-absorption. We have decided to ramp down manufacturing in Italy, but it will take some time. In the short term, the unfavourable split between equipment and services also has an impact. The major drivers behind the targeted 12% profitability over time will be growth in services and thermal balancing, the turnarounds of the battery business and Voyage as well as the recovery of the marine newbuild market. Additionally, we are addressing the impact of cost inflation with price realisation.