We hosted a service-themed investor call with our CFO, Arjen Berends; President of Marine Power, Roger Holm; and Vice President of Energy Services, Markus Ljungkvist on June 6. No new unpublished information was disclosed during the call.
The recording of the call is available here and the presentation slides are here.
Arjen Berends, the CFO, started the call by presenting the overview of service operations in Wärtsilä. The service business is seen as well-performing and of high importance to Wärtsilä. A significant portion of the volume comes from services. In the last 12 months ending in Q1 2023, services have been 50% of the order intake, and 47% of the net sales.
Service business is a big and important contributor to growth and profitability, and a vital driver for customer satisfaction, with an increased share of wallets from existing customers, deeper penetration of the installed base, decarbonisation retrofits, and new business models.
The order intake and net sales have grown double digits in services both compared with 2021 and pre-Covid state of 2019. When comparing the order intake of the last 12 months to 2021, there has been a 23% growth. Compared to 2019, the pre-Covid state, order intake is 20% higher.
Moving up the service value ladder in the Marine
In Marine, the development of services is good. The order intake has grown by 24% when comparing the last 12 months ending in Q1 2023 to the year 2021, and by 20% compared to 2019, pre-Covid state. The development can also be seen in net sales and order books.
The key growth drivers for Marine services are good activity in key segments, growing installed base, moving up the service value ladder through increased agreement coverage, and growing retrofit business connected to decarbonisation.
Wärtsilä engines will generate service revenue for an average of 34 years. The installed base is increasing in 4-stroke engines, where we are close to 56 gigawatts of the installed base, with a 7% increase since 2019.
The lifecycle sales have a sweet spot between 5 and 15 years of age of the installations because that is where most service activities take place.
The services in Marine can be divided into three distinct revenue streams: transactional, agreements, and retrofit projects. Transactional means spare parts and field services, where growth is captured through long-tail customer development, increased share of wallet, and pricing strategies. The customers are served in different places around the globe, depending on where they are operating the vessels. On average, transactional services account for 60% of the service top line in Marine. The target is to convert existing transactional customers to service agreements and through that move up the service value ladder. Today, around 30% of the top-line growth is coming from agreements. The third revenue stream, retrofit projects, helps our customers on their decarbonisation journey and can include different types of upgrades to improve efficiency, hybridisations, or energy-saving devices, among others. The interest towards retrofit projects is increasing because of the future regulations related to decarbonisation. Today, around 10% of the top-line growth is related to retrofit projects.
Wärtsilä is growing the transactional sales and the share of wallets while the cost-to-serve is continuously also improving. The sales per kilowatt installed for transactional businesses today is 12% higher than in 2019, pre-Covid state. Because of the development in internal processes and automated processes, we have been able to decrease the ratio of non-billable vs. billable resources in field services, by 6%+ in 2022, compared to 2020.
There are also a lot of synergies on the service side between Marine and Energy, for example, where the spare parts are served from the same warehouse for both Marine and Energy customers. In addition, the same field service resources are used around the globe.
On the Marine agreements, the primary targets are high-value assets where uptime and efficiency are important. The agreements are developed by moving up the service value ladder, starting from transactional agreements, and moving towards the guaranteed asset performance agreements. Moving step by step on the value ladder has the potential to increase the euro per kilowatt sales two to three times.
When talking about data analytics, we combine data-driven AI and our internal know-how with online connectivity. This is how we provide a value that no one else in the industry can. For example, Wärtsilä has 11 Expertise Centres where the only focus is on serving the agreement customers. The agreement renewal rate is over 90%. Continuous measurement of fuel consumption and connectivity enables prediction and fast and proactive actions to support the customers. This combination puts Wärtsilä in a unique position in the markets.
The share of installations under the agreement is expanding faster than the installed base organic growth rate, and different types of vessels are coming in under the agreement more than before. Sales to agreement installations grew by 10% compared to pre-Covid levels. Guaranteed Asset Performance agreements ensure assets’ operational reliability and efficiency. The targets are mutually agreed upon based on customer-specific needs.
The Marine industry is moving extremely fast towards tighter regulation in environmental matters. Certain rules and regulations driven by IMO, as well as regional regulations, are increasing in recent years. Pressure from the owners is increasing for us to look at how they can improve their installations and create maximum flexibility. The key is on combining the financial feasibility with the decarbonisation targets. Around 48% of the fleet is not CII compliant in 2023, and 72% will not be compliant in 2027 if no action is taken. We are engaging with customers in defining the best-possible upgrade path for their fleets via our Decarbonisation Services.
Moving up the Service Value Ladder in Energy
When looking at any services, whether in Marine or Energy, it is related in many ways towards growing the installed base. The installed base in Energy has grown from around 53 gigawatts in 2019 to 60 gigawatts in 2022.
The customer segments in Energy services consist of industrials, independent power producers, utilities, and others. The running profile for the installed base can be divided into baseload and balancing power, where balancing power means below 3,000 operating hours per year and baseload above 3,000. Most of the customer segments are using around half balancing and half baseload power.
An important factor for growth in Energy services has come from increasing the agreement coverage. Converting non-agreement customers to agreement customers has resulted in an agreement coverage addition of over 2 GW during 2020-2022. High customer satisfaction has been proven by increasing agreement renewal rates of over 90% and increasing agreement coverage rates on newbuild projects. Agreement customers cover over 50% of the new build projects.
The value for our customers is created by moving up the service value ladder, which in Energy, as in Marine, starts from transactional services, such as spare parts and field services. Moving up the service value ladder has the potential to increase the euro per kilowatt sales even up to five times.
Seven operational support and maintenance centres provide a lot of value-adding activities to our customers. As an example, when Covid started, 50% of the customers’ issues were solved remotely. Now, 98% of the issues are solved remotely within the same day. This adds a special value for the customers and differentiates our services from our competitors. Over 20 years of experience in performance reviews guarantee the performance, efficiency, and availability of our customers.
Renewable energy adds complexity to energy production, and we help our customers to integrate and optimise their hybrid power plants. Our decarbonisation services are outcome-based long-term agreements where we optimise customers’ Energy systems for the lowest levelized cost of Energy while ensuring system reliability.
Looking at the number of orders with service agreements, do you have an idea about where that number can get to, as a percentage of the total services?
There are a few key drivers on the Marine side. One key driver is that the complexity of future fuels will drive more agreements because we will need more competencies on board for the operations. The second key driver is that the higher the asset value gets, downtime will be more expensive. The third key driver is efficiency, which will be going to the next level with green fuels because the whole cost-to-operate installations will go higher. This means that the payback on efficiency is much shorter, and that is fully supported by our agreements.
On the Energy side, it is more about different agreement types. Utilities want to operate themselves, and IPPs want full operation and maintenance from Wärtsilä. It is also good to remember that there is no “one size fits all” agreement, not in Marine nor in Energy.
If the average service agreement is two times the revenue of a normal transactional service, where can that get to? What does that mean for your addressable market on a 10-year view?
The numbers and journey are not clear to anybody. If we look at the historical trend, both in Energy and Marine, there is a growing trend, where we see more and more agreement coverage. A lot depends also on how the external market develops. The pressure on decarbonisation will make a big difference, when fuels get more expensive, and agreements increase related to fuel efficiency. If carbon taxes are kicked in, the speed and pressure will grow even further. The fact is that number of agreements has been strongly growing throughout the years as we can see from the numbers that were presented. We also anticipate that this growth is not stopping here on the agreement side.
How is your ability to add value through your digital tools and has that progressed over the last five years?
Expert Insight is the tool we use to connect data from the installations to algorithms to learn, to prevent, for example, breakdowns in advance, and it has evolved a lot.
It starts to be the key decision criteria from a customer side on why they want to have an agreement with us. Combining the know-how we have with the connectivity in the Expert Centres, and the segment understanding is not easy to copy, which allows us to be the only ones doing it. On a global scale, Expert Insight, AI and other digital tools we use are one of the key contributors and we will also continue to develop those. We also have in-house experts that are constantly developing the tool.
We use the same tool for Energy and Marine, either from the power plant installation or from the vessels. We use algorithms where we learn based on data to prevent, for example, breakdowns in advance and to be able to react before anything happens. And as could be seen from the presentations, we have been able to take down the unplanned maintenance significantly for installations with Expert Insight.
Is services still a major driver for you to get to a 12% operating margin?
Yes, it is still an important driver.
Do you mean that customers stay with Wärtsilä for 34 years on average? How has this been calculated?
This means, that on average, the lifetime of new build installations is around 34 years, depending on the vessel segment. It also depends a lot on the owner and how critical the operations are. Even in old vessels, owners are more likely to follow the maintenance manual and do proper maintenance if the operations are critical. Towards the end of the vessel’s lifetime, owners will try to milk out what they can from the installation and spend less on services. That is why 5-15 years is the sweet spot for services, but there are also older installations where we have good service business depending a bit on where the vessel operates.
You talked about 30,000 ships needing to take action to comply with the CII regulations. What will be the most common actions they will be taking?
Most will take down the speed. A more radical action is to change the cylinder bore size of a large 2-stroke engine to smaller bore size and upgrade it accordingly. However, we will need all tools in the toolbox over time. Currently, we are more into efficiency upgrades, such as hybridisation or how to improve efficiency in general. Over time, we will get to fuel conversions as well.
How does decarbonisation impact service revenues? Do dual-fuel engines generate more service in euros than conventional engines?
We have a lot of dual-fuel engines out there, so it depends on what we mean by dual fuels. It is better to talk about multi-fuel because dual fuel has meant that the engine can run on gases and liquid fuels. What we are selling today are dual-fuel engines that can run on diesel and methanol, for example. So, our customers will have fuel flexibility with our technology. There is no significant difference from a service point of view between a traditional diesel engine and a multi-fuel engine.
On which customer segments is service still below the last peak in volume terms?
The biggest hit we saw during Covid was in the cruise segment, and they are more or less back to normal operations now. In the large picture, we are back to normal operations. We have seen a good increase in container segment activity, which everyone is expecting to calm down now when the prices are coming down. We are seeing more activity on offshore support vessels.
What has happened to your 2-stroke service business? When you divested your 2-stroke engine business, the idea was to continue to service those?
We have continued to do that, and our 2-stroke service business has grown very well during the last few years. Both on the transactional side, meaning spare parts and field service, but also on upgrade projects such as radical derating. We have more upgrades on the pipeline where we look at fuel conversions in the future.
If you would acquire a 2-stroke business, what would the service synergies be with the 4-stroke business?
We will not quantify the synergies, but I think they are more in logistics, global coverage, competence, and capabilities.
Does increasing share of balancing power with respect to baseload, dilute your service growth potential in Energy?
If you look at the whole fleet we have today, even if we have grown in balancing, the mix between baseload and balancing is going to stay stable. The growth in balancing power is additional. We think that as long as we sell performance, it does not matter what the maintenance cost is.
What is the addressable client base you are targeting with Decarbonisation Services?
Small utilities, for example, in the Caribbean or Africa, as well as industrials, because many of the industrial customers have put a 30% CO2 reduction target by 2030. The only way for them to reach these targets is by adding renewables to their captive installations, and it is very difficult for them to manage. We have very good capabilities to help our customers with this.
What is the service potential in the energy storage business?
The service potential is limited and less than what it is in the power plant business.
