Yet another profit warning from Vestas -- Numerous component failures increase warranty obligations

For the fourth year running Vestas last month reduced profit expectations for the current financial year -- the company's eighth profit warning since January 2002. Despite saying it will achieve its projected turnover of around EUR 3.4 billion in 2005, Vestas' replaces its forecast 4% profit margin with a forecast deficit. The exact size of Vestas' loss for 2005 will depend on the year's final quarter. "Production and delivery schedules for the remaining part of 2005 include considerable operational risks which might have further adverse effect on the overall profitability," says Vestas. Furthermore, CEO Ditlev Engel warns there is "still a risk" associated with meeting warranty obligations on operating turbines. For the moment the company has reduced its projected profit margin to minus 3%.

The good news is that Vestas believes next year will be better. Turnover is projected to increase to EUR 3.8 million, resulting in a profit margin of 4-7%, depending on "operational risks from component shortages and other potential capacity restraints."

The reasons for the poor expected result for 2005 are severe component shortages leading to delays in shipments and project completion, "substantial" additional warranty provisions due to "continued poor quality of components," cost overruns on North American orders and poor profitability on contracts agreed by Vestas' former management, which nonetheless must be treated as high priority. "The terms and conditions of the underlying contracts, all signed before May 2005 -- the launch date of Vestas' strategic plan The Will to Win -- leave no other choice," states the company. As a result, completion of more profitable orders has been pushed into 2006.

Engel took up the reins as Vestas' new boss May 1. Since then, the terms of all large orders are controlled by an internal "contract review board," with the result that contracts with a combined value of close to EUR 1 billion have been turned down this year, says Vestas.

Losses on contracts

Loss-making orders have been concentrated on the North American market, with losses exacerbated by delayed deliveries, "giving rise to shipping, installation and commissioning costs in excess of project budgets." Vestas reports that if the profit margin for North American orders, which account for 25% of its 2005 turnover, was the same as for orders elsewhere, the year's projected deficit would have been a profit of EUR 135 million.

The future is bright, says Vestas, which reports that customers have been lining up for turbines for the next two to three years. The improved visibility, says Engel, means Vestas can get control of its supply chain problems, raise product prices and demand better contract terms. Vestas does not specify its price increases, but other sources quote them as 20% on the American market.

BETTER margins

Coupled with an extension of the US government's production tax credit for wind power, improved internal efficiency, better capacity utilisation and, "most importantly," improved profit margins on projects in 2006, higher prices will lead to a higher turnover and higher earnings, says Vestas.

Wind turbine manufacturers have been criticised for launching new turbines before they are fully developed -- and Vestas has felt the economic consequences of doing so, not least in the need to bring all 80 turbines at its Horns Rev offshore wind plant ashore for repairs. The company says it is postponing series production of its largest turbine, rated at 4.5 MW, to 2009. "Resources are now allocated to other development projects with a significantly higher earnings potential," it says.

In its third quarterly report, released November 24, Vestas stresses the need to improve product reliability, which it describes as "the most important technological challenge" it faces. It admits to "numerous component failures in Vestas' products" and says the main focus of its research and development is to reduce the failure rate. Improved control and efficiency of work procedures and production continue to be a major task, says the company.

Vestas recently launched a major exercise in identifying and quantifying problems with Vestas turbines in the field, including the cost of meeting warranty obligations. The arrival of the results on Engel's desk the day before release of the third quarter report, was a "coincidence," he says. Engel declines to specify the identified cost, but concedes the sum is a "major contribution" to the lowered expectations for 2005. Also in 2006 Vestas has to set aside "an unsatisfactory amount for warranties." Engel is unable to say how long it will take Vestas to implement solutions. "This is not just something we can fix overnight." But he believes the company has got to the bottom of the issue. "I sincerely hope this is a one time event," he says of the revelation of warranty costs.

Share price drops

Four days after publication of its third quarter report, Vestas' share price had dropped 30% on the Copenhagen exchange, though was 30% higher than its level before Engel took over.

Industry analysts had a field day, with speculation running rife about Vestas' increasing exposure to takeover from an international conglomerate. Among names analysts pulled out of the hat as potential buyers, were Mitsubishi, GE Energy, Shell, Alstom, Hitachi, Hyundai and Fuji Heavy Industries.

Engel says the focus is on building a better balanced and more profitable Vestas, even at the expense of market share.