Wärtsilä Oyj Abp (WRT1V) Earnings Call Transcript & Summary

[Audio Gap] After the summer. And if I start to make a quick summary, where we stand right now on the market situation and some of the themes. And then it's a rather short summary, and then we will turn over the ball to you, and we open up for the Q&A. I think that's the setting for today. So if we look at the market situation, I would say, first of all -- and you could see that in Q2 as well, the service business, both in Marine and Energy is continuing to grow in a very interesting way. And we see this growth continuing. I mean, if you look -- it's a little bit of the same. We talk -- as you know, we talk about the service value ladder, and it starts with the spare parts and service hours. It moves on to agreements, then we have retrofit projects and then performance based. And you can say that we are growing in all these steps and also in both Marine and Energy. And so you could say this is -- it is actually a concrete proof point that our strategy is coming into action and it's also creating results. And you can say, for instance, we see that we get more and more customers into agreements. We move them up. And especially on the Energy side, we have a customer base that is not -- have been not in agreements. We are bringing them in slowly, but surely, steadily. We see that the running hours in energy is actually going up in spite of the share of balancing is increasing. We see that the overall total running hours of the portfolio is going up. And of course, that is very beneficial for this type of business. And on the Marine side, we see a high level of utilization. I think the utilization rate, for instance, on the cruising side is now above 90%, 93%, I think latest stat, which is, of course, beneficial. But it's not only about cruise, we also see a broad set of activities across all segments on the Marine side. And we see positive development also for performance-based services. We have launched that you saw also in the past quarter the decarbonization services, this is final and this is still at an early stage, but we think this is very interesting where we engage in discussions with customers on the Energy side, on performance-based, a little bit the same as we are doing on the Marine side, but we are now bringing the concept to the to the Energy side. And we see some other very interesting discussions there. And we do see this as an overall trend, and it continues in a positive way. Then if we look on the new build side, and we look on energy, I think we see a lot of activities. I mean the -- if we start -- storage is clearly back after a quarter of, you could say, digesting the new price and cost level. But we continue to see a high level of activity. On the thermal side, there is also a lot of activity in terms of early discussions on new projects, et cetera. You saw that in Q4 our order intake, I think it was 34% of our order intake was -- in thermal was related to balancing. So balancing is coming along. And you saw the latest act, I think the final name was something Inflation Mitigation Act or something like that in the U.S. I mean, basically, a big package clubbed and signed by the President also. And we see that having a continued positive impact on the mid- to long-term future on our business -- Energy business in the U.S., clearly, with an even stronger focus on local footprint as well. On the new build, on the Marine side, I think it's going in the right direction. I mean, considering that we have stopped all export to Russia we have compensated for that, and we are moving forward. And we see -- although -- I mean, you know Clarksons -- if you look on the overall ship contracting is a little bit down this year, but it is expected to come back next year. When we see the segments that we are active in and the possibilities, we see -- I mean, coming from a low level, we shouldn't say that, but still, it's going in the right direction also on the new build side. We see a lot of activities on LNG, clearly, driven by the current market price situation for energy and gas overall. And that is clearly leading to a lot of activity on the Marine Systems side on our Gas Solutions business. We also continue to see the fuel spread for extra stuff are very, very big right now. But our customers are making a lot of money. So it's still rather slow considering that people are not bringing in vessels. COVID has also had an impact on that, of course, because retrofit yard capacity in China has been a bit down because of COVID. But in general, I think we see a positive market situation. So what are the challenges though, also? And I think it's the same theme as we talked about earlier this year. It's cost inflation. And as we talked about, we saw an acceleration of cost inflation, especially in connection with -- in February, March, with the war, but also the COVID shutdowns. I would see maybe the increase of inflation we have seen it capped out, but it's still a high inflationatory pressure. And we have a portfolio and order backlog where we have a mix of different contracts. In some contracts, we can compensate ourselves by negotiations, but in some contracts in the backlog, we are locked in, so to say. So the overall net effect of everything coming together is a cost inflation pressure. When it comes to pricing power, our pricing power, I think on the services side, this we have a strong price realization. And also, I would say, a new build, both in Marine and Energy, we also have a strong price realization. But the existing order backlog is a challenge. It's a mixed picture. I think those were a quick summary of where we stand right now after Q2 and coming back after the summer, so to say. I mean you also saw the twist, the measures we are taking to ramp down our manufacturing. And this is ongoing. Of course, this is a situation that -- it's a very -- it was not an easy decision to take. And of course, it's creating quite a lot of dynamics and emotions in Italy, fully understandable. And we are working our way through that according to the Italian legislation, and we are moving on, so to say. And at the end, we will have a footprint in Europe that is competitive, and that is also scalable for future growth. On the Russian side, you also saw that we have exited now Russia completely with the exception maybe for a handful of people that still have administrative tasks. We have moved out. I mean first of all, I mean we -- all businesses to customers in Russia has been stopped already. But we, as you know, we had quite a lot of software development in Voyage. We have now moved that out to Finland and to Serbia and we are operating there. And we have made this transition with the full support of our customers and a lot of credit to the team that has made this change. However, of course, this change, which has been quite unprecedented, it has delayed the turnaround of Voyage overall, absolutely. Okay. I think that's a short summary from my side. So let's open up for Q&A. And Hanna-Maria, if you can help us to moderate it.

Happy to do it. Thank you, Hakan for the introduction. First, Daniela, I think you had -- you were the first time raising your hands.

I will start with 2 things. The first 1 sort of regarding your comments in the beginning on service where you seem to be pretty optimistic about the level of activity. I understand, as you have said before that this year is still a mix that is more in towards equipment. But -- when do you see the mix eventually turning back again? I guess is it a 2023 event? Or do you still have a dilutive effect from backlog for a bit longer? That's my first question. Then I can ask the other 1 after maybe.

Yes. No. So you're right. I mean, this year is still a new build year, and it's because you could say -- as you know, we had an all-time high order intake on -- particularly on the Energy new build side in Q4 last year, Mexico, et cetera, et cetera. And we are delivering that backlog this year. And even though we are growing both in services because of this, we are growing even more on new build, and that makes this year being a lot of new build here. Of course, this all-time high order intake. It takes about 12 to 18 months to deliver. So from that perspective, you could say that next year, you should still -- you should start to see a turnaround of the mix. However, I would also like to highlight that we haven't had a thing to consider in the equation. And that is, of course, the development of our storage business. Because now, I mean, we had a fairly slow start to the year, but we do see it picking up. So this statement will this balance come back to a normal balance in 2023? It's a little bit too early. It will depend a lot on the order intake now in storage for the remainder of this year.

And the second question was a bit more in terms of understanding from a competitive perspective with FX, how should we think about it? Because I believe in the past, you used to price all the engines in euros. Obviously, with the current situation, I guess, that would be quite favorable to you. But from another side, a big chunk of your customers are in EM regions where we've seen like a lot of volatility on FX. So I mean, how should we think about this in terms of like modeling and competitive dynamics here? Do you see it -- what's happening to the euro largely has a benefit or has a bottleneck or...

No. So I would say we see a strong dollar. And that, in general, has a positive effect because of -- yes, we sell in dollars and we have a cost level in euro. So a strong dollar is in general, good for us. I think the 25% we communicated that of our overall turnover is U.S. dollar denominated. So the FX, strong dollar will have a positive impact for us.

Then you have Eliason.

Johan, we can't hear you.

Yes, sorry. Now, I think you can. So I was wondering about storage. You seem to be very positive on the developments here. And now we also have Fluence numbers for the second quarter. And it seems like you took back a lot of market share. Do you see this continuing going forward? And I mean the Fluence is sort of reporting a negative gross margins on the sales they are effectuating, is that the situation for you as well in storage? I think you have previously talked about gross margins being positive and EBIT being negative, but now with the cost inflation, is this also true for your revenue recognition in storage?

So if we start with the top line and the market prospects, I think we see strong market prospects. I mean we have been keeping the price discipline. And also now, I think the market has adopted in many countries, price indices, I mean, based on material price indices in a completely different way. And the market has digested the price level. And we -- so we see a positive development in terms of market opportunities. Then if we look on our P&L, gross margin is still positive, clearly, but EBIT is negative, also clearly. So it's the same message from us before.

Good. And I know you got this question at the Capital Markets Day, wouldn't it, to some extent, it makes sense for you to monetize the value of your storage business if you consider that Fluence today alone is a 1/4 of your market cap roughly. Is the view the same that this will be a core part of your business? And would you say that the Energy business could be as important as a 1/4 of your business a few years down. I think you've always alluded to that your balancing power is more profitable in the power plants, and that will be the case in the future as well. So will the power plant still be the main profit generator would you see in the midterm for you?

So I mean, if we start from the back of your question. So clearly, the thermal side is more profitable. both from an equipment but also from a life cycle perspective because we also talked about that the -- at least immediate service on battery storage is lower than the normal service business. So that's 1 comment. Then on the battery storage, it will continue to grow. And it is battery storage. It is an integrated part of that as of today. You could -- I mean these 2 technical solutions, the thermal and the storage, they are complementary. And we still say that and we do see that. So from that perspective, it's interesting. The profitability is lower, absolutely in storage and we are working on that by scaling and improving the profitability step by step. That is still the plan, so to say. And we do see the volumes are coming that I can say. Yes.

But as you say, they are complementary, and we see that the storage is growing very rapidly right now, but we don't see a massive recovery of the order intake for the thermal balancing power, although you mentioned it was 34% of your business. What needs to happen here?

Well, as of now, we find both of these parts of our business interesting and part of that sort of going forward. I think also, I mean, market valuation, and you know that better than me, but they go up and they go down. I think Fluence had quite a ride up and down, so to say. So now as we said, storage is an integral part. The other element, of course, on storage, where we think we have an edge and customers tells us that we have -- our core customer tells us that we have that is that we have the Power System Optimization view on this. I mean we are a power system company fundamentally. This is part of our DNA. And this is bringing different generating assets together thermal storage, wind, solar, and integrating it with the platform and for the lowest overall energy cost and best uptime reliability. I think this is also something we are exploring. And we -- it's also part of the decarbonization services. And this is where our plan also is to unlock value both for customers and ourselves in terms of performance-based contracts going forward, combining storage and thermal and digital solutions.

Next question comes from Tomi Railo.

Hakan and Hanna, can you hear me?

Yes.

Yes.

Yes, my traditional questions concerning the storage, which we were talking about. So do you think that loss of the storage business will be smaller or greater this year compared to last year. You were talking about the direction, but what direction will we see this year? And maybe also on the orders, since we know quarterly order levels and last year's levels, are you able to guide if your storage orders will be higher this year compared to last year?

I mean we don't give guidance for the full year. I mean we guided for Q3 that it will better same period last year. I think we see a positive development clearly for the order intake on storage. But you have seen how fast these changes. So -- but now we can -- it seems like the market has adapted and it's moving ahead in a good way, where it will be for the full year, it's very hard to say. There is a lot of uncertainties, quite frankly, because you could just imagine that the raw material prices. Now, okay, everybody has been introducing price indices and you know that lithium-ion or lithium-phosphate has been going up. It's very hard to predict even if you could say we are now kind of protected but how we lithium-ion prices develop and therefore, then the pricing cost level. So I'm a bit careful making forecast for the full year. But right now, we clearly see that there is a positive traction in the market for [ storage ].

And the profitability direction.

And the profitability direction. I think it's clearly so that if you look on the first half of this year, we had lower volumes, and we were still building up a cost structure, R&D, project management, and that will have an impact on the full year result. Then how much of that we will be able to recuperate from now until the end of the year, it's also a little bit uncertain. That's why sorry, Tomi. But I'm not going to be specific on this 1 either because it's 2 elements. We clearly had a negative deviation during the first half of the year because of the -- you could say, the limbo in the market, but we are catching up. What the net effect will be that we will have to see.

Next question comes from Nancy Ni.

I just wanted to go back to the lithium point. We've kind of been obviously seeing stories about Chinese lithium production struggling and also sort of industrial power cuts. So I was wondering sort of how you see this impacting storage? Do you expect sort of another round of price hikes and whether perhaps your battery suppliers are quite dependent on Chinese lithium demand. So I think I've seen sort of some of your products use CATL or Samsung batteries.

So I mean, to answer -- 2 parts of the answer. I mean, first of all, I think we have a very strong supplier relation. So in terms of having available capacity for the market demand, I think we have a good situation. But to your point, the material to make statements about material prices. It's very, very hard because of the volatility and the uncertainty. So there, I cannot -- I would be guessing if I gave you an answer on that.

Okay. Understood. And then I just wanted another kind of quick question on, I suppose, the kind of gas situation in Germany right now, have there sort of been any other new impact with developments on Wärtsilä?

No, I think short-term, we clearly see in Europe but also in other markets that people are taking a step back and if they are running on coal, and they are also running an HFO on some of our dual fuel and multi-fuel engines. So it's really the world is going back to the cheapest and the cheapest and also going back to the energy sources that are available, i.e., coal. There is -- in Europe, there is, of course, an intensive resourcing of gas going on. I mean looking at the U.S., looking at some other countries in the world. And you know it also, there is this scrambling for LNG terminal capacity and projects coming along. But of course, that will take a couple of years. demand side, people, of course, are trying to -- the politicians are talking about lowering the end of temperate now. So this is what is what is going on. There are no quick fixes in our view. In parallel, and this is our view, this will also accelerate the renewable journey. Because renewables -- it becomes a question not only of sustainability in Paris Agreement. It also becomes a question of national security, national sovereignty. And so we see even further to confirm the interest, but also this takes years. And when we look at renewables and resuming in Europe, I think the key challenge now is not capital. The key challenge is permits -- to have permits to build offshore wind farm because everybody wants green power, but not in my backyard. We have that type of discussion. And that is a political process that will take time. And -- but eventually, we need to be those wind parks to say. I think that's how we see it. But we don't see that everything now. Everybody is just scrambled to find gas and the whole renewables journey has stopped. Actually, I see increased focus, but I do also see increased political turbulence and permitting, which is at least in our view, this will -- this is the next political hot topic that we need to resolve.

Next question comes from Erkki Vesola...

And then I also -- sorry to complement that because, of course, there is a lot of discussions on nuclear as well. And to extend the lifetime, we all know it might not be so easy. Maybe you can slow down the ramp up. I think nuclear will be there. Clearly, it's a big solution. But the key challenge, I would say, if you take a bit of a strategic perspective, is nuclear is expensive compared to renewables. If you look on the cost per kilowatt hour. And I think that would give an indication long-term of where we are heading, so to say. Then, of course, there are also considerations about security of the fuel. But I think the fundamental here is that if you look at the price, the energy cost, it is significantly higher from here.

Next question comes from Erkki Vesola.

Can you hear me?

Yes.

Okay. Then on the Marine side, last year, we saw very strong order intake from Navy in the second half, especially in the equipment side. Do you see that the same could happen also this year considering the political situation.

I mean, clearly, it's -- I mean if you talk on the overall, there is, in general, increased activity in the Navy space. I mean, if you look on the German shipbuilding programs, if you look on U.S. Navy, et cetera, et cetera. So there is a strong logic. But then -- on 1 side. On the other side, these are you could say, a little bit project-based purchasing efforts from the navies and that takes time to materialize. So I would be careful just to translate this to a significant -- in short -- I mean, increased short-term growth. Long-term, there is a clear trend. There is increased spending, there is increased interest, and that will benefit the business. But short -- it takes -- the process is to slow so to see immediate impact right now.

So you wouldn't say that you are in the phase of active discussions in the segment now?

No. I mean we are in the segment with our Shaft Line Solution business and there is a demand. And as I said, we are well into the market. But it's not -- it takes time for -- to ramp up the volumes in the market because the whole purchasing process in that context takes time. It's a slow process.

Next question comes from Antti Kansanen.

First 1 would be kind of on cost inflation. And you mentioned that it's perhaps topping out but staying on a relatively high level. But how should we think about kind of your dependency on European kind of the supply chain and your own production. If we kind of see this extreme energy price movements kind of gradually rolling through via hedging and via contract prices I mean, among your suppliers. Is this something that you feel that you have been sufficiently pricing when you're selling new equipment? Or is there a fear that there's another kind of wave of inflation hitting kind of your supply chain over the next winter, let's say?

No. So if you look at our supply chain and where it's based, I mean, you could say we have a significant share of it in Europe clearly in euro-denominated countries, I would even say. And we have a relatively small exposure to China, which, of course, in these times of geopolitical uncertainty, there are both pros and cons. But the fact of the matter, we do have a fairly high exposure to euro-denominated countries in our supply chain. So in terms of euro inflation, that will have impact. Then, of course, this is a hidden effect. I think we have gone through as many others and our team has gone through what does high inflation mean. I think we have -- there's been so many years with lower inflation. But now we really know what it means. So -- and in some areas, we have also introduced material price indices. So I think there is a higher level of preparedness and focus on this, I would say going forward.

Is there a reason to be fearful of availability of some of the components, if kind of the energy price is so dramatic that it leads to shutdowns on European production among your suppliers? I mean -- I mean, I'm just thinking, what's the downside? I mean your purchases go up, but then you index it to your clients and pass it through, but could there be availability issues. So how do you see the risk assessment?

I mean this is -- I mean first of all, we haven't seen anything of this yet, I would say. I think the -- what we have seen in the beginning of the -- I mean, after the war and also China lockdown is on the classical commodities like on electronics like on some of the special matters. So far, we haven't seen these type of effects that you are talking about. So I think here, we will need to monitor this very closely, but we haven't seen any tendency so far on that phenomenon that you are talking about.

All right. Then the second question would be on services and kind of the growth that you were referring to the strategic kind of goals that you have and you have moved forward. But is there a cyclical element in your service growth in the past, like said, well, have you seen kind of your clients holding parts and kind of increasing inventories because there's been this kind of a supply chain issue. So is there some elements that we could see maybe contracting going into '23 in your service business?

So I mean, if you look on the service business, and as you know, this is more half of this business. So within that half, there is, of course, different buckets. I mean, holding our spare parts, we don't see this as a significant driver of the growth that we are experiencing. It's broad and it's not as far as we understand the holding our spare parts. There is probably a bit of it, but it's not as we see it a major driver. The major driver is that we increased the level of agreements, the utilization of equipment and performance based, so to say. Then other cyclical elements in our service business. Yes, there are some which relates to certain maintenance cycle, both on the Energy and the Marine side. And they are in a fairly favorable position right now, but that is not also the major driver for the growth. So yes, there is a little bit of cyclicality that is favorable now but it's not the major driver. It's a contributor. I would say -- and I would rather say also on the opposite, what it has been really holding us back and what I would like to have seen us grow even more is on the retrofit part of our business. Because retrofit, we have suffered, I think we talked about that on the shortage of electronics because when we do retrofit, we need new computers a lot. So there is actually -- when we move into a situation with less electronics constraint, I would say even further business potential in those areas.