Wärtsilä Oyj Abp (WRT1V) Earnings Call Transcript & Summary

Welcome to Wärtsilä Q3 '24 pre-silent call. I'm Hanna-Maria Heikkinen, and I'm in charge of Investor Relations. Today, our CFO, Arjen Berends, will start with key messages. And after that, there is a possibility to ask questions. So in the case, you have a question, please use raise your hand functionality in teams. And in the case you don't have possibility to use that functionality you can also send an e-mail to me. Please Arjen, time to start.

All right. Thank you, Hanna-Maria. A few comments upfront before we go to Q&A, I would say third quarter pretty much developed in line with our expectations. Good development in both end markets, I would say. Marine service environment continues to be stable. Equipment side, good momentum continues, basically supported also by the decarbonization journey and the pressure from regulation coming in, but also, let's say, fuel efficiency, as I've been talking about also earlier. We see good activities in key segments for us, let's say, cruise, ferries, offshore, et cetera. Also good to note, many of you might have seen it already, Clarkson published, let's say, updated estimates earlier, last week actually, now projecting, let's say, ordering of vessels in 2024 to be close to 2200 vessels. And now I'm talking vessels bigger than 2000 gross tonne. So really up, let's say, what I said -- I think it was about 15% to 17%, up from what they expected in March. So really good. Also for the years after, actually, the contracting levels are adjusted upwards. So there is clearly more expectations of ordering and going to the higher levels. Now that it is Clarkson forecast and then I'm talking Clarkson forecast including offshore, is that for all the years between now and 2028, at least I remember by heart, contracting of vessels is well over 2,000 per year. Also new build orders for container ships have been also revised up substantially actually, which is also good for us. Let's say we are very active in that market now and also with auxiliary engines. So all in all, I think it's positive sign, let's say, this is upgrade by Clarkson and supported well, let's say, our anticipated volume development as well. Lack of yard capacity, we have been talking about that quite much over the past months, I would say. It's also good to -- if you have access to Clarkson material, there was also some good material there as well about yard capacity. There is a graph somewhere in that material that -- in 2011, basically global yard capacity reached at maximum. So if you would say that is 100%, then the low point was actually in 2020, 2021 around, that's about 60% of that 100%. Since then, capacity has been growing. Now we are slightly over 70% at the end of, let's say, this year, estimated and the estimation by Clarkson is that by 2030, we will be around 80%, 85% of, let's say, 2011 peak level again, where it's quite remarkable that China is growing most or -- it's actually not remarkable, but that's typically their strategy. So actually, if the China line or the China yard capacity expands as it is in that statistics, China on its own will be higher than their peak level in 2011. So they are clearly the fastest grower. Renewal is required. We have been very old average fleet age. I think is about 17 years for the average fleet. Never in history, the fleet has been on average that old. So I do believe that also yards understand that something needs to happen, and there is an opportunity ahead. Along in energy, let's say, the outlook remains good for both EPP and ES&O. Lumpiness is always there -- has always been there. I would even say it's increasing because order sizes tend to get bigger. So that's something to keep in mind. On the service side, the utilization of our installed base is quite stable actually, which is a good thing, despite the fact that, let's say, more of the installed base is used for balancing power and let's say, our running hours stay rather stable actually. So that's a good thing. And combining that with moving up the service value ladder gives also still good opportunities for growth. Also in energy, I think it's good to remember and it's actually also applicable to marine, but let's say, I would say even more for energy that also lumpiness in service can be an issue. Let's say, typically, when we have life cycle agreements we book 24 months, let's say, as order intake, but we only book it, let's say, when the plant is operational. So if you sell a new build plant still to be built, let's say, we only book the order intake once, let's say, the plant is ready to run, so to say. Yes. Good progress, I would say, towards our financial targets. I think you've seen it over the past quarters. I do expect that, that will also continue going forward. I'm confident that we will reach all our financial targets. We do already for most of it, but let's say the profit part is still some way to go, but I'm confident on that one as well. Cash flow continues on a good level, quite happy with that as well. Again, I've said it now many times, negative working capital, I wouldn't consider the normal. Will it change this year? Most likely not. At least I don't foresee it, but somewhere in next year, I expect that we move slightly into, let's say, positive working capital numbers again. That's it in short from my side, open to any questions.

[Operator Instructions] Johan Eliason. You are the first one. Please go ahead.

I'll shoot. You didn't say anything about the strategic review you are doing with businesses left and right. I think it's now almost a year since you announced it.

Yes. No, let's say, we have said before that, let's say, when there is news to say, we will come with that holding one go to everybody at the same time. And so far, there is not any news to announce. We are still looking into it.

And then you're still expecting a lot of equipment deliveries in the second half of this year, I assume. So is the message on the margin sort of not necessarily peaking in the second half of this year, still the same or...

Yes. Let's say, we have stated that at the end of Q2, let's say, it's a relative margin. It's not the absolute margin, let's say, is the percentage that is, let's say, you could say, pushed down due to the fact that the mix between new build and services is going more to new build in the second half of the year. That's correct.

And anything on the quarters? Will it be very Q4 tilted or will you start already in Q3 with the deliveries?

I will not comment on that. Let's say, that needs to be seen.

Yes. And then the final question just on -- you mentioned the container vessels being interesting for you from their auxiliary point of view? I mean they have 2 stroke engines. Is there in any way, somehow that you have cooperation with the buyer of your 2-stroke business, so that makes it a little bit easier for you to sell the auxiliary and the service for both the main and the auxillary or that's just not quite connected?

I think it has a lot to do with the fact -- actually, it has a lot to do with decarbonization and let's say, the new fuels. If you take methanol enabled, for example, let's say that's more complex. So actually, the decarbonization is, you could say, decommoditizing let's say, what used to be a very commoditized business, which is auxiliary engines. Main engines is totally different, but auxillary was very commoditized. But with technology proceeding and getting more complex, let's say, our capabilities and, let's say, our opportunities are also getting better. And that you can also see, I think if you look at the road show material and you look at market shares, if you take the market shares without or, let's say, yes, exclude or let's say, purely focused on the new fuels, it's bigger than, let's say, what it is if you include everything, which clearly shows that, the technology getting more complex is helping us in sales.

Next question comes from Daniela Costa.

I have a question, it is more like on competitive landscape on energy storage rather than on Q3 or anything. But just maybe to understand a little bit better who you could see there -- they are your main competitors because I've been seeing sort of slightly conflicting data, for example, Bloomberg NEF lists you within the top energy storage manufacturers and integrators. But for example, Wood Mackenzie lists companies like Sungrow and Fluence, but not Wärtsilä. Has the competitive landscape changing? Or are we looking at different parts? And I wonder, particularly on the Chinese, if you are seeing them outside of China, given they seem to have a pretty good access to the underlying battery technology.

It's a very good question, and it's not so clear picture, to be honest, let's say. We used to be a top 3 player, basically Fluence, Tesla and Wärtsilä. I would say also due to our, you could say, selective approach that we have been taking some years back already, I think we are now top 6, 7 or something like that, depends a bit on, let's say, what kind of statistics you look at. Good to remember that our track record with execution has been super. We have no incidents, no nothing, and I think that cannot be said by anybody else. I think we are still considered by many customers as the Tier 1 -- as a Tier 1 supplier. Well, now a lot of new entrants come in typically battery suppliers that also believe they can do system integration. You could call them Tier 2, Tier 3 or even sometimes, I think. Future still needs to say or tell or prove that they can deliver according to plan. I think if that fails, I think customers will be very, very hesitant to continue with those. So yes, there is a lot of entrants. There is a lot of newcomers, but quality is questionable, I would think.

And I believe I have asked this before, but just wanted to double check, I'm not missing it. Did you ever disclose who will you supply batteries, the batteries from, who you buy them from? Not even all region.

No, we have multiple suppliers.

The next question comes from Panu Laitinmäki.

I have 2 actually. First, starting with the margins. I guess this is something we have asked earlier, but -- given that you were at like 10.7 for the first half and you have 12 and you just said you are confident. Can you once again walk us through kind of what will get you to 12 because you had mix tailwind, service was big, and then we know that the equipment will probably grow more going forward. And -- you have been saying that service is the biggest driver, but how does it kind of add up? Do you see that your margin within service will increase so much that you get to 12 or -- yes? This was the question.

It's a very good question. I believe that, our moving up the service value ladder has not come to an end. I think there's still a lot more opportunities that we can harvest on. There are other items as well, the 3 years, the closure, but that's already actually in the books, that was also part of the journey turning around the Voyage business. I can tell you now that if you combine -- because now the old Voyage business, part in portfolio business, part in marine. If you combine it together, actually, we are now profitable. And we have been loss making -- deeply loss-making, I would say, for a long time. So then also on the new build side, the recovery, the move that we have done with energy to move more from, EPC to EQ, deliveries clearly helps, the profitability. The risk profile of the civil and engineering on an EPC contract is so much higher, and that can clearly be seen. So I see still a lot of opportunities to further grow both on the new build side as well as on the service side, both in volume as well as in margin.

Okay. Just to clarify. So Voyage, like the legacy business as total is now profitable?

Correct. Correct. So what we used to have as a separate division, basically Voyage business is now distributed, as I said, portfolio business as a piece and then marine as a piece. But if you now would combine it together, it's profitable.

Okay. So it's a big change. The second question is on the energy. I mean, Hakan told us a few weeks ago that you see good sentiment in the energy business, but you are not able to announce all the orders. And now we have seen some order announcements. So basically, the question is that have you announced all you got? Or how does it kind of look like for?

I think this is always a bit of a difficult prediction. I would say, we never announced everything we got, because we simply don't get the approvals from the customer, but we actually try with basically any and all big order, but many customers don't want to have this out. So where we can, we do and okay, now it was coincidently perhaps a little bit more than what you used to, but it's not all we have received.

And you're happy about Q3?

At least I cannot complain. Can always have more, but I will not complain.

The next question comes from Erkki Vesola.

Regarding your Gas Solutions, the order intake has been actually very active. Do you have second thoughts on the business position within Wärtsilä as it is still to be divested?

No. We have no second thoughts of any of these businesses. They have been quite well reviewed from, you could say, all angles. They don't fit our strategy. They don't decarbonize and they don't support moving up the service value ladder. The gas installations being regasification or reliquefaction on its own don't decarbonize. They might be a piece in the chain, but that's not good enough for us. We want products that support decarbonization and then they fall out.

And the fact that they are to be divested, it doesn't kind of hinder you from getting new orders?

No, you would be stupid not to accept new orders. If you can get the business more profitable, you can get a better price and a good order book is also helpful. So yes, we continue business as usual until it's sold.

The next question comes from Tomi Railo.

Tomi from DNB. A couple of questions. Starting with the order-related ones. You announced this origin battery order to Australia. Can you comment just is it booked for already second quarter, first quarter? Or is it something for third quarter?

No, that was in the second quarter already, I think.

So it's all been already booked in...

The books already -- yes.

Okay. And then the Royal Caribbean order for life cycle agreement. Can it be or should we compare it to the carnival order you booked years and years ago, which was for 12 years agreement, EUR 900 million, 79 ships. Is there any kind of help for us? How should we expect you to book that? And is it similar kind of value per vessel and so on? Any help there?

No, I will not open that up. It's, of course, much less vessels, I think it's 37 vessels by heart instead of -- in the Carnival, in the start, I think we had 70 vessels in my memory. So it's almost double, in Carnival case. In Carnival, we also have sharing the fuel benefit. Royal agreement is not like that. It's more like a guaranteed asset performance agreement. So there are clearly differences. But otherwise, I will not open it up in more detail money-wise.

That's helpful. But you will book something at least?

Sure. These are operating vessels. So there is no pullback.

Okay. And then the third question, back to the profitability and your commentary on the second half and maybe on the fourth quarter specifically. I understand the mix, but I would also assume that your equipment profitability is improving year-on-year. As especially last year's third quarter, you still had those lower quality legacy deliveries. These in mind, you would still impact -- you would still assume that the equipment profitability improvement year-on-year is not enough to kind of offset the margin pressure from the mix point of view?

I'm not sure if I follow. Yes, you're right. Last year Q3, we still were burdened by, this cost [Technical Difficulty] projects, the final sale of it. So that is clearly a benefit now in Q3 this year. But yes, margin improved in that sense. But yes, it all depends on the mix. There is a lot more new build expectation in the second half than what we saw in the first half. So the mix will change it. So the 10.7% that we saw in the first half of the year will be a lower percentage in the second half of the year.

All right, although the mix of mix is improving, so equipment is improving?

Yes. But also, we have a lot of equipments and not all the equipment makes the same margin either. So there are also differences within projects.

The next question comes from Antti Kansanen.

Just a question on something that you mentioned, Arjen, you talked about kind of the lumpiness and the size of the deals increasing on the power plant side. Could you talk a little bit more what is causing this? And I mean your demand is transitioning to balancing side, which probably is not as big orders as on the base load. Just maybe a clarification on what's driving this trend.

I would say it's mainly related to the storage side. There we see really a size increase. Sorry, it was not clear perhaps there, but it's mainly on the storage side.

Okay. Well, that makes sense. And then secondly, on the Marine Services, I guess we've seen an acceleration, especially on the project side. And I guess this refers to the retrofit side. Is this something that you're going forward seeing growing the fastest? And is there something on the, let's say, more transactional side, which is maybe slowing down? I mean, there has been a little bit of an earlier seasonality this year on the vessel traffic. So anything on that?

Yes, I would say that it's always a bit difficult to predict exactly how it goes, but we clearly anticipate in the project side good growth, and that is driven by retrofits. We do quite many retrofits and the need for retrofits is also increasing quite significantly, being at hybrid installations, being it 2-stroke derating solutions, being it all kind of other energy-saving devices. So I would believe that, that is also typically one of the first steps that customers take in order to improve on the CII rating and improve their fuel efficiency. The ultimate is, of course, the new fuels, but a lot needs to happen also in the ecosystem to make that really accelerate. So I believe strongly in a good growth of the retrofit business. Also, okay, it's happening already, but I also believe that, that will continue.

Yes, because I wanted to understand better because on the services side, you obviously have this drive to get more agreement-based services. And then you're also seeing growth on this more project type of a business. So does that have -- and what kind of implication it has on margins? Because I'd assume that you value the visibility on the agreement side versus on the transactional, the margins can be extremely good. Then on the project type of work, we don't really kind of -- the profitabilities can vary quite a lot. This is more like a new equipment type of margins, more like a service type of margins. So -- you probably won't give any numbers, but any talk on -- yes.

No, you're fully right, Antti. There is a hierarchy in margins also within service or mix within service, yes, has an impact on the whole, overall service margin quarter-on-quarter basically. Although, if you look long term, it's a rather stable development. Of course, in the retrofits, which are not as profitable as spare parts that I can say, but more profitable than the new build typically. Yes, if they certainly ramp up significantly, yes, that has a mix impact within the service revenue streams. That's a fully correct assumption.

Okay. And then the last one for me is the working capital side. And if you could walk us through what will normalize going into '25 and '26 on the working capital elements, which is on a very extraordinary levels at this point of time.

Yes, that's a good question. And I can say predicting working capital is one of the most difficult things, same, of course, relates to cash flow as well. We have been doing a lot of good things in the past years, I would say, with working capital. The way we deal with receivables, of course, inventory optimization, if you now have one factory less, you can have everything in one place instead of having it in two places. Much more flexibility within the production, supply has been very close to our STH as well. There are lots of things happening over the past years that really supports us having a much better working capital level than what we used to have. Not to forget that, we are also -- have been spending quite a lot of effort with sales people basically to educate them on the importance of payment terms. And you don't win always on payment terms, but I can clearly see and notice that also our sales force is much more aware of cash flow and getting the best cash flow out of a project basically. So instead of just having a down payment and a milestone payment and delivery, we get more and more also midterm delivery payments or even more than one. So there are a lot of actions that have resulted in where we are. At some point of time, even if you have -- there's a very good down payments, which we clearly have, at some point of time, you need to buy the equipment to build the installation. So that's why I say, okay, we have been probably a little bit now too much benefiting from all these good advances, of course, on top of all the other good actions that we have done. And that's why I'm a little bit skeptical that this will not last forever as a negative working capital. It's not normal. If you look long-term history, over the past, I would say, 10 years or so, I think our working capital to sales ratio has been about 80-ish percent. If you look at the quarterly graph, I think on a 5-year horizon, it's about just below 4%, if I remember right. Now we are negative. I would say the new normal is probably not back to the 8%, the long-term average. I think the new normal is probably between 0 and call it, 5-year average, I would say that's probably where normal would be in my view. But in working capital, as I'm sure you understand, there are so many moving parts. We have so many businesses and so many moving parts. It's not that easy to exactly say when this will exactly happen.

But I mean you're not exactly guiding weakening demand. And as long as the demand is good, you will get orders and you will get advanced payments and your book-to-bill will be above 1. So...

Fully correct. And then also the fact that service is growing, which is transactional and that converts much faster from contract to order basically and delivery and cash in that also clearly supports. So there are many elements that work in our favor at the moment. But negative, I still claim is not normal. It will not probably go positive this year, but next year, I would expect it to happen.

Now, I did not see any, yes, we have -- so Panu Laitinmäki, please go ahead.

Yes. Maybe not related to Q3. But I mean we have seen that new cruise ships are being ordered and they are bigger than they used to be. So I assume they need bigger engines or more of them. So what would be kind of the value of a potential order for you currently from a cruise ship? And how does that compare to what it was like 5 years ago?

It's typically not bigger engines. I think the biggest engines are already in there, typically more engines -- and is gensets. So basically, you drive a generator for the whole electricity on board a vessel. From a value point of view, it can go up even to, let's say, EUR 30 million, EUR 40 million, I believe. And I think there is a slide actually in our roadshow deck that has a bit of indication of what we could score per vessel type.

The next question comes from Mikael Doepel. By the way, regarding Arjen's comment about our roadshow material. So as a reminder, our roadshow material, it's always on the cover page for Investor Relations. And there on Slide #34, you can see the typical Wärtsilä Marine ordering per vessel. So please take a look at that slide. Sorry, Mikael, now your time.