Good morning, everyone, thank you for calling in. Welcome to this second quarter 2017 update. The usual disclaimer slide. Let me jump straight into the key highlights. Overall, a solid performance in the quarter. Order intake increased almost 50% year-over-year and reached 2.7 gigawatts. On the first half of the year, we saw an increase of 12%. Revenue was EUR 2.2 billion, a decrease year-over-year, but for the first half of the year, basically on par with 2016. Solid earnings with an EBIT margin of 12.6%. Also good to see a good, strong performance in the service business, both from a revenue point of view and from an EBIT margin point of view. We have launched a share buyback program of EUR 600 million.
As usual, I will talk about the orders and the market, Marika will talk about financials. We will come back to outlook and Q&A. The overall regulatory environment, I would say, basically unchanged compared to last quarter. The trends to auctions and competitive tenders continue. We now, as expected, see it in all our regions and anticipate that that will be the new normal going forward. The market is transitioning to an auction and competitive tender market. Looking a bit more in detail, in Americas, no major change. We see the PTC structure is what drives the market in the current PTC cycle and, of course, also the increased competitiveness of wind, as we have talked about before. Of course, again, I am really satisfied with the order intake and the strong position we have in the U.S. market.
In Latin America, was probably the first region that started with auctions and we have seen good success for Vestas in Latin America. We expect auctions to continue. We will see in Mexico, Argentina, Bolivia, probably also Chile. There is an announced auction in Brazil for Q4. Those have been postponed before, but that at least what has been announced. In EMEA, starting with Europe, we have seen the first two auctions being held in Germany. The citizen wind park has taken out the absolute minority of those auctions. In Spain, in total for renewable energy, eight gigawatts has been auctioned and wind has taken about four of those eight gigawatts. Sweden has done an extension on the green certificate system, which is positive, and we have had a good order intake from there. We are also seeing auctions in markets such as Turkey and Russia.
Very much the same, but of course, from a much lower base in the Middle East, where we expect an auction in Saudi in Q4. China keeps the five-year plan and is executing on that plan. There exists curtailment in the market, but we also see good progress of addressing that curtailment. India also going to auctions that create some short-term uncertainty, but the 2022 target remains in place. I would say for the broader Asia-Pacific region, we see targets in place in most markets. Vestas is in this transition, continuing to build our leadership position. The transition is, of course, fundamentally positive. It is a sign of wind's competitiveness against other technologies and will longer term create a market that is less reliant on policy decisions and therefore reduce volatility. We are confident in our strategy and our financial ambitions. We know the levers.
It is about Levelized Cost of Energy, and it's about operational excellence. We will continue to leverage on our global reach, our scale, and our technology and service leadership. Going a bit more into the details. As I said, order intake very, very good in the quarter. 2.7 approximately gigawatt, a 49% increase year-over-year. U.S., Sweden, Argentina, Germany, and China were the main contributors to the order intake and accounted for more than 70%. We saw a drop in the average price per megawatt in the quarter to 0.81. This is due to a mix of factors. Firstly, we have a negative currency effect in the quarter. Secondly, a fairly high proportion of Chinese orders where the scope is very different from the rest of the world. Thirdly, in the quarter, we had no turnkey orders. That, of course, again is a scope issue.
Lastly, the dynamics of the market remains very competitive, and especially with the increased number of auctions and competitive tenders. Looking at the order intake also on a regional basis, you see Americas up 68%, very much driven by U.S. Also good activity levels in Argentina offsetting decline in markets such as Brazil and Canada. In Europe, or EMEA, I should say, we see good activity level across many markets in Europe, but primarily then Germany and Sweden. The difference year-over-year is primarily the Statkraft order. In Asia-Pacific, strong development in China. We saw that in Q1, and we see that also in Q2 with a good increase in orders and also good activity levels in India, Australia, and South Korea. In the quarter, we have also further strengthened our product offering, and Vestas is in a very good position.
We are the only company in the industry with significant volume and track record both on the 2 and what used to be a 3 and now is a 4-megawatt platform. On the 2-megawatt platform, we have announced new rotor sizes that will increase the production with up to 7%. On the 4-megawatt platform, then we have increased the power rating as well as the rotor sizes with the potential to increase production more than 20%. Again, a broad portfolio covering all different wind conditions and markets. Looking at delivery then, both in the quarter and for the first half year, we see a decline in delivery. It is basically in Europe and Asia. America is strong, very much, of course, driven by the U.S. In Q1, we, of course, also have help from the PTC components that was delivered in the U.S.
In EMEA, we see a good improvement and strong development in the U.K., but also solid activity levels in markets as Germany, France, Turkey, but not compensating for the drop we're seeing from South Africa, which basically is standing still for the moment and also a low activity level in Sweden. From a low level, we saw a decline in Asia-Pacific. Here, actually, India and China are stable on their levels, but the decline comes from that we're seeing very low activity from other markets in Asia-Pacific for the beginning of this year. Order backlog increased by EUR 200 million, equally between wind turbines and services, and now stand at €20.2 billion. That is despite, again, a negative FX impact of approximately EUR 600 million.
The focus for the joint venture that we have on offshore together with our partner, Mitsubishi Heavy Industries, the focus for them in the quarter was to complete the first V164 project and get that fully commissioned, which it is now, also launching a new power upgrade of the 8 MW platform to 9.5 MW, and continue to look at a very healthy order backlog. I hand over to Marika.
Thank you, Anders. If we have a look at the income statement, we continue to deliver a stable Q2, although very tough comparison compared to Q2 of last year, which you clearly see when you make the comparison. I would like to highlight that we deliver a very strong EBIT margin of 12.6%, despite an impairment of a test facility that obviously have an impact on the P&L of EUR 28 million. All in all, very strong performance, and you can also see on the EBIT, although a decline in absolute numbers, it is a strong performance, and we also in this quarter deliver a very healthy gross margin, getting close to 22% in the quarter.
The SG&A cost continues to be of high focus for us, and you also see when it comes to the volume and all the impact that we have from cost out on the products that we continue to get a good leverage from our position when it comes to revenue. We are down now to 6.7% here in Q2 of this year. Clearly in percentage, a decline compared to last year. Very high focus on the SG&A also going forward. Service business, which is obviously a good mix in the quarter with a strong performance. You see an increase of 14% compared to last year, which also have an impact on the gross margin, obviously. Here we deliver a very good margin of 19.4%.
I would like to remind you that we continue to see very high, good, stable margins in the service business, you will also, going forward, see certain lumpiness. It's definitely a good mix when it comes to for the overall company. Anders talked about the order backlog increase despite the headwind we have on currency. Balance sheet continues to be strong and obviously something that we have been striving at and continue to strive at, having a very strong balance sheet. Our net cash position increased to EUR 2.6 billion , and you have a positive net working capital development of EUR 209 million, and I will come back to the movements. The solvency ratio remains within the boundaries of 30-35, we're close to 31% solvency in this quarter.
Again, a very strong performance on the balance sheet and I would say control over the position we had and continue to have. If we have a look at the change in net working capital, you see more or less the same pattern over the last 12 months and the 3 months. What we have said, in terms of using the inventory for instead of investing in additional capacity, we have done that for the last 2 quarters and that's also why you see a negative cash flow in these 2 quarters. That doesn't mean that we have changed our methodology when it comes to produce for orders. The underlying methodology remains, but instead of, again, investing in additional capacity, we utilize the inventory. We build to a certain extent for inventory.
All in all, tight control over the net working capital over the last 12 months as well as over the last 3 months. A positive control over the net working capital. Warranty provision and lost production factor is just a reflection of the focus on the high quality of our products. You see the lost production factor remains below 2%. A very stable performance, although also here you will see certain fluctuations among the quarters. You see that in Q2, we are getting closer compared to other quarters in terms of consumption. We are getting closer to the provision, but it's all in line with expectation and all in line with what we see as relevant provisions also in this quarter. The cash flow statement, again, no surprises. We continue to have good leverage from our operating activities.
We are, in that respect, very healthy when it comes to generating cash flow from operating activities. You see a negative swing in the net working capital, again, as expected, and that generates a negative free cash flow of EUR 151. The cash flow from financing activities is obviously impacted by the dividend payment made earlier this year. The total investments, again, solid. You see an increase compared to last year, planned for, a good reflection over the technology and the activity in the company. We continue to invest primarily in the capitalized R&D, but also in molds. Obviously the molds have to be changed when we change technology, just to be very clear. Capital structure, a good performance also on the capital structure. You see here we are net debt to EBITDA, well in the territory or well below continuously. We are negative 1.4 .
Obviously the focus remains. Solvency ratio also here, solid performance well within the boundaries and slightly up compared to last year, but more or less in line. The share buyback program that Anders announced earlier is EUR 600 million. Also bear in mind that we actually did a share buyback earlier this year of EUR 100 million, and we also paid dividends. We are in the EUR 1 billion range when it comes to return to the market. There's no changes in our dividend policy, and the priorities for capital allocation remains unchanged. The return on investing capital, obviously more than double digit at this point. Very healthy levels and driven by the strong performance on both income statement and the control over the balance sheet. By that, I give the word to Anders.
Thank you, Marika. Outlook, we maintain the outlook for 2017, which means revenue between EUR 9.25 and EUR 10.25, EBIT margin between 12%-14%, total investment approximately EUR 350 million, and a free cash flow of minimum EUR 700 million. Also worth noting is that it's based on current exchange rates and previous outlook, of course, based at the exchange rate at that time. Since then, we have had a headwind on the exchange rate, primarily USD to EUR. With that, we go over to Q&A.
Thank you. Ladies and gentlemen, if you have a question for the speakers, please press zero one on your telephone keypad. Please respect a limit of two questions at a time, and please hold until we have the first question. Our first question is from David Vos, Barclays. Please go ahead.
Hi. Good morning, Anders. Good morning, Marika. Thank you for taking my questions. I have the following. Could you please, on the U.S., firm up what your delivery schedule looks like for the rest of the year? We've asked that question at Q1. You said you needed a little bit more time for that. Is that time now passed, and can you therefore be a little bit more specific about what you think in the U.S.? Also, could you comment on, with respect to order intake there, how you are tracking versus your expectations going into 2017? The second question would be, if you could specify whether you can still offset the observed price erosion in the market with your usual mix of cost out productivity and engineering as you have been able to do in the past. Thank you.
Thank you for your questions, David. Let me start with the U.S. I think overall, of course, really happy with the performance of the U.S. as we were also during the end of last year with the PTC components, also, of course, what we see this beginning of this year when it comes to taking the orders on that potential. I think when it comes to delivery, of course, you never know what exactly falls into the year and what comes out of the year. I think from a visibility point of view, of course, with the orders that we now have taken, we feel good about the U.S. market and our position in the market. I will not get into any sort of precise delivery schedule. When it comes to the other part, there is, of course, the potential of PTC components for 2021.
There, we have definitely started the discussions with the potential customers. There is an interest in that, it's too early to speculate on how that will pan out. Honestly, I don't think that we will know that for sure, experience of previous PTC cycles, until the very end of the year. The other question, probably a bit on how we see PTC components on order compared to continuous construction, I think it's fair to say as expected, the majority of the early orders are around continuous construction, but also fair to say that we see some PTC components order also coming in. On your other question on how we handle the market and the competitive situation that we see in the market, the levers we have in place, as before, it is very much about focusing on Levelized Cost of Energy.
That, of course, are two main components in that. One is the technology, that is more generation from new technology as we have also then launched this quarter, so it is about the product. The other big part of the equation is, of course, the cost out that we will continue to drive. I think we are familiar with the levers to continue to increase our competitiveness in the market. How it will influence margins, I think what we say there is, of course, that we maintain our margin outlook for this year.
Thank you very much. I'll rejoin the queue. Thanks.
Thank you.
Thank you. Our next question is from Akash Gupta from JPMorgan. Please go ahead.
Yeah. Hi, good morning, everybody. My first question is on the price per megawatt development. If you look at the headline numbers, obviously it implies down 9% year-on-year, but you have cited various factors behind it. What I'm after is that if you strip out this factor and look for like-for-like price development, maybe if you can help with that, because your U.S. competitor reported that it was like flat pricing in their renewable orders. That's question number one.
Yeah. It's actually very hard to single out. It is a mix of factors, as I said. What is maybe a little bit easier to single out is, of course, the currency effect, that is 0.02, I think, in the quarter. It is really the factors that I talked about. It is about the scope, in this case then, mainly two parts of the scope, which is a higher proportion of orders from China, which, rule of thumb before has been that a megawatt there, from a scope point of view, it's about half the value of a megawatt outside China. The scope is very different there. The other part is that in this specific quarter then, was that we had no turnkey orders.
As I also said, lastly, we see an increased competitiveness in the markets very much driven by the auctions and the competitive tenders. That also nothing new, as I said. We, of course, seen auctions in parts of the markets before. I would argue very competitive tenders in the U.S. and an auction-like system, especially in the PTC cycle. We all know that is a longer cycle. What is different now is, of course, that we see this now in all different markets. Exactly on the 0.8% year-over-year, what in these different buckets, very hard to say, of course, they all play a role.
Okay. My second question is on the guidance, which is still EUR 9.25 to EUR 10.25 in the billion wide. I was expecting maybe you would be narrowing the guidance at this point of time, but you have left it unchanged. Two questions here. One is on, do you expect maybe some revenues moving from this year to next year? Is that the reason why the guidance is so wide? Secondly, does this guidance factor in announced orders so far in third quarter at all?
Okay. The guidance we have, well, we have done the similar analysis as we do, and the similar forecasting and simulations as previously. Just to highlight that nothing new actually for us is that we have a busy second quarter, but that also means that we have a lot to deliver. A lot of it is, you also see a currency headwind at this time, that also taken into consideration when we talk about the low range of the guidance. We also have a lot of deliveries late in the year that actually have to be performed as expected. There, we would have the regular weather, crane, and everything else that could potentially go wrong. No differences in how we have made the analysis. We're still striving for the higher end, as we always do.
Thank you.
Our next question is from Kristian Johansen, from Danske Bank. Please go ahead.
Yes. Thank you. My first question is on the in-for-out orders. Obviously the order intake has been quite strong. Can you just give a bit of flavor on the level of in-for-out orders you've received this year versus what you expected at the beginning of the year?
Okay. On the order side, in terms of the in-for-out, you would see normally, in the earlier part of the year is when you see most of the in-for-out orders. Having said that, you would also see that some of the U.S. PTC components would qualify for in-for-out to a certain extent. The portion of in-for-out in this particular quarter, it's high, or fairly evenly spread. China could be one of those countries, for example. Nothing abnormally high or abnormally low, at this point in Q2.
In line with sort of what you expected at the beginning of the year, is that?
Yeah, that's what I'm saying, Kristian. Yes.
Okay, great. My second question, obviously, there's a lot of focus on the impact from auctions here. As you mentioned, Latin America has sort of been a first mover with auctions, which has been around for a while. When you look at sort of the average project margin for your Latin American business, where auctions has been around for a while, is there a notable difference to the rest of your business?
No, that's a little bit what we have said also. You would have a low China scope, you would have a fairly low U.S. scope. You would have a higher India scope, for example. All in all, what is important for us, and as Anders have highlighted when it comes to scope, is obviously the price per megawatt. Having said all of that, the request, even if we have very little in Q2 when it comes to EPC contracts or nothing, we see that all in all, that is increasing a little bit, or the demand for EPC contracts is increasing. The margin is not related. Obviously, when you have a higher scope, you have more parameters to work with. All in all, the margin is fairly similar independent on the scoping of the projects, because you also have a lower cost on a lower scope.
Okay. Despite the average price dropping here in Q2 on order intake, we shouldn't expect a similar impact on the margins.
Correct.
Excellent. That was all for me. Thank you.
Our next question is from Kester Wong from ABG. Please go ahead.
Yes, thanks a lot. My first question is regarding your payout of cash to investors. You're paying out roughly EUR 1 billion this year, which I think, on a normalized basis is roughly also your free cash flow, given the timing differences around New Year this year. Is this also sort of a fair assumption going forward that you now have the balance sheet you want, and you can more or less pay out your entire free cash flow? That's my first question, please.
Well, what we have said is that the dividend policy remains, and that's the 25%-30%. The share buyback will be the cash that we have, or if we have any excess cash during the course of the year, we will obviously invest in the business firsthand, and we will also do bolt-on acquisitions, as we have said. Haven't found anything at this point, obviously. Then we have said also that then we will revisit whether we return to the market. In this case, we thought that the timing and the sizing was appropriate. We are not committing to any certain level because obviously we want to have and continue to have the strong balance sheet we have at this point.
Fair enough. It's fair to say that you're comfortable with the balance sheet you have then today, I suppose. You can decide whether you want to comment on that. My second question is also a little bit about the prices here in the quarter getting a lot of attention. When you participate in these auctions, where, as Anders said, things are getting very competitive, is it your impression that you are sort of getting a higher proportion of orders today than you did before the introduction of auction systems on the back of competitive Levelized Cost of Energy? If you can talk a little bit about maybe the dynamic of LCOE really coming in spotlight in the introduction of auction systems.
It's very dangerous to generalize, but I think, of course, there are some common themes on the auctions. As I said, I would say that we've seen auctions for quite some time. The difference now is that we actually see it in all regions. If I look at our performance the last year, the last two years with auctions and competitive tendering, as I said, in the U.S., very similar to an auction kind of system where you have a longer period, usually, to deliver on because they are a bit more forward. Maybe Brazil is the most extreme example where there has been some auctions that are called A minus five, which means that the customer bid for an energy PPA five years from now. They are a bit more forward-looking in that, even if Brazil maybe is the most aggressive in that sense.
That, I would say, is very characteristic of the current PTC scheme we are in as well. Having said all of that, I must say I'm really confident with our position when it comes to growing faster than the market during these last two years that I have talked about. I'm confident in the competitiveness of Vestas. Having said that, of course, there are also differences between auctions. Sometimes it's differences in timing, sometimes there are high requirement of local content, sometimes there are other type of local requirement, which you, of course, also have to take into account.
That means that the Levelized Cost of Energy from the turbine as such is the % that plays into the overall PPA price that is then bid in the auction can vary quite a lot, dependent on the different other requirements that are in place in order to participate in the auction. A generic answer, but also with the caveat that it's very hard to say that all auctions have the same criteria.
If I can just follow up, Anders, as you mentioned that some of these auctions have very long lead times. Is that also sort of a part of the explanation why there sort of seems to be a general impression that the prices come down together with the auctions, basically since we are talking about technology that will be available three, four years from now, where Levelized Cost of Energy is expected to be lower and hence people can also bid a lower price?
Yeah. No, that is correct. Very simply put it in a feed-in, probably a little bit simplistic, but to take the extremes. In a very stable feed-in tariff environment, of course, we and the rest of the market, we sold the product we had on the shelf. If that qualified with the PPA within the feed-in tariff, the project was being built. If you then take the other extreme, as I talked about, probably Brazil then that has an auction where the customer then bids for a PPA that is 5 years from now when it is going to be built. Of course, if we then use the current technology, you will never win that auction, obviously. There, you have to partner early with the customer and anticipate the Levelized Cost of Energy to some extent on the technology you have.
Those are the 2 extremes, and then you have everything in between that when it comes to timing and, as I said, different other qualification criteria into the auctions.
Thank you.
Thank you. Our next question is from Dan Togo from Handelsbanken Capital Markets. Please go ahead.
Yeah, thank you. If I just can follow up on the last comment you made here, Anders, in an event, like you mentioned, for instance, in Brazil, if you commit five years, three years down the road, together with a partner, what kind of commitment do Vestas take here, and what are the risks, so to say? That's the first question.
Yeah. For competitive reasons, of course, I will not go into exactly how we partner with our customers and what kind of commitment we are doing. It's, as I said, a very competitive market.
I'm assuming you need to make a commitment of some kind.
Of course, I think we all have to bid the technology that we feel confident we will have at that point in time.
Okay, thank you. Then a more up-to-date question relating to the strong pipeline that you have of 4.3 gigawatts, which you mentioned as being under completion. How should we think about that in the coming quarters? Is that more or less all to be delivered throughout the second half, and how will it be split between Q3 and Q4?
If you look at the megawatt or the projects under completion, are you asking in terms of You're looking at the completion on our inventory, or?
Exactly.
Yeah. There you have to note that also we have the turbines booked under inventory that is supply only, you also have turnkey project on top of that would have an impact on the P&L. It's hard to make a one-to-one. The underlying methodology when it comes to how we book and what we book remains unchanged. You cannot make the match in that perspective. We obviously are busy, if that's the underlying question.
Well, I guess the majority of the 4.3 gigawatt will be delivered throughout second half.
Yeah, that's a fair assumption.
Yeah. Thank you.
Our next question is from Pinaki Das from Bank of America Merrill Lynch. Please go ahead.
Hi. Many thanks for taking my questions. I'd like to follow up on this megawatt equivalent under completion. That number is up significantly compared to last year. You had 4.3 gigawatts now at this stage. Last year, you were at three gigawatts. I just wanted to understand, when you look at the second half, what has changed that you have a much higher inventory number, although you're not expecting higher volumes year-on-year, in 2017 versus 2016? Why is the inventory so much higher now than at the same stage last year?
Basically, what I said is that in terms of activity level, we can decide, obviously, to invest in overall capacity, and we can decide that we use our position when it comes to net working capital and thereby increase the inventory. That is basically what you have seen this year, and that is a deliberate choice. The activity level, if everything goes according to plan, will be high, definitely. You also have to bear in mind, even if the vast majority is for activities 2017, you would also have some activity entering into 2018. It's not everything in 2017. Obviously, the higher activity level also means certain uncertainty, and that's why we have made the simulation and have the similar view as we had beginning of this year.
You're almost suggesting that there's some sort of a capacity constraint, and therefore they're investing in the inventories now. As we know that 2017 is a slightly lower year than 2016, there should not be that much of a capacity constraint, no?
Overall, if you see how much we have increased our capacity without making any major investments, we obviously optimize the usage of our capacity, and that's also why we. At this point, we can afford to build inventory to meet the overall demand. What I'm saying is that not everything is for 2017. Some can chip into 2018.
Thank you so much. My second question is around your FX headwinds, and you mentioned that obviously in your guidance, you obviously didn't factor in whatever effects might change over the year, which is fair enough. You also have the backlog, which has now been adjusted down by FX. What I wanted to understand is, most of the PTC components have already been delivered in Q1. That FX is kind of already gone. You would have still some orders which you booked maybe end of last year or early this year, which will probably be delivered in Q2 and also Q3, Q4. What is your strategy around, do you hedge the FX on the orders that you've already booked?
Going forward, Two orders that you might book, is FX an issue or is it more like it's an ongoing thing where the pricing will be slightly different because of FX?
I see where you're coming from, Pinaki. All in all, we try to be as naturally hedged as we possibly can, and that's where obviously the global industrial footprint and also the sourcing capability that we have is extremely important. When we talk about the currency effects and the headwind on the guidance is primarily translation impact. You don't see the transaction impact. At any time, if we don't have the perfect hedging position, then we hedge the specific project, but that we don't do until we have a firm order intake.
Again, sort of reconfirming on that, when you had booked orders in the U.S. end of last year, for delivery in 2017.
That has already been dealt with.
Yes. Do you already hedge the FX on it?
Yes. When we book the firm order intake, yes, then we hedge the contracts.
You basically have a negative impact on your backlog, but you might have a separate positive financial item somewhere. Is that the way I should think about it?
Yeah. Translation impact, yes. If you have a negative impact from the US dollar, you would see certain positive impact on, in particular fixed capacity cost. That would be fairly minor as we still have a big euro base.
Do you have a financial asset in front of it? Do you have an FX contract which is in the positive territory now and obviously you have a negative impact in the backlog?
Okay. Do you mean the contract? I would say that's fairly insignificant. All in all, when it comes to the backlog, it's the translation. Also when you look at the forecast going forward.
Thank you so much.
Our next question is from Pascal Amit from SEB. Please go ahead.
Yes, good morning, Marika and Anders. Pascal Amit from SEB. Two questions from my side. Firstly, production in second half, will you continue to produce at full speed in the second half of the year? That is my first question, please.
Yeah. We will continue to produce on full speed or sort of current level. Then, as you know, we have production facilities in all the major geographies and that is a little bit common to the last question as well, that of course, we have an overall production capacity, then you have individually regional capacity production as well. Of course, the advantage of being global is to try to always match the utilization with the demand in the market. There is, of course, a physical limitation a little bit, depending on how the market goes, on how much you can optimize that. There is no slowdown in manufacturing. If you look at blue collar workers, they are fairly constant.
Okay. How should we be thinking about the inventory level by the end of the year? Normally, you draw down on the inventories in the second half of the year. How should we think about that in 2017?
Obviously, we will utilize the inventory at the end of the year. Exactly what position we would have, we are not commenting on, but that would be a normal pattern, yes.
Okay, perfect. Just a question relating to guidance. A lot of questions relating to your top-line guidance. When I look at your margin guidance, the lower end of the 12%, can you explain why we should not see the normal kind of seasonality for margins in the second half? You're essentially indicating flat margins in the second half compared to the first half of the year. Why shouldn't we see a positive impact from leverage? Are there some one-off costs or is it pricing which is hitting your margins in the second half? If you could elaborate on that, please.
Well, all in all, if everything goes according to plan, yes, there would be a very high activity level, but that also means that your suppliers works perfectly, that all the logistics works perfectly, that you get all the cranes that you have ordered, and that you don't have any snowstorms at the wrong timing. When we make the analysis and do the simulation, this is the considerations we have, and that's why we have chosen to keep the guidance, because there will be a normal uncertainty. On top of it, you have a currency headwind at this point when it comes to translation.
No one-offs which we should be factoring in the second half of the year?
Not that we foresee.
Sorry, Marika, I didn't understand that.
We don't foresee any major one-timer effect in the second half.
Okay. Just one final question. You're launching a number of new products for your four megawatt platform. Should we be expecting any significant ramp up in R&D or tangible CapEx from that?
We feel very comfortable with the efficiency we have on the CapEx level, i.e., capitalized R&D in that respect, and I think we have proven to be very efficient both on accommodating new technology and capacity. The guidance that you see this year, we feel comfortable with the level that we are at. Obviously you would have an impact from activity level primarily when it comes to molds.
Okay. The EUR 450 million level annually, we can also extrapolate that to 2018, 2019 due to these product launches?
Well, as I said, the CapEx level that we have is something that we feel comfortable with.
Okay. Thank you very much. That is all from my side.
Thank you.
Our next question is from Marcus Dahlander from Carnegie. Please go ahead.
Thank you. My first question is also regarding the guidance and FX effect. If you could quantify how big of a negative impact the currency movements we've seen thus far have had on the top line or will have had on the top line by year-end.
Well, most of the negative headwind will come in the forecasting part when it comes to currency, and that's again, translation. What we see is around 2%-3% impact from currency.
Okay. Thank you very much. The second question, the EUR 28 million impairment charge. Could you just provide some more details on that? What is it exactly?
Yeah, absolutely. The EUR 28 million impairment is a reflection of usage of a test facility. Therefore, as the usage of this particular test facility, we assume going down, and that's why we have impaired by EUR 28 million. That is a reflection of how much we anticipate that we will use it going forward. Obviously we have other test facilities that we're moving the testing to. Depends on the type of turbine, obviously.
Okay. Stupid question maybe, does this have anything to do with the burning turbine in Denmark?
No, absolutely not.
Okay. Thank you.
Thank you.
Our next question is from Alok Kataria from Société Générale. Please go ahead.
Hi. Thanks for taking my questions. Maybe first one, just following up on the CapEx and the whole inventory production capacity issue. Is that partially reflective of the expectations of how the U.S. market will pan out with the high volumes in the next few years? Obviously we don't really know how it pans out later on. Of course, related to that being some of the new markets, Russia, Turkey, et cetera, seem to be insisting on a high level of local content that requires factories. Should we sort of expect CapEx to creep up in terms of % of sales going forward? That was number 1. The second 1 was if you could just comment on developments on the end markets and particularly U.S. and Germany.
U.S., of course, some of your peers flagging off a push out of installations from perhaps 2018 to 2019, 2020 due to tax equities issues. Germany where, of course, the whole citizen wind park, unpermitted, let's say, citizen wind parks winning the auction seem to be creating some sort of a vacuum potentially in latter part of 2018, early 2019. Any comments over there would be helpful. Thanks.
If we start with your CapEx questions, I think that, as I said earlier, the overall platform that we have is extremely useful also, not only when it comes to production, but also sourcing. The increases we have seen when it comes to capacity within the range that we have guided for this year, we are very comfortable with. We have also said that as we have a very strong working capital position and a very efficient one, we will, when we see fit, use the inventory or use the position to actually being able to build inventory without having a major impact on the overall position that we have on net working capital and cash flow. There's no changes.
What I would say that when it comes to local content requirement, the global footprint, and the know-how that we have to enter into new markets, both when it comes to production, sourcing, is extremely valuable. Also on that note, we are extremely efficient when it comes to accommodating any local content requirements.
Yeah. Should that drive higher CapEx? If you have to build factories in Russia or Turkey.
That's why I said, as we are extremely efficient in the use of our CapEx and also moving molds if necessary because they are movable, we're talking about a lower level of investments. We don't see any changes in our CapEx requirements going forward.
Okay, great.
Okay, let me try to
See if I can answer your other questions. I think on the U.S. tax equity, there are no news in this quarter compared to what we said in the last quarter. I think it's, of course, to start with, extremely hard to speculate about U.S. political situation and a possible tax reform to start with. Of course, there is a theoretical, then a possible impact on the tax equity. I think that is, of course, a theoretical impact. If I look at the market again, if I look at order intake we take in the U.S., and if I look at the discussions we have with our customers, we have not really changed our view of the market size of the U.S. in the current PTC cycle. Germany, I think that is a good question. I think it remains a little bit to be seen.
The difference between the citizen wind park and the non-citizen wind park is, of course, as you say, that the citizen wind park have a longer time before they have to complete the projects, and they don't need a building permit to participate in the auction. There is potentially a longer lead time on citizen wind park projects compared to non-citizen wind park projects. How that will pan out, and of course, the two first auctions now, the absolute majority went to citizen wind parks. I think how that will pan out will, of course, depends a lot on their internal time schedule. A negative there is that they don't have building permits. That would point to a longer process. A positive is, of course, like always, time to generation is always positive for your business case if you have a project.
Of course, there is a natural tendency to try to get the projects done as quick as possible from a time to money point of view. I think it's very hard to say how these two pans out. From an overall timing perspective, no doubt that they have a longer time to completion. I think there will be one more auction with the current ruling, and the auction after that, there will be no preferential treatment for the citizen wind park.
Are you seeing a push out of the U.S.? I can appreciate that the overall market size view over 2017, 2020 hasn't changed, but just the phasing within that, would you agree with some of your peers saying that the phasing within the 2017, 2020 timeframe is shifting out a bit more towards 2019, 2020 rather than 2017, 2018?
What we said before was, I think in line with the overall market, that we expect 2017 from a delivery point of view to be lower than 2016. That we maintain. I think then it's very hard to predict. Again, if I look at it more short term and order intake and the projects we are firming up now as firm orders for the first half, I feel fairly good about the position.
Okay. Fair enough. Thanks.
Our next question is from Kapil Singh from Macquarie. Please go ahead.
Hi. Morning, guys. Just a follow-up on the last question around the German market. Anders, do you think next year, the German demand for 2018 will be quite bleak given this sort of push out on the citizen-based projects, as well as the fact that those feed-in tariff projects awarded in 2016 were most likely to be commissioned in 2017?
I think likely from a delivery point of view, of course, 2018 will be down on 2017. Exactly how much, I think it's very hard to predict now. That, we will get clarity on once we start to see orders firming up around this citizen wind park. Of course, there will be a point in time where the market goes to the sort of auction volumes that has been decided. Exactly when that will happen, I think it's hard to predict because of what I just said then. They have a possibility of a longer lead time. On the other hand, of course, they have an incentive to get to generation as early as possible. Yeah. That's of course, something we have to stay close to and understand better now as we start to see those auctions turning into orders.
Yeah. Okay. My second question is about Mexico. That's obviously not been a huge market for you guys. What was the main drivers of winning the recent 424-megawatt project? Did it come down to price? Was it technology? Was it the four-megawatt platform?
Which market did you say?
The Mexican market.
I must say that we actually have a fairly good position in Mexican market already from before. I would say that our market share in Mexico is probably in line or maybe slightly below our global average. Mexico always been a solid market for us and of course, we are happy for the order.
Our next question is from Sean McLoughlin from HSBC. Please go ahead.
Thank you. Good morning. My first question, just coming back, Marika, to a comment you made earlier about demand for EPC contracts increasing. This doesn't seem to square with the argument that lower scope impacted your order pricing in Q2. I was just wondering, can you specify which regions, which markets are looking at more turnkey, and how do you expect this trend to impact your pricing going forward?
Normally we would have a maximum around 5% of EPC contracts. We clearly see depending on markets, but I would say a very typical turnkey and EPC market would be India, for example. You also see other markets where you see certain requests. We didn't have anything in this quarter, which obviously have an impact on the price per megawatt, as Anders highlighted. This is not blowing anything out of proportion, but I think also from a competitive perspective, that you can do any type of project or project is extremely valuable when you have a global footprint as we have. Obviously, the customers comes from anywhere in the world, we have the possibility to provide any type of contracts and scoping of contracts.
Thank you. Thinking as well about the buyback and the lack of M&A, you've mentioned yourself bolt-on acquisitions. I'm just wondering if in the context of that, you could give us any further thoughts on your strategic aims to broaden your product offering to storage.
Yeah. As I said, I think our strategy remains that we have done some bolt-on acquisitions, as you know, in the service business. If we find the type of bolt-on smaller acquisitions, we will of course look at it. Also clearly stated as before that we don't see any attractive, big type of acquisitions consolidations for us. We are looking at, as we also talked about before, that we see an interest in the market for hybrid type of systems. It's from a megawatt point of view, currently, fairly small projects, but we think very interesting projects for the longer run. They are quite often a combination between wind, in some cases solar, but almost in all cases, some kind of storage or increased capacity factor by new technologies towards the grid. That could be different kind of storage.
It can be pumped hydro, it could be batteries, it can be pure enhancement on how we handle the grid connection. Those projects we think are all very interesting. Again, our value add in those project is, of course, to take the project responsibility. It's to invest and look at the technology of energy management, is what kind of gains we can do on the wind side with an enlarged project. We're not looking to acquire a battery company and start manufacturing batteries or a PV panel company to start manufacturing panels. We think that our other company is more suited and has the scale on those components into those projects.
Thanks, Anders. Does that also mean that there's also an internal R&D ramp in this area?
No, as I think I've talked about before, we have an innovation part of our organization that are looking at a lot of different technologies. When we see a bigger interest in a certain area, we move the resources into that area and try to be prudent as usual of keeping the overall frame.
Thank you.
Our next question is from Mark Freshney from Credit Suisse. Please go ahead.
Hello. I have three questions for you, please. Firstly, one of the things you didn't mention for the lower pricing in the backlog is the Power Mode. I'm just wondering if that's important because most turbines now come with this Power Mode. Secondly, on the FX rates. If we put aside all of the financial hedging that you do when you win an order, is it fair to say that you have had a large competitive advantage over the last three years in the U.S., as you've been able to ship sometimes complete systems from Europe into the U.S. for some of the three-megawatt projects, and basically manufacture in Europe 20% cheaper than you would in the U.S.? If you strip away the hedging, there seems to be a big competitive advantage that you've had.
Thirdly, just on the auctions, we're now in a system where auction prices are basically the market price for power. I'd be interested to hear, Anders, whether you think the days of competitive auctioning Be coming to an end, and we'll move to a system where auctions won't matter or won't take place, and how that would impact your business.
Okay. Your first question, the Power Mode definitely also is a factor in what we discussed. As you rightfully point out, of course, if we, for example, had most 3.0 megawatts in our order price per megawatt a couple of quarters ago and now have mostly 3.6, of course that has an impact. Of course, you can always discuss, and that's why it's so hard to say exactly what this was. Is that then a pricing issue or is it a product rating issue? That's of course what makes the discussion a bit more complicated. On a like-on-like basis, of course that we have higher power rating and therefore more megawatts. That of course has an impact. I will say on the U.S. question, I would say a bit the opposite.
I think the big competitive advantage that we had during the last two years in the U.S. is actually our U.S. manufacturing. If you look at the absolute majority of the volume we have sold in the U.S. and a very big part of what we expect to do, well, let's see, is on the two megawatt platform that we have fully localized in the U.S. I think that is actually an advantage. We are currently in the process of also, because the good thing is that on the manufacturing side in the U.S. and on the blade side, we can also do the three megawatts. We're actually looking at localizing the three megawatt now as well, and started up that work for the U.S. That I think has been one of the keys for us in the U.S. market.
On the auctions and market price, as I said, we are in the transition. Wind is reaching what you can call grid parity, even if I don't really like the word, because it's very hard to define, because there will always be policy in the energy industry, and that goes for renewable, and that actually goes for fossil fuel as well. Of course, once we reach the point where we clearly see no insight, it's possible that there will be another type of system. For me, that will have many similarities to what we now call the auction system. It will be then based on the electricity need in the different countries, and they are dependent on how the setup of the energy market is. You can view it as an auction or just a tendering for capacity.
I think the key question there for me is that if you do an auction, you have to have something that you auction out. I guess that is a little bit what you are thinking as well. That is then that you either have a monopoly of power in the market or there is just one grid operator or something. You have to have, of course, in an auction, something that is auctioned out. Otherwise, as you say, it's a market where it's just sort of built when need arise. Since energy markets overall in the minority markets are policy, there is a policy, I think you will see this type of system where you plan for additional capacity, and there is some party that sort of do the overall capacity planning, and therefore it will be an auction-like system.
Okay. Thank you very much.
Our next question is from Claus Almer from Nordea Markets. Please go ahead.
Yeah, just one question from my side. There has been a lot of question regarding all these auctions and the impact on pricing, of course. Can you put a little bit of flavor on the quality of the backlog? Should we see the current backlog being of equal quality as what you are going to deliver in 2017? That would be the question.
Well, I would say what we have said earlier. First of all, we have a very high quality on the order backlog, and we have no intention to lower the quality of the order backlog. How it will pan out exactly. Also bear in mind that you have anything from six months to up to 24 months, and when and how that potentially will increase in terms of deliveries because there is more forward sell, then we have to come back to that. All in all, it is a very high quality on the order backlog.
That would be the same answer when we asked this question in the past, where you normally, Marika, said, "Well, yeah, the quality is equal to what we have seen being delivered.
That's a little bit the point also, Claus, when Anders talk about the price per megawatt, because you don't necessarily see a correlation between the price per megawatt and the margin of the projects. Obviously, when I talk about the quality of the project, it is a margin question as well. We take good, healthy projects. That's the methodology.
When I talk about quality, that will be on project margins, of course.
Yeah, that's what I say. There's no correlation on price per megawatt and the project margin.
Perfect. Thank you so much.
Our next question is from Lars Kjell from Nordea Credit Markets. Please go ahead.
Yes, hello. Also a question related to these auctions. Anders, did you say that you didn't expect all these auctions to have a negative impact on your margins going forward? Did you say that before? That would be my first question. Secondly, also related to these currency movements, could you indicate just roughly how big of a percentage of your sales is in US dollar or US dollar-related currencies? That would be my questions.
Yeah. No, we have not started to guide for margins further on than what we normally do. We keep our guidance on the margin for this year. Overall margins, we will follow our normal process for when we do the next guidance. What we talked a lot about, of course, was that there is a competitive pressure in the market. There are a lot of levers on competitiveness, and price is one of them. As we have talked about, now there is a lot of other levers as well. When it comes to the margins, we feel that we also know the levers, and those are the levers we are working on. I have not given any indefinitely promise on margin development for Vestas. We will follow our normal process there on how we guide for our EBIT margin going forward.
What was the second question? US dollar.
U.S. dollar. Okay. The order of magnitude of the U.S. dollar. I would like to highlight again that our assumption is to be as naturally hedged as possible. When it comes to U.S. dollar, obviously the U.S. market is a U.S. dollar-based market, and that's a good portion of our revenue. There we are more or less 100% naturally hedged as we have a big operation in the U.S. That's also what I would like to highlight again, is that it is primarily as we report in EUR, the primary currency impact that we see is translation. It's not transaction as we try to be very naturally hedged. Exactly how much is U.S. dollar-based, I would go for the U.S. market. That's where we primarily see it.
Some of the emerging market, but the vast majority of the U.S. dollar base is U.S.
Okay, excellent. Thank you very much.
There's room for one more last question.
Our last question is from Geoffrey Fong from Morningstar. Please go ahead.
Good morning, everybody, thanks for the question. I have two questions, if I may. The first one is going back a little bit to the deliveries. We have seen lower deliveries in the quarter, but very strong and high manufacturing activity, I think a lot of things has to do also with the transfer of risk. Can you give a little bit more color on that? Should we read something into that? That's my first question. The second question is also coming back a little bit on the share buyback. I appreciate the point which was raised on the earlier question regarding the flexibility, can you please come back a little bit on, let's say, your decision to go for share buybacks instead of raising the dividend?
In my opinion, the dividend can be raised, given the fact that your profitability has increased on a structural basis the last couple of quarters. Thanks.
If I start with the last question then, I think we are happy with the policy that we have outlined, our way of looking at the share buyback, the share buyback we've decided this year, of course, the policy that we've also outlined of when we think it's prudent to maintain the balance of having a strong balance sheet, which we continue, think is very important. When we see rooms then for share buyback. Dividend policy is, of course, at the end of the day, a question for the board. As I said, from management, we are definitely happy with the policy we have. When it comes to the activity level also for the second half, it's as I think Marika explained, we are a project business.
We see timings of, as you say, when we recognize the revenue, so the completion of the project, which of course we play a big part of, but also our customer, also we are then dependent on enormously very high activity levels towards the end of the year. To do the revenue recognition, we have to look at things also outside our control. We have mentioned all the normal weather, seasonality, supply from subcontractors, we also have grid connections from the customer and things like that the customer has to be ready for in order to do the final revenue recognition. As usual, we have uncertainty of that timing towards the end of the year. Okay. With that, again, a reminder of the Q3, that we will have that on the 9th of November.
I just want to thank you for calling in, thank you for your questions, and thank you for your interest, and I'm sure I will see at least some of you during the next couple of days. Thank you.