Ørsted has the wind at its back

Formerly the ‘Danish Oil and Natural Gas’ (Dong) company, Ørsted (DK:ORSTED) has transformed itself from a fossil-fuel-intensive business to a renewable energy darling. Seeing the writing on the wall for hydrocarbons much earlier than competitors, the group sold its upstream oil and gas business to Ineos in 2017 and offloaded its liquefied natural gas operations to Glencore (GLEN) in December. The last piece of the green puzzle will be phasing out coal from its Danish power stations – due to happen in 2023. 

As it shed these assets, Ørsted made a big push into offshore wind. From building the world’s first offshore wind farm off the coast of Denmark in 1991, the group has become the global leader with a 24 per cent share of the offshore wind market outside of China. It has 6.8 gigawatts (GW) of installed offshore wind capacity with a further 8GW in its pipeline still to come.

There have been permitting delays in the US, which is likely to push back the start of construction on four projects to 2024. Even so, Ørsted believes it can still hit its target of 15GW of installed capacity by 2025 and sees these US hold-ups as one-off events rather than the norm.

Green is the new black

Together with its expansion into onshore wind and solar, Ørsted is aiming to hit over 30GW of renewables capacity by 2030. There are a number of opportunities this year to bolster the pipeline, with up to 27GW of offshore capacity due to be awarded across the likes of Germany, Japan, the US and UK. Uptake of offshore wind is being aided by falling costs as the technology advances and scale increases. There are also regulatory tailwinds as more countries set decarbonisation targets and use green initiatives as a tool for a post-pandemic economic recovery. The UK, for example, is looking to quadruple its offshore wind capacity to 40GW by 2030 as part of its net zero ambitions. Broker Jefferies predicts that global offshore wind installed capacity (excluding China) will grow from 22GW in 2019 to 159GW by 2030. It also believes Ørsted’s cash profits (Ebitda) will triple across the same time frame from the DKr17.5bn achieved in 2019.

Ørsted is mainly focused on Europe right now – with the UK accounting for over 50 per cent of installed capacity – but there is a burgeoning opportunity in the nascent US market. Thanks to the acquisition of Deepwater Wind in 2018, the group currently owns all of the 30 megawatts (MW) of installed offshore capacity in the US. While such dominance is unlikely to last, Ørsted is developing a further 2.9GW-worth of projects and is well-positioned to capitalise on any opportunities that come from a climate-friendly Biden administration. Even if there is Republican obstruction at the federal level, individual states are still pushing ahead with green projects. Jefferies forecasts that US offshore capacity will surge to 24GW by 2030.

Unlocking further value

Building wind farms is capital-intensive, although interest-bearing net debt had dropped to DKr8.2bn at the end of September, down from DKr22.3bn at the half-year stage. This came as DKr20.5bn of proceeds from divesting its distribution and residential power assets pushed free cash flow up to DKr13.2bn. Funds from operations currently stand at 36 per cent of adjusted net debt, above the group’s 30 per cent target.

Ørsted can prevent balance sheet strain by ‘farming down’ its assets – selling stakes in them – and recycling the capital into new projects. It’s not difficult to attract suitors as investors are drawn to the stable, predictable cash flows. Having completed 15 farm-downs since 2010, Ørsted has shown an ability to recover most, if not all, of its original investments. It is looking to farm down the Borssele 1 and 2 farms in the Netherlands in the first half of 2021.

This earnings stability is partly why Ørsted is popular among sustainability-orientated funds, including the Pictet Global Environmental Opportunities Fund (LU0503632878). “Its business model involves selling electricity to customers (such as central governmental authorities or large corporates) through long-term contracts typically lasting 10-20 years, which provides long-term visibility on future cash flows and stable revenues,” says senior investment manager Luciano Diana. Indeed, 90 per cent of Ørsted’s cash profits are from long-term contracts or regulated activities with a hedging strategy mitigating exposure to volatile power prices.

Reaching new heights

Ørsted’s shares tumbled at the beginning of December after Danish authorities handed it a DKr6.6bn tax bill tied to the Walney Extension and Hornsea 1 wind farms in the UK. The Danish Tax Agency argues that the future value of these wind farms was established at the design stage in Denmark in 2015 and 2016, while Ørsted maintains the farms were constructed, owned and operated by British subsidiaries that are already taxed in the UK. The group is appealing the decision and seeking to defer payment until the case is decided.

Should Ørsted be unsuccessful, it is guiding to a hit to net present value of up to DKr4bn and this could set a precedent for its other non-Danish wind farms. But it can take measures to avoid such taxes on future projects. Jefferies believes a resolution will be reached through litigation or arbitration and, given that Ørsted has not changed its financial outlook or investment plans, the broker sees only a “small short-term downside risk.”

The shares have now fully bounced back and look set to continue marching upwards. They aren’t cheap, currently trading at 49 times consensus 2021 earnings, although, as the more bullish forecasts used in the accompanying table show, there's a lot of variation in expectations. The high rating reflects the soaring appetite for green stocks. Ørsted’s shares have been getting more expensive, leaving the likes of Royal Dutch Shell (RDSA) and BP (BP.) in their wake. As the oil majors scramble to ensure they are not caught out by the energy transition, they may end up wishing they’d followed Orsted’s timely reinvention.  

Some may see the valuation as overstretched, but we don’t think this is a case of market overexuberance given the wealth of growth opportunities. True, Ørsted’s market share may fall as more players enter the renewables space. But the size of the overall market will expand as demand for offshore wind capacity increases – perhaps even more than anticipated if green hydrogen takes off. Those waiting for a better entry point should note that we are only at the beginning of the race to net zero. Ørsted is the world’s largest renewables pure play, offering investors a front-row seat to a multi-decade growth story.

Last IC View: Buy, DKr 715, 29 Apr 2020