EUR 850.00 For Business Accounts Only

Morningstar | Orsted's Value-Accretive Releveraging to Offset Returns Below Expectations for Ongoing Projects

We reiterate our fair value estimate of DKK 450 per share along with our narrow moat and stable trend ratings after Orsted's Nov. 28 capital markets day, in which the company updated its capital allocation, provided financial details on its projects, and extended its mid-single-digit dividend growth policy from 2020 to 2025, in line with our estimate. We believe the shares are fairly valued.

The group now guides for an internal rate of return of 7.5%-8.5% for seven projects sanctioned or about to be sanctioned in Europe, Taiwan, and the United States. This is well below our 12% estimate. The downside is driven by three sources. First is Taiwan, where the group guides for capital costs excluding transmission lines of around DKK 27 million/megawatt for the first 900 MW to be sanctioned in 2019, twice as much as the European projects' costs, versus our DKK 18.1 million/MW estimate. The significant cost increase is driven by design revisions to enable the installations to withstand typhoons. The second source is the fact that Orsted incorporates the projects' development costs, not capitalized, in the calculation, unlike us. The last source is a scope difference as the awarded German project with no subsidy, Cluster 1, will eventually be sanctioned, unlike what we expected. These negative items are partially offset by capital costs for European projects under construction well below our estimate. The group guides for capital costs of DKK 13.5 million/MW, implying a 35% decline versus 2017 guidance due to larger turbines and supply chain maturation.

Orsted said that out of 11 significant projects, 9 have exceeded budgeted IRR by an average of 2 percentage points due to best-in-class execution. Therefore, one can reasonably assume that the 7.5%-8.5% IRR guidance is conservative. Adjusting our estimates for new projects will have a mid-single-digit percentage negative impact on our fair value estimate, offset by additional capacity by 2025.

Orsted significantly increased its investment envelope from a previous wide range of DKK 45 billion-140 billion over 2018-23 to around DKK 200 billion over 2019-25. A chunk of the increase will be dedicated to additional offshore wind capacity of 2-3 gigawatts by 2025. Based on the new operating and capital cost indications provided during the capital markets day and assuming no Taiwan-like cost inflation, we estimate that Orsted could achieve an IRR of around 9% of this incremental 2-3 GW capacity. Related value creation would offset value dilution from IRR below our expectations for ongoing projects.