POSITION: In the previous blogpost, my teammate analyzed NRG Energy’s strategy on diversifying into green energy and took the stance that such a shift may not be in the best interest of the company. In this blog post I will be taking a similar stance, but for DONG Energy.
DONG Energy: The company was formed in 2006 by the merger of 6 Danish companies with an operational portfolio of Wind energy, Bioenergy, Distribution & Customer Solutions, and Oil & Gas. The six original companies were involved mainly in gas distribution and electricity generation from its inception, but the group now envisions to be the market leader in off-shore wind power production. It plans on doing so by divesting heavily from their traditional natural gas assets and converting their coal and gas power stations to biomass. The company is now the largest off-shore wind farm company in the world with over 1000 operational offshore wind turbines.
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| Figure 1: Phasing out from traditional generation |
FINANCE:
Taking a dive into their finance, my first thoughts were to assess the price to earnings ratio of the company, but I discovered that only about 20% of their equity is publically traded and decided that this may not be the best metric for the task. My second thought was to simply look at the company’s earnings to know if they are making money on their investments. DONG Energy has had a very impressive EBITDA growth of 93% in 2016 from that in 2015.
The increased EBITDA can be attributed to a couple of main factors such as a decrease in cost of sales in distribution and customer solutions, increased revenue from wind power, and gain in disposal of non-current assets in wind energy. What interests me is the increased revenue from wind energy as this could potentially break the point I am trying to get across.
The increased revenue in the wind energy was primarily due to increased construction contracts (“related to transmission systems in the UK, as well as the German offshore wind farm Gode Wind 1 and the British Burbo Bank Extension for partners.”) whereas sales from wind energy has decreased by DKK 193 million ($ 27.5 million). This reduction in wind power sales was caused due to a reduction in Wind Energy Content by 7 percentage.
The point I am trying to get across here is that, when a company plans to invest only in wind energy, it is essentially being more vulnerable to change in revenues that could possibly arise due to variability associated with wind power. Another risk I foresee is a scenario when there is an excess generation of renewables at a particular location, it could lead to getting no return or even negative returns in the worst case scenario.
All data and pictures have been taken from DONG Energy's website
My main concern here is that you haven’t maintained focus w.r.t. your main point. The point is that brown companies are doomed if they try to become green. But your argument isn’t convincing. You examine a measure of earnings and tell us that it has increased a lot. How does this convince me of your point? You discuss some reasons for the behavior of earnings, but this discussion doesn’t do the job in terms of convincing me that Dong’s strategy is a bad one. You close by telling me a story about vulnerability to a single, variable source of generation, but this argument seems orthogonal to your facts. I appreciate the effort, but I must say that this is a weak post. Suggestion: is Dong doing well or badly? Overall. What do people think about their growth strategy? Figure this out … you don’t need all the financial statement stuff … and tell us the answer and whether or not you agree. Keep it simple.
ReplyDeleteFinally, note that it is problematic to look at the level of earnings (EBITDA). Big companies tend to have big earnings. So it’s hard to learn much about how a company is running its business by looking at earnings, in-and-of-itself. This is why we typically scale by something from the balance sheet, like assets, or market cap, or enterprise value … etc.. A firm with a big EBITDA/Assets ratio is earning a lot of $$ with relatively few assets. Good! (this is like ROA). It is important to scale things to account for size.
Grading Rubric (badly formatted because comments don’t allow formatting)
Possible “grades:” Excellent (E), Very Good (VG), Good (G), Could be Better(CBB)
Takes a clear position: G
Substantiates the position: CBB
Informs the casual reader: CBB
Clarity/quality of exposition: G
I appreciate that your group focused on a topic and has analyzed specific companies on the topic. However, I believe that the position you presented in this post is not strong enough. To state that you will be taking a similar approach as your teammate, but for DONG Energy instead of NRG is not sufficient as they are different companies with different strategies. Most importantly, the evidence you provided did not help support your position that diversifying into green energy may not be in the best interest of the company.
ReplyDeleteYour finance argument did not support your position. EBITDA is not an appropriate measure and the decrease in sales of power is not significant. Furthermore, revenue from construction contracts are important and demonstrate growth of the firm as it plays a key role in the ability to finalize critical projects. Ultimately, I would like to emphasize the importance of taking risks in any business. Looking at DONG Energy strategy, it is clear that their strategic decision is to be a global leader in renewable energy. To accomplish this, the DONG Energy must undertake a comprehensive transformation of their business. DONG Energy has gone from being one of Europe’s most coal-intensive utilities to pursuing renewable energy.
http://assets.dongenergy.com/DONGEnergyDocuments/com/Investor/Annual_Report/2015/managements_review_en.pdf