Windar Photonics — Retrofit activity driving growth in the short term

FY18 revenues increased by 58% year-on-year to a record €3.5m (in line with our estimate) despite supply chain issues, which have now been resolved. Gross margin rose by 8.9pp to 50.2%, reflecting the full year benefit of the second-generation LiDAR, which was released in early FY17. Administrative costs (excluding amortisation and depreciation) decreased by €0.3m to €2.1m despite the impact of the new sales and service office in China, investment in wind analytics software and support for OEM turbine integration. This demonstrates the beneficial effect of cost-saving initiatives in FY17. The combination of higher revenues, better gross margin and reduced operating costs enabled Windar to get substantially closer to its goal of reaching break-even. EBITDA losses (excluding warrant costs and exceptional items) narrowed from €1.2m to €0.3m (also in line with our estimate).

As noted above, the increase in revenues helped cut EBITDA losses to €0.3m. The beneficial impact on cash flow of higher revenues could have been wiped out by higher levels of trade receivables, but the invoice discounting arrangement meant that the increase in trade receivables was only to €0.3m and the €0.6m decrease in trade payables actually had a more marked impact on cash flow. The decrease in trade payables arose because levels were unusually high at the end of FY17 and returned to normal during FY18. Investment in capitalised R&D (net of grants) was higher than FY17 (€0.3m vs €0.2m). Free cash outflow was almost double at €1.3m. This was offset by a subscription in the summer, which raised £2.2m (gross) at 82.5p/share. Net cash (excluding restricted cash and Growth Fund Loan) increased by €0.6m during the year to €1.7m at end FY18.

Since the company has yet to announce that an OEM is going to integrate Windar’s LiDAR into new turbines, we model a cautious approach to OEM adoption, with minimal revenues from this segment in either FY19 (where our estimates are unchanged) or FY20. This is despite the news that the world’s largest new wind farm in China, with 1,440 turbines planned, stipulates deployment of LiDAR meeting Windar’s specification on each turbine. Management believes that it has the only solution meeting the technical specification and desired price-point because it uses solid-state lasers. Moreover, several OEMs that have been working with Windar on direct integration of LiDAR will be supplying turbines for this project. The project is scheduled for completion by the end of 2020, which means the first LiDAR units will need to be delivered in early FY20 so that they can be integrated into turbines prior to installation and commissioning at the wind farm. Management is consequently confident that multiple turbine OEMs will eventually adopt the technology; the uncertainty is whether this will happen in FY19 or FY20, with timing dependent on how quickly each OEM completes its internal certification process. We will revise our estimates when Windar announces certification of the first OEM integration.

Our revenue projections therefore focus on the retrofit market. We assume that the Chinese distributor that placed the order for 300 units in December 2017 places a follow-on order of similar size to the first one later this year to satisfy demand for retrofit installations in the country and that the Vestas relationship begins to convert interest from wind farm operators in North America into orders during H219. This is more likely following the appointment of a sales manager in April 2019 to nurture the Vestas relationship. The Vestas activity is currently focused on two specific projects in the US with a collective estate of over 300 turbines. One of the independent power providers (IPPs) involved operates a further 900 turbines in North America. Based on these assumptions we model deliveries of c 500 LiDAR units in FY19 compared with an estimated 300 units in FY18, rising to c 850 units in FY20. This generates 71% revenue growth in FY19 and 35% in FY20.

In June 2018 Windar signed a global distribution agreement with wind turbine manufacturer Vestas Wind Systems. Following this, Vestas has begun to market and sell Windar’s two-beam LiDAR system as a retrofit aftersales solution to the wind industry. This was an exciting development for Windar because Vestas is the largest maintenance provider in the industry. It has more than 78GW of assets under service, of which more than 8GW are non-Vestas turbines. According to Global Wind Energy Council statistics, 78GW is 13% of the global cumulative installed wind capacity. Assuming an average turbine size of 2.5MW, this 78GW represents around 31 thousand turbines. The agreement is consistent with the strategy adopted in 2016 of using external distribution partners in retrofit markets. It connects Windar to a service network of more than 10,000 people in 63 countries.

In April 2019 Windar entered into an exclusive agreement with the Technical University of Denmark (DTU) to incorporate software from DTU that can deliver extreme load reductions on turbines of 5–10% and thus increase the expected operational lifetime of a turbine by the same amount. This improvement can be achieved without requiring changes to be made to existing controller systems. Windar anticipates that the new software will be launched during 2020, complementing its existing yaw alignment optimisation technology.

Since there remains considerable uncertainty on when volume sales to OEMS are likely to begin, and these could be at least as large as retrofit sales, we continue to present a scenario analysis rather than a formal DCF-based valuation. This analysis shows what revenues and profits could look like at different levels of market penetration, without being specific as to the year in which the company will reach that level. Noting that management’s stated targets for penetration of the retrofit and OEM segments are 2% and 33% in 2021, respectively, we adopt these levels as the higher bound of our analysis (Exhibit 1). For the lower bound of our analysis, we adopt the level of market penetration, ASP, gross margin and operating costs used in our FY19 estimates, while excluding £150k interest as we have no visibility of what this could be in future years. The rate of growth required to meet management’s stated target is substantially higher than the growth profile adopted in our estimates, which model segmental penetration of 0.3% (retrofit) and 0.1% (OEM) in FY20.

The retrofit section of our analysis assumes that a meaningful percentage of existing turbines will be equipped with Windar’s LiDAR over time. This can only be achieved if wind farm operators move to a ‘one turbine per LiDAR’ methodology, using LiDAR to increase power output and turbine lifetime as well as reducing maintenance costs. Windar is well placed to benefit from this trend as it is the only established company (two Chinese companies recently entered the market) able to offer systems at a cost-point where it is possible to mount LiDAR on individual turbines to give real-time monitoring of the speed and direction of incoming wind. Moreover, it is already in trials with the majority of wind turbine OEMs and has access to 14% of global installed wind capacity through its distribution agreement with Vestas Wind Systems. There is no certainty in the retrofit sector either of when widespread deployment will commence. The order for 300 units received in December 2017 indicated that the industry was beginning to adopt the methodology, but since the supply chain issues affecting FY18 have meant that there are a few of these 300 units still to be shipped, there have been no follow-on orders to confirm that the transition to volume deployment will be sustained. The agreement with Vestas has yet to have a material impact on revenues. However, the fact that the tender for the largest wind fam in China so far specifies one LiDAR per turbine is a good indication that this methodology has started to be adopted.

With regards to direct integration by OEMs into new turbines, once one OEM starts to offer turbines with integrated LiDAR, it is highly likely that others will follow so they too can offer equipment with enhanced efficiency and lifetime.

At present, Windar is trading on prospective multiples that are in keeping with a company on the cusp of profitability, with FY19 EV/sales of 3.4x and P/E of 123x. Once the company starts to report further sizable orders in the retrofit market or its first OEM integration, this will demonstrate to investors that it can potentially achieve its market penetration goals. The profits that may be realised in this event are shown in Exhibit 2. Applying even a modest 10x P/E to the profits achievable from either a 1.0% penetration of the retrofit segment or 5.0% penetration of the OEM segment (both of which are lower than management’s stated target) would justify a share price substantially higher than the current level.