Doosan Heavy: The trouble with national champions
The company has not reported net profits since 2013, the same year that revenues began to shrink, says Melissa Brown, IEEFA’s Director of Energy Finance Studies, Asia
If you spent a day on Doosan Heavy’s website, you could be forgiven for coming away with the impression that the company is in good health. This is a proud company that embraces the vocabulary of leadership in global power and water markets, but for investors nursing losses of 77% over the past five years, Doosan’s challenges are more obvious than its strengths.
Global investors are well aware that leading power equipment companies have been struggling. Whether it be Siemens, GE, or Mitsubishi Heavy, the clean energy transition has exposed the habits of global leaders accustomed to protected markets that are now embracing the new economics of clean power.
Investors in Doosan Heavy now face some painful choices. Although the company talks about making “a shift” in their business portfolio, the new strategy relies heavily on continued preferential market access at home, subsidized research and development (R&D), and generous financial support for projects overseas. This may give investors some breathing room, but when a company’s fundamentals have broken down, the only question is not its glorious past, but whether it will deliver value in the future.
In Doosan Heavy’s case, anyone committing capital should be prepared to ask three hard questions that go to the heart of the company’s financial outlook.
WHEN WILL DOOSAN HEAVY’S CAPITAL STRUCTURE STABILIZE?
Analysts are no longer surprised that Doosan Heavy’s operating results are very weak. The company has not reported net profits since 2013, the same year that revenues began to shrink. Despite a modest rebound in 2018, Doosan Heavy’s revenues have fallen 30.6% over the past six years, reflecting a long‑term decline in orders as new technology and market trends have transformed the power equipment market. Based on 2019 data available so far, weak orders and financial losses continue to be the norm despite one-off project wins.
With its debt at three times the value of its investors’ shares (equity) and operations losing money in 2019, the big risk is Doosan Heavy’s unstable capital structure. This is a debt-laden company with weak cash flow to put up against significant refinancing obligations in 2020 as it must repay 709.0 billion South Korean won (US$597.8 million) in bond debt. The company has in the past relied on government guarantees from the Export-Import Bank of Korea (KEXIM) and the Korean Development Bank (KDB) to issue US$ bonds offshore.
Meanwhile, at home, Doosan has been forced to rely on highcost asset-backed funding strategies including the securitization of project receivables. This is a risky trade that may solve current cash flow problems while making long-term financial problems worse.
The company’s third quarter 2019 results highlight the seriousness of near-term liquidity risks, as the mix of short-term versus long-term debt rose from 50.2% at the end of 2018 to 74.6% at the end of September. This is a sign of stressed credit fundamentals that could increase the urgency of asset sales, enhanced credit support, or recapitalization.
HAS THE COMPANY’S R&D BEEN PRODUCTIVE?
Doosan Heavy’s weak order book, patchy cash generation, and financing problems are, in some ways, old news. The question now is whether Doosan Heavy has the technology and resources needed to be a viable competitor in the new era of clean power. Although the company clearly misjudged the pace of change in energy markets, it has maintained steady R&D investment totaling 942.6 billion South Korean won (US$794.8 million) over the past five years.
But has management chosen the right technologies to focus on, and will this R&D investment deliver high value sales soon enough to generate the cash needed to stabilize the company? It frames the issues this way:
Recently, interest in environmentally-friendly power generation is increasing as a solution to the problem of CO2 emission and fine dust reduction which are emerging as a global problem. As a result, Doosan Heavy Industries & Construction has selected gas turbine as the key future growth engine of the company and expects to increase the market demand for combined-cycle power plants.
The domestic rationale for Doosan Heavy’s investment was set in motion in 2013 when the company joined a government-funded effort to develop a 270-megawatt (MW) gas turbine with a larger turbine to follow. The company hopes it will be on the inside track to displace foreign competitors in the Korean market once it has a fully certified turbine to offer.
Unfortunately for investors, Doosan Heavy’s move into the combined-cycle gas turbine market raises more questions than it answers. The company’s gas turbine is not expected to be ready for market until 2022, a timeline that does not favour the company. Despite the fact that Asia features strongly in gas growth scenarios, there is also a risk that optimistic forecasts may be undercut by the growing competitiveness of renewables plus storage alternatives. While import substitution may provide a protected home market, competition in open markets will be tough against seasoned competitors such as Siemens, GE, and Mitsubishi Heavy who are the recognised global market leaders in gas turbines.
Doosan Heavy has also looked for ways to revive its nuclear fortunes by investing US$40 million in NuScale Power—a U.S.-funded small modular nuclear reactor company that hopes to develop a new market niche. Doosan plans to collaborate with NuScale on manufacturing and market development as well. While new nuclear technologies are a hot topic, there are two negatives for Doosan Heavy in the medium term. First, the NuScale collaboration is not expected to result in a marketable product until 2025 at the earliest. Second, it’s not yet possible to evaluate what benefits Doosan Heavy may realize if NuScale’s technology makes it to market.
In other innovative parts of the power equipment market, it is notable that the company has yet to establish a meaningful foothold outside Korea. This is particularly obvious in the wind power market. Although Doosan Heavy has claimed a leading engineering, procurement and construction (EPC) role in the domestic wind market, it is not a globally competitive renewable equipment manufacturer and remains reliant on partners such as American Superconductor (AMSC) for high-value electrical control systems.
HOW SHOULD MORAL HAZARD BE FACTORED IN?
Doosan Heavy is not alone in failing to grasp the significance of the energy transition. Many power companies and their suppliers are restructuring to stay afloat. The question now is, who should pay the price for Doosan Heavy’s lack of foresight?
Equity investors have lost confidence in the company’s stock which now trades below 6,000 won (US$5.13) per share. Fixed income investors may stay at the table a while longer if they are offered added yield, but only as long as South Korean government guarantees are available to stabilize the balance sheet. In the meantime, foreign power companies are also willing to do business with Doosan Heavy on the condition that Doosan brings large amounts of government-supported concessionary financing to the project—often for fossil-fuel projects that other lenders will not touch.
The problem here for taxpayers is obvious. Borrowers and buyers don’t do business with Doosan Heavy on its merits; they do business with Doosan Heavy because it can extract subsidies from the Korean government.
And Korean taxpayers face one final problem. Not only are they subsidising Doosan Heavy’s funders and foreign buyers, they are almost certainly paying something other than a competitive market price for electricity at home. Even a cursory reading of the company’s plans for gas turbines suggests that it expects to own the Korean market. At a time when energy transition globally is leading to a new focus on price transparency and competitive auctions, managed power markets with legacy vendor preferences cannot be expected to capture real value for consumers.
The point for Doosan Heavy investors is that moral hazard situations are a natural by-product of this type of market intervention, and they result in unstable outcomes. After all, governments change, new technology disrupts markets, and public preferences shift, sometimes in very unexpected ways that cause long-lasting damage to public institutions.
Are the government and Korea’s leading financial institutions prepared to take responsibility for tilting the odds in Doosan Heavy’s favour? If investors are still waiting for an answer to that question, it may be time to run for cover. Support for the home team may help Doosan Heavy survive this year, but it is unlikely to result in the type of leadership that would enable the company to compete and win without taxpayer support. If Korean policymakers are pondering this question, it may be time for them to look at a recent Asian case study that investors certainly remember—the recent failure of Singapore’s Hyflux.
Melissa Brown (email@example.com) is IEEFA’s Director of Energy Finance Studies, Asia