Turbulent times impacted Verdo’s results in 2022 – positively and negatively

by CFO Kenneth R. H. Jeppesen

2022 was marked by a series of unusual, almost extreme, events. In February, Russia attacked Ukraine in a war that has since led to major impacts on Europe. The war, the aftermath of a global COVID-19 pandemic and pressure on logistics chains all contributed to what is often called an ‘energy crisis’.

In parallel with the energy crisis, and partly fuelled by it, significant inflation was seen for the first time in many years, which also led to rising interest rates over the year.

Despite these extreme events, the Danish and European economies have performed surprisingly well. Unemployment remains very low, and many sectors are seeing skills shortages. Demand has not fallen as much as one might expect given the crisis and inflation, but energy consumption in Denmark has dropped significantly for private households (around 10 per cent compared to previous years). We have also felt this at Verdo.

Earnings

Verdo was highly impacted by the above factors in 2022, positively and negatively. Energy prices soared during the year, peaking in the third quarter. Group revenue was DKK 5.4 billion and operating profit (EBITDA) was DKK 409 million. Both are much higher than in previous years and than budgeted.

Profit after tax for the year was DKK 238 million.

The result is primarily due to Verdo Trading A/S having an exceptionally good year, with high demand for wood pellets and carbon products, and gains in Verdo Produktion A/S, where our power plant had record earnings on electricity production.

Conversely, Verdo Teknik A/S has been under pressure from the market situation. Prices of almost all commodities rose dramatically, and the municipalities (our street lighting and traffic light customers) did not receive more money despite this inflation. We therefore saw a large drop in orders, and thus in revenue and earnings.

Verdo Energy Systems A/S had a year with low activity, but very high sales. We therefore expect some years with higher revenue for Verdo Energy Systems A/S after a number of difficult years.

Despite soaring electricity prices – or perhaps because of these – Verdo Go Green A/S had a challenging year. Many private customers chose to switch from fixed-price to variable-price electricity.

The balance sheet was reduced following the divestment of Verdo Tele, completed in 2022. Conversely, equity and solvency increased after a profitable year. Equity is now DKK 907 million and the solvency ratio is 30 per cent. Both are pleasing developments.

Commercial and regulated business

Operating profit (EBITDA) in Energi & Forsyning – the Group’s regulated areas – was DKK 295 million, while the commercial areas – Verdo Trading A/S, Verdo Energy Systems A/S, Verdo Teknik A/S and Verdo Go Green A/S had EBITDA of DKK 169 million.

Overall, the regulated and commercial business areas both performed better than in 2021, and better than budgeted. The conclusion is thus that the extreme fluctuations in the economy and energy markets have had a positive effect on the Verdo Group.

The solvency ratio for the regulated companies is 25 per cent, while it is 48 per cent for the commercial companies (which are subject to competition).

Impact of high energy prices

While the high prices for energy and commodities have contributed very positively to the Group’s revenue and earnings, they have also affected working capital. Working capital has been very high at times during the year. This is particularly because Verdo Trading A/S and Carbon Partners AS both handled large contracts, as did Verdo Go Green A/S. The high prices in these meant that the Group’s working capital has been significantly higher than before.

Verdo has good management of liquidity and working capital. It has therefore been possible to expand the Group’s credit facilities as necessary. These expansions have given Verdo the necessary liquidity to act on all interesting contracts in the market. This has clearly demonstrated the strong and trusting partnership with the Group’s banks. All credit lines have now been normalised.

Four old heating cases resolved

Immediately after year end, Verdo agreed with the Danish Utility Regulator to adjust heating prices by a total of DKK 65 million. This is due to taxes that were included in heating prices as a result of the amounts Verdo wrongly charged consumers in earlier years. It must now be agreed with the Danish Utility Regulator when and how quickly to return the DKK 65 million to heating customers in Randers. Provision has been made for the amount in the annual accounts. The decision brings a final end to four old cases in Verdo Varme A/S and Verdo Produktion A/S.

A few enquiries were received during the year, but no new cases have arisen for which refunds are expected. The provision made in 2021 in Verdo Produktion A/S for the period prior to 2010 and the provision for energy saving measures in Verdo Go Green A/S are therefore the only matters yet to be decided. There has been good dialogue with the Danish Utility Regulator.

The water tariffs in Verdo Vand A/S from 2020 until now were finally approved in 2022 without any corrections. The water tariffs are therefore deemed to be resolved.

Verdo is very pleased to have resolved the old cases, as they negatively affect both our customers and the Group. We are working actively with all authorities to resolve the last outstanding issues.

Uncertainties regarding recognition and measurement

Return on invested capital in the 2000–2009 period for Verdo Produktion A/S.

Back in 2021, when the Group’s production company was investigating similar matters for the 2010-2017 period, indications were found that Verdo Produktion A/S had recognised a return on invested capital of up to DKK 69 million during the 2000-2009 period. It has not been possible to identify a direct legal basis for recognising this return, and discussions have therefore been initiated with the Danish Utility Regulator concerning the matter.

Discussions have continued throughout 2022, but it is still unknown when they are expected to be concluded. Verdo Produktion A/S has therefore continued to recognise the provision made in 2021, corresponding to the entire identified return on invested capital.

Output model

The Danish Utility Regulator contacted the Group in 2021 about the sector’s usual method for allocating costs between electricity production and heat production – the ‘output model’.

The Group is still in dialogue with the Danish Utility Regulator about the use of the model. At present, it is not possible to assess whether this enquiry may result in financial consequences for the Group.

Interest on external credit union loans

The Group received questions from the Danish Utility Regulator in 2022 regarding the inclusion of interest in price demonstrations in the Group’s production company. The discussions concern interest on loans taken out by Verdo Produktion A/S with external credit institutions, as a result of a change in practice in the calculation of interest in the price demonstration in 2018.

The Group deems that the change in the practice of Verdo Produktion A/S is correct, and the interest can be seen as a necessary cost and thus included in the share of heat production. At this stage, it is not possible to assess the potential accounting implications or when the discussions are expected to be concluded. This has therefore not been recognised.

Events after the accounts were closed

The war in Ukraine continued into 2023, and there are currently no indications when it will end. This has led to greater volatility in both market prices and interest rates than we have seen for many years, and this is set to continue. There is consensus that interest rates will be generally higher than in previous years, and this will affect the Group’s credit arrangements.

However, Verdo is in a strong position to handle these fluctuations, as the financial leverage (ratio of earnings to interest-bearing debt) is significantly lower than in previous years, and the debt is generally decreasing. Financial leverage of 0.4 is very satisfactory and far below our target.

After the end of the financial year, we saw a marked drop in energy prices – particularly for electricity, gas and wood pellets – while wood chips continue to trade at high prices. This had a big impact on earnings in the first months of 2023, when it was necessary to sell some products at a loss.

We expect earnings to be below the 2023 budget level given the falling energy prices. This also means earnings that are significantly lower than in 2022.

Overall, we are satisfied with the changes in the Group’s operations, performance and ratios, and we expect to continue implementing our ‘StepTogether’ strategy in the coming years.

Calculation of ratios

Ratios have been calculated based on the Danish Finance Society’s recommendations, and definitions are stated in the accounting policies. Annual revenue and ratios have been calculated after adjustment for special items (see note 3, page 93 of the financial statements).