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  1. 1. Solar-power industry Power up – the sun has come out September 2006 Pranab Kumar Sarmah, CFA Tel: (852) 2848 4441 E-mail: Daiwa Securities SMBC Hong Kong Limited Daiwa Institute of Research (H.K.) Ltd
  2. 2. Contents Why the solar industry? How to reap the benefit from this high growth industry? What should be the right valuation? Share-price drivers Supply-chain timing: likely to provide additional alpha Secular growth in the renewable-energy industry Demand drivers for solar-power systems Supply chain – benefiting from strong demand Silicon – shortage should be over in 2008 PV cells – cost and new technology is the key PV modules – advantage of being near to end-market will disappear Systems assembly – fragmented and close to end market Materials other than silicon – low risk of tight supply Capital investment in the supply chain- moderate to low Market forecast: annual revenue growth to exceed 25% Highlighted PV-cell companies Kyocera (6971 JP) – Silicon shortage to limit growth of the solar-energy business Motech Industries (6224 TT) - Banking on production efficiency Sanyo Electric (6764 JP) – Concern persists in terms of profitability Sharp (6753 JP)- Solar-power business will be the next growth pillar SunPower(SPWR: NASDAQ) – Technological strength in the area of high-efficiency PV cells Suntech Power (STP; NASDAQ) – Vertical integration to pay off from 2008 Regional top-pick idea 2
  3. 3. Why the solar industry? Sustainable high-growth prospects PV cells: 2005-2010 volume growth: 5.6x, CAGR of 41%, annual market size 8-9GWp by 2010 PV systems: 2005-2010 revenue growth: 3.4x, CAGR of 28%, revenue to exceed US$25bn in 2010 from US$7.6bn in 2005 PV cells: 2005 to 2010 revenue growth: 3.6x, CAGR 29%, revenue to reach US$11bn by 2010 Solar grade silicon: 2005-2010 revenue growth: 3.8x, CAGR 30%, revenue to reach US$2.6bn by 2010 Ample opportunity for growth beyond 2010 as solar power will account for only 0.25% of electricity production globally by then. Entry of Asian suppliers may lead to upside surprises for volume growth – potentially faster-than-expected cost reductions. Investment indicators turning positive for the solar industry, especially for PV-cell makers sector valuations are approaching an attractive level (a 31x PER on our FY06 forecasts) given the 24% correction in our newly- introduced ‘Solar Index’ since May 2006 the prospects for improved silicon supply in 2007 are getting better we expect PV-cell ASPs to remain firm for a few quarters due to large order backlogs the risk of share-price drivers diminishing has declined as oil prices have fallen already and the interest-rate-hike cycle has slowed Silicon shortage should be over by 2008 – solar grade silicon production to reach 42,000 tons by 2008, up from 13,000 tons for 2005, and supply to exceed demand marginally that year. Profit margins for cell makers will remain healthy for the next few quarters. A portfolio approach is recommended for this high-beta industry – We recommend that investors build up core holdings in strong PV-cell makers now and shift a portion of their portfolios from silicon makers to equipment makers next year. We initiate coverage of the largest Taiwanese PV-cell maker, Motech (6244 TT), with a 2 (Outperform) rating. Target price-NT$630 We initiate coverage of Chinese integrated PV-cell maker, Suntech Power (STP US), with a 3 (Hold) rating. Target price-S$27 We reiterate our 2 rating on Kyocera (6971 JP), as we believe the stock is undervalued We are positive on Sharp (6753 JP)’s PV-cell business, but cautious about others. We have also put crystalline PV-cell technology leader SunPower (SPWR US) on our watch list. 3
  4. 4. Valuations of highlighted stocks Company Price Local Mkt cap Ticker Target Net mgn Op mgn ROA ROE PER (X) PBR PSR CCY (19/9) (US$ m) Rating price (%) '05 (%) '05 (%) '05 (%) '05 05 06F 07F (X)'05 (X)'05 Motech Industries 6244 TT 507 2,174 2 630 26.0 27.9 35.8 46.3 59.1 30.2 15.3 28.1 15.4 Suntech Power STP US 26 3,872 3 27 13.6 18.9 6.4 7.6 84.7 39.8 27.1 6.0 10.7 Sunpower Corp SPWR US 29 2,015 NR n.a (20.1) (16.5) (5.0) (6.1) n.a 66.5 37.5 6.9 8.7 Kyocera Corp 6971 JP 9,990 16,264 2 n.a 5.9 8.7 3.6 5.1 26.9 20.6 19.8 1.5 1.6 Sharp Corp 6753 JP 2,105 19,896 3 2,000 3.2 5.9 3.5 8.1 26.0 23.0 21.1 2.1 0.8 Sanyo Electric 6764 JP 248 3,951 NR NA (26.7) (3.0) (27.3) (87.3) n.m. n.a 28.8 4.1 0.3 Weighted Average 49.2 36.0 24.9 8.1 6.2 Source: Companies, Daiwa Risk factors to consider Demand-specific risks Potential cuts in government subsidies government-subsidy programmes are difficult to change once implemented supporting green energy/solar power has become an political issue, as it generates employment Volatility of oil/coal prices Rising interest rates Supply-specific risk Raw-material shortages Many new entrants due to low entry barrier in solar-cell production Production risk due to low inventory is declining Inventory levels among PV-cell makers have been rising since 1Q06 A sudden surge in demand from the electronics industry may hurt the solar industry Technology risk – New disruptive technology may change the industry 4
  5. 5. How to reap the benefits from this high- growth industry? Key solar-power related companies by market cap A few mid-cap stocks in the solar-power area Kyocera Corp MEMC Electronic Materials Inc Introducing Daiwa’s Solar Index Renewable Energy Corp AS Suntech Power Holdings Co Ltd Since the beginning of 2005, the index is up Tokuyama Corp 33% and 22% YTD. Q-Cells AG Solarworld AG High volatility – a portfolio approach is Motech Industries Inc Sunpower Corp recommended. Conergy AG E-Ton Solar Tech Co Ltd Evergreen Solar Inc Solon AG Fuer Solartechnik US$bn Sunways AG 0 3 6 9 12 15 18 Source: Bloomberg; Daiwa Daiwa’s solar index 220 Companies’ includes 220 Comparison with other indices ConergyAG 200 200 MEMC Electronic Materials Inc 180 Motech Industries Inc 180 Q-Cells AG 160 Renewable Energy Corp AS 160 Solarworld AG 140 Sunpower Corp 140 Suntech Power Holdings 120 Tokuyama Corp 120 100 100 80 80 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Solar Index Nasdaq SOX Global Energy Index Solar Index Source: Bloomberg; Daiwa Source: Bloomberg; Daiwa 5
  6. 6. Share-price drivers Changes in government policy and Solar index vs. oil price Solar index vs. silicon price raw-material price/supply trends will 220 (US$) 80 220 (US¢/pound) 83 be key share-price drivers 200 75 70 200 81 79 180 180 Consistent but statistically 160 65 60 160 77 75 insignificant relationship with silicon 140 120 55 140 120 73 71 price increase 100 50 45 100 69 67 Oil prices and interest rates 80 40 80 65 Jan-05 Sep-05 Nov-05 Jan-06 Sep-06 Jan-05 Sep-05 Nov-05 Jan-06 Sep-06 Mar-05 Jul-05 Mar-06 Jul-06 Mar-05 Jul-05 Mar-06 Jul-06 May-05 May-06 May-05 May-06 risk is already known, however, no Solar Index (LHS) Oil Price (RHS) Solar Index (LHS) Silicon spot price (RHS) correlation with oil price YTD. No significant correlation with the Solar index vs. Taiwan solar sales trend for the industry Solar index vs. Fed fund rate related co’s monthly sales we expect the correlation to (%) (NT$m) increase once the industry 220 200 5.5 5.0 1,200 1,000 220 200 increases in size and more 180 4.5 4.0 800 180 160 investors pay attention to the 160 140 3.5 3.0 600 140 400 industry’s fundamentals 120 2.5 2.0 200 120 100 100 1.5 0 80 80 1.0 Apr-05 Apr-06 Jan-05 Feb-05 Mar-05 Jun-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Feb-06 Mar-06 Jun-06 Sep-06 May-05 May-06 Jul-06 Jan-05 Sep-05 Nov-05 Jan-06 Sep-06 Mar-05 Jul-05 Mar-06 Jul-06 May-05 May-06 Taiwanese solar related companies monthly sales (LHS) Source: Companies, Daiwa Solar Index (LHS) Fed Interest Rate (RHS) Solar index (RHS) 6
  7. 7. What should be the right valuation? We think earnings-based valuation is more appropriate than asset- Valuation comparison with other high- backed valuation growth sectors Despite a share-price correction in 2Q06, solar-related companies are trading at an FY06F PER (x) US high growth Cos average FY06F PER of 29x vs. 14.9x for S&P (based on IBES consensus forecast). 40 Asian high growth Cos Supply chain is low to moderate capital intensive and high growth expectation, 35 (employee bonus adjusted) therefore PER and PEG ratios are important. Solar sector A sum-of-the-parts (SOTP) valuation method may be applied to multi-product 30 companies that derive a portion of total earnings from solar power related Asian high growth 25 business Cos Comparison with other high-growth companies 20 Discounted cash flows? 40% 45% 50% 55% 60% 65% 70% 75% EPS CAGR (05-07) Source: IBES; Daiwa Required PER PER (x) Risk-adjusted PER (x) @10% discount rate Risk adjusted PER (x) @ 15% discount rate 2006F 2007F 2008F 2009F 2010F 2006F 2007F 2008F 2009F 2010F 2006F 2007F 2008F 2009F 2010F 10 8 6 5 4 10 8 8 7 6 10 9 8 8 7 Attractive 20 15 13 10 8 20 17 15 14 12 20 18 17 16 15 30 23 19 15 13 30 25 23 21 18 30 27 25 23 22 40 31 25 21 17 40 34 30 27 24 40 35 33 31 29 50 38 31 26 21 50 42 38 34 31 50 44 42 39 36 Expensive Forecast: 2005 to 2010 volume growth: 5.6X, CAGR 41% 2005 to 2010 revenue growth: 3.4X, CAGR 28% 2005 to 2010 earnings growth: 3.0X, CAGR 25% Source: Daiwa 7
  8. 8. Supply-chain timing: likely to provide additional alpha Initial hype cycle 2004-2005 – Any solar-power-related stocks. Silicon shortage until 2007 – Positive for silicon and established PV-cell makers; negative for new entrants and panel/system integrators End of silicon shortage (after 2007) – Positive for equipment makers, panel makers, systems integrators; negative for silicon makers From 2010 – Game to start for winners and losers Investment timing 2006 2007 2008 PV-industry Neutral Positive Long-term positive statnce Earnings mometum Will continue to grow at approximately 25% CAGR De-rated due to Re-rating to a Valuations Re-rating supply conerns and Re-rating stops- normalized valuation assumptions normalized valuation high valuation Silicon Positive Neutral Cautious Supply exceed Balanced demand supply profit Earnings mometum Companies will continue to enhance profit margins due to price increase demand, ASP ane margin and ASP stabilizes margin drops Valuations Valuation re-rating, backed by earnings surprise No furtther re-rating De-rating PV-cell/module makers Neutral Positive Long-term positive statnce Margin to stablise - Earnings will grow due to volume increase. Margin decline due to raw material price Margin will improve, Earnings mometum incresaed long-term ASP to declining, margin to stablizes; focus hike, low upside surprise potential earnings accelerate supply contracts on new cell technology De-rated due to Gradual re-rating in the anticipation of ease Valuations Re-rating supply conerns and Re-rating stops- normalized valuation assumptions of materail supply and strong 2007 growth high valuation Equipment makers Neutral Positive Neutral Upside to earnings is low and cell makers are slow to add capacity Eranings will accelerate due to capacity Earnings growth to Earnings mometum due to supply shortage increase by cell makers normalize Re-rating will start in the expectation of Re-rating will stop as forecasted capacity Valuations No re-rating capex increase expansion to lose mometum Source: Daiwa 8
  9. 9. Screening of PV-cell makers Cost competitiveness – Motech and SolarWorld PV-cell makers – operating margins (2Q06) (%) have consistently maintained high operating 40 margins, followed by E-Ton and Q-cells. 35 30 Long-term material-supply and PV-cell sale 25 agreements – Established large players such as 20 15 Sharp, Q-cell, Suntech and Motech and vertically 10 integrated companies like REC and ErSol 5 0 Ability to commercialise new technology – Q-cell SolarWorld SunPower E-ton Kyocera* Sharp* ErSol Motech SunTech Sanyo* Q-Cells and Sharp are leading the race, followed by Kyocera, ErSol & Suntech * For solar division Source: Companies; Daiwa Valuations at less than a 30x FY07 PER and high EPS CAGR – Apart from SunPower, all other PV- PV-cell makers – PER and EPS CAGR ranking cell/module makers are trading at below a 30x (x ) (%) FY07F PER. Motech, E-Ton, SunPower, SunTech 40 FY07F PER 100 EPS CAGR 05-07F and Ersol’s forecasted EPS CAGR (by Daiwa and 30 IBES forecast) is above 50%. 20 50 Sharp, Q-cell, Suntech, Motech and SolarWorld 10 meet our selection criteria 0 0 SolarWorld Suntech Sharp Ersol Qcell E-Ton* Motech* SunPower Sanyo SunPower Suntech Sanyo Kyocera Sharp Motech SolarWorld Ersol Qcell E-Ton * Adjusted with employee bonus Source: IBES; Daiwa 9
  10. 10. Secular growth in the renewable-energy industry We believe that demand for renewable energy will Breakdown of sources of energy (2004) continue to increase over next 10 years due to: Natural gas Neuclear Year 2004 6% Wind increasing environmental problems, 21% Hydro 2% 2% the need to diversify sources of energy, Waste/combustion 2% Solar Cude oil increasing prices of traditional fuel sources, such as oil, 38% 0% coal, natural gas, etc. Other 7% falls in the capital intensity of renewable-energy production equipment through economies of scale and Geothermal technological advancements, and Biomass 1% government incentives. Coal 4% 24% Source: IEA; Daiwa Renewable energy market share Power-generation cost (TWh) CAGR 2001-2020 (%) 10,000 Solar PV: 28% 40 (US¢/kWh) Wind: 22% Marine (tidal/wave/ocean) 9,000 45 Solar thermal: 20% 35 25-40 Geothermal 40 8,000 Geothermal: 10% 30 35 7,000 Biomass: 9% Solar-thermal 6,000 Small hydro: 9% 25 30 Solar PV Marine: 7% 25 5,000 20 Large hydro: 2% Wind 4,000 20 15 1-15 3,000 Small hydro 15 10 4-10 2,000 10 6-8 5-7 2-7 Large hydro 2-6 5 2-4 1,000 5 Biomass 0 0 0 2001 2010F 2020F Solar Biomass Wind Oil Geothermal Gas Nuclear Coal Source:EREC; Daiwa Source: IEA; Daiwa 10
  11. 11. Demand drivers for solar-power systems Demand for solar power is accelerated by: Energy production by source (crude oil equivalent) Risk management WW Latin America Energy sources need to be diversified Africa Ecological considerations EU15 Korea Reduction of carbon-dioxide missions is a China long-term issue – ‘Kyoto protocol’ Japan Between 2008 and 2012, Japan will try to Germany reduce CO2 emissions by 6%, the EU by USA 8%, and the US by 7%. 0% 20% 40% 60% 80% 100% Cost reductions Coal Crude Oil Gas Nuclear Hydro Geothermal, Solar, etc. Other Source: IEA Current simple payback period is 15 years in many countries NYMEX price trends for energy resources Financial incentives 150 130 110 90 70 50 30 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Crude Oil Gas Coal Source: Bloomberg 11
  12. 12. Demand driver – break-even cost analysis Prices of PV-systems have Production cost forecast Average retail electricity dropped by 40% and 20% over the (€/kWh) for solar energy (US¢/kWh) price past 10 years and five years, 1.2 Break-even point at high sun shine area 30 25 respectively 0.9 Break-even cost at low sun shine area 20 More cost reductions necessary 0.6 15 With an annual production-cost 0.3 10 reduction target of 5%, solar 5 energy would be cost competitive 0 0 South Korea Japan Germany China Italy Taiwan India UK US 1990 2000 2010 2020 2030 2040 for peak power generation in the Utility peak cost 2.5 hr/day 5 hr/day Bulk cost EU between 2010 and 2020. Source: EC Vision report, Daiwa Source: Compiled by Daiwa Module prices by region (per watt) Pay back period (Years) Payback periods (Years) Payback period 9 45 US$4/W 45 0% 8 40 US$6/W 40 5% 7 35 US$8/W 35 10% 6 30 30 5 25 25 4 20 20 3 15 15 2 10 10 1 5 Financing cost 5% 5 Installation cost= US$6/watt 0 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005P 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.20 0.25 0.30 0.35 0.40 0.45 0.50 US Japan (100Yen) Germany (€) Electricity cost (US$/KWHr) Electricity cost (US$/KWHr) Source: Company materials, compiled by Daiwa Source: Daiwa Sun hours = five hours per day; Service life = 10 years for invertors and five years for battery 12
  13. 13. Demand driver – financial incentives Four types of government incentives 1,800 Annual installed capacity trend (MW) Monetary grants 1,600 eg, in Japan subsidies of ¥90,000 per 1kW were granted in 1,400 2003, ¥45,000 in 2004, and ¥20,000 in 2005, In Germany, 1,200 schools are granted a maximum of €3,000for installing a 1,000 solar-power system. In California, US$2,800 per 1kW is 800 granted. 600 400 Tax benefits 200 Attractive to corporations and individuals that adopt the self- 0 return system. Types are: interest on loans for installing 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 solar system is tax-deductible, accelerated depreciation for Japan Germany US investment in solar systems,etc. Source: IEA, compiled by DIRA. Higher feed-in price for solar-generated energy This feed-in pricing system is popular in the US and Europe. Outline of national programmes by country Feed-in Rebates/ Investment Net Incentives are offered when solar power is sold to a utility Soft loans Tax tariff grants incentives metering Consumer Enterprise Consumer Enterprise Consumer Enterprise Consumer Enterprise company. In Germany, utility company pays three times the Germany Japan Ο Ο Ο Ο Ο Ο Ο Ο Ο Ο regular price for solar power. USA Australia Ο Ο Ο Ο Ο Ο Ο Ο Ο Ο Ο Ο Ο Austria Ο Ο Ο Low-interest loans Canada China Ο Ο Ο Ο Ο Ο Ο Ο This incentive is not very attractive because the immediate Denmark Finland Ο Ο Ο monetary benefit is not evident and interest rates currently France Ο Ο Ο Ο India Ο Ο Ο Ο Ο Ο are generally low. Israel Italy Ο Republic of Korea Ο Ο Ο Government incentives historically have had a significant Mexico Netherlands Norway Ο Ο Ο Ο Ο Ο impact Portugal Spain Ο Ο Ο Ο Ο Ο Ο Ο Sweden Government incentives are expanding worldwide Switzerland Ο 13 UK Ο Ο Ο Ο Source: Various materials, compiled by DIRA
  14. 14. Supply chain – benefiting from strong demand The silicon-based supply chain is the most Silicon based solar energy system supply chain Silicon W afer Solar Cell M odule System Installations prominent supply chain this decade Ticker Silicon-based products accounted for 91% of total PV market, while thin-film (including a- Si) based products accounted for just 9%. (Photo) (Photo) (Photo) (Photo) Hemlock Private/US 4043 JP Supply-chain activities involved: Tokuyama M itsubishi M aterials 5711 JP W acker W CH GR Collection of high-grade silicon M EM C W FR US SUM CO 3436 JP Processing of the silicon for actual use, ie, M . Setek Private/ Japan wafers PV Crystalox Solar AG Private/ Europe JFE Private/Japan REC NO Adding the functions of the PV cell REC ErSol ES6 GR SolarW orld SW V GR PV-module making Schott Solar Private/ Germany BP Solar 5051 JP Systems makers/installers. Yingli Solar Private/ China (IPO lis Kyocera 6971 JP There are over 500 companies globally Q-Cells M otech Q CE GR 6244 TT involved in the various processes throughout E-ton 3452 TT the supply chain of the PV industry. SunPow er SPW R US Suntech STP US Sharp 6753 JP Sanyo 6764 JP M itsubishi 6503 JP Sunw ays Photovoltaic SW W GR Evergreen ESLR US Solon SOO1 GR Aleo AS1 GR Tenesol Private/ France IBC Solar AG Private/ Germany Concergy CGY GR SAG Solarstrom SAG GR Phoenix SonnenStrom AG PS4 GR Source: Daiwa Sunset Solar Private/ Europe 14
  15. 15. Important supply-side trends Vertical integration versus horizontal-expansion model We think the vertical-integration model has more long-term merits – Due to the high material content (comparable to TF-LCD industry), the focus of the PV systems supply chain will be on reducing materials/component use, and vertically integrated companies will have advantage here. Industry fragmentation in the mid-stream process We expect industry fragmentation in mid-stream processes to accelerate from 2008 once sufficient raw materials are available. The focus after an increase in silicon supply will be supply and demand for materials other than silicon, and demand for production equipment. New technologies The focus is on new PV-cell technology now and new systems design in the long term Average operating margins Typical cost structure of solar systems (%) 15% Polysilicon 60 Silicon 30% Solar 9% Ingot growth wafer wafer Solar 4% Sawing 46% 50 Cell Cell 7% Others Module 66% Solar 40 Module 16% Others + Labor Solar 30 System 13% Others 20 7% Packaging 10 20% Installation 0 8% Inverter 2004 2005 2006 15 6% Others Source: ITRI Source: Daiwa
  16. 16. Important supply-side trends Technology-driven cost-reduction plan and market potential Increase in system size Cost of power generation > 50 US cents/ Shift from standalone to integrated systems kWh Systems with power storage capability System design Component systems System development to improve independence 26 US cents/KWh Active network Appearance of thin- control film/compound semicon solar cells 20 US cents/ kWh New materials 12 US cents kWh for sharp cost Focus on Cell design/processto cut cost reduction Efficiency improvement with Cell ultra-thin films /multi-junction 6 US cents/ kWh technology cells New materials (dyes etc); new cell structures New material Thin film/compound semi Cystalline Silicon Market potential Year 2002 2007 2010 2020 2030 Source:NEDO; Daiwa 16
  17. 17. Silicon – shortage should be over in 2008 Silicon production was not able to keep pace (MWp) Solar grade silicon supply and demand with PV-cell production due to: 8,000 7,000 the high process entry barrier to the industry, 6,000 longer production ramp-up times, and 5,000 4,000 the high capital requirement. 3,000 We expect demand and supply to be 2,000 1,000 balanced in 2008, due to: 0 increased capacity, 2003 2004 2005 2006F 2007F 2008F 2009F 2010F Silicon available (MWp) Average cell processing capacity (MWp) lower silicon consumption, backed by thinner Source: Companies, Daiwa wafers and the higher conversion efficiency of cells, and Silicon market share (by volume)-2005 declines in double orders and the stocking up Sumitomo 3% Louyang on silicon by mid-stream companies. Mitsubishi 9% 1% Hemlock By our estimates, at least 60% annual solar- Tokuyama 24% cell-production growth is needed to maintain 16% tight silicon demand and supply. MEMC Wacker REC 13% Chemi 17% 17% Source: Companies, Daiwa 17