Alternative Energy Team Jenny Cosgrove*, CFA Head of Utilities and Alternative Energy, Asia-Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6619 jennycosgrove@hsbc.com.hk Gloria Ho*, CFA Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6941 gloriapyho@hsbc.com.hk Summer Huang* Associate The Hongkong and Shanghai Banking Corporation Limited +852 2996 6976 summeryyhuang@hsbc.com.hk *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1
2 Sector structure Solar Wind Asia-Pacific Equity Research Upstream Developer Upstream Developer GCL-Poly Huaneng Renewable Xinjiang Goldwind Huaneng Renewable OCI Datang Renewable China Ming Yang Power Datang Renewable Trina Solar China Wind Power Sinovel China Wind Power Suntech Power China Longyuan Power Group Suzlon China Longyuan Power Group LDK Solar China Guangdong Nuclear Power Group United Power Yingli Green Energy Motech Industries Gintech Energy Source: HSBC
Sector price history: MSCI Global Alternative Energy Index price history (August 2009 June 2012) 140 The decline is in line with 120 the drop in average selling prices thorough out the solar value chain (from 100 polysilicon to modules) Asia-Pacific Equity Research Index value 80 60 40 20 0 Aug-2009 Nov-2009 Feb-2010 May-2010 Aug-2010 Nov-2010 Feb-2011 May-2011 Aug-2011 Nov-2011 Feb-2012 May-2012 Source: MSCI, Bloomberg 3
Sector description Solar The sector comprises manufacturers along the value chain of solar PV system (mainly modules and inverters) and solar farm developers who are the end users of the solar products. Currently solar modules are manufactured using two technologies, crystalline and thin-film. The crystalline technology involves casting or drawing molten silicon (semiconductor) into silicon ingots, then cutting it into wafers and further processing it into modules. Thin-film consists of depositing photovoltaic material (e.g. CdTe, CIGS) on a substrate such as glass. The crystalline technology is dominant because of its higher conversion efficiency from solar irradiation to electricity. Jenny Cosgrove*, CFA Head of Utilities and Alternative Energy, Asia-Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6619 jennycosgrove@hsbc.com.hk *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations The solar PV system (crystalline technology) manufacturing value chain begins with polysilicon, then wafers, cells and modules, with inverters as peripheral devices. Key players for polysilicon in Asia includes GCL-Poly, OCI and LDK. Many of the companies have achieved vertical integration along the wafer to module chain. Notable global leading companies include Yingli Green Energy, Trina Solar, Suntech Power, and LDK. Thin film players include Sharp, Kyocera, and Trony Solar. Solar farm developers are only beginning to emerge in Asia, mainly in China where solar installations are growing from a low base. Major players at this stage are China Guangdong Nuclear Power Group, China Wind Power and the renewable energy arms of the Chinese independent power producers such as China Longyuan Power Group, Huaneng Renewables, and Datang Renewables. Wind The sector comprises manufacturers of wind turbines and wind farm developers. Similar to the solar sectors, wind farm operators in Asia are the renewable energy arms of the Chinese independent power producers such as China Longyuan Power Group, Huaneng Renewables, and Datang Renewables, and independent group China Wind Power. Key wind turbine manufacturers in Asia are Xinjiang Goldwind, Sinovel, United Power (a subsidiary of China Guodian Power Group), China Ming Yang Power, and Suzlon, the majority of whom are global top 10 players. Two prevailing wind turbine technologies are direct drive and the traditional gearbox, each with their own merits. Currently the predominant product for most of manufacturers is the 1.5MW turbine. Key themes Solar sector The solar sector in Asia has performed poorly since 3Q11. Large oversupply across the value chain drives down product average selling prices (ASPs) and puts pressure on margins. On the demand side, Europe, China and the US represented 72%, 8% and 6.9% of the global demand in 2011. We expect global PV installations to remain flat over FY12-13. The European debt crisis has led to feed-in tariff (FIT) cuts in a number of countries, including Germany, Italy and Spain, and also made it more difficult to secure project financing. We expect the oversupply situation to take time to correct and it will require extensive consolidation, with less efficient operators exiting the industry through bankruptcy or halting production. 4
We believe the key to survival will be to (1) maintain strong balance sheets, especially in terms of working capital management and leverage; (2) focus on R&D to raise the conversion efficiency of products; (3) seek production cost efficiency to achieve higher margins; and (4) avoid over-expansion of capacity to minimise capital expenditure and preserve cash flow. A more recent industry theme is that large Chinese manufacturers (especially module makers) are actively involved in solar farm development projects, many of which are in the US and Europe. We believe that margins for developing and then selling solar farms are relatively low. Nevertheless, the greatest benefit for the Chinese companies is it guarantees demand for the products (e.g. modules) they manufacture. Wind sector The wind sector is in a similarly difficult situation as the solar sector. Oversupply has seen a sharp decline of turbine prices. FIT cuts have also led to declining global installation demand. In China an additional constraint for wind power has been limited grid connection. As at end of 2011, only about 70% of the installed capacity had been connected to the grid. This is a largely the result of the grid lacking the resources to connect the growing number of wind farms; another factor is that it is more expensive for the state-run grid to acquire wind power than traditional coal-fired power. While Asian wind turbine manufacturers (mainly Chinese companies) face financial challenges to survive the downturn, the future looks brighter. They are looking forward to developing the inter-tidal and eventually the offshore wind market with large turbines (from 2.5MW to 6MW) and expanding overseas through wind farm projects outside Asia. Sector drivers Solar and wind sector Raw material prices: polysilicon for solar and rare earth for wind Polysilicon is the key raw material for the solar sector. In 2011 the polysilicon price dropped from cusd71/kg to USD30/kg. Falling polysilicon prices benefit companies downstream but have also forced many polysilicon manufacturers out of business. Prices continued to drop in 2012 but at a slower rate. Direct drive wind turbine manufacturing requires rare earth materials, including neodymium, praseodymium and dysprosium. From 2011 to mid-2012 rare earth prices rose by between 3.2x and 6.2x, pushing up costs for certain turbine manufacturers. However, rare earth prices started to fall in 4Q11, easing cost pressures. Political environment: Feed-in tariff, renewable energy targets, and anti-dumping tariffs Global demand is dependent on the policies of countries with high installation targets, such as Germany, Italy, the US, and China. A feed-in tariff (FIT) is an incentive provided by the government to solar and wind farms or rooftop solar installation owners. As the cost of solar and wind power generation is still higher than other traditional sources of power (e.g. coal), the FIT is a key consideration as it affects the returns on each project. Many countries are moving towards having a greater proportion of their energy mix generated by renewable energy. The EU has set 20% as its base target by 2020 and China has an 5
installation target of 20GW for solar PV power and 100GW for wind power by 2015. Different states in the US have different targets. Anti-dumping sentiment is another political concern. In May 2012 the US Department of Commerce hit Chinese solar companies with preliminary punitive import tariffs on modules produced in China or made of Chinese-made cells. Many Chinese companies responded by sourcing cells from other countries for the production of modules outside China. The final ruling is expected in October 2012. European solar companies are pursuing similar cases in Europe. In early June 2012, Chinese polysilicon manufacturers jointly filed a trade case with China s Ministry of Commerce against US polysilicon imports. In January-May 2012, more than 40% of China s imported polysilicon was originated from the US. Should an import tariff be imposed on US polysilicon, the Chinese downstream module manufacturers would suffer from higher cost of production. Financing Constructing solar and wind projects, especially for utility scale projects such as solar/wind farms, require large investment outlays. Normally about 80% financing comes from bank borrowings. Financing has become more difficult since the European debt crisis and the higher cost of capital makes solar/wind project returns less attractive. Key segments Solar sector China The Chinese companies have a presence along the value chain, from polysilicon to modules, as well as in inverters. Taiwan Taiwan solar companies are mainly cell manufacturers. Their prices are on average 5-10% higher than cells manufactured in China, a reflection of their quality and efficiency. Valuation We currently adopt a ROE implied PB valuation methodology for our stock coverage. In the solar industry, players are struggling for near-term survival and market share with low or negative earnings and the industry is undergoing heavy consolidation. 6