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DrKW Equity research

Renewable Energy | Germany

Initiation on sector 20 July 2005

Solar IndustryA bright future

Online research:www.drkwresearch.com

Bloomberg:

DRKW

Please refer to the Disclosure Appendix at the end of this report for all relevantdisclosures and our disclaimer. In respect of any compendium report covering sixor more companies, all relevant disclosures are available on our websitewww.drkwresearch.com/disclosures or by contacting the DrKW ResearchDepartment at the address below.

Dresdner Kleinwort Wasserstein Securities Limited, Authorised and regulated by the Financial Services Authority and a Member Firm of theLondon Stock Exchange PO Box 560, 20 Fenchurch Street, London EC3P 3DB. Telephone: +44 20 7623 8000 Telex: 916486 Registered inEngland No. 1767419 Registered Office: 20 Fenchurch Street, London EC3P 3DB. A Member of the Dresdner Bank Group.

SolarWorld (Buy)Current 78.9Target 90

Market cap 1bn

Conergy (Hold)Current 84.3

Target 80

Market cap 0.8bn

Research Analysts

Alastair Bishop

+44 (0)20 7475 1594

[email protected]

James Stettler

+44 (0)20 7475 2357

[email protected]

Price relative

25 2 9 16 23 30 6 13 20 27 4 11 18APR MAY JUN JUL

90

100

110

120

130

140

150

160

(SOLARWORLD vs. DJSTOXX)(CONERGY vs. DJSTOXX)

Source: Thomson Financial Datastream

The solar industry has grown at an average rate of over 30% p.a. over the past

decade. While a reliance on political support increases industry risk, the longer-term

direction of such support is clear. When combined with solar technology cost

improvements, we expect the solar industry to grow at 25-30% p.a. until the end of

the decade. We initiate on SolarWorld with a Buy and Conergy with a Hold.

Growth industry: Environmental initiatives coupled with a desire for energy security and

diversification are driving political support for renewables and hence solar power. In

conjunction with ongoing cost reductions in solar technology, the Photovoltaic (PV)

industry looks set to grow at a rate of 25-30% p.a. out to the end of the decade.

Risks to our view: Barring a notable shift in political support, short-term supply

constraints, particularly with regards to the availability of silicon, are likely to be thelimiting factor for industry growth. A sharp interest rate rise could also impact forecasts.

Solar vs. Wind: As balance sheet strength is unlikely to emerge as a notable competitive

advantage in the PV sector, as it has in the wind industry, we see greater potential for

listed PV firms to successfully compete long-term, relative to a wind industry counterpart.

Stock picks: We initiate on SolarWorld, a vertically integrated PV manufacturer, with a

Buy recommendation and peer-group derived 90 target price. For Conergy, a solar-

specific integrator and distributor, we initiate with a Hold recommendation and 80 price

target.


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Solar Industry 20 July 2005

2

ContentsIntroduction................................................................................................................3Solar industry overview ............................................................................................5Industry growth drivers...........................................................................................11Risks to industry growth.........................................................................................17

Equity opportunities................................................................................................19SolarWorld................................................................................................................22Conergy.....................................................................................................................28Appendix The value chain....................................................................................33


3/44


3

IntroductionThe solar industry has grown at an average rate of over 30% p.a. over the past

decade. While a reliance on political support increases industry risk, the longer-

term direction of such support is clear. When combined with PV cost

improvements, we expect the solar industry to grow at 25-30% p.a. until the end of

the decade. We initiate on SolarWorld with a Buy recommendation and 90 target

price and Conergy with a Hold recommendation and 80 target price.

Scientists and politicians broadly agree that the use of fossil fuels is contributing to global

warming. The current reliance on fossil fuels is also raising concerns over both a

countrys level of energy dependency and the scale of its long-term fuel costs.

A greater adoption of renewable energy appears to offer at least a partial solution on all

accounts. While wind power is currently the most economic of the renewable energy

technologies, its intermittency of power production means that it alone is only likely to

partially replace fossil fuels. Other renewable energy forms, including solar power, are

thus expected to witness significant growth in the coming years.

Solar industry overviewPhotovoltaic or solar technology generates electricity through the conversion of light

energy. According to the International Energy Agency (IEA), the PV industry has grown

at an average rate of 33% p.a. since 1993. We estimate annual growth of 25-30% out to

the end of the decade.

Industry growth drivers

Over the medium-term, the PV industry is likely to remain dependent on the level of

political support. To date, solar industry growth has been driven by support from just 3

countries (Japan, Germany and the US) though the emergence of new markets (China

and Spain in particular) offers significant growth potential, as well as reducing single-

market risk.

Longer-term, the relative success of the PV industry will be determined by the industrys

ability to lower costs in order to compete with traditional power generation alternatives on

a stand-alone basis. Depending on a PV systems location, solar technology currently

generates electricity at a price of 0.20-0.60/kWh. While multiples above the cost of

traditional fossil fuels, it should be remembered that solar power has the advantage of

being able to be located at the point of energy usage. As a result, solar power used in

distributed applications (roof-top systems, building integrated PV) competes not with

centralised power generation costs but with far higher final electricity prices.

As a historical rule of thumb, the cost of solar power has fallen by 20% for every doubling

of production, equivalent to an annual price decline of 5% since the mid 1990s. Looking

ahead, we anticipate that this rate of cost reduction will continue, driven by a combination

of scale benefits (as plant sizes increase) and technological improvements (in respect to

the size, efficiency and thickness of a solar cell amongst others). We thus expect solar

power to move into the realms of competitiveness during the next decade.

Risks to industry growth

Due to the political nature of the industry, a detrimental change in a core markets

support for PV is arguably the single biggest risk to our forecasts. Within Germany, the

main PV market in Europe, a change in the EEG (renewable energy) law in 2008 is seen

as a potential negative for the industry. In our view, while support may be lowered, it is

likely to remain at a good level due to the solar industrys strong job creation potential

within Germany and the technologys limited impact on final electricity prices.


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4

Barring a significant decline in political support, we do not expect demand to be the

limiting factor in industry growth. The availability (or lack) of silicon is likely to be a far

more relevant near-term growth limiter. A sharp increase in interest rates in a core PV

market, though not likely near-term, could also impact demand for PV systems.

Equity opportunities Solar vs. Wind

To date, equity investments in renewable energy have focused on firms situated in the

wind industry (mainly turbine suppliers). Wind power has now become big business. Due

to a change in customer mix (from small funds to large utilities) and a subsequent

increase in average project size, balance sheet strength has become a more important

variable in a turbine buyers decision-making process. Listed manufacturers, unable to

compete on financial strength against the likes of GE and Siemens, are increasingly

being forced to compete on price, to the detriment of margins.

In contrast, such conglomerates have long represented the solar sector. However, balance

sheet strength is unlikely to become such a significant competitive advantage in the PV industry,

in our view. Assuming that solar industry growth continues to be driven by distributed grid-

connected applications as opposed to utility scale centralised projects, as in the wind sector,

single project size will not notably increase, and only the number of projects will rise. Balance

sheet strength under such a scenario will thus be of less importance for determining the supplier

for any one project. As a result, there appears to be greater scope for listed solar firms to

successfully compete longer-term, relative to a wind industry counterpart.

Within Europe, there are currently few listed PV companies through which to play the

industrys strong expected growth. With relative size likely to be an increasingly important

competitive advantage (for scale benefits not balance sheet), we focus only on the

largest listed investment opportunities and thus initiate on SolarWorld and Conergy.

SolarWorld

SolarWorld is a highly vertically integrated PV manufacturer, present across the entirevalue-chain. While such a degree of integration could limit the companys ability to

internally fund growth longer-term, the security of supply it currently offers is allowing for

strong profitability in a time of material shortages. We initiate with a Buy recommendation

and a peer-group derived target price of 90.

ConergyConergy is the largest solar-specific systems integrator and distributor in Europe. Given

the low level of capital employed in its business, the company has been able to

comfortably outgrow the overall industry in recent years. While we expect strong growth

to continue, we have concerns over the long-term barriers to entry and the impact of this

on future profitability. We initiate with a Hold recommendation and a peer-group derived80 target price.

Peer group comparison

(x) 2005E 2006E 2007E 2008E 2009E 2010E

P/E

SolarWorld 22.2 17.3 16.1 14.6 13.5 12.0

Conergy 24.9 17.1 15.0 13.4 12.4 11.4

IT hardware sector 20.8 17.6

EV/sales

SolarWorld 3.4 2.3 1.8 1.4 1.1 0.9

Conergy 1.3 0.9 0.7 0.6 0.5 0.4

EV/EBITA

SolarWorld 13.7 10.9 10.2 9.3 8.6 7.7

Conergy 13.8 9.3 8.1 7.2 6.5 5.9

Source: DrKW Equity research estimates


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5

Solar industry overviewThe solar industry has expanded at an average rate of 33% per annum since 1993,

with growth in the subsidised grid-connected market far higher than that achieved

in the off-grid sector. To date the key markets have been Japan, Germany and the

USA, though new markets (notably China and Spain) are emerging.

Derived from photo, the Greek word for light, and Volta, the electricity pioneer of that

name, photovoltaic or solar technology generates electricity through the conversion of

light energy. While the French physicist, Becquerel, originally discovered the PV effect in

1839, its use in industry did not occur until the 1960s. Initially designed for use in space

applications, terrestrial uses for solar power have become standard, as the technology

has developed. The use of solar power in an increasing number of applications is fuelling

strong industry growth.

ApplicationsThe end use for solar cells can simplistically be divided into two categories, off-grid and

grid-connected. Between 1993 and 2003, the off-grid market grew at an average rate of

13% p.a. (in countries covered by the International Energy Agency), compared with 44%

p.a. for the grid-connected market. While such figures underplay the true growth in the

off-grid market, as rural electrification projects in developing countries are not included,

expansion has certainly been slower. This is despite off-grid applications already being

economic in many circumstances. The market split between off-grid and grid-connected

applications has shifted significantly in favour of the latter as a result.

Annual installations of solar power (MWp)

Source: IEA, DrKW Equity research

Over 80% of solar cells are currentlyused in grid-connected applications

Annual PV installations by application in selected IEA countries

Source: IEA, DrKW Equity research

0

10

20

30

40

50

60

70

80

90

100

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Off-grid Grid-connected

(%)

0

50

100

150

200

250

300

350

400

450500

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

(MW)

Germany Japan USA Total


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6

Off-grid applications

Off-grid is currently the most natural market for solar power, with growth that can be fully

justified by economics. The off-grid market includes the use of PV in consumer products,

communication and signalling applications and rural electrification projects. One example

of the potential growth opportunities in consumer applications can be found in the

automotive industry. Within Germany, both Audi and Mercedes already offer solar

integrated sunroofs as an optional extra on some high-end models. As highlighted in arecent paper by the CEO of RWE Schott Solar, if all cars were to incorporate such a PV

system, around 3GW per annum of PV cells would be required in just this one

application.

Grid-connected applications

The grid-connected market is made up of centralised systems (commonly referred to as

solar farms) and distributed applications (e.g. roof-mounted systems, Building Integrated

Photovoltaic applications (BIPV)). Despite current cost issues, the grid-connected PV

market has witnessed far higher rates of growth due to increasingly supportive

government policies.

End-marketsGiven the industrys subsidised nature (for grid-connected applications), it is unsurprising

to see that growth has been geographically concentrated. Just three markets (Japan,

Germany and the US) currently account for more than 85% of global installed PV

capacity.

Japan

With almost half of the global installed PV capacity and solar production located in the

country, Japan has been instrumental in the PV industrys early development. Notable

growth in the country began with the introduction of the 70,000 roofs program in 1994. In

combination with net metering and research and development support, such government

policies have led to the installation of over 1.1GW of solar power by the end of 2004.

Such support has also proved successful in helping lower the cost of solar power and in

establishing a thriving domestic industry (note that 3 of the top 5 cell manufacturers are

domiciled in Japan). According to the IEA, the typical PV module price in the country has

fallen from 927/Wp in 1994, when the programme began, to 446/Wp in 2003,

equivalent to an average annual price decline of almost 8%.

Potential for market growth: The government is targeting 4.8GW of PV capacity by

2010. The main support scheme currently in place is the Residential PV Dissemination

Programme (RPVDP). Although subsidies under the scheme have been cut in recent

years, from US$862/kWp in 2003 to just US$191/kWp in 2005, it still remains a strong

industry driver when offered in collaboration with other local policies. It should be notedthat the high residential electricity price in the country (averaging around 0.20/kWh) is

supporting the industrys development from an economic perspective.

Risks to market growth: Given the countrys lacklustre macro economic outlook, both

government and regional budgets are under pressure. The RPVDP is scheduled to expire

at the end of March 2006, though early industry estimates suggest that subsidy funding

will run out by as early as August. Only a fifth of the 300 regional governments have

currently committed to continue offering PV subsidies beyond the current fiscal year if no

RPVDP is in place. If PV support programmes were ended it would clearly be negative

for the industry. It should be noted, however, that the current RPVDP subsidy only covers

3% of the system cost (i.e. it is fairly insignificant in itself). Japan may thus emerge as thefirst unsubsidised PV market.

Japan, Germany and the US accountfor over 85% of the global installedPV capacity

Japan is currently the largest PVmarket. A reduction in subsidysupport in FY06 may, however,moderate future growth


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7

Germany

As in Japan, the initial German solar support scheme (the 1,000 roof programme),

launched in late 1990, focused on the distributed grid-connected market. Support was

accelerated through the 100,000 roof programme (from late 1998) and through the

adoption of a feed-in tariff under the initial renewable energy law (EEG) in 2000. The

latter policy helped Germany overtake the US in 2001 in terms of installed PV capacity.

The current and updated EEG law, implemented in August 2004, provides a guaranteed20-year feed-in tariff, offering companies the certainty required to invest in the industry.

As with early government policies, the new EEG law favours distributed grid-connected

applications, with a higher initial feed-in tariff and a lower rate of subsidy decline post

2005 (5% p.a.) than for other market segments (6.5% p.a. for open space systems). As

at the end of 2004, almost 800MW of PV had been installed in the country.

It should be noted that the EEG does not use net metering as a support mechanism. As a

result, all solar power generated is fed into the grid at the fixed price, regardless of the

systems location (i.e. whether it is on a roof-top or in a solar farm). The technologys

advantage of being able to be situated at the source of energy usage is thus ignored

under the current support mechanism.Changes to the German EEG law

( cents/kWh) 01-Apr-00 01-Jan-04

Roof-tops

30kW 45.7 54.6

>100kW 54.0

On facades

30kW 45.7 59.6

>100kW 59.0

Open space

Source: German Federal Ministry of Environment, DrKW Equity research

100kWp NA 45.7

Source: German Federal Ministry of Environment, DrKW Equity research

Potential for market growth: The EEG law adopted in 2004 has proved extremely

successful. According to the renewable energy consultant ObservER, Germany installed

more than Japan in 2004 for the first time in over a decade (363MW vs. 280MW). Other

sources (e.g. Photon International) put the figure for Germany as high as 600MW. Either

way, strong growth is expected to continue if support remains in place.

Risks to market growth: The current EEG law is up for renewal in 2008. If, as currentopinion polls suggest, the CDU-led opposition wins the upcoming election, there is a risk

that industry support could be cut. Given the solar industrys job creation potential (due to

the industrys high domestic growth and Germanys first-mover advantage in European

PV development) and its low impact on consumer electricity prices, we would expect

support for solar to remain at a good level, even if overall renewable energy support is

lowered.

Germany overtook Japan for the firsttime in 2004 in terms of MWinstalled. Strong growth is expectedto continue in the coming years dueto supportive legislation


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8

USA

Once the leader in PV development, the US has since dropped to third in terms of installed

PV capacity, largely due to the lack of an integrated federal policy. Within the US, only

California has seen strong sustained development and currently accounts for over 80% of

the countrys total installed capacity. Although a federal policy is currently in place (the

1997 Million Solar Roof Initiative), a lack of funding behind the scheme has limited its

impact. Growth has thus been driven by state support mechanisms. 2001 data highlightedthe mismatch between state and federal support, with only US$66m out of the total PV

budget of US$470m for that year coming from federal sources. At present, 32 States

currently offer net-metering schemes and a number have implemented Renewable Portfolio

Standards. As at the end of 2004, over 300MW of PV had been installed in the country.

US state-wide support for PV (as at the start of 2005)

State RPS Solar requirements of RPS Net metering

Arizona 0.2% in 2001 increasing to 1.1% in 2007-12 50% PV in 2001-03, 60% in 2004-12 No

Arkansas None None Yes

California Increase 1% p.a. from 2003 to at least 20% by end of 2017 None Yes

Colorado 3% by 2007, 6% by 2011, 10% by 2015 4% from solar Yes

Connecticut 4% by 2004, rising to 10% by 2010 None Yes

Delaware None None Yes

Georgia None None Yes

Hawaii 8% by end 2005, 10% by end 2010, 15% by end 2015, 20% by end 2020 None Yes

Iowa 105MW from renewables None No

Kentucky None None Yes

Louisiana None None Yes

Maine >30% of retail sales from eligible renewables None Yes

Maryland 7.5% renewable requirement by 2019 None Yes

Massachusetts 4% by 2009, plus 1% each year thereafter None Yes

Minnesota 1,125MW wind by end of 2010; approximately 125 MW biomass None Yes

Montana None None Yes

Nevada 5% in 2003, rising to 15% by 2013 5% must be solar Yes

New Hampshire None None YesNew Jersey 6.5% by 2008 0.16% from solar by 2008 Yes

New Mexico 5% by 2006, rising to 10% by 2011 None Yes

New York 25% by 2013 None Yes

North Dakota None None Yes

Ohio None None Yes

Oklahoma None None Yes

Oregon None None Yes

Pennsylvania 18% by 2015 0.5% from solar Yes

Rhode Island 6% by end of 2019 None No

Texas 2GW of new renewables installed by 2009 None Yes

Utah None None Yes

Vermont None None Yes

Virginia None None Yes

Washington None None Yes

Washington DC 11% by 2022 0.386% from solar Yes

Wisconsin 2.2% by end of 2011 None Yes

Wyoming None None Yes

Source: US Database of State Incentives for Renewable Energy, DrKW Equity research

The lack of a coordinated federalpolicy has hampered industry growth


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9

Potential for market growth: The Senate version of the 2005 Energy Bill contains two

policies that, if incorporated in the final legislation, would be supportive for US PV

industry development. Firstly, a 10% federal RPS by 2020 is included. Secondly, the

Senate version contains the US PV industrys first solar tax credit since 1982. Under the

credit, homeowners purchasing PV or solar thermal systems would receive a 30% tax

credit (worth up to US$2,000) through to the end of 2009. Given the size of the overall

Energy Bill, however, it is unclear what will make it into the final version and indeedwhether the legislation will be approved before the 2005 congressional session ends. In

the absence of a federal policy, industry development is likely to be driven by increasing

state support California, for example, is currently in the process of adopting its own

million-roof programme and New Jerseys Clean Energy Program, targeting 90MW by

2008, is also proving a success.

Risks to market growth: Of the three core PV markets, the US has the greatest

potential. However, a clear federal policy is lacking. The risk appears to be not that

industry development declines but that installation rates just continue to stagnate.

Rest of Europe

While a number of countries in Europe outside of Germany have adopted solar support

mechanisms, few to date have proved as successful. A too low support level and/or too

small a budget have been the main causes of such relative policy failure. With the

relatively recent change in government and the adoption of a more proactive renewable

policy, Spain looks the most likely European market outside of Germany to witness

notable near-term PV growth.

Spain benefits from a very good natural solar resource. As a result, the unsubsidised cost

of PV electricity in Spain is around half that in Northern European countries. The current

Spanish renewable law offers systems of 100kWp or below an attractive 41.4/kWh feed-

in tariff (up to 150MW) and a 21.6/kWh tariff for larger systems.

PV support mechanisms in Europe (as at the end of 2004)

Country Programme

Austria No specific PV programme at present

Belgium 0.15/kWh feed-in tariff

Cyprus 0.12-0.26/kWh feed-in tariff as well as investment subsidies

Czech Republic 0.2/kWh feed-in tariff, reduced VAT (5% vs. 22%) and investment subsidies

Denmark No specific PV programme at present

Estonia No specific PV programme at present

Finland Investment subsidy (up to 40%)

France 0.15/kWh feed-in tariff for projects


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10

Rest of the World

Outside of the traditional market regions, China arguably shows the greatest promise for

near-term PV development. While a desire for improved air quality is one driver behind the

countrys push for renewable energy, Chinas basic need for power generation capacity is

likely to prove far more potent. Solar powers suitability off-grid is particularly beneficial in a

developing market industry estimates suggest that there are 30 million inhabitants in

China currently living without access to electricity. As part of Chinas required powergeneration needs, the country recently announced a renewable energy law that is expected

to lead to 10% of total power generation capacity coming from renewable energy by 2020

(up from 3% in 2003). Under the scheme, Chinas electricity grid is obligated to buy all

electricity generated from renewable energy sources at a price determined by the State

Council. It is as yet unclear what specific support will apply to solar.

Chinas need for electricity is fuellingdemand for PV systems


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11

Industry growth driversThe growing adoption of renewable energy is being driven by rising environmental

concerns, a desire for energy security and by improvements in alternative energy

technology. We expect that such drivers will ensure annual solar industry growth

of 25-30% until the end of the decade.

Rising political supportGlobal energy policy is increasingly being driven by environmental awareness and a

desire for both energy security and diversification. With the oil price pushing record highs

and the gas price rising, the current level of reliance on traditional fossil fuels is being

called into question. A greater adoption of renewable energy appears to offer at least a

partial solution on all accounts.

The Kyoto Protocol has been the most high profile political policy for environmental

improvement. The agreement, adopted in 1997 by a number of industrialised nations,

aims to reduce greenhouse gas emissions to a proportion of each countrys 1990

emission level by 2012. Following Russias ratification in November 2004, the Kyoto

Protocol came into force on 16 February 2005. The US and Australia have so far refused

to ratify the treaty.

GHG reduction targets under the original Kyoto Protocol

European Union commitmentsCountry Target (100 = 1990) Country Commitments (%)

Australia 108 Austria -13

Bulgaria 92 Belgium -8

Canada 92 Denmark -21

Croatia 95 Finland 0

Czech Republic 92 France 0

European Union 92 Germany -21

Estonia 92 Greece 25

Hungary 94 Ireland 13

Iceland 110 Italy -7

Japan 94 Luxembourg -28

Latvia 92 Netherlands -6

Liechtenstein 92 Portugal 27

Lithuania 92 Spain 15

Monaco 92 Sweden 4

New Zealand 100 United Kingdom -13

Norway 101 EU Total -8

Poland 92

Romania 92

Russian Federation 100

Slovakia 92Slovenia 92

Switzerland 92

Ukraine 100

United States of America 93

Source: Emissionstrategies.com, DrKW Equity research

Probably the most efficient way of meeting a countrys Kyoto target is through a reduction

in the use of traditional coal-fired power plants and a move to cleaner power sources.

While Combined Cycle Gas Turbines (CCGT) are currently the most efficient alternative,

concerns over the long-term gas price suggest that energy diversification is also

desirable. With nuclear power remaining both socially unpopular and opaque in regards

its full lifetime cost, renewable energy and within that the PV industry stands to benefit.

Environmental concerns and a desirefor energy security and diversity isdriving political support for renewableenergy


12/44


12

PV cost improvementsAs a historic rule of thumb, the cost of solar power falls by 20% for every doubling of

production, which has been equivalent to an annual price decline of 5%. Currently, the

average price of a solar module is around 3/Wp. 1-2/Wp is required to move into the

realms of competitiveness.

Cost comparison

A solar module typically represents around 60% of a total PV systems cost, the other

40% being balance-of-system components and installation expenses.

The cost per kWh of the electricity generated is not surprisingly dependent on the

strength of sunlight and thus the PV systems location. A 1kWp system typically produces

1800kWh/year in Southern California, compared with just 850kWh/year in Northern

Germany. Based on a 25-year system lifetime and a 7% cost of capital, solar power

currently costs somewhere between 0.20-0.60/kWh depending on the systems location.

Annual CO2-savings from investments of 5bn

1When replacing a hard coal power plant of installed fleet

Source: Siemens

Solar power currently generateselectricity at a cost of 0.20-0.60/kWh, depending on thesystems location

Cost breakdown of a typical 3kW grid-connected PV system

System design and

installation

20%

PV Cell

42%

PV Module

18%

Balance of System

20%

Source: United Nations Environment Programme

9GW 3GW 7GW 6GW 1GWOutput:

C02 Reduction for investment of 5bn per power plant type

1

30

22

16

10

20

5

10

15

20

25

30

CCPP Nuclear Wind STPP Photovoltaics

Reduction

MntOO

2/a

30

22

16

0

5

10

15

20

25

30

30

22

16

10

20

5

10

15

20

25

30

CCPP Nuclear Wind STPP Photovoltaics

30

22

16

10

20

5

10

15

20

25

30

CCPP Nuclear Wind

30

22

16

10

20

5

10

15

20

25

3030

22

16

10

2


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13

PV system costs

Solar module cost (/Wp) 3

Module as % system cost 60%

Total system cost (/Wp) 5

Total system cost (/kWp) 5000

System lifetime (years) 25

Discount factor 7%

Annual cost of system 429

Sun hours per year

Northern Germany 850

California 1800

Cost per kW/h ()

Northern Germany 0.50

California 0.24

Source: DrkW Equity research estimates

PV cost reduction

Lowering the cost of solar power is essential to the industrys long-term success. We

expect such cost reductions to be achieved through both technological innovation and

improvements in manufacturing. As regards the latter, a study carried out by BP Solar

suggested that the price of solar panels could be lowered to competitive levels by scaling

up factories to around 500MW. KPMG Netherlands reached a similar conclusion in a

1999 study carried out for Greenpeace. Given the rate of industry development, some

industrial participants have suggested that a smaller volume could be required. Improved

production methods also have the potential to help lower the cost of solar power. For

instance, a reduction in energy usage in silicon production, lower silicon wastage in the

sawing process, fewer breakages in cell production, a decreased variation in product

quality and a higher level of automation in module manufacturing should all reduce costs.

From a technology perspective, an increase in cell size, a reduction in the thickness of a

cell and an improvement in its efficiency are all targeted in order to lower costs.

A standard cell currently measures 6 inches in length. As the industry move towards

larger cells, costs should decline, due to a reduction in sawing waste and an increase in

plant MW volume potential.

An average crystalline silicon cell currently has a thickness of between 250-300m. This

is expected to decline to below 200m by the end of the decade. While only the first

c.50m is required to absorb the sunlight, maintaining structural strength at such

thicknesses is proving difficult. A reduction in thickness has clear implications for material

usage and thus input costs.

A typical crystalline solar module currently achieves an efficiency of 14-17%, compared

with a theoretical maximum of around 28%. This relatively low level of theoretical

electricity conversion is caused by a combination of bandwidth limitations (less than half

of all energy in the solar spectrum is currently utilised), electrical resistance, solar

reflection and heat losses. Increasing a cells bandwidth is likely to require the use of

multi-junction (stacked or microcrystalline) cells, which incorporate a number of different

semiconductor materials. Reducing resistance and reflection, however, should be

achievable with current technology.

PV cost reductions are expected to

come from both economies of scaleand technology improvements


14/44


14

Competitiveness is application dependent

When analysing how far solar power currently is from being competitive, the application

in question needs to be considered. As mentioned earlier in this report, off-grid systems

are already financially viable on a stand-alone basis, given the level of grid investment

offset. The same is true for a number of consumer applications, where the use of low

cost/low efficiency cells can already compete with traditional power sources. It is the grid-

connected market that currently relies on subsidies. Even here, the level ofcompetitiveness varies by application.

Centralised grid-connected applications: For the foreseeable future, solar power is

unlikely to be an economically attractive centralised power generation source in the

majority of markets. To be effective in such an application, solar power must compete

directly with traditional power generation alternatives. Although the PV industrys strong

development has led to significant cost reductions, the cost of electricity generation is still

in the range of 0.20-0.60/kWh, multiples above the nearest alternative.

Cost comparison

Power generation source cents/kWh

Gas 3-6

Nuclear 3-6

Coal 2-4

Hydro 2-8

Wind 4-12

PV 20-60

Bio-Energy 5-6

Source: CERA, EU Commission, DrKW Equity research estimates

Distributed grid-connected applications: In our view, the most interesting medium-term

application for solar power is distributed grid-connected systems. While currently reliant on

political support for development, the use of solar panels in rooftop and building integrated

applications is already not too far from being economically attractive. When used in suchapplications, solar power is not competing against the power generation cost of traditional

energy alternatives per se but the final electricity price. This is higher due to grid connection

costs and utility profit margins. Furthermore, given solar technologys intra-day power

curve, with the bulk of electricity generated during the middle of the day, a distributed grid-

connected system typically competes with peak electricity prices.

A summary of the average electricity price in the major solar markets highlights that solar

power is not too far from being competitive in the distributed grid-connected market.

When used in distributedapplications, solar power competeswith peak electricity prices, not powergeneration costs

Solar power curve vs. spot electricity prices

Source: Fraunhofer Institute


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15

A selection of residential electricity prices

Country Residential electricity price ( cents/kWh)

Germany 17

Italy 19

Japan 20

Spain 10

UK 10

US 8

PV power 20-60

Source: Eurostat, EIA, SolarWorld

Competitiveness is relativeWhile lowering the cost of solar power to achieve economic efficiency is almost certainly

required longer-term, it should be remembered that being competitive is a relative and

not absolute concept. Most industry experts agree that the cost of traditional fossil fuels is

likely to rise in the coming years due to supply constraints. With a solar cells typical base

material being silicon, the worlds second most abundant element, the same is unlikely to

occur with solar power (once short-term supply restrictions are overcome). The cost gap

should thus close far quicker than ceteris paribus conditions would suggest.

A prime example of the relative potential for solar power (and indeed for other forms of

renewable energy) can be seen in the US market. During the late 1990s and early part of

the current decade, the US power generation industry significantly invested in new CCGT

capacity, basing their investment decision on an assumed long-term gas price of around

US$3/MMBtu. With growth in the gas supply not matching CCGT capacity expansion, the

cost of natural gas has sharply increased in recent years. This rise has notably altered

the industrys long-term price assumption for natural gas, as seen in the following chart.

The importance of such a notable and ongoing shift in the long-term assumed cost for

natural gas should not be underestimated. Based on a long-term price forecast of around

US$3/MMBtu, CCGT is the natural choice for future capacity expansion. However, with a

current price assumption of US$4-5/MMBtu, other forms of power generation become

increasingly attractive.

Although solar power is unlikely to directly benefit from such a trend, as its high cost means it

is currently far from being a viable centralised power generation source, it should still benefit

indirectly. The rise in total US power generation costs from the increase in the natural gas

price is feeding through to the end-consumers electricity price. Average US residential

electricity prices have risen by almost 10% since 1999 as a result and currently stand ataround US$9/kWh depending on the state. Such a price rise is making an investment in

distributed grid-connected solar applications increasingly attractive.

With rising fossil fuel prices, solarpower is becoming increasinglycompetitive by default

Change in the US power industrys long-term gas price assumption

Source: EIA, DrKW Equity research

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

2017

2019

2021

2023

2025

US$ per thousand cubic feet

AEO 1997 AEO 1998 AEO 1999 AEO 2000 AEO 2001

AEO 2002 AEO 2003 AEO 2004 AEO 2005


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16

Time to competitivenessWith the price of traditional fossil fuels likely to continue as the supply-demand imbalance

grows, end-user electricity prices should follow suit. Assuming an annual increase in real

electricity prices of 2% and by factoring in ongoing price declines for solar power of 5%per annum, we can obtain an approximation for when grid-connected distributed PV

power will turn economically competitive. Under our assumptions, PV power should

become competitive between 2010 and 2030, depending on the systems location.

US residential electricity price (US cents/kWh)

7.50

7.70

7.908.10

8.30

8.50

8.70

8.90

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Source: EIA, DrKW Equity research

Solar power should move into therealms of competitiveness in the nextdecade

Electricity generating costs for PV and utility prices low

Source: RWE Energie AG, DrKW Equity research estimates

0.00

0.10

0.20

0.30

0.40

0.50

0.60

2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

per kW/h

Util ity peak power (lower-end) Uti lity peak power (upper-end)

Solar power (low sun hours) Solar power (high sun hours)


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17

Risks to industry growthThe PV industry is partly reliant on political support for development. Any negative

change here remains a notable risk to industry development. Near-term silicon

supply shortages and a sharp rise in interest rates could also negatively impact

industry growth.

Changing political supportAs long as solar power remains uncompetitive in its own right for certain applications, the

PV industry will rely on government support. While such support is beneficial, it does

increase the inherent level of risk surrounding the industrys outlook. The level of political

support is likely to vary as a function of perceived price development, job creation and

lobbying.

Price development: If the price of solar power fails to develop favourably (i.e. decline)

under a supportive subsidy programme, politicians may question the success of such

schemes. Current PV price rises, due to supply shortages, are hence undesirable over

the long-term.

Job creation: Strong industry support in both Japan and Germany has created

thousands of jobs. Political support is more likely to remain if job creation continues. This

may prove important in Germany when the EEG law comes up for renewal in 2008; the

potential for additional domestic job creation in the German solar industry appears to be

far greater than in the wind industry given the domestic markets greater growth potential

and Germanys first mover-advantage in establishing a European PV industry base.

Political lobbying: As the number of rooftop solar systems rises, the revenue base of

utilities will typically fall. This may be enough to encourage such firms to lobby against

continued government support for the solar industry.

Geographic diversification of the industry and technological improvements should

decrease reliance on political support. Until then, however, industry growth is likely to

remain linked to the overall level of support in place.

Silicon shortagesBarring a significant decline in support, demand is not expected to be the main

determinant of solar industry growth in the next few years. The availability of supply, of

electronic or solar grade silicon in particular, is more likely to be the limiting factor.

A PV cell requires a lower level of silicon purity than that used in a semiconductor wafer.

As a result, the solar industry has historically relied on top-and-tails and other off-cuts

from the semiconductor industry for its silicon supply. With the solar industrys strong

growth, however, core production is now also being used. Of the c.27,000 tonnes of

purified silicon produced in 2003, approximately one-third was used in the solar industry.

With 750MW of solar cells produced in the year, this equates to around 12 tonnes of

silicon required per MWp of solar power.

During a period of semiconductor industry weakness at the start of the decade, an

excess of supply caused silicon prices to fall to US$25-30/kg. At such levels, silicon

manufacturers were unable to justify capital investments. Although silicon is the second

most abundant element in the Earths crust, it is both expensive and complex to process.

This period of capacity under-investment, when coupled with both the recent recovery in

the semiconductor industry and the ongoing strength in the solar sector, has led to a

reversal of the supply-demand imbalance.

A negative change in a core marketssupport for PV is the largest near-term risk to industry growth, in ourview

A lack of silicon in 2005/06 isexpected to moderate solar industrygrowth


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Recent capacity constraints have caused the price of some silicon contracts to effectively

double to around US$50/kg. Spot market prices have even risen as high as US$75/kg.

Although at such prices capacity expansion is once again extremely economical, not all

silicon manufacturers are investing significantly to increase production volumes. Many

suppliers are demanding long-term price contracts with solar companies before investing

in new facilities to mitigate the risk of another downturn. Even for those silicon

manufacturers willing to expand capacity, lead-time remains an issue. A new polysiliconplant typically takes two to three years to plan and build, which suggests to us that supply

is likely to remain constrained until at least 2007. Under such a scenario, competition for

supply between the solar and semiconductor sectors appears almost inevitable. As

silicon is typically a smaller proportion of total cost in a semiconductor chip than in a solar

cell (


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19

Equity opportunitiesAs balance sheet strength is unlikely to emerge as a notable competitive

advantage in the PV sector, as it has in the wind industry, we see greater potential

for listed PV firms to successfully compete long-term, relative to a wind industry

counterpart. Within the PV sector, those companies located at the wafer and cell

manufacturing stages look best positioned longer-term.

Solar vs. WindAlthough the wind industry has suffered from volatile end-markets in recent years (largely

due to the boom-bust nature of the US market), long-term growth is expected to remain

strong, driven by ongoing political support, improving technology and the need for energy

diversification (i.e. the same drivers as behind solar industry expansion).

Balance sheet risk

Despite, or perversely because of, wind powers increasing competitiveness, the long-

term opportunities for equity investors appear to have diminished. Simplistically, the

problem is that wind power has become big business. With the final customerincreasingly a large utility and no longer a small fund or developer, projects have grown

in size. Larger projects imply an increased level of risk in construction and maintenance.

As a result, balance sheet strength is becoming increasingly important in a turbine

buyers decision-making process.

While independent listed manufacturers are arguably offering better technology, there are

relevant question marks over whether they can compete longer-term for the larger

projects against an industrial conglomerate (General Electric and Siemens). The one

thing that such conglomerates can undoubtedly offer ahead of any of the listed turbine

manufacturers is balance sheet security. As a result, listed manufacturers are

increasingly being forced to compete on price, to the detriment of margins.

In contrast to the recent emergence of conglomerates in the wind industry, the solar

sector has long had a significant number of such companies within it, predominantly

positioned in the cell manufacturing stage of the industry. While a large conglomerate

potentially has access to a greater level of funding required for growth (though not

always, if the company has less focus in this area), balance sheet strength is unlikely to

become such a significant factor in the PV industry as it has in the wind industry, in our

view. Assuming that solar industry growth continues to be driven by distributed grid-

connected applications, as opposed to utility scale centralised projects as in the wind

sector, single project size should not notably increase, and only the number of projects

will rise. Balance sheet risk under such a scenario should thus be of lower importance fordetermining the supplier for any one project. As a result, there is greater scope for listed

PV firms to successfully compete long-term, relative to a wind industry counterpart.

Relative pricing power

As the wind industry has developed and utilities have replaced small funds as the typical

end-customer, the ability of suppliers to set prices has decreased, with margins coming

under pressure as a result. Looking ahead in the PV industry and assuming the grid-

connected distributed PV market develops as expected, the average customer will be a

household (via a systems integrator) commanding a relatively lower level of pricing

power. As a result, solar industry suppliers should be in a stronger relative position with

regards price setting.

Equity investments in solar powerappear to us to have the potential forgreater longer-term returns relative toa wind industry counterpart

Balance sheet strength is lessimportant in the PV industry


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20

PV industry investment criteriaSimplistically, there are five stages in the solar industry. While all are important to the

overall industrys development, the value-added is not evenly distributed between the

stages. In our view, the highest long-term value-added will likely occur in the wafer and

cell manufacturing areas.

Silicon suppliers: As the provider of the PV industrys core base material, siliconsuppliers are benefiting from the growth in solar power. Current supply shortages are

improving pricing power, though capacity constraints should be largely resolved by

2007/08. Given the long lead-time required to change production levels, industry

profitability is likely to remain cyclical in the long-term. The emergence of a second end-

market for poly-silicon in solar power (along with the semiconductor industry) should,

however, reduce some of this volatility.

Wafer manufacturers: This is a core value-added process within the crystalline silicon

PV market, with high technology content and good barriers to entry. Given the expected

emergence of thin-film technologies in the years ahead, the growth in the independent

wafer industrys available end-market is likely to be below that of the overall PV industry.Growth for pure-play wafer manufacturers may also be reduced if the level of vertical

integration in the industry increases.

Cell manufacturers: This is arguably the most interesting stage of the solar industry,

which may explain why virtually all of the conglomerates present in the industry have

exposure to this area. In addition to incorporating a good level of value added in the

production process, the cell manufacturing industry does not have the growth limitations

of the wafer-manufacturing sector. While cell manufacturing in itself is a fairly standard

procedure across the industry, comparative advantage is created by both a companys

scale, level and quality of automation, average cell efficiency as well as consistency (i.e.

standard deviation) of cell efficiency. Given that a modules efficiency is set by the quality

of its weakest cell, consistency of a cell manufacturers product is extremely important.

The largest specific risk for cell manufacturer is probably technology change a

company focused on just one technology type could lose out if a breakthrough occurs in

another technology form.

Module manufacturers: As with wafer manufacturers, module manufacturers are

typically only required in the crystalline silicon PV market. The manufacturing process

tends to be labour-intensive, which suggests that those manufacturers located in high

cost countries may struggle longer-term against low-cost competitors. Given supply

shortages along the value chain, barriers to entry are relatively high at present, with those

module manufacturers having access to cell supply contracts at an advantage. This

value-added is likely to decline, as supply issues are resolved.

Systems integrators: Such businesses act as final stage contractors and distributors.

The advantage of systems integrators is the low level of capital employed in their

business model and the reasonable barrier to entry created by current supply restrictions.

The key value-added is the strength of client and supplier relationships. As the lack of

supply corrects and the industry grows, mainstream-contracting firms may look to enter

this space, which could put pressure on current incumbents.

Longer-term, we see the earlierstages of wafer and cellmanufacturing as offering highervalue-added


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Vertical integration or specialisation?As a reflection of the PV industrys varying technologies, the production process is non-

homogenous and, in practice, many of the stages outlined above are merged or

integrated to differing degrees. For thin-film companies, wafer manufacturing is an

inherent part of the cell manufacturing process. Even in the crystalline silicon cell market,

some wafer manufacturers are increasingly attempting to form their own supply of solar

grade silicon. Likewise, some cell manufacturers also produce their own or some of their

own wafers and modules.

While there are benefits to being vertically integrated, particularly in light of the current

material shortages, we believe the industry will move towards increasing specialisation in

the long run in order to concentrate economies of scale and focus R&D spend. Given the

industrys expected strong growth, required capital expenditure levels are likely to remain

high in the years ahead. For any level of investment, a focused or pure-play company

will likely be able to grow faster than a vertically integrated competitor. In our view,

gaining scale during the current period of strong industry growth is essential for a

company to establish a competitive long-term position. A focused approach appears to

offer an easier route to achieving scale.

While not entirely related to the business strategy, it is perhaps no coincidence that of the

top-ten cell manufacturers, those manufacturers with a more focused approach (i.e. only

cell and module production) have achieved significantly faster growth in recent years

than those that are highly vertically integrated.

Industry growth - Vertical integration vs. specialisation

Market position Manufacturer Strategy MW 2001 MW 2004 % change

1 Sharp Focused 74 324 338%

2 Kyocera Vertically-integrated 54 105 94%

3 BP Solar Vertically-integrated 54 85 56%

4 Mitsubishi Electric Focused 14 75 436%5 Q Cells (private) Focused 0 75 NM

6 Shell Solar Vertically-integrated 48 72 51%

7 Sanyo ThinFilm 16 65 306%

8 RWE SCHOTT Solar Vertically-integrated 23 63 178%

9 Isofoton (private) Vertically-integrated 19 53 185%

10 MoTech Solar Focused 4 35 900%

Source: Photon International, DrKW Equity research

Investment options are currently limitedWithin Europe, there are currently few listed solar companies through which to play the

industrys strong expected future growth. In the wafer industry, only SolarWorlds

business (Deutsche Solar) is quoted at present. Of the cell manufacturers, none of thetop ten are currently listed within Europe and again SolarWorlds business (Deutsche

Cell) is the largest listed European play on this market. Module manufacturing is an

unconsolidated market. While listed European manufacturers do exist (e.g. Solon, Solar-

Fabrik) they are all currently relatively small in size. Finally at the end-stage of systems

integration and distribution, only the market leader, Conergy, is of significant size.

With relative size likely to be an increasingly important competitive advantage, as

companies benefit from economies of scale, we focus on the largest listed investment

opportunities in Europe. We thus initiate on SolarWorld and Conergy.

While there is a short-term benefitfrom being vertically integrated, weexpect companies to specialise overthe long-term


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22

SolarWorldSolarWorld is a highly vertically integrated PV manufacturer, present across the

entire value-chain. While such a degree of integration could limit the companys

ability to internally fund growth longer-term, the security of supply it currently

offers is allowing for strong profitability in a time of material shortages. We initiate

with a Buy recommendation and a target price of 90.

Company overviewFounded in 1998 by the current CEO and largest shareholder (27.6%), Frank Asbeck,

SolarWorld focused on renewable energy project management for its first ten-years of

operation. Although the company began trading in solar equipment (modules and inverters) in

1995, it was not until 1998 that the business was officially refocused as a solar energy company.

In 1999, SolarWorld entered module manufacturing through the acquisition of a 71.3% stake in

the Swedish module company GPV, the minorities in which were bought out in 2002. In 2000,

the company acquired an 82% stake in the wafer manufacturing business, Bayer Solar (bought

out minorities in 2002), and, in 2001, its second module operation was founded (Solar Factory).Vertical integration was largely completed by the start-up of a cell business (Deutsche Cell) in

2002 and a silicon supply JV (Joint Solar Silicon) in 2003. SolarWorld has thus positioned itself

as one of the most vertically integrated companies in the PV industry.

PositivesSecurity of supply: SolarWorld operates a three-tier strategy to ensure adequate access

to silicon feedstock. As well as having an in-house silicon supply JV with Degussa (Joint

Solar Silicon), SolarWorld has built up a successful cell recycling operation (Solar

Materials) and has signed a 10-year supply agreement with Wacker, starting in 2007.

When combined with its internal wafer manufacturing business, SolarWorld is in a strong

position in terms of having access to supply across the whole value chain. This is provingto be a competitive advantage at present, given current feedstock shortages, and is

allowing the company to operate at super-normal profit margins within its wafer business

(note the Q1 EBIT margin of 31%). We do not expect the silicon and thus wafer supply

constraints to be fully resolved before 2007 at the earliest.

High value-added production processes: Although we question the long-term value-

added in both module manufacturing and product distribution, SolarWorld is also

positioned in the more attractive areas of wafer and cell manufacturing.

NegativesCapex requirements: Capital expenditure has averaged almost 50% of sales over the

past four years. Although the capital requirement in growth companies is typically

significant, SolarWorlds high level of vertical integration implies that a greater level of

capital expenditure is required to achieve any given level of scale. As a result, the

company appears more reliant on external sources of funding for growth than a more

focused manufacturer. One positive, that partly offsets the companys high capital

expenditure burden, is the significant level of investment subsidies obtained due to the

companys location in East Germany. Funding from both the EU and the local state

currently subsidises around 35% of all capital expenditure.

Dividend policy: Paying a dividend is not typically seen as a negative. However, in a fast

growing industry such as solar, with high capital investment requirements, paying a dividend

without FCF support is potentially taking money out of the business that would be better spent

re-investing. To the end of 2004, SolarWorld had paid out 7m in dividends and obtained

32m from issuing new equity. Net debt at the end of 2004 stood at 40m or 32% of equity.

SolarWorld is a highly integratedsolar manufacturer, present acrossthe entire value chain


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Technological change: Through a highly vertically integrated business model,

SolarWorld is geared in to the fate of the crystalline silicon PV market. The emergence of

alternative cell production methods (eg. string ribbon, thin-films) could put pressure on

the future demand for the companys products (particularly wafers). For the next few

years at least, this risk, while relevant, appears limited.

Divisional overviewJoint Solar Silicon: Founded in 2003, Joint Solar Silicon is a JV between Degussa(51%) and SolarWorlds wafer manufacturing division, Deutsche Solar (49%). The

company is researching a solar grade silicon production method based on the

decomposition of silane (a gas consisting of silicon and hydrogen) in a tube reactor.

While the project has suffered some delays in the laboratory stage (pilot production was

originally planned for 2004), the company is currently planning a test production run (20-

100t) in 2005, with full-scale pilot production (800t) to follow in 2007/08.

Deutsche Solar: The division is the largest wafer manufacturer in Europe and, according

to internal estimates, joint largest globally with the Japanese manufacturer, M.Setek.As a

wholly owned subsidiary of SolarWorld, Deutsche Solar manufactures mono- andpolycrystalline wafers for both its parent companys operations and for external cell

manufacturers. Note that 40% of wafers are currently exported (mainly to Japan), which

leaves SolarWorld more exposed to FX fluctuations than many of its domestic peers. In

2004, the capacity of the company reached 120MW, which is expected to double to

240MW by 2007. Within the division, SolarWorld operates its highly profitable Solar

Materials business unit, which is focused on the recycling and reuse of waste solar cells

in new wafer production. According to the company, around 20% of its silicon supply

should come from recycling by the end of 2005. Given the recycled materials apparently

much lower cost (up to 40%), Deutsche Solar should be at a competitive advantage.

Deutsche Cell: Deutsche Cell is the cell-manufacturing subsidiary of SolarWorld. The

company has produced crystalline silicon cells since 2002 and had a production capacity

of 30MW by the end of 2004 producing cells with 15-16% efficiency. Capacity is targeted

to rise to 60MW in 2005, 90MW in 2006 and 120MW by 2007. The wafers used by the

company are exclusively supplied by SolarWorlds Deutsche Solar subsidiary. Compared

with its market leading position in the wafer industry, SolarWorld is a relatively small

player in the cell manufacturing industry (ranked 13 th in 2004 in terms of output). Building

up scale rapidly will be important if SolarWorld is to become an established cell

manufacturer longer-term (a secure wafer supply should make this task easier).

GPV/Solar Factory: As mentioned earlier in this report, module manufacturing tends to

be labour intensive with relatively low value-added and thus limited barriers to entry.

Through its two wholly owned subsidiaries (GPV and Solar Factory), SolarWorld has

attempted to increase its competitive position through a higher level of automation in the

production process. According to internal estimates, every 1MW of modules produced by

SolarWorld requires two employees, which compares to 5-6 employees for many of its

domestic competitors and 15+ for a typical Chinese manufacturer.

SolarWorld: All module trading and distribution activities are carried out in-house under

the SolarWorld brand. Longer-term, as more established distributors emerge,

SolarWorlds competitive position in this area may come under threat if growth cannot be

maintained.


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ForecastsSolarWorld has achieved 40% average annual sales growth since 2000 and witnessed a

doubling of sales in 2004 following the introduction of the new EEG law in Germany. With

strong domestic growth expected until at least 2008 (when the EEG is up for renewal) and

new markets emerging (Spain in particular), we look for 33% average annual sales growth

out to 2010. Note that for 2005, SolarWorld is targeting sales of more than 280m.

In 2004, SolarWorld achieved a group EBIT margin of 16.5% up from -3.1% in 2003.

While higher volume was the main driver, the use of wafers from inventory (costed at

2003 market rates but sold at higher 2004 prices) also aided profitability. Note that the

cost of materials as a percentage of sales fell from 89.4% in 2003 to 46.5% in 2004.

Even without the repeat of this effect, we expect further margin improvement in 2005,

due to continuing end-market strength. For 2005, we estimate a group EBIT margin of

24.9%. As supply constraints ease and competitive pressures rise, we expect margins to

moderate towards 12% by 2010. Longer-term we see a group margin of 8-10% as

realistic.

Divisional summary

m (Y/E 31st Dec) 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

Sales by division

Deutsche Solar 38 54 75 78 111 153 204 242 295 358 436

Deutsche Cell 1 17 63 90 121 146 183 227 283

GPV & Solar Factory 5 10 23 34 79 131 176 212 266 331 412

Trade in modules 17 36 43 47 104 200 316 427 535 667 829

Eliminations (9) (20) (35) (78) (157) (269) (362) (438) (549) (684) (851)

Group sales 51 82 109 98 200 305 454 589 729 900 1,110

EBIT by division

Deutsche Solar 9 7 5 4 14 40 43 44 47 47 48

Deutsche Cell (1) 1 11 14 22 23 26 30 31

GPV & Solar Factory (2) 0 0 0 4 9 11 13 13 15 19Trade in modules 2 1 4 (7) 5 14 22 26 29 33 41

Energy 0 1 1

Net unallocated expenses 0 4 (7) (1) (1) (2) (2) (3) (4) (5) (6)

Group EBIT 9 13 2 (3) 33 76 96 102 112 120 134

EBIT margin by division (%)

Deutsche Solar 23.7 13.0 6.7 5.1 12.6 26.0 21.0 18.0 16.0 13.0 11.0

Deutsche Cell 5.9 17.5 16.0 18.0 16.0 14.0 13.0 11.0

GPV & Solar Factory -40.0 0.0 0.0 0.0 5.1 7.0 6.5 6.0 5.0 4.5 4.5

Trade in modules 11.8 2.8 9.3 -14.9 4.8 7.0 7.0 6.0 5.5 5.0 5.0

Group EBIT margin 17.6 15.9 1.8 -3.1 16.5 24.9 21.1 17.4 15.3 13.3 12.0

Source: SolarWorld, DrKW Equity research estimates


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P&L statement

m (Y/E 31st Dec) 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

Sales 51 82 109 98 200 305 454 589 729 900 1,110

Change in inventories of finished goods 3 2 3 26 (15)

Own work capitalised 0 2 0 0 0

Other operating income 6 13 6 10 11

Cost of materials (32) (53) (73) (88) (93)

Staff costs (6) (9) (13) (19) (31)

Depreciation and amortisation (5) (7) (9) (15) (16)

Other operating expenses (8) (16) (20) (17) (23)

EBIT 9 13 2 (3) 33 76 96 102 112 120 134

Net Financial income (0) (0) (4) (6) (4) (3) (3) (3) (3) (3) (3)

PBT 9 13 (2) (9) 29 73 93 99 109 117 131

Income tax (4) (4) 0 4 (10) (27) (35) (37) (40) (43) (47)

Minorities (1) (1) (0) 0 0 0 0 0 0 0 0

Deutsch Solar profit until acq' date (3)

Net income 1 8 (2) (5) 18 45 58 62 69 74 84

EPS () 0.16 0.81 (0.16) (0.47) 1.57 3.55 4.57 4.91 5.41 5.86 6.59

EPS pre goodwill amortisation () 0.94 (0.01) (0.30) 1.57 3.55 4.57 4.91 5.41 5.86 6.59

DPS () 0.15 0.18 0.09 0.09 0.18 0.53 0.69 0.74 1.08 1.17 1.32


Owing to a build-up of working capital and significant capital expenditure requirements for

production expansion, we estimate a free cash outflow of 36m, equivalent to -12% of

sales in 2005.

Cash flow summary

m (Y/E 31st Dec) 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

Operating cash flow (pre WC) 7 13 24 48 88 102 93 102 111 124

Change in working capital (14) (17) (11) 29 (64) (49) (36) (35) (40) (41)

Capex (50) (87) (31) (32) (59) (49) (50) (53) (56) (58)

Capex as % sales 60.5 79.7 31.4 16.2 19.4 10.8 8.5 7.2 6.2 5.2

FCF (56) (90) (18) 44 (36) 4 8 14 15 26

FCF as % sales -68.7 -82.6 -18.2 22.2 -11.8 0.9 1.3 2.0 1.7 2.3



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Cash flow statement

m (Y/E 31st Dec) 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

Net profit before taxes 13 (2) (9) 29 73 93 99 109 117 131

Depreciation and amortisation 7 8 15 16 22 27 31 34 37 41

Depreciation 5 7 12 16 20 25 28 31 33 36

Goodwill Amortisation 1 2 2 0 0 0 0 0 0 0

Other Amortisation 0 0 1 1 1 2 2 3 4 5

Net interest income 0 4 6 4

Interest paid (0) (4) (6) (3)

Net interest paid 0 0 (0) 1 0 0 0 0 0 0

Result from valuation at equity 0 0 1 0 0 0 0 0 0 0

Loss / income on disposal of assets (6) 0 0 0 0 0 0 0 0 0

Proceeds from investments grants 2 8 17 1 21 17 0 0 0 0

Taxes reimbursed / paid (9) (2) 1 2 (27) (35) (37) (40) (43) (47)

Operating cash flow (pre WC) 7 13 24 48 88 102 93 102 111 124

Increase / decrease in inventories (20) (12) (8) 11 (45) (40) (27) (27) (30) (28)

Increase / decrease in other working capital 6 (4) (3) 18 (20) (9) (8) (8) (10) (13)

Change in working capital (14) (17) (11) 29 (64) (49) (36) (35) (40) (41)

Cash flow from operations (7) (3) 13 77 23 53 57 67 71 83

Total Capex (50) (87) (31) (32) (59) (49) (50) (53) (56) (58)

Capex - Deutsche Solar (19) (56) (9) (18) (26) (18) (17) (18) (18) (17)

Capex - Deutsche Cell (7) (19) (12) (11) (16) (12) (12) (11) (11) (11)

Capex - GPV/Solar Factory 0 (5) (9) (2) (13) (12) (13) (13) (13) (12)

Capex - Trade in modules (2) (1) (1) (1) (4) (6) (9) (11) (13) (17)

Capex - Energy (19) 0

Other 7 3 0 0 0 0 0 0 0 0

Cash flow from investments (43) (83) (31) (32) (59) (49) (50) (53) (56) (58)

Proceeds from / repayments of debt 17 35 30 (28) 0 0 0 0 0 0

Proceeds from addition to equity 17 15 0 0 43 0 0 0 0 0

Dividends (2) (3) (1) (1) (2) (7) (9) (9) (14) (15)

Cash flow from financing activities 32 47 29 (29) 41 (7) (9) (9) (14) (15)

FX (0) (0) (0) 0 0 0 0 0 0 0

Net change in financials (17) (40) 11 16 5 (2) (1) 5 2 11


Due to the inventory sell down in 2004, working capital as a percentage of sales fell from

71% in 2003 to just 23% in 2004. This decline is likely to partly reverse in 2005. From

2010, we forecast working capital to represent 28% of sales.

Working capital summary

m (Y/E 31st Dec) 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

Inventories as % sales 32.0 44.6 44.9 58.2 23.4 30.0 29.0 27.0 25.5 24.0 22.0

Accounts receivable as % sales 12.0 13.1 13.2 18.9 6.5 14.0 14.0 14.0 14.0 14.0 14.0

Accounts payable as % sales 7.6 22.4 12.3 5.9 7.1 8.0 8.0 8.0 8.0 8.0 8.0

Trade Working Capital 19 29 50 70 45 110 159 194 230 270 311

Trade Working Capital as % sales 36.4 35.3 45.8 71.1 22.7 36.0 35.0 33.0 31.5 30.0 28.0


We expect net debt to fall from 40m in 2004 to 35m in 2005, following the H1 capital

raising, which yielded 43.1m. Given the high capital requirements of SolarWorlds

vertically integrated business model, the company may become reliant on additional

external financing for growth if internal cash management is not suitably controlled.


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Balance sheet

m (Y/E 31st Dec) 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

Fixed assets

Intangible Assets 23 26 36 35 35 37 37 37 37 36 34

Property, plant and equipment 45 84 114 130 146 180 201 219 237 256 274

Financial assets 1 1 1 0 1 2 3 4 5 6 7

Deferred taxes 2 2 3 8 4 4 4 4 4 4 4

Total fixed assets 71 113 154 174 185 222 244 264 282 301 318

Current assets

Inventories 16 37 49 57 47 91 132 159 186 216 244

Trade accounts receivable 6 11 14 19 13 43 64 82 102 126 155

Tax receivables 2 3 2 1 1 1 1 1 1 1

Other receivables and assets 3 4 3 2 4 4 4 4 4 4 4

Marketable securities 2 1 0 0 0 0 0 0 0 0 0

Liquid funds 61 43 14 20 27 32 29 28 33 35 46

Prepaid expenses 0 1 0 1 0 0 0 0 0 0 0

Total current assets 89 99 83 101 91 171 229 274 326 382 450

Total assets 160 212 238 275 276 393 473 538 608 683 768

Current liabilities

Short-term borrowings 10 22 42 52 25 25 25 25 25 25 25

Trade accounts payable 4 18 13 6 14 24 36 47 58 72 89

Tax payables 1 0 0 8 8 8 8 8 8 8

Current provisions 6 2 3 2 12 12 12 12 12 12 12

Deferred income 0 0 0 1 0 0 0 0 0 0 0

Other current liabilities 2 2 4 12 9 30 47 47 47 47 47

Total current liabilities 22 44 62 73 69 99 128 139 150 164 181

Long term liabilities

Noncurrent borrowings 27 31 37 51 42 42 42 42 42 42 42

Other noncurrent liabilities 10 12 21 34 34 34 34 34 34 34 34

Provisions for pensions 0 0 0 0 0 0 0 0 0 0 0

Other noncurrent provisions 0 0 0 0 0 0 0 0 0 0

Total long term liabilities 37 44 57 85 76 76 76 76 76 76 76

Share capital 5 5 6 6 6 13 13 13 13 13 13

Capital reserve 81 87 101 101 101 137 137 137 137 137 137

Translation reserve (0) 0 0 0 (0) (0) (0) (0) (0) (0) (0)

Retained Earnings 3 12 4 1 18 61 112 166 225 286 355

Shareholder's Equity 89 103 110 108 124 210 262 315 375 435 504

Minorities 6 14 0 0 0 0 0 0 0 0 0

Deferred taxes 6 7 8 9 8 8 8 8 8 8 8

Total equity and liabilities 160 212 238 275 276 393 473 538 608 683 768

Net debt/(cash) (27) 8 65 83 40 35 38 39 34 32 21

Gearing (%) -30.5 8.0 58.9 77.5 32.2 16.7 14.4 12.3 9.0 7.4 4.2 Source: SolarWorld, DrKW Equity research estimates

Valuation and recommendationAs seen in our estimates, we forecast strong top-line growth for SolarWorld over the

coming years. Given the companys growth characteristics, we base our target price on a

comparison with the IT hardware sector (including the semiconductor industry). Based on

our estimates, the IT hardware sector currently trades on a 2006 P/E of 17.6x, with 18%

EPS growth factored in for that year. Given the higher expected earnings growth for

SolarWorld (29% in 2006) and lower level of expected cyclicality in end-market demand,

we believe a 10% premium is justified. We thus obtain a target price for SolarWorld of

90 and initiate with a Buy recommendation.

Given the industrys higher expectedgrowth and lower cyclicality, wevalue SolarWorld at a 10% P/Epremium to the IT hardware sector


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ConergyConergy is the largest solar-specific systems integrator and distributor in Europe.

Given the low level of capital employed in its business model, the company has

been able to significantly outgrow the overall industry in recent years. While we

expect strong growth to continue, we have concerns over the long-term barriers to

entry and the impact of competition on future profitability. We initiate with a Hold

recommendation and a 80 target price.

Company overviewThe CEO, Hans-Martin Rter, and Chairman of the Supervisory Board, Dieter Ammer,

established Conergy in 1998. The company acquired the German solar wholesaler AET

Alternative-Energie-Technik GmbH in September 1999 and expanded into the Spanish

market with the purchase of the wholesaler ALBASOLAR in December 2000. A position

in the US market was obtained through the acquisition of Dankoff Solar Products earlier

in the current year. Through both acquisitions and organic growth, Conergy is currently

present in 15 countries worldwide. In 2004, over 94% of group sales were generated inGermany. Conergy is targeting 50% of group sales from international markets within five

years.

PositivesLow capital intensity: Due to the limited level of manufacturing carried out in-house and

the low level of working capital tied up in the distribution business (aided by good current

payment terms), Conergys capital employed was just 1m in 2004, giving it a ROCE of

286%. The far lower capital requirements of the business should allow the company to

grow rapidly over the next few years, without any strain on the companys balance sheet.

High value-added at present: Balance of system components, system design and

implementation currently account for around 40% of the total cost of a typical PV system.

Given the lower capital requirements at this end of the value-chain, companies are

currently enjoying both high margins and high returns on their capital employed due to a

relative lack of competition.

NegativesDecline in value added: Given the industrys early stage of development, a significant

proportion of a distributors business is currently customised systems integration, which

typically offers a higher margin than an off-the-shelf system. As the industry matures

and production volumes increase, the level of standardisation in equipment and systems

is likely to rise. If Conergy is unable to lower costs at the same rate as the level of value-

added in its service declines, its margins will come under pressure.

Increased competition: In addition to increasing the level of product standardisation,

greater industry volumes are likely to encourage new entrants (possibly from other

building distribution channels). If Conergy is unable to maintain its currently strong

distribution relationships, particularly when it attempts to expand internationally, returns

will suffer.

Supplier risk: In 2004, Conergy obtained 60% of its PV modules from just one supplier,

namely Sharp. Although the percentage sourced from this one supplier is expected to fall

to 50% in 2005, reliance on any customer, even one as large as Sharp, does introduce a

certain level of company-specific risk. It is worth noting that Conergy sources from morethan 15 module suppliers, which somewhat mitigates this risk.

Conergy is a specialist integrator andwholesaler of PV products


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Divisional overviewVoltwerk Group: Conergys Voltwerk business is involved in the design, financing,

construction and operation of renewable energy projects (predominantly in the solar

sector) for closed investment funds. By the end of 2004, Voltwerk had implemented PV

projects with a combined output of 21MW and enjoys a market share of c.40%. While the

division has achieved reasonable growth in operations, profitability is capped by the strict

returns focus of the investment funds. One notable area of concern relates to a potential

future change in the German tax law. While far from certain, there have been some

political moves to reduce the tax incentives attached to investment funds. If this were to

be introduced, the interest in solar funds from private investors and hence part of the

business for Voltwerk could be significantly impacted.

SunTechnics Group: The SunTechnics business has been active in the sale and

installation of complete PV systems for final-use customers since 1996. SunTechnics is

also sub-contracted by Voltwerk to work on centralised projects. In 2004, the business

diversified into solar thermal systems with the latter representing c.10% of sales last year.

Conergy is looking to generate around half of sales from non-PV sources within 5 years.

According to the company, SunTechnics is the European market leader in engineering

complete solar systems, with a market share of 21.2% in 2004 (13.4% in 2003). Not

surprisingly, its position in Germany is strong (23.9% market share in 2004, up from

17.7% in 2003).

AET Group: Whereas SunTechnics focuses on end-consumers, AET sells both products

and complete systems (PV and solar thermal) to installers and electrical fitters. Given its

strong domestic position (market share of 24% in 2004) and its relatively less price-

sensitive customer base, margins tend to be higher in this business. Maintaining strong

long-term relationships with the core resellers is key to the business long-term success.

Conergy (DMS&CS): Conergys Development, Manufacturing, Sales and Central

Services (DMS&CS) division is involved in the manufacturer of mounting systems,

inverters and solar thermal collectors and the procurement of other solar products. The

products manufactured/procured are sold to AET, Suntechnics and directly to

wholesalers, predominantly under the Conergy brand.

ForecastsGroup revenues have grown from 1m in 1999 to 285m in 2004, a CAGR of 210%. As a

result, Conergy is currently the largest PV systems integrator in Germany. For 2005, the

company is targeting sales of at least 500m, implying up to a doubling of sales over the

prior year period. Given the business lower capital expenditure requirements and its

potential for international expansion, we estimate that Conergy should be able to outgrow

the overall PV market over the next few years. Out to 2010, we forecast sales to grow at

a CAGR of 36%.

Despite our strong top-line growth expectations, we estimate that Conergys margins are

likely to come under pressure from 2007 onwards, as supply constraints ease and new

competitors emerge. We estimate a peak EBIT margin of 9.6% in 2006, declining to 6.5%

by 2010. If Conergy can increase the level of in-house production, a higher EBIT margin

may be obtainable. Note that Conergy is targeting a medium-term EBIT margin of 10%.


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Divisional summary

m (Y/E 31st Dec) 2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E

External sales by division

Projects (Voltwerk Group) 42 52 62 68 74 80 86 93

Engineering (SunTechnics Group) 31 91 193 280 350 435 538 663

Wholesale (AET Group) 42 108 214 310 387 481 594 733

Development, Manufacturing, Sales & Central Services 7 34 77 119 148 184 228 281

Group Sales 73 122 285 546 777 959 1,180 1,446 1,771

EBIT by division

Projects (Voltwerk Group) 2 3 3 4 4 4 5 5

Engineering (SunTechnics Group) 0 6 19 31 35 39 43 46

Wholesale (AET Group) 3 10 26 37 43 48 51 55

Development, Manufacturing, Sales & Central Services (3) 0 3 5 6 7 9 11

Consolidation (1) (1) (1) (1) (2) (2) (3) (3)

Group EBIT (1) 1 19 50 75 86 97 105 115

EBIT margin by division (%)

Pro

renewable en drkw 79209 n

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