TODAY’S STUDY: THE ENERGY FUTURE (SOLAR, BATTERIES, ELECTRIC CARS AND UTILITIES)
Will Solar, Batteries, and Electric Cars Re-Shape the Electricity System?
20 August 2014 (UBS Q Series)
Batteries and solar at the tipping point: Electricity users will become generators Solar systems and batteries will be disruptive technologies for the electricity system. Steeply declining battery and solar system costs will enable multiple new applications. In this note, we focus on the impact on the utilities and auto sectors. Our proprietary model suggests a payback time as low as 6-8 years for a combined EV + solar + battery investment by 2020 – unsubsidised. We see Europe, and in particular Germany, Italy and Spain, leading this paradigm shift due to high fuel and retail electricity prices.
EVs entering the mass market, battery demand could grow exponentially We forecast a c10% EV and plug-in hybrid penetration in Europe by 2025. While the initial growth should predominantly be driven by incentives and carbon regulation, the entry into the mass market should happen because EVs will pay off. The expected rapid decline in battery cost by >50% by 2020 should not just spur EV sales, but also lead to exponential growth in demand for stationary batteries to store excess power. This is relevant for an electricity mix with a much higher share of (volatile) renewables.
Opportunities for utilities: Customers, smart grid and decentralised backup In this decentralised electricity world, the key utilities’ assets will be smart distribution networks, end customer relationships and small-scale backup units. Utilities should be able to extract more value in (highly competitive) supply activities, as customer needs will be more complex. Large-scale power generation, however, will be the dinosaur of the future energy system: Too big, too inflexible, not even relevant for backup power in the long run. Overall, sector EPS could grow 13% by 2025 on capex and higher-margin supply businesses, but differences between the companies should be large.
Stock conclusions: Best and worst positioned players In utilities, retail- and distribution-heavy companies with strong balance sheets should emerge as structural winners while generators are likely to be losers. We highlight Enel and Iberdrola as main beneficiaries and Verbund and Fortum as potentially most negatively affected. In autos, BMW and Valeo are our top picks. In Chemicals, we favour Umicore for Cathodes, Hitachi Chemical for anodes.
Why read this report?
Solar and batteries will be disruptive technologies Solar panels and batteries will be disruptive technologies. Solar is at the edge of being a competitive power generation technology. The biggest drawback has been its intermittency. This is where batteries and electric vehicles (EVs) come into play. Battery costs have declined rapidly, and we expect a further decline of >50% by 2020. By then, a mass segment EV will have almost the same sticker price as a combustion engine car. But it will save up to €2,000 per year on fuel cost, hence, it will begin to pay off almost immediately without any meaningful upfront "investment". This is why we expect a rapidly growing penetration with EVs, in particular in countries with high fossil fuel prices. Thanks to EV-driven economies of scale, we also expect the cost of stationary batteries to drop c50% by 2020. Based on our proprietary analysis, battery storage should become financially attractive for family homes when combined with a solar system (and an EV). As a consequence, we expect transformational changes in the utility and auto sectors, which we discuss in this report.
Key controversial debates
Can solar ever be economically viable without subsidies due to its intermittent character? Our answer: YES. The market is not yet looking at the topics of solar, EVs and stationary batteries with a holistic view. Our proprietary model shows it is the combination of the three that makes solar fully competitive and that has the potential to bring disruptive changes to the electricity sector. Here are the maths: One can leverage the EV purchase with an investment in a solar system and a stationary battery. By doing so, one can optimise the self-consumption of solar power and minimise the "excess waste" of solar electricity. And what also may matter to many EV buyers: The electricity used to drive the car is carbon-free. The combination of and EV + solar + battery should have a payback of 7-11 years, depending on the country-specific economics. In other words, based on a 20-year technical life of a solar system, a German buyer should receive 12 years of electricity for free (purchase in 2020).
Will EVs and plug-in hybrids ever be cost-competitive in the mass market? Our answer: YES, especially in the case of pure battery EVs. Already today, from the perspective of the consumer, the 3-year total cost of ownership (TCO) of a Tesla S model is similar to that of a comparable petrol combustion engine car such as an Audi A7, especially in markets with high fuel prices like Germany – a country where purchase incentives are almost non-existent. We think that by 2020, shrinking battery and solar cost will make EVs in the mass segments the cheaper alternative over a car life cycle in most European markets. While on a global basis, EV sales for the remainder of the decade should be mostly carbon/fuel standards and related incentives, we think penetration rates will accelerate significantly after 2020 driven by compelling economics. As a conservative 2025 scenario, we think c10% of new car registrations in Europe will be EVs.
If EVs and solar are that disruptive, is it a threat or an opportunity for utilities? Our answer: IT IS A NET OPPORTUNITY. On the one hand, there will be an accelerated paradigm shift away from large-scale conventional power plants. Even a blue-sky 20% EV / plug-in hybrid penetration would only add 5% to power demand, which will be more than offset by energy efficiency in other areas. On the other hand, the trends offer vast opportunities for utilities in smart grids, value-add services in end customer supply and decentralised backup power generation. These positive drivers should more than offset the gradual extinction of large-scale power plants, even though we expect intense competition for end customers, also from non-utility industries. The impact on company level varies a lot depending on the positioning in the value chain.
Impact on utilities
The closer utilities are to the end customers, the better they should be able to benefit from the transformational changes. The number of end customers and the size of the distribution grid are key metrics to look at. On the other hand, we think the generation-heavy utilities will be relative losers, as large-scale power stations will hardly fit into the new, de-centralised electricity world. Europe should be the fastest-moving region. Outside Europe, we think the US (south-west) and Australia could be amongst the early movers. Other regions, such as Asia and LatAm, should follow the trend in Europe with a substantial time lag due to worse EV/solar economics and structurally rising power demand, which will have to be met with new large-scale power plants.
Key beneficiaries: ENEL (Buy, PT €5.15) and IBERDROLA (Buy, PT €6.00) enjoy large customer bases and are owners of large distribution networks assets. Also, both companies will have a solid balance sheet to support the required infrastructure capex. Finally, profitability of their conventional generation assets in Europe is already subdued, which implies only moderate remaining downside risk to earnings in this business.
Potentially affected: FORTUM (Sell, PT €12.70) and VERBUND (Neutral, PT €14.70) are both generation-heavy utilities, with a relatively small position in distribution networks and clients. Baseload power plants (nuclear/hydro) generate the bulk of earnings, and we see structural downside risk to earnings on lower-for-onger power prices. Only a new remuneration model would improve the outlook. We acknowledge that in particular Fortum intends to accelerate investments in decentralised generation, but the opportunity seems relatively small compared to the downside risk in hydro/nuclear generation.
Impact on auto sector
Most OEMs (Toyota and Tesla excepted) are still developing electric powertrains reluctantly. Developing new powertrain as partial substitutes to Internal Combustion Engines (ICE) should be a negative sum game for several years as OEMs face higher development budgets and lower product margins with few incremental sales if any as demand should be largely driven by regulation and CO2 compliance. Later on we think True cost parity with ICE from a buyer's perspective will spur replacement demand especially as consumers see added benefit from self-generation of electricity as an additional cost reduction. This should lead to further economies of scale for OEMs, particularly in battery costs, and make EVs profitable for OEMs. Lower repair costs should undermine the profitability of after-market. The first phase of EV growth should disproportionately benefit component suppliers, in our view, with new electronic content for power management as well new materials to optimize weight, for example. As EVs grow faster than the industry, some suppliers may also, like OEMs, suffer from the weight of legacy assets in ICEs.
BMW (Buy, PT €105)
Whilst this is not new, BMW has again demonstrated superior strategic thinking and a solid sense of timing in developing a separate brand for electric vehicles, and the strong start to the “i” brand without production glitch should keep BMW at the forefront of electrification. Based on our analysis, it appears that consumers already benefit from cost parity or better in some countries. Interestingly, we calculate near-parity for the i3 and the X1 in Germany, where purchase incentives are limited to an exemption of an annual road tax, and in the UK, where purchase incentives are fairly generous (£5,000).
BMW’s operating performance continues to impress by delivering margins well within the guided 8-10% range and 2013 seemingly the trough of the earnings cycle. We are concerned about the risk of fragmentation in Premium auto segments undermining returns but we believe that BMW is in a better position than other “incumbents” to navigate a changing Premium market. We expect BMW’s re-investment cycle will peak earlier than at peers. We also note that financial services leverage has now been reduced to a level where finco claims on cash should moderate and leave improved scope for dividends.
Valeo (Buy, Key Call, PT €130)
The first phase of EV growth will disproportionately benefit component suppliers, in our view, with new electronic content for power management as well as new materials to optimize weight, for example. As EVs grow faster than the industry, some suppliers may also, like OEMs, suffer from the weight of legacy assets in ICEs. Valeo screens well as it offers solutions to improve ICE efficiency (stop-start, air intake module, double clutch transmission, electric turbocharger) as well as solutions for electrification (charger-inverters, hybrid4all, battery management, power electronics and range extender).
Valeo should continue to offer best-in-class organic growth (10%), margin expansion potential and scope for higher cash generation (capex reaching a peak this year). Order intake should reach €16-17bn this year (vs c€15bn over the past 2 years) with China currently running at 4x H114 OE sales. Our upside case, based on the order intake fully translating into sales, assumes Valeo can generate an underlying EPS of c€12 in '16 (implied PE of 7.7x), or almost 40% annual growth.
Beneficiaries in Chemicals
Umicore (Buy, PT €40) is a long-term play on the substitution potential of metal chemistry in future mass market applications. The company has 3 core business areas, which are Recycling (66% of EBIT), Energy and Battery Materials (8%), Performance Materials – Zinc plating (18%) and Catalysis (24%), and overheads of -16%. Umicore has the most advanced cathode technologies for lithium ion batteries with exclusive usage in most high value electronics applications, and has the lowest cost per kWh solution available to the market for automotive. Umicore is also the only metals "recycler of last resort" for metal residues from electronic scrap recyclers, spent process and automotive catalysts containing high levels of platinum group metals, jewellery industry scrap and residues and complex residues from precious metals miners globally. We see EBIT growing by 75% over the next 5 years driven by a 40% capacity increase in recycling which has already committed volume from the market, ramp up of production of electric and hybrid vehicles and Umicore's recent entry into the truck heavy duty diesel catalyst market. Stock trades on 17x 2014 P/E for a 5 year EPS CAGR of 13% versus the other key technology game changer stock Novozymes, which trades on 31x 2015E PE for 8% earnings CAGR.
Hitachi Chemical (Buy, PT ¥2,200) enjoys the largest share of the global market for lithium-ion battery anode materials. Regarding car-mounted products, the company is developing natural graphite anode materials for electric vehicles and amorphous carbon anode materials with excellent input characteristics for hybrid electric vehicles. Expansion has primarily come from use in lithium-ion batteries mounted in Nissan Motor's Leaf model. Meanwhile, products for use in consumer electronics lithium-ion batteries recently seem to be enjoying volume growth from some customers after profitability had slackened due to previous intensification of competition. In our view, this could stem from demand for '18650' cells by Tesla, which mounts large volumes of these compact, consumer-electronics batteries. We believe this could be a driver going forward. Making Shin-Kobe Electric Machinery a wholly-owned subsidiary in FY12 meant that Hitachi Chemical now has a wide-ranging line-up of electrical storage devices, including lead batteries, lithium-ion batteries, and various types of capacitors. In the autos-use area, management aims to increase sales of products such as lead batteries for 'Idle Stop' systems and also plans to combine various power storage devices to offer industrial systems for reducing power consumption in peak demand times and for levelling out power use.
Impact on European industrials
Decentralised generation, electric vehicles and storage offer attractive opportunities and some challenges for Siemens, ABB and Schneider Electric, in our view. Simply speaking, moving the location of the power generation from location A to location B requires investment in infrastructure to distribute and control the energy flow. As suppliers of transmission and/or distribution equipment and software this is positive for Siemens, ABB and Schneider, in our view. In addition, decentralised power generation by renewable sources such as solar power increases the need for software and hardware to control and optimise demand/supply, again benefitting the three companies.
The smart grid is to a great extent about information management. You gather live data on the ebbs and flows of electricity in the grid and use software to optimise the allocation of the energy in the system. With the smart grid, decentralised generation, mobile consumers, prosumers and renewables, supply and demand data that has historically been captive to the traditional power-generating utilities and grid operators will be made available to third parties, such as the equipment suppliers. This opens up for the creation of, for example, virtual power plants where a solution of equipment and software from, say, Siemens can match buyers and sellers of electricity. Managing the vast amount of data that will flow through the smart grid will be a challenge that requires significant investment. As mentioned earlier in this document, our colleagues in the utility team believe the European smart grid is a EUR 290bn capex opportunity. There is little doubt in our mind that Siemens, ABB and Schneider Electric will look to capture a significant proportion of that revenue opportunity.
Our top pick is Siemens (Buy, PT €105). At current price levels we find the stock attractively priced relative to its peers. The stock should re-rate as the company de-risks Transmission and launches the next round of cost cutting efforts in 1H15. The re-rating should be boosted further by a future part or full disposal/spin-off of the healthcare assets as well as other smaller parts of the portfolio. A potential catalyst for the stock will be the Capital Markets Day "Vision 2020" in Berlin the 9th of December. Our PT is based on EV/EBIT and PE multiples (2015e). At our PT the stock would trade on 10.5x calendar 2015e normalised EBITA, in line with sector mid-cycle multiple. Siemens generates 16% of group revenues in the power networks business. Siemens claims a number 1 position in the market for grid automation and a number 2 position in the market for rail electrification and smart grid services.
UBS proprietary model is available on UBS Neo
The cost of batteries and solar systems (panels, inverters) are the main drivers of economics. In our main scenario, we assume an 8% p.a. decline in EV battery costs and a 4% p.a. decline in solar system costs. On this basis, a combined investment in a solar system, stationary battery and EV would have a 7.3% ROI (before interest) in 2020 (vs. 1.8% today). Another key swing factor is the price of fossil fuels, which we assume to increase 1.5% p.a. The following figure illustrates these key sensitivities, on a ceteris paribus basis.
We also provide our interactive proprietary model to our clients, in which all the key assumptions can be modified. It also offers the market-specific input data for the main European countries (solar irradiation, fuel and electricity prices). It is available under the following UBS Neo link: https://neo.ubs.com/shared/d1fXWW5AKk6