China Renewables Round-up 2022.07.18

Index Performance vs. Benchmarks

The TMC China Solar/Wind/Battery Index rose 2.1% last week, significantly outperforming the CSI300 (-3.7%) and the U.S. Energy sector ($XLE -3.3%).

Notable Moves

Prices of key commodity inputs for solar panels and batteries have remained high. Polysilicon has continued to hit new highs as downstream demand is showing no sign of weakness and planned maintenance for polysilicon manufacturers in July and August has intensified supply tightness.

Lithium carbonate prices have held firm in July, while other key battery material inputs have come down significantly month to date, namely iron ore (-18%), nickel (-15%), and cobalt (-22%).

Our indexes do not include mining or polysilicon stocks due to concerns around relative cyclicality and market fragmentation. In general, high prices and abnormally high margins and returns on capital should catalyze increased production of commodity inputs, ultimately leading to increased supply and lower prices, which will mostly benefit advanced manufacturers with pricing power and scale advantages.

688598 KBC Corporation +17% last week, +11.8% month to date

Top pick KBC Corporation was the largest gainer this week, surging on news that KBC landed BYD as a customer for its new business segment, carbon-ceramic brake discs.

Carbon-ceramic brakes are significantly lighter than standard cast iron brakes and enable a 5% to 7% improvement in range for electric vehicles. Because the range for a specific model is usually fixed by auto manufacturers, the use of carbon-ceramic brakes allows for a reduction in the capacity of the battery pack, the most expensive component and limiting factor of EV production. A ¥50,000 pack could be reduced by ¥2,500-3,500 by switching to carbon-ceramic brakes.

However, the price of ceramic brakes is still too high for mass adoption at ¥10,000 per set, compared to ¥500 to ¥1000 for cast iron brakes. Penetration rates will rise significantly as prices come down. Soochow Securities estimates that carbon ceramic brakes could become a ¥10 billion market by 2025, assuming 10 million EVs produced annually and a 20% penetration rate at ¥5,000 per set.

In the long run, this segment has the potential to be larger than KBC’s core business. KBC’s advantage in manufacturing carbon-based materials for silicon wafer production gives them an opportunity to lead the carbon-ceramic brake market in cost and scale. I don’t believe that the company’s present market valuation includes any significant value for this emerging line of business.

002245 Jiangsu Azure -6% last week, -14% month to date

Jiangsu Azure was the biggest drag on index performance last week and month to date. The stock is worth a closer look now as it is one of the cheapest in the index based on analyst forward estimates.

The Company’s wholly-owned subsidiary, Tianpeng, is taking share from Japanese and Korean incumbents in the power tool lithium-ion battery market. Tianpeng is the only domestic cylindrical NCA (Nickel Cobalt Aluminum) cell manufacturer that has broken into the supply chain of the five largest power tool companies. Thanks to a significant cost advantage in lower power cells and a strategic emphasis on higher power and automotive cells at market leader Samsung SDI, Tianpeng has increased its market share from 8.8% in 2020 to 15% in Q1 2022. The Company is expecting cell production to increase 70% in 2022 and is currently building out capacity to nearly triple production by the end of 2024.

The Company has multiple business segments which have somewhat obscured the rapid growth of Tianpeng, which has grown revenues 10-fold over the past five years, growing from 13% to 40% of overall revenues. The stock’s valuation could rerate if Tianpeng is spun out or as Tianpeng becomes the biggest driver of overall results. The stock currently trades at 29x trailing earnings and about 10x 2024E earnings, roughly half the forward valuation of the TMC index.

Issues currently weighing on the stock are guidance flat overall profit year over year in H1 2022 and a recent 2.5 billion yuan capital raise to fund capacity expansion, resulting in about ~10% dilution. The rising price of raw materials for lithium-ion batteries caused gross profit margin to contract from 20.4% to 17.5% in Q1 2022. The recent moderation in nickel, cobalt, and aluminum prices could reverse this trend in future quarters.

Corporate Announcements

Multiple companies in the index reported preliminary H1 results last week, with a handful announcing triple-digit earnings growth:

Industry News

The International Renewable Energy Agency (IRENA) released a report on renewable power generation costs in 2021 last week. Despite rising solar module prices, the overall levelized cost of energy (LCOE) of solar power declined 13% from 2020 levels, falling well below the cost of running the average existing fossil fuel plant. It is estimated that renewables installed in 2021 will save $55 billion in 2022 alone, given the extent of the fossil fuel energy crisis. Solar and wind remain on track to be the cheapest source of power, renewable or otherwise, in the decades to come.

Global weighted average total installed costs, capacity factors and LCOE of newly commissioned utility-scale solar PV, onshore and offshore wind, 2010-2021:

The weighted average LCOE of utility scale solar PV compared to fuel and CO2 cost only for fossil gas in Europe, 2010-2022:

Global weighted average total installed cost, capacity factor and levelized cost of electricity trends by technology, 2010 and 2021:

300750 CATL has regained its wide lead in the Chinese automotive battery market as lockdowns eased across China and affected customers (Tesla) restarted operations. The Company has also been making strides in new battery technology that holds promise for higher energy densities without the trade-off of higher material costs.

Top pick Longi Green Energy and Shenzhen Energy (000027) have set up a joint venture to open an inverter factory in Xuzhou, Jiangsu province. The two companies will invest CNY 5.3 billion ($791 million) in the new facility, which will have a capacity of 10 GW. We have seen a similar strategy of horizontal integration at Tesla, which released its own solar inverter last year. The solar inverter industry is seeing rapid growth and high profitability, despite fairly heavy fragmentation. 300763 Ginlong Technologies, a component of the TMC Index focused on solar inverters, has recorded a ~300% increase in revenue and earnings over the past three years.

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