Regional Industry Focus Electric Equipment (Overweight) Refer to important disclosures at the end of this report DBS Group Research . Equity 22 Aug 2018 Opportunities for ESS market and KOSPI: 2,247.9 electric equipment players KOSDAQ: 769.8 Korea’s ESS market saw 20-fold growth in 1H18 Analyst Regional Research Team Further growth to be spurred by PV-based ESS [email protected] Eyes on PCS manufacturers in ESS value chain Top pick Top pick: LS Industrial Systems 12-mth Company Price Rating Mkt Cap Target 20 Aug (KRW bn) Price Renewable energy-connected ESS to drive ESS market growth. (KRW) In 1H18, Korea’s energy storage system (ESS) market grew 20- (KRW) fold y-o-y to 1.8GWh (1.13GWh for peak-load shifting or peak- LS Industrial 71,300 2,139 90,000 BUY cut ESS, 0.68GWh for renewable energy source (RES)-connected Systems (010120 KS) ESS). We estimate new ESS capacity to be 0.75GWh (0.34GWh for peak-cut, 0.41GWh for RES-connected) in 2H18 and to reach Our coverage / companies on our radar 2.56GWh in 2018 (+333% y-o-y). With most discount benefits Hyundai Electric regarding ESS set to be rolled back in 2021, peak-cut ESS & Energy System 64,900 662 77,000 BUY demand is likely to decline going forward. However, the RES- (267260 KS) connected ESS market should see growth, driven by photovoltaic RS Automation (PV)-connected ESS. For 2018, supply of PV-connected ESS is 14,150 129 N/A Not rated estimated at 1.1GWh representing 43% of total new ESS (140670 KS) installations. With the Renewable Energy Certificate (REC) weighting on PV installations in woodlands being reduced, there Source: Bloomberg Finance L.P., DBS Bank should be fewer small-scale PV projects but more large-scale ones. This should boost the ESS market, as large PV projects tend to adopt high-capacity ESS. Against this backdrop, new ESS installations in Korea are projected to be above 2GWh per annum over the long term. Focus on power conditioning system (PCS) companies in ESS value chain. PCS is a core component for renewable power generation systems and ESS. It accounts for the second largest portion of total ESS building costs after batteries. Although battery prices dropped sharply in the past few years, PCS prices have declined marginally. We expect this price trend to continue for PCS going forward. European peers point future direction for Korean players. We can draw a mid/long-term growth outlook for Korea’s renewable energy and ESS industries from cases in Europe, which saw an expansion of renewable energy and ESS a few years before Korea. Against this backdrop, Europe’s major electric equipment players (Siemens, Schneider Electric, ABB) enhanced their future growth potential, resulting in significant stock outperformance vs. General Electric in the US which was behind them in investments in new growth areas. LSIS to be key beneficiary of ESS market growth. LS Industrial Systems (LSIS) is our top pick for the sector. While there are concerns over a q-o-q profit decline, due to sharp growth in 2Q18, we believe that it is time to accumulate the shares, given strong growth potential of the ESS market and subsequent benefits for the company. We also recommend keeping an eye on Hyundai Electric & Energy System and RS Automation and waiting for earnings growth factors to materialise. ed: CK/ sa: LEY, CS Industry Focus Electric Equipment T able of Contents I. Summary & focus charts 3 II. Check on Korean/overseas ESS markets 7 II-1. Acceleration of global trends towards renewable energy after adoption of Paris agreement II-2. Why the spotlight on ESS? II-3. Analysis of Korea’s rapidly-growing ESS market III. ESS value chain 15 III-1. Various players in ESS value chain III-2. Why PCS is attractive in ESS value chain IV . Overseas electric equipment companies 17 IV -1. Sharp share price gap between US General Electric and European companies IV -2. European electric equipment players leading Industry 4.0 revolution IV . Company profiles 20 LS Industrial Systems – Top pick 20 Hyundai Electric & Energy System 26 RS Automation 31 Page 2 Company Focus Electric Equipment I. Summary & focus charts. ESS can address duck curve problems in power grid However, there are critical problems in PV power generation Korean ESS market grew 20-fold y-o-y in 1H18 equipment. Not only are power generation costs high, but PV Interest is high in the domestic ESS market. According to a power generation causes instability to power grids. A higher press release from the Ministry of Trade, Industry and Energy portion of PV power generation could cause the ‘duck curve’. (MOTIE) on 17 Jul, 1.8GWh of new ESS capacity was added in The duck curve, which was discovered and coined by the 1H18 (20-fold increase y-o-y). There was widespread doubt California Independent System Operator (CAISO) in 2013, about the economic feasibility of the ESS market but this was refers to net load dropping sharply between sunrise and sunset dispelled by strong government policy support in 2017. upon an increase in PV power generation, forming a graph that looks like a duck’s belly. ESS can help resolve several In early 2017, the Korean government introduced aggressive problems caused by the duck curve. incentives to expand the penetration of peak-cut ESS, including expansion of basic tariff discounts by three times and a 50% As such, the RES-connected ESS market grows together with charging tariff discounts for light-load hours. As a result, the the expansion of solar PV power generation. Increasing the use average payback period for ESS investments has decreased of renewable energy (including solar PV) has been the global from 10 to 5 years. With most discounts set to decrease from trend since the adoption of the Paris Agreement in Dec 2015. 2021, demand for peak-cut ESS should weaken over time. This has also led to sharp growth for the industries related to However, potential demand for peak-cut ESS is estimated to be renewable power generation, such as ESS and electric over 10GWh, indicating strong growth potential and an equipment. The Korean government and companies have no accelerated penetration, depending on government policies. choice but to join the trend. Grow th of renewable energy-connected ESS to move in sync Mark ed growth likely for PCS w ith expansion of solar PV system installations in Korea Growth of the ESS value chain should boost growth of other As for ESS connected with renewable energy source (RES), the areas. First of all, we expect sharp growth of the battery market should move in line with the penetration of solar PV industry, considering that batteries account for the largest power generation system in Korea. According to the 8th Basic proportion of ESS costs. Significant growth is also projected for Plan for Electricity Supply and Demand released at end-2017, power conditioning systems (PCS), which represents the the government plans to add solar PV power generation second largest portion of ESS building costs. PCS is a core capacity of 30.8GW between 2018 and 2030. The target is component for renewable power generation and the ESS increasing accumulated capacity fivefold or more by 2030 from ecosystem. While battery prices have dropped sharply over the 5.7GW at end-2017. past few years, PCS prices have shown only a limited decline. PCS is a kind of inverter, which has been used for industrial automation equipment for decades. As such, we see limited downside room for PCS prices, compared to battery prices. Page 3 Industry Focus Electric Equipment A nnual supply of power generation equipment (wind power/ A nnual supply of power generation equipment (wind power / solar PV) globally solar PV) in Korea : Efforts to increase use of renewable energy continue : Notable growth of solar PV power generation equipment Wind power (Korea) PV (Korea) Wind power (global) PV (global) (MW) (MW) 120,000 1,500 100,000 1,200 80,000 900 60,000 600 40,000 20,000 300 0 0 Source: GWEC (Global Wind Energy Council), British Petroleum Statistical Source: Korea Energy Agency Renewable Energy Center, The 8 th Basic Plan Revie w, DBS Bank for Electrici ty Supply and Demand, DBS Bank Problems of ‘Duck Curve’ and positive effects of ESS adoption • Renewable power generation (especially solar PV) lacks in the morning and evening when power demand is high. Therefore additional conventional power supply (nuclear, oil, coal, gas, etc.) is required. • Gas power plants are widely used, as they can be easily started and stopped. However, this could Duck curve cause an increase in gas prices. problems • Frequently turning on and off nuclear/oil/coal power generation could increase costs, and weaken power grid stability. • A sharp net load rise at a certain time requires construction of additional power plants and transmission/distribution networks. • ESS can store energy during midday when solar PV power generation is high and discharge it in the Effects of ESS morning and evening, thus lowering net load effectively. adoption • This removes the necessity to start/stop other power sources frequently, improving costs and system stability as a result. Source: Scottma dde n Mana ge me nt Consul ta nts, DBS Bank Outlook for Korea’s ESS market Solar PV-connected ESS likely to grow substantially : Cumulative supply of 12.5GWh by 2022 Cumulative ESS supply in Korea (LHS) Supply of new wind power-connected ESS New ESS supply in Korea (RHS) Supply of new solar PV-connected ESS (GWh) (GWh) Supply of new peak-cut ESS 15 3.0 2.6 (GWh) 2.2 2.3 2.3 3.0 2.6 12 2.4 2.0 2.5 0.0 2.2 2.3 2.3 2.0 9 1.8 0.1 0.2 0.2 2.0 1.1 0.1 6 1.2 1.5