Siemens Gamesa Renewable Energy

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1 ST pain, LT gain? (YE18 Price Target cut from 26. to 17.5; Recommendation upgraded from Neutral to Buy) 3Q17 results and guidance for 4Q17: A weak performance in Q3, a 6% slash in the order intake and low indications for Q4 triggered a severe market correction with the stock down c3% in one week. YTD, the stock is down 23%. Although the reasons behind the disappointment - halt in the Indian market, delays in US Safe Harbor contracts conversion and offshore volatility - could be temporary, in the ST the stock should remain pressured. November could enhance visibility with Q4 results disclosure (7 th ) and a CMD presentation. Synergies > 23mn: Annual 23mn synergies in a steady state would mean a c.2pp EBIT margin boost but such a margin increase is unlikely given the mounting pricing pressure. We are assuming an Underlying EBIT margin uplift from 8.1% in 217 to 9.2% by 22, driven by a recovery in WTG brought on by the appropriation of synergies and some normalization in market conditions. Long term gain? We set a YE18 Price Target of 17.5/sh, after revising our estimates. The industry continues to face important challenges such as pricing pressure from auctions, growing competition from solar PV or ongoing overcapacity but the growth outlook for wind power remains buoyant. On an underlying basis, the stock trades at a minor discount to Vestas while the upcoming CMD may bring upside risks on synergies execution and EBIT margin expectations in the medium-run. 22 FCF Yield ex-growth would stand at c12% F (vs. 1%F) and in such a no-growth scenario (from 22), our DCF valuation would still provide a c15% simple upside to current market prices. Although in the ST, the stock should remain pressured by the lack of visibility, for those patient to endure a tough Q4 and a weak 1H18, Siemens Gamesa is an enticing play. BUY. Siemens Gamesa Renewable Energy Buy High-Risk 5 Sep. 17 (16:32) Spain Siemens Gamesa vs. IBEX35 vs. DJ Stoxx DJStoxx 6 Source: Bloomberg. XIV IBERIAN CONFERENCE IBEX Siemens Gamesa 6 Sep-16 Mar-17 Sep September, Cascais, Portugal Full details and registration now at Stock Data Price (1 st Sep): Price Target (YE18): 17.5 # shares (mn): M. Cap ( mn) / F. Float: / 33% Reuters/Bloomberg: SGREN.MC/SGRE SM Avg. Daily Vol. [ ']: Major Shareholders: Siemens (59%), IBE (8%) Estimates F 218 F 219 F 22 F PE Adj Dividend yield.%.7% 1.3% 12.7% 1.1%.9% 1.5% FCFE Yield 3.9% 2.5% 13.1% n.s. 2.2% 6.% 7.8% FCFF Yield 4.% 1.7% 15.7% n.s. 5.8% 8.7% 1.1% PBV EV/EBITDA (1) EV/Sales (1) (1) EV is fixed with current market cap and MV of remaining items. Analysts Flora Trindade, CFA flora.mericia.trindade@bpi.pt Phone Historical Recommendation Date Recommendation 29-Jan-16 Neutral 29-Jun-16 Buy 6-Sep-16 Neutral Note: Historical recommendation for Gamesa and Siemens Gamesa. Source: BPI Equity Research. Available on our website: BPI Online, and Bloomberg at NH BPD.

2 Equity Research Siemens Gamesa September 217 Consensus and Stock Momentum BPI estimates/consensus EBITDA Consensus ( mn) EPS Consensus ( /sh.) Revenues 8% 3% 2% EBITDA -5% -16% -1% 1 2 EBIT 7% 7% 6%.8 Net Profit 29% 2% 15% 8 ND/Cash -49% -62% -48% Y 18Y 19Y. 17Y 18Y 19Y Market Price Rating ( /sh.) Fair Value Comparison ( ) Market Recommendations Price Target Consensus Price Neutral 28% Positive 36% Sep/15 Sep/16 Sep/17 P/E P/BV Consensus BPI Negative 36% Current Market Price Source: Bloomberg and BPI Equity Research. Main Assumptions PF 217F 218F 219F 22F Global new cap. (GW) Volumes (GW) Price/MW ( ) NWC/sales 8.1% 2.2% -.3% -5.5% 1.8% 1.1% 1.%.5% Capex/Sales 5.2% 3.8% 4.8% 1.9% 6.3% 5.% 3.5% 3.5% Sales ( mn) WTG O&M Underlying EBIT ( mn) WTG O&M Underlying EBIT mg 5.3% 6.4% 8.4% 9.7% 8.1% 8.2% 8.9% 9.2% WTG 4.1% 5.2% 7.6% 9.3% 7.1% 7.1% 8.% 8.3% O&M 11.8% 12.6% 13.4% 13.2% 16.5% 16.5% 16.5% 16.5% Source: Siemens Gamesa, BPI Equity Research. 2

3 216PF 217PFF 218F 219F 22F 221F Equity Research Siemens Gamesa September 217 Siemens Gamesa at a Glance Shareholder structure Others 33% Order Book (GW) Iberdrola 8% Siemens 59% WTG 3Q16 3Q17 Services Annual wind installations per region (GW) 8 6 Annual wind installations onshore vs offshore (GW) Onshore Europe Onshore Asia Offshore Onshore N. America Onshore Others Onshore Offshore Onshore - Suppliers market-share in 216 Envision 3.7% Ming Yang 3.7% Siemens 3.9% Others 25.% Vestas 16.5% GE 12.3% Goldwind 12.1% Gamesa 7.% Offshore - Suppliers cumulative market-share (YE16) Bard Others 3% Sinovel 5% 2% Areva 5% Senvion 7% MHI Vestas 15% Siemens 63% Guodian 4.2% Nordex 5.% Enercon 6.6% Historical EBIT ( bn) and Underlying EBIT mg Estimated Revenues ( bn) and EBIT mg % 9.2% >8% % 8% 4% 5 % LTM Jun16 LTM Jun17 Guidance LTM Sep17 WTG Services Underlying EBIT mg Source: Gamesa, BNEF, BPI Equity Research. Revenues Underlying EBIT mg EBIT mg 3

4 F 218F 219F 22F F 218F 219F 22F Equity Research Siemens Gamesa September 217 INVESTMENT CASE WIND INDUSTRY IN CONSOLIDATION MODE The merger between Siemens and Gamesa followed a wave of M&A or JV deals in the sector, including GE and Alstom, Nordex and Acciona as well as Vestas and Mitsubishi, to name a few. The trend has also expanded across the value chain with GE acquiring LM, the leading provider of blades, late last year. The industry consolidation has improved the positioning of the involved parties including Siemens Gamesa - which has consequently increased the competitive pressure in the market. WIND POWER GAINING RELEVANCE At the end of 216, worldwide wind installed capacity reached 487GW (GWEC), after adding 54GW during the year. This showed a deceleration from 215 when over 6GW were installed, mostly due to China. Still, since 21, average annual growth reached 22%, boosted in the onset by attractive regulatory incentives and more recently by the growing competitiveness of wind power. Wind installations (GW) % CAGR 4 3 Wind capacity additions (GW) Wind capacity additions forecasts (GW) Source: GWEC. In offshore alone, installed capacity reached 14GW by YE16, with the UK maintaining the leadership, securing around 36% of worldwide offshore installed capacity followed by Germany. China surpassed Denmark after adding 592MW, and is now the third largest country in offshore installed capacity. After a dull 216, with c2gw installed, wind offshore capacity additions are expected at around 6GW in 217, mostly in Europe (mainly Germany, UK and Netherlands) and Asia (mainly China). 56 Source: BNEF Offshore cumulative capacity (GW) Offshore new capacity (GW) YE16 Offshore Wind by region Netherlands 8% Sweden Belgium 1% 5% Others 1% UK 36% 2 4 Denmark 9% 1 2 China 11% Germany 29% Source: BNEF. Source: GWEC 4

5 Equity Research Siemens Gamesa September 217 In 217, new wind installations (onshore + offshore) are expected at around 59GW, mostly supported by growth in emerging markets (although India has been a disappointment so far which may drag down final figures) and offshore (where Siemens is one of the main players). 218 is expected to show a modest 3% yoy growth in capacity additions mostly due to flat additions in Europe and Asia. These areas should return to growth from 219 (5-6% average), combined with LatAm and the US. In the US, despite doubts following the new administration comments, RPS in several states, growing demand for PPAs and bi-partisan support for PTCs phase-out scheme should help to support market expansion. YE16 Installed Wind Capacity by region Africa & ME 1% Latam&Caribbean 3% Pacific region 1% N. America 2% Wind capacity additions 217 by region Africa & ME 3% Latam&Caribbean 6% Pacific region 1% N. America 17% Asia 42% Europe 33% Asia 49% Europe 24% Source: GWEC, BNEF. AND IN THE LONGER TERM, WHAT S THE FUTURE FOR RENEWABLES? The IEA estimates a 3% rise in global energy demand to 24. In this scenario, renewable energy is the one facing the strongest growth forecasts. By 24, the IEA estimates that c.4% of all power generation capacity will come from renewables and that by that time the majority of the renewable energy generation will be competitive without subsidies. Solar PV costs are expected to decline by 4-7% by 24 and onshore wind by 1-25%. Over the period to 24, renewables account for almost 6% of all new power generation capacity additions leading wind and solar combined to have more installed capacity than any other source of generation by 24. This will obviously bring some challenges including the strengthening of electricity grids and management of the availability and interruptibility of renewables power plants. Share of global demand met by renewable energy Total demand Renewables Indirect renewables Electricity (Thousand TWh) New Policies Scenario 24 23% 37% Scenario 34 58% Heat (Thousand Mtoe) 9% 5. 15% % Transport (Thousand Mtoe) 3% 2.6 Note: New Policies Scenario: takes into account existing energy policies and announced intentions such as those submitted for COP21. Current Policy Scenario: considering only policies firmly enacted as of mid Scenario: pathway to limit long-term global warming to 2ºC above pre-industrial level. Source: IEA. 7% In the more optimistic scenario, renewable energy share in generation increases to around 6%. Under this scenario, wind alone is expected to represent some 18% of total generation by 24 vs. c3% back in % 2.7 5

6 Vestas GE Goldwind Siemens Gamesa Enercon Nordex Guodian Ming Yang Envision Others Equity Research Siemens Gamesa September 217 Evolution of the power generation mix in the 45 Scenario TWh 34 1TWh Unabated fossil fuels 67% Source: IEA. Nuclear 11% Hydro 16% Wind 3% Solar PV 1% Other renewables 2% Other renewables 11% Unabated fossil fuels 16% Solar PV 9% Nuclear 18% The growth outlook for wind power is buoyant and Siemens Gamesa following the merger are clearly better positioned to take advantage of these trends. The industry however continues to faces some challenges ahead such as the growing competition from solar PV, the ongoing overcapacity or the lack of storage capacity and grid integration issues. As time goes by, repowering should also represent a new stream of opportunities. CCS 8% Wind 18% Hydro 2% Global power sector investment in ($ tr, 215) Source: IEA..8 CCS NPS 45 NPS 45 NPS 45 Fossil fuels Nuclear Renewables Other Bioen ergy Hydro Solar PV Wind SIEMENS GAMESA RELATIVE POSITIONING In 216, Siemens Gamesa was the fourth largest player in onshore installations with a combined market-share of 1.9%, behind Vestas (#1; 16.5%), GE and Goldwind. Wind onshore capacity additions market-share 4% Wind offshore cumulative market-share (216) 3% 2% 1% 16.5% 12.3% 12.1% 1.9% 6.6% 5.% 4.2% 3.7% 3.7%3.3% 13.5% 12.6% 1.2%1.% 5.3% 5.2% 4.8% 4.7% 3.4% 25.% Areva 5% Bard 3% Sinovel 2% Others 5% % Senvion 7% MHI Vestas 15% Siemens 64% Source: BNEF. Source: BNEF. In offshore, Siemens is the market leader with a cumulative market -share of over 6%, followed by MHI-Vestas with around 15%. New offshore capacity is expected to accelerate in 217 to c6gw (c2gw i n 216, mostly in Europe). 6

7 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 USD/MWh Equity Research Siemens Gamesa September 217 MAIN INDUSTRY TRENDS (i) Industry Overcapacity Average onshore WTG prices have been under pressure due to overcapacity in the sector and strong competition. Bloomberg New Energy Finance (BNEF) estimates a total turbine nameplate production capacity of c.123gw this year vs. demand of 59GW, implying a capacity utilization of 48% vs. 54% in 215. Overcapacity is mainly witnessed in China and Europe. Wind Turbine Nameplate capacity (GW) Nameplate capacity vs. Demand Capacity China China North America Europe Europe LatAm+RoW Note: LatAm+RoW demand forecasts include offshore. Source: BNEF. Demand North America LatAm+RoW (ii) Increasing number of auctions Additionally, after years of generous premium tariffs, several countries have started to introduce competitive auctions for new capacity awards. According to IRENA (International Renewable Energy Agency), the number of countries opting for auctions has increased from 6 in 25 to at least 67 by mid-216. This has fostered competitive pressure whilst removing the burden of incentives over a country s electricity system budget as in the past. Average prices in recent auctions stand well below previous regulated tariffs, ultimately putting pressure also on turbine providers. Average prices in auctions (21-16) (USD/MWh) Wind Turbine Price Index ( mn/mw) Solar prices 1 1 Wind prices Source: IRENA. (iii) Bringing pricing pressure Pricing pressure has been mainly witnessed in markets where overcapacity is more significant such as China but also in markets where auctions are the main award mechanism. Competition is coming also from solar PV, which is competing directly with wind power for new capacity in capacity auctions. Source: BNEF, Bloomberg. 7

8 Dec-9 Jun-11 Dec-12 Jun-14 Dec-15 Jun-17 Equity Research Siemens Gamesa September 217 Auctions prevail in markets where Gamesa standalone is a key player, such as India or Brazil. India hosted the first wind auction in February 217 (1GW). A total of 1GW was awarded in this auction. The auction brought tariffs down to USD 51.9/MWh (IRN 3.46/KWh), below the feed-in tariffs prevailing in any Indian state (c. IRN 5/KWh). There has been a clear slowdown in the market with no further visibility on new MWs on top of the auctions launched by the government. Two additional auctions could take place in the remainder of the year, each totalling 1GW. Some industry sources are pointing to capacity additions of 1-3GW this year in India vs. initial expectations of 4-5GW. (iv) Mitigated by ongoing cost reductions Technological progress alloyed to the ongoing effort to reduce costs of wind turbines has been allowing the industry to mitigate the impact from pricing pressure, protecting margins. In fact, wind is now cost competitive with conventional energy sources in several markets driven by technological advancements and the trend is expected to continue (IEA estimates a further 1-25% cost reduction in wind onshore). Wind Turbine Price Index ( /MW) and SGRE Wind Turbine SGRE.4 Levelized Cost of Energy ($/MWh) Source: BNEF, Bloomberg Wind Solar PV CCGT Nuclear Coal Source: Lazard. Although there are other drivers, further cost reductions are expected to come in a great part from the use of larger and more efficient turbines with increased hub heights and rotor diameters. Increasing rotor diameter and height is believed to be the best way to access more power from wind turbines. Turbine size evolution - onshore Source: Berkley Lab, Nature Energy. 8

9 216PF 217F 218F 219F 22F 221F 222F 223F 224F 225F 3Q16 4Q16 1Q17 2Q17 3Q17 Equity Research Siemens Gamesa September 217 Turbine size evolution - offshore Source: Berkley Lab, Nature Energy. (iv) And growing weight of the services division Turbine manufacturers are working to expand their services/o&m units which bears higher margins and more stable CFs. An aging fleet, with several wind farms already out of the warranty period, opens a n expanding market for O&M services and specific offerings for improved efficiency, life extension or reconditioning products. Vestas services a fleet of 71GW vs. 54GW for Siemens Gamesa, including 7.7GW from offshore. We estimate Siemens Gamesa O&M revenues at 1.2bn in FY17 (11% of total sales), with a margin of 16.5%. Vestas has boosted its exposure to the services business through the acquisition of two independent service providers UpWind (>3GW) and Availon (>2.6GW) in late 215/early 216, which should help it to have some margin cushion going forward. Notwithstanding, the O&M/services business also faces some challenges as large utilities are trying to increase the share of in-house maintenance. (v) Offshore reducing costs and requiring lower tariffs The offshore industry had a target of reducing prices to around 1/MWh by 22. However, in 216 several tenders in Northern European markets were already set below the 1/MWh mark Netherlands 72.7/MWh (July) and 54.5/MWh (Dec.); Denmark 64/MWh (Sept.) and 49.9/MWh (Nov.). According to GWEC, these prices do not include transmission costs, which could add up some 6-12/MWh and still stand clearly below the 1/MWh mark. Although these prices have to be analysed considering the characteristics of each specific market (su ch as location, access to grid, etc.), it shows a clear downward trend and may lead some countries to accelerate their offshore growth plans. Offshore is one of the main growth axis in wind power, with installed capacity expected to grow at a 3% CAGR16-2. Fleet under maintenance (MW) Source: SGRE. Siemens Gamesa Services: Revenues and EBIT ( mn) Onshore Offshore 2% 15% 1% 5% % Revenues EBIT mg Source: SGRE, BPI Equity Research. 9

10 Equity Research Siemens Gamesa September 217 FINANCIAL ESTIMATES Visibility on strategic guidelines, portfolio rationalization and capex plans are still relatively scarce. A strategic presentation will be hosted in November. Until then, we detail below the main assumptions behind our financial model. Disappointing 3Q17 the first quarter for the combined group Q3 (Apr-Jun) sales reached 2693mn, down 7% yoy, impacted by a decline in WTG sales (-9%). Sales were impacted by the downturn in the Indian market following the introduction of auctions. Excluding India, sales would have increased 1.6% yoy. Underlying EBIT margin pre-ppa (or excluding 36mn integration costs and 124mn amortization of intangibles fair value from the PPA) came at 7.8%, down 1.3pp yoy (8.6% excluding India). India was the main individual market for Gamesa on a standalone basis, representing 38% of volumes in 216 and 29% in 215, which would be equivalent to some 2% of the combined group. In 3Q16, India was responsible for sales of 273mn and 38mn EBIT, with an implicit margin of 13.9% (vs. average 9.6% margin for Gamesa group). This compares with a negative EBIT contribution of 18mn in 3Q17. The introduction of auctions has led to a freeze in the market that is still adapting to the new tendering rules. There are further auctions scheduled, which considering the typical lag between the auction award and the materialization of orders may extend the volume pressure for Siemens Gamesa in the short -term. Siemens Gamesa also recognised some delays in the US market with developers postponing the conversion of orders included in the Safe Harbor contracts (the phase-out of PTCs started in projects that started construction before the end of 216 were entitled to 1% of the PTC; projects are considered to be under construction if a minimum of 5% of the capital cost has been incurred). Management expects these orders to be more concentrated in Again this seems to be a temporary issue that should also affect other WTG providers. Order intake down 4% and implicit Q4 EBIT margin guidance at 4% On top of the weak financial performance during Q3, Siemens Gamesa already reported a relevant slash in the order intake. At the end of June, the order intake reached 693MW, from 1662MW a year before. On top of the halt in the Indian market (45MW in 3Q16), the delays in US Safe Harbor contracts, orders in markets such as EMEA and Europe also shifting towards 2H of calendar year as well as volatility in the offshore market are pointed out as reasons behind the order intake disappointing performance. Siemens Gamesa believes these are temporary issues, expected to be recovered in the coming quarters. LTM Sept17 EBIT margin is expected to stand at or above 8%, implicitly meaning an EBIT mg for Q4 of c.4%, which is clearly a very low level. We would have to go back to to see EBIT margins of 4% (or below) in one quarter for Gamesa standalone. India contribution ( mn) 3Q16 3Q17 Sales EBIT EBIT mg 13.9% -72.% Source: Siemens Gamesa. Guidance ( mn) LTM Sep17PF LTM Sep16PF Rev enues Underly ing EBIT (pre-ppa) c Underly ing EBIT mg (pre-ppa) > 8% 9.1% NWC/sales -3% to +3% 3.2% Capex 74 Source: Siemens Gamesa. Stock price ( /sh) and EBIT mg evolution EBIT mg 12% 8% 4% % 1 5 GAM -4% -8% % Source: Gamesa, Bloomberg. 1

11 FY16PF 217F 218F 219F 22F 221F 222F 223F 217F 218F 219F 22F 221F 222F 223F 217F 218F 219F 22F 221F 222F 223F Equity Research Siemens Gamesa September 217 Main modelling assumptions: - Sales up 4% in 217-2F We estimate onshore volumes of 8.1GW by 22 and offshore of 2.9GW, implying total volumes of 11GW by 22, from 9.2GWF in 217F. This implies volumes 217-2F CAGR of 6%, of which 3% for onshore and 18% for offshore, which we believe is relatively conservative considering industry estimates of 1% CAGR for onshore and 26% for offshore. Volume growth of 6% compares with sales growth of 4%, mainly impacted by an assumed 2% decline in average selling prices. For the services division which includes the maintenance of 54GW currently and some 59GW estimated by 22, we are assuming a sales 217-2F CAGR of 5%. Volumes (GW) 16 Sales assumptions ( bn) Sales and Average Selling Price Onshore Offshore WTG Onshore Services WTG Offshore 5 1. Source: BPI Equity Research still tough... Underlying EBIT margin of 8%-9% in 217-2F Annual synergies of 23mn in a steady state would be equivalent to a c.2pp EBIT margin boost. In our estimates however, we are assuming that Siemens Gamesa will have to use part of these synergies to have a more competitive offering, sharing a part of the synergies with clients, trying to preserve its base EBIT margin. As such, we are assuming an Underlying EBIT margin (excluding PPA amortization and integration costs) uplift from 8.1% in 217 to 9.2% by 22 (9.5% by 223), driven by a recovery in WTG following an expected normalization in the Indian, US and offshore market and the appropriation of synergies. Considering integration costs (.8%,.9% and.2% of sales in , respectively), average EBIT margin in 217-2F (ex-ppa amortization) stands at 7.8%..8 Sales ( bn) Avg prices ( mn/mw) Source: Siemens Gamesa, BPI Equity Research. 218 will still be a tough year impacted by pricing pressure. EBIT margin is therefore expected to remain roughly flat in 218 with the incorporation of synergies roughly offsetting the expected pricing pressure and integration costs. In the initial plan, over 5% of synergies were expected to be extracted already by year 2. In our forecasts, we are assuming c. 16mn synergies in 218 vs. 15mnF of integration costs. Assumed synergies represent some 1.4% of total sales which should be used to offset integration costs and to be more competitive in the current context of pricing pressure and therefore not bringing a meaningful contribution to margin expansion in

12 217F 218F 219F 22F 221F 222F 223F 224F 225F FY16PF 217F 218F 219F 22F 221F 222F 223F Equity Research Siemens Gamesa September 217 EBIT / EBIT mg (reported and underlying) % 9% 6%. 3% Reported EBIT ( bn) Reported EBIT mg Underlying EBIT mg after integration costs Underlying EBIT mg Source: Siemens Gamesa, BPI Equity Research. - Higher capex in on commitments assumed; 3.5%F of sales from 219 The merged entity should continue to use a flexible and modular capex approach, dependent on the pace of growth. For 217PF, we are assuming the capex guidance given by the company of 74mn (6.3% of sales), impacted by commitments already assumed. In 218, capex should still be slightly above the LT average at an assumed ratio of 5% of sales or 56mn. Considering the modular capex approach, we have assumed a capex/sales ratio of 3.5% from 219 onwards, consistent with a lowsingle digit revenue growth. - NWC/sales... assuming conversion towards % In 216, PF NWC/sales stood at -5.5% and we are assuming the group should be working towards a c.% ratio until there is further visibility on guidance. We are modelling a NWC/sales ratio of +1.8% for 217 vs. a guidance of -3%/+3%, +1.1% for 218 and c.% in the long run. - Average FCF of 35mn in 218-2F As a consequence of the assumptions detailed above, we expect Siemens Gamesa to see its net cash position of 236mn at the end of June declining to 77mn by YE17, with a Q4 CF consumption of c 159mn, of which 189mn from capex and 56mn from working capital. Going forward, a normalization of NWC and capex as well as the incorporation of synergies implies an average FCF of around 35mn in 218-2F (still impacted however by the cash outflow related with Adwen and SWP quality provisions), equivalent to an average FCFE yield of 5%. We estimate ROCE to surpass our WACC assumptions only after 22. ROCE vs. WACC 2% ROCE 16% 12% WACC 8% 4% % ROCE/WACC Source: BPI Equity Research FCF estimates ( mn) F 218F 219F 22F EBITDA NWC Financials&Taxes Capex Dividends Others (incl Provisions) Source: Siemens Gamesa, BPI Equity Research. 12

13 Equity Research Siemens Gamesa September 217 VALUATION & RECOMMENDATION Siemens Gamesa will hold a Capital Markets Day in November, when the group is expected to share with the market the main strategic guidelines, the progress of integration and financial targets. In the meantime, Q3 results (Apr-Jun) already reflected the combined company financials. The fiscal year was changed to October- September to align with Siemens reporting. Market Performance Siemens Gamesa is down 23% YTD vs. a 27% hike of its closest peer, Vestas. The stock was up by c.3% until mid-may and started correcting since then, mostly triggered by concerns around profitability levels after recognising pricing pressure brought on by auctions, specially the one in India (first one in February) which is a key market for Gamesa on a standalone basis and a major market for the combined group. The correction has accelerated following Q3 results as the combined group reported disappointing EBIT margins and a weak guidance for Q4 as well as a strong decline in the order intake. The low visibility on the combined group strategy and targets has also played its role, we believe. WTG players performance 24 2 Vestas Siemens Gamesa 8 Goldwind 4 Suzlon Nordex Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Source: Bloomberg. According to our estimates, Siemens Gamesa is now trading at an EV/EBIT17-18F of 15-19x on reported figures or 9.5x-9.6x on an underlying basis, at a slight discount to Vestas ( x). 17.5/sh YE18 Price Target We value Siemens Gamesa through DCF, with an explicit period until 23, and a WACC of 8.5%. We revised our estimates following Q3 results, with an average 18% underlying EBIT cut driven by more conservative sales assumptions (on average prices and volumes). We have also adjusted our valuation for the provisions at Adwen and SWP quality provisions. These provisions total 1.1bn currently ( 498mn NPV in our SoP), and we have assumed that c5% would be expensed in We set a YE18 Price Target of 17.5/sh Sum of Parts ( mn) EV Method WTG EV DCF Adj. Net debt YE18F (1) 328 Financial Investments BV Equity Value # shares (mn) 681 YE18 Price Target ( /sh.) 17.5 (1) YE18F Net cash of 17mn adjusted for 498mn provisions NPV. 13

14 Equity Research Siemens Gamesa September 217 Source: BPI Equity Research. India... temporary or not? According to GWEC, the main WTG suppliers in India are Suzlon, WindWorld, Siemens Gamesa, Vestas and Regen. The manufacturing capacity is estimated at 9.5GW and during 216, capacity additions reached 3.6GW, the fourth largest in terms of capacity additions worldwide (behind China, the US and Germany) and a record for the country. The acceleration in new capacity additions was driven by the end of the GBI (Generation Based Incentive) by 216/17 and the cut in Accelerated Depreciation benefits. Expectations that new orders in the non-auction market could help to compensate the slowdown brought on by the new auction system ended up not materializing leading to a freeze in the market. This year, new installations could range from 1-3GW vs. initial expectations of 4-5GW. On top of the 1GW auction back in February, India has announced two additional auctions of 1GW each. The country has a target of reaching 175GW of renewables by 222, of which 6GW of wind power by 222 from c.3gw currently, which would put average annual additions at 5-6GW! Hence, although not clear how long it will take to see the market normalising on the volumes front, we believe this slowdown should mainly reflect the adaptation of the market to the new auction system, not putting at stake the strong growth prospects in a wider timeframe. This said, we are likely to see much lower prices going forward and therefore, some margin pressure following the strong levels witnessed in the latest years (1-15%), the impact of the new auction system and the competition for new orders. Better positioned following merger Gamesa and Siemens Wind Power lacked the scale to compete in an increasingly demanding industry context, on a standalone basis. The combined group is now much better equipped to weather the sector challenges with (i) a diversified geographic footprint; (ii) a wider product range with exposure to the growing offshore segment and (iii) r oom to grow in O&M services (incl. offshore) supported by a (iv) healthier financial backup (Siemens). But not without risks Integration and execution risks are the most obvious in the initial stage of the merger process. Portfolio rationalization could be a challenge as well as harmonising the groups components strategy (blades, gearbox/direct drive,...). Synergies are targeted at 23mn, from year 3, representing some 2pp of current sales. The growing number of countries making a transition to an auction system, the growing competitiveness of solar and the overcapacity in the industry should increase the pressure to lower the LCOE (Levelized Cost of Energy) and consequently turbine prices. As such, we are unlikely to see a 2pp EBIT margin increase sin ce Siemens Gamesa is likely to use this cushion to improve its product offering competitiveness and preserve the 8-1% target EBIT margin. Upgrading to Buy The last quarter of 217 and the first semester of 218 are likely to mirror EBIT margin pressure brought on by tough pricing trends. However, in a wider timeframe, Siemens Gamesa is well placed to benefit from the industry s resilient growth prospects. 22 FCF Yield ex-growth would stand at c.12%f (vs. 1%F) and in such a no-growth scenario (from 22) our DCF valuation would still provide a c15% simple upside to current market prices. For those willing to endure the short term hiccups, the recent correction offers an interesting entry point. BUY. Changes in estimates 217F 218F 219F Rev enues -1% -9% -11% Underly ing EBIT -11% -21% -18% Underly ing EBIT mg -1.pp -1.2pp -.8pp EBIT -44% -61% -43% EBIT margin -4.pp -5.4pp -3.5pp Underly ing NP -7% -17% -17% NP as reported -45% -62% -43% Net debt/cash -94% -89% -69% Source: BPI Equity Research. Changes in valuation Now Before Chg WTG EV % Adj ND % Fin Inv % Equity Value % YE18 PT % Source: BPI Equity Research. Sensitivity to LT EBIT mg and WACC ( /sh) Perpetuity EBIT mg 7.% 9.% 11.% 9.5% WACC 9.% % % % Source: BPI Equity Research. 14

15 Equity Research Siemens Gamesa September 217 SIEMENS GAMESA MERGER Main terms Gamesa and Siemens announced their merger in June last year, following the confirmation of negotiations in the beginning of February. The merger was effective last April. Siemens received shares representing 59% of the merged entity and Gamesa s shareholders retained the remaining 41% (Iberdrola 8%). The exchange ratio valued Gamesa at 4bn equity value (market cap pre-deal) and Siemens at 5.8bn. As part of the deal, Siemens paid a DPS of 3.75/sh to Gamesa s shareholders. The merged company remains listed and headquartered in Spain. #4 wind onshore player; #1 in offshore Siemens Gamesa secured an 11% market-share in 216, the 4 th largest player in wind onshore. Both companies have a combined backlog of 21bn ( 5.7bn Gamesa bn Siemens), a combined installed base of over 7GW (Vestas 82GW) and a fleet under O&M of 54GW (Vestas 71GW). Strong complementary fit Gamesa and Siemens show a strong geographic fit with Gamesa stronger in LatAm and Asia Pacific regions whilst Siemens has a stronger foothold in North America and Europe. The client type of both groups is also different with Gamesa mainly focussed on Southern European utilities and local IPPs in emerging markets whilst Siemens mostly focussed on Northern European and US utilities as well as local IPPs in developed markets. Siemens and Gamesa geographical footprint Siemens WP Stronghold Siemens WP Stronghold Gamesa Stronghold Gamesa Stronghold Gamesa Key Market Siemens Wind Power key market Market served by both Siemens Wind Power existing factory Siemens Wind Power factory under construction Gamesa existing factory Gamesa factory under construction Source: MAKE, Gamesa. The complementarity extends to the product range. The wide product portfolio range should be under revision in an effort to rationalize the group s offering. Gamesa s product range is basically onshore (offshore through Adwen), in markets with capacity restrictions (limited transmission capacity, unlimited land), which are typically emerging markets such as India or Brazil. Siemens on the other hand, has a strong position in offshore whilst in onshore it is mainly focused in land constrained markets/position limited (areas where there is a fixed amount of land, not limited by the capacity that can be accepted by the grid), such as Europe. On top of this, in the onshore segment Gamesa has a strong offering in the low-wind and medium-wind segments (but also for high-wind segment capacity 15

16 Equity Research Siemens Gamesa September 217 constrained markets such as Brazil) while Siemens is mainly stronger in medium-wind and high-wind segments. Larger turbines (>3MW) are typically suitable for land-constrained markets while capacity-constrained markets typically use turbines with a capacity of 1.5-3MW. Siemens and Gamesa product portfolio Siemens Wind Power Gamesa Onshore Mainstream Position limited pr oduct Capacity restricted pr oduct High wind Medium wind Low wind High wind Medium wind 1 D3 SWT G G MW Low wind Offshore 1 G4 + D7 SWT (1) Source: Gamesa. Better equipped to face sector trends Although obviously not immune, Siemens Gamesa is now better prepared to face the pricing pressure and overcapacity in the industry as the merger provides scope for synergies appropriation and a complementarity of their geographic footprint and portfolio of products. Additionally, with several players in the industry embarking in consolidation moves, Gamesa would be in a much weaker competitive position in relative terms on a standalone basis and would most likely be forced to sacrifice margins in order to be price-competitive. Cost and Revenue synergies: 23mn in 3 years Gamesa expects run-rate synergies of 23mn, pre-tax, in 3 years (vs. an initial plan of 4 years). Cost synergies are expected to represent some 8-9% of total, while the remaining should come from revenue synergies. The majority of the synergies should be extracted in the onshore business (c7%). Total synergies of 23mn represent some 2.1% of 216PF revenues, which compares with c.3% in the Nordex/Acciona deal. Still, as we have mentioned before, we believe that an EBIT margin increase of this magnitude (2pp) is unlikely given the growing competitive pressure. Siemens Gamesa Chairwoman Rosa María García CEO Markus Tacke CFO Andrew Hall Source: Siemens Gamesa. Synergy target by function 3-4% 1-2% 1-2% 1% 1% 1-2% Procurement Supply Chain Technology Project Management Source: Siemens Gamesa. G&A and other Sales Revenue synergies should come mainly from the product and market complementarity mentioned above, both in the turbines (onshore/offshore) and services (widening service offering to more MW and additional services). 16

17 Equity Research Siemens Gamesa September 217 Cost synergies are the most relevant ones and comprise: - Procurement: optimising the insourcing/manufacturing capacities, taking advantage of scale in the purchase of components and consolidating the logistics and supplier base. - Supply chain: rationalization of the product portfolio with limited expansion requirements expected. - Technology: streamline R&D costs and avoid overlap of efforts in some areas with a balanced product portfolio. - Project management: identifying overlap in operations and optimization of resources allocation. - G&A and other: reducing structure costs and grouping resources in markets where both companies are present. Integration costs on the other hand are expected to amount to some 2-22mn during the first 3 years. We are assuming that integration costs are mainly concentrated in the first two years ( 189mn vs. 21mn total). Shareholders Pact Siemens and Iberdrola signed a shareholders pact last June. The most relevant points of the Pact are included below: - CFO: Siemens appointed the CFO for a maximum period of 18 months. Beyond that period, Iberdrola has the right to appoint the CFO. - As long as the shareholders pact is in place, the following resolutions will not be passed (i) increase in share capital more than 1%; (ii) any acquisition, disposal or contribution to another company of assets worth more than 15% of Gamesa s total assets; (iii) any merger, demerger or global assignment of assets and liabilities which entails a change in assets of more than 15%; (iv) winding-up and liquidation of Gamesa and (v) change in the number of Board members. - Squeeze-out and/or delisting of Gamesa: if in a period of 18 months, Siemens formally launches a takeover bid for all shares of Gamesa in which a squeeze-out is implemented or the GSM resolves the de-listing of the shares or Siemens/Gamesa formally initiate a delisting offer: the Floor price to be offered will be 18.15/sh (to be adjusted if there are dilutive operations in the meantime); the consideration shall be entirely in cash. - If Iberdrola intends to sell more than 1% of Gamesa it has to issue a written notice to Siemens. If Siemens wants to buy it must send a written notice to Iberdrola within 1 business days. - In the event that Siemens breaches determined the obligations contained in the Pact, Iberdola has the right to sell its shares of Gamesa. Siemens is obliged to purchase such shares at the higher of 22/sh or closing price of Gamesa on the day of the Breach plus a premium of 3%. - The agreement may be terminated at any time if there are material breaches or if Iberdrola s stake in Gamesa falls below 5%. 17

18 Equity Research Siemens Gamesa September 217 P&L ( mn) CAGR PF 217 F 218 F 219 F 22 F 16-2 F Revenues % EBITDA % EBITDA adj % EBITDA adj. mg. 12.8% 14.8% 12.3% 9.8% 9.6% 11.2% 11.6% -2% Depreciation & others % EBIT % EBIT adj % Net financial results % Income tax % Others n.s. Minority Interests % Net Profit reported % Net Profit adj % Balance Sheet ( mn) CAGR PF 217 F 218 F 219 F 22 F 16-2 F Net Intangibles % Net Fixed Assets % Net Financials % Inventories % ST Receivables % Other Assets % Cash & Equivalents % Total Assets % Equity & Minorities % MLT Liabilities % o.w. Debt % ST Liabilities % o.w. Debt % o.w. Payables % Equity+Min. + Liabilities % Cash flow ( mn) PF 217 F 218 F 219 F 22 F + EBITDA Chg in Net W.C Income Taxes = Operating Cash Flow Growth Capex Replacement Capex Net Fin. Inv = Cash Flow after Inv Net Fin. Exp Dividends Paid /- Equity Other =Change in Net Debt Net Debt (+)/Net Cash (-) Growth, per share data and ratios PF 217 F 218 F 219 F 22 F Sales growth 22% 23% 215% 1% % 6% 5% EBITDA Adj. growth 27% 42% 162% 5% 8% 7% 6% EPS Adj. growth 92% 37% 17% -11% 2% 13% 8% Avg. # sh (mn) Basic EPS EPS Adj. Fully diluted DPS Payout 25% 27% 148% 25% 25% 25% 25% ROCE (after tax) 8.7% 16.5% 2.5% 5.7% 4.% 6.7% 8.% ROE 7.7% 11.7% 17.8% 5.8% 4.4% 7.1% 7.8% Gearing (ND/EV) -2% -4% -18% -1% -2% -8% -15% Net Debt/EBITDA Source: Company data and BPI Equity Research (F). DCF assumptions Re 11.% Rf + CRP 4.% Beta Equity 1.17 Market Premium 6% Rd 4% Tax rate 3% D/EV 3% WACC 8.5% Perpetuity EBIT mg 9.% Source: BPI Equity Research. 18

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