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DISCLAIMER: Disclosure statements provided on the last page of this report are an integral part of this document.

Poland, Renewable energyPEP

Reuters: PEPP.WA Bloomberg: PEP PW 1 April 2011

Renewables are trendy Recommendation BUY. 12M Target Price at PLN 45.0

The company has over 1GW of wind projects in the pipeline to be delivered by

2014, which should allow PEP to run 360MW on its own, and 80MW will be

operational as of year-end 2011. The company’s expertise in the biomass

segment should also allow PEP to build and operate biomass-fuelled power

units – its strategy includes construction of two 30MW units of this kind. A

successful SPO with 1.57m shares sold at 6% above minimum price should help

PEP reach these goals. We believe the risk to green electricity pricing has been

greatly overstated, as have the Mondi lawsuit implications. The recent

questioning of the safety of nuclear technology may actually boost demand and

support for renewable electricity sources – all renewable energy indices have

rallied recently, some by over 10% in the last two weeks, not to mention CO2

pricing growing by 20% YTD. Our NPV-based equity valuation for PEP points to a

value of PLN 986m, or PLN 45 per share (fully-diluted), and the comparable

valuation yields a per share valuation of PLN 46.4. The company’s lasting +15%

DY as of 2016 and a 51% upside to the sum of PEP’s NPVs vs. the current

market price inclines us to recommend BUY.

In mid-March the company sold 1.57m new issue shares (8% dilution) in a non-prospectus placement. These shares were sold at PLN 28.5, 5.6% above its minimum level, and PEP’s net inflows from the SPO amounted to PLN 42.4m. The cash inflow from the SPO will help finance the company’s CAPEX programme, including spending on the development of 450MW of wind farm projects, construction of 70MW of wind farms, construction of a pellet production line and a 30MW pure biomass-burning power unit.

PEP’s strategic objectives have switched decisively from energy outsourcing to all-kinds of renewables exposure – their SPO objectives are strong evidence of this. The company’s activity in the wind segment remains widely underestimated – PEP currently owns only 22MW of capacity, but few have noticed that 176MW of wind projects developed by PEP will be running by year-end, with another 151MW under construction. PEP intends to develop 1GW of wind projects by 2014, with its wind capacities growing to 80MW this year and to 270MW in 2014.

The company’s exposure in the biomass segment is also growing healthily. The company has been gaining expertise in the construction and running of biomass-fired power units (for Mondi), contracting forest biomass (for Mondi again) and in contracting and producing straw pellets (own pellet production). Together, these should give rise to PEP owning and operating biomass-fired power units, with the first one likely to be completed by 2014.

PEP’s multi-segment growth should allow EBITDA to double by 2013 vs. 2010 and an anticipated three-year net profit growth of 49% by 2013. Moreover, with the impact of investments delayed by a few years, PEP’s current actions are warranting one-off-adjusted EBITDA / net profit of PLN 381m and PLN 122m respectively (five-year CAGRs of 26.9% / 12.1%) in 2016. The lawsuit with Mondi and potential changes to regulations in the renewable sector represent the key risks to the company’s financials.

The sum of PEP project NPVs yields a fully-diluted company equity value of PLN 986m, or PLN 45.0 per share. The comparative valuation (2011–13; P/E and EV/EBITDA-based) yields a share valuation of PLN 46.4, and the recent flight from nuclear technology has boosted this by 5% over the last two weeks. Because the sum of PEP project NPVs offers a 51% upside to the current valuation, we have set our recommendation at BUY. PEP: Financial summary PLN in millions, unless otherwise stated

2009 2010 2011E 2012E 2013E Sales 106.1 176.0 195.6 290.6 342.5 EBITDA 50.3 91.3 102.9 152.2 188.4 EBIT 40.4 80.4 89.9 121.6 147.0 Net profit 46.9 61.6 66.6 76.8 91.9 EPS (PLN) 2.4 3.1 3.1 3.5 4.2 P/E (x) 12.2 9.5 9.6 8.4 7.0 EV/EBITDA (x) 10.6 6.9 9.1 9.0 8.8

Source: Company data, DM BZ WBK estimates

Recommendation

Portfolio weighting

BUY

Overweight

Price (PLN, 31 March 2011) 29.7

Target price (PLN, 12M) 45.0

Market cap. (PLN m) 633

Free float (%) 100.0

Number of shares (m) 21.9*

Average daily turnover 3M (shares) 31.6k

EURPLN 4.03

USDPLN 2.85

* fully diluted

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Price WIG RebasedBuy HoldSell

The chart measures performance against the WIG index. On 31/03/2011, the WIG index closed at 48,730.

Main shareholders % of votes

Generali pension fund 16.0

Pioneer Pekao Investment Management 11.5

ING pension fund 5.5

Company description

PEP specializes in industrial outsourcing and renewable energy production.

Research team:

Paweł Puchalski, CFA

+48 22 586 80 95 [email protected]

PEP 1 April 2011

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Contents

Contents........................................... .............................................................................. 2

Valuation........................................... ............................................................................. 3

Key company findings............................... ................................................................... 6

Financial results and forecasts.................... .............................................................. 13

PEP’s risk-reward profile............................. ............................................................... 25

Growth to renewable sector in Poland................ ...................................................... 32

Financial statements and forecasts ................. ......................................................... 33

Throughout the report we use share prices as of March 31, 2011.

PEP 1 April 2011

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Valuation Comparable valuation

Fig. 1. PEP: Comparable valuation Mkt Cap P/E EV/EBITDA Company Country Price Currency (EURm) 2011E 2012E 2013E 2011E 2012E 2013E PEP Poland 29.70 PLN 146 9.6 8.4 7.0 9.1 9.0 8.8 Diversified

BKW FMB Energie AG Switzerland 64.95 CHF 2,639 13.8 12.8 12.6 8.7 8.3 7.7 EDF Energies Nouvelles SA France 37.20 EUR 2,886 21.9 17.7 14.6 13.5 12.0 10.5 Innergex Renewable Energy Inc Canada 9.56 CAD 414 41.7 39.5 46.2 12.3 11.5 11.1 Innergex Renewable Energy Inc Canada 9.56 CAD 414 41.7 39.5 46.2 12.3 11.5 11.1 Greenko Group PLC India 212.50 GBp 287 27.0 24.8 13.4 17.6 15.1 8.5 Alerion Cleanpower SpA Italy 0.57 EUR 251 15.4 35.6 12.4 12.2 11.0 6.8 China Datang Corp Renewable Power China 2.32 HKD 1,532 14.1 10.4 8.1 11.1 9.3 8.6 Greentech Energy Systems Denmark 17.30 DKK 123 9.8 8.5 n.a. 7.5 6.9 n.a. Sechilienne-Sidec France 19.81 EUR 563 15.2 14.4 13.8 10.6 10.2 10.5 Terna Energy SA Greece 3.42 EUR 374 23.3 13.2 7.3 14.2 9.8 7.9 Energy Developments Ltd Australia 2.60 AUD 297 10.8 8.7 8.1 5.0 4.1 3.5 Median 15.4 14.4 13.0 12.2 10.2 8.6

Wind Theolia SA France 1.34 EUR 149 15.8 8.5 n.a. 10.7 8.5 n.a. Arise Windpower AB Sweden 42.30 SEK 150 41.9 14.8 6.6 16.3 12.7 10.0 China Longyuan Power Group Corp China 8.36 HKD 5,655 19.8 15.6 13.0 11.3 9.7 8.9 China WindPower Group Ltd Hong kong 0.83 HKD 556 10.8 8.1 6.8 8.7 5.7 n.a. Aerowatt France 13.09 EUR 26 n.a. 28.2 26.2 11.8 10.8 11.1 PNE Wind AG Germany 2.57 EUR 118 14.3 12.1 10.5 10.0 9.6 10.3 EDP Renovaveis SA Spain 5.07 EUR 4,421 41.5 29.5 23.2 10.2 9.0 7.9 Iberdrola Renovables SA Spain 3.05 EUR 12,862 30.1 25.4 21.8 11.9 10.6 10.0 Gamesa Corp Tecnologica SA Spain 7.33 EUR 1,802 26.6 18.6 13.1 7.3 6.3 5.5 Median 23.2 15.6 13.1 10.7 9.6 10.0

Hydro&Nuclear Verbund AG Austria 31.35 EUR 10,891 21.0 16.9 16.3 13.5 11.7 11.1 EGL AG Switzerland 700.00 CHF 1,422 11.5 10.1 8.5 8.1 7.2 7.3 A2A SpA Italy 1.14 EUR 3,581 15.0 12.0 11.5 7.8 7.1 7.1 Energiedienst Holding AG Switzerland 54.80 CHF 1,397 14.4 13.4 n.a. 7.6 7.0 n.a. Median 14.7 12.7 11.5 8.0 7.2 7.3

Waste-to-energy/Biomass Covanta Holding Corp United States 17.08 USD 1,795 35.5 30.2 31.6 7.7 7.9 n.a. Primary Energy Recycling Corp Canada 1.34 CAD 131 15.4 17.7 69.1 7.4 6.7 6.8 4Energy Invest SA Belgium 2.64 EUR 33 37.7 14.7 12.6 22.2 8.2 6.8 Median 35.5 17.7 31.6 7.7 7.9 6.8

Biogas Envitec Biogas AG Germany 11.05 EUR 165 25.3 27.8 n.a. 8.9 8.1 n.a. BKN biostrom AG Germany 1.33 EUR 10 22.1 12.1 n.a. n.a. n.a. n.a. Median 23.7 19.9 n.a. 8.9 8.1 n.a.

Total Median 20.4 14.8 13.1 10.6 9.2 8.6

Source: Company data, Bloomberg, DM BZ WBK estimates

We believe that a comparison with European diversified energy giants is pointless with

regard to PEP’s valuation, so we have compared it with a more applicable peer group –

companies dealing in renewables. However, since there are also significant differences

within the renewables sector, for the purpose of our PEP comparative valuation we have

chosen two sub-sectors: ‘wind’ and ‘diversified’, both well represented by the companies

listed (peer groups of nine and eleven companies respectively).

PEP 1 April 2011

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It turns out that both the aforementioned segments trade at very similar P/E and

EV/EBITDA ratios, so that the outcome of comparing PEP to either of these come in

very close on all levels. Nevertheless, we notice very significant differences between

comparisons in P/E and EV/EBITDA ratios – PEP remains very inexpensive with respect

to the first, and there is only a small comparable valuation upside implied by EV/EBITDA

comparisons. As we see it, there are two issues behind this: the scale of PEP’s wind

farm disposals remains far more significant to its bottom line than to its EBITDA but,

most importantly, PEP and its peers are at different points in their growth. PEP is

growing its renewables business, where very heavy new debt loads are required –

PEP’s adjusted net debt will grow by over PLN 1bn – while other companies investment

programmes may be less aggressive or closer to completion.

Based on the aforementioned ratios, PEP’s 4Q’2010 report and on our 2011-2013

estimates for the company, we arrive at PEP’s equity value amounting to PLN 48.9 per

share (comparison to wind segment) and to PLN 44.0 per share (comparison to

diversified segment). Overall per share valuations are ranging from PLN 27.5 (2013’s

EV/EBITDA – diversified) to PLN 71.9 (2011’s P/E – wind).

Fig. 2. PEP: Equity valuation implied by comparable valuation In PLN per share

P/E EV/EBITDA 2011E 2012E 2013E 2011E 2012E 2013E

Diversified 47.8 51.1 54.8 44.4 38.1 27.5 Wind energy 71.9 55.4 55.2 37.5 33.6 39.5

Source: DM BZ WBK estimates

The comparable valuation reveals PEP’s phenomenon upside – the company trades at

a 47.1% discount with respect to P/E ratio, and the discount reduces significantly to

19.3% based on the EV/EBITDA ratio. Understanding the usefulness and applicability of

both these ratios to investors, we have decided to apply equal weights to P/E and

EV/EBITDA outcomes. The comparative valuation for 2011–13 implies a per share PEP

valuation of PLN 45.7.

Fig. 3. PEP: Comparable valuation - summary In PLN

P/E EV/EBITDA 2011E-13E 2011E-13E Average

Diversified 51.3 36.6 44.0 Wind energy 60.8 36.9 48.9 Average 56.1 36.8 46.4


DCF valuation

In the valuation process, we commonly rely on a discounted cash flow approach.

However, the DCF approach implies there’s Terminal Value in the company, which we

find very unfortunate in PEP case. Every project of the company has got its defined

lifetime, so that we have decided to value every project using the NPV approach, which

actually represents the calculation of DCF over the entire project’s life. Below we

summarize NPV calculations of every PEP’s project under consideration:

1) Windfarms operated by PEP : WACC at 10.4%, flat electricity price at PLN

400/MWh, CAPEX at EUR 1.5m / MW, EURPLN exchange rate at 3.8x, project’s

life of 20 years for each project, total 360MW operated, PEP’s equity inflow at 25%.

Sum of projects’ NPV: PLN 291m ;

PEP 1 April 2011

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2) Windfarms projects sold by PEP : average net profit on disposals at EUR 125k /

MW in 2011 and falling 4.5% p.a., 2014’s projects (own ones) sold at lower costs

yielding net profit of PLN 745k / MW, total amount of projects disposed of in years

2011-2014 at 482MW. Total discounted impact on PEP’s valuation: PLN 193m;

3) Biomass-burning power plants : assumption of construction of two 30MW units

each – 51% stake held in the first one operating as of mid-2014, the other one

(100% stake held by PEP) operating as of mid-2017, project’s life at 30 years, flat

electricity price at PLN 425/MWh, WACC at 10.4%, each unit’s CAPEX at PLN

329m, PEP’s equity inflow at 20%. Sum of projects’ NPV: PLN 82m ;

4) Pellet production lines : three facilities running for 20 years each, assumed annual

price indexation for changes to straw price, WACC at 10.4%. Sum of projects’

NPV: PLN 72m ;

5) Minor projects (Zakrzow & Mercury): NPV calculated till project’s life ends,

maintained current trends in productivity and profitability. Sum of projects’ NPV:

PLN 10m ;

6) Saturn (cooperation with Mondi): assumed maintained trends in productivity and

profitability. Project’s NPV: PLN 220m (does not include PLN 270m of debt

repayment);

7) Net debt: sum of 2010’s net debt at PLN 56m, adjusted for PLN 42m cash inflow on

the most recent windfarm disposal transaction (Pagow), adjusted for PLN 43.4m

cash inflow from SPO, adjusted for discounted PLN 16.8m cash inflow from

management options until 2014, adjusted for the discounted PLN 80m of non-

refundable grant for two new windfarms to be received in 2012 (replaces bridge

loan visible presently as debt). Total net cash at PLN 118m .

Fig. 4. PEP: WACC calculation

Risk free rate (10-year Polish T-bond yield) 6.2%

Unlevered beta 1.0

Levered beta 2.1

Equity risk premium 5.0%

Cost of equity 16.8%

Risk free rate (10-year Polish T-bond yield) 6.2%

Debt risk premium 1.0%

Tax rate 19%

After tax cost of debt 5.8%

%D 58%

%E 42%

WACC 10.4%

Source: Damodaran, DM BZ WBK estimates

We estimate PEP’s total valuation, based on the sum of separate projects’ NPVs,

settles at PLN 986m. This equals to the fully-dilute d PLN 45.0 per share.

PEP 1 April 2011

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Key company findings PEP was founded in July 1997 by three private equity funds represented by Enterprise

Investors. In 2002 Polenergy Investors BV, an SPV established by the Allianz group

investment fund investing in CEE energy-related enterprises, provided additional funds

in exchange for becoming a minority PEP investor. In April 2005 the company

conducted an IPO, during which the two key investors sold a 30.3% stake in the

company at a share price of PLN 7.8. In February 2006 the company’s free float

reached 100% as PEP shareholders sold all their remaining holdings to the market.

Fig. 5. PEP: The company’s future recapitulated

In MWe / MWt

0

100

200

300

400

500

600

2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Biomass unitWind operationalEnergy outsourcing (electricity) Energy outsourcing (heat)


As we see it, the Polish Energy Partners’ strategy focuses on three key areas:

1) Energy outsourcing projects;

2) Wind farming: development, disposals, control;

3) Renewable energy from biomass.

Below we provide a concise insight into each of these focal points.

1. Outsourcing projects

The company used to specialize in the development of energy projects, which were then

built and operated by the company under long-term agreements. The company provides

its clients with co-generated heat and power (CHP) through the newest technologies

and equipment. PEP can provide either greenfield or brownfield outsourcing – the

company can take control of and optimize a client’s existing power units, or it can build

brand new units from scratch. Both approaches can be undertaken under long-term

sale-and-lease back agreements.

Thanks to its highly competent outsourcing services, PEP offers its industrial clients a

broad set of advantages, some of the most important being:

• Operational benefits . PEP guarantees the budgeted amount of quality energy and

also takes care of the technical side of a project (servicing, construction, modernizing,

PEP 1 April 2011

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and efficiency maximization). The impact of PEP’s cost synergies (shared between PEP

and the customer) should not be underestimated.

• Financial benefits . A transaction with PEP, if a CHP plant is taken over as the result

of a project, releases the customer’s capital, which may then be used to fuel growth in

its core business. The effectiveness ratio is usually geared up as well.

• Investment benefits . A significant investment program can easily be implemented

by any customer while keeping its own resources intact since PEP organizes the

financing of the project on his own.

• Business benefits . The customer can focus entirely on optimising its core business.

To date, PEP continues its cooperation with Mondi in the largest Polish energy

outsourcing project. PEP’s expertise has been affirmed by Mondi and cooperation

between the two companies has been extended into two additional projects in 2006 and

2009. Mondi remains fully dependent on PEP’s installations, with all of the heat and

electricity used by Mondi produced in units leased from PEP.

Fig. 6. Poland: 2009 energy outsourcing market

In % of GJ

PEP 59.7%Fenice 16.4%

Dalkia 8.3%

SFW Energia 6.9%

EETEK 3.0%

Other 5.7%

Source: Company data

2. Wind farming

PEP developed its expertise in wind farm development in Poland and has a total

pipeline of over 1,000MW of developed projects by 2014. Given the scarcity of fully

developed wind projects in Poland, the company is able to either sell its projects (at the

pre-construction stage) or to retain control and build and operate the wind farms on its

own. As of the end of 2010 the company had developed 257MW of wind farm capacity,

of which 177MW was sold to third parties to raise the capital necessary for self-owned

wind farm construction. PEP’s first 22MW wind farm became operational in early 2007,

while another two projects (totalling 58MW) will be completed by year-end 2011.

According to the company, acceleration of the development process in coming years

should boost sales volumes, which will provide the cash injections necessary to support

the growth of PEP’s own wind farm capacity to a potential 270MW in 2013 (company’s

assumption) and 360MW in 2015 (own assumption).

PEP 1 April 2011

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Fig. 7. PEP: Wind projects recapitulated

In MW

200257

429

715

919

1019 1019 1019

22 2280 80

150

270

360 360

0

200

400

600

800

1,000

1,200

2009 2010 2011E 2012E 2013E 2014E 2015E 2016E

Cumulative developed w ind projectsOperating w ind projects


3. Renewable energy from biomass

There are various options for participating in biomass-related growth in Poland and PEP

is trying to take advantage of two of them. On one hand, the company has singed long-

term contracts with the owners of local hard coal-fired power units to deliver straw

pellets that can be used for co-burning. The first pellet production facility was in

operation for the whole of 2010, the second greenfield investment become operational

in late 2010 and the third is scheduled to come online in late 2011. Together, these new

facilities will expand PEP’s pellet production capacity to 150k tons per year.

Another approach to biomass is to construct a pure biomass-burning 30-35MW

generating plant. PEP is currently negotiating with a customer for electricity to be

produced from such a facility, and the venture is scheduled to become operational in

2014. Reportedly there are three entities interested in separate pure biomass-burning

power units, including KGHM, and the company eyes up to five installations of this kind.

Still, the lack of progress in negotiations with KGHM, the first of these, over the last 12

months trims our expectations to two biomass installations.

Fig. 8. PEP: Biomass/pellet capacity

0

20

40

60

80

100

120

140

160

180

2009

2010

2011

E

2012

E

2013

E

2014

E

2015

E

2016

E

2017

E

2018

E

2019

E

2020

E

Pellet production capacity ('000 t) Biomass units capacity (MW)

Source: Company data, DM BZ WBK estimates, * 50% in first biomass unit held

PEP 1 April 2011

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Company projects in operation

Fig. 9. PEP: Location of projects

WF Puck

2007, 22 MWe WF Suwałki 2009, ok. 41 MWe

(sold)

WF Tychowo 2009,ok.34 MWe

(sold)

WF Jarogniew/ Mołtowo

2010, 20 MWe (sold)

WF Modlikowice 2011, 24 MWe

WF Łukaszów 2011, 34 MWe

Biomass South 2010, 60 000 T

EC SATURN 2002 122 MWe, 619 MWt

EL MERCURY 2006 8MWe

EC ZAKRZÓW 2000 4 MWe, 36 MWt

Biomass North 2009, 30 000 T

Biomass East 2011,60 000 T


Four years ago the list of PEP’s projects consisted of a few energy outsourcing deals

and just one pending 22MW wind farm. As is clear from the map above and the list

below, the company has changed significantly since then – its thrust into the renewables

segment has resulted in a flood of new projects. PEP currently operates and fully

consolidates six energy projects, with another three to be completed by year-end 2011

and a fat project pipeline for years to come:

Saturn project . The largest CHP plant of its kind in Poland, operated by PEP under a

20-year alliance agreement with Mondi Swiecie (agreement expires in 2022), provides

Mondi with the heat and energy required for its operations. Additionally, a newly

installed circulating fluidized bed boiler (CFB) allows for the production of green energy

through the utilization of bio-fuels such as bark, sawdust and chips, including bark left

over from the wood used in paper making. Finally, in 2009 PEP converted the switched

off hard coal-fired unit into a biomass-fired unit using Bubbling Fluidized Bed

technology. This newest addition to Mondi’s capacity can produce up to 115 tons of

steam per hour, allowing for the production of 115k MWh of renewable electricity p.a. All

projects for Mondi generate over PLN 300m of EUR-denominated debt to PEP, which is

collateralized by a comparable amount of long-term receivables recorded in PEP’s

assets. In case Mondi backs out of a venture, PEP will receive the NPV of scheduled

cash payments to the company, which makes this project relatively safe for PEP.

Additionally, the alliance agreement provides PEP and Mondi with possible shared cost

PEP 1 April 2011

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savings achieved by PEP’s operation of the boilers, which is a potential upside for the

company’s results.

Zakrzow project . This 3.4 MWe electric and 36.3 MWt thermal rated power facility

supplies quality energy to both the Whirpool plant and the neighbouring city of Zakrzow

under a 20-year contract that began in 2000. The project included the turn-key

construction of a CHP plant together with the required infrastructure (gas pipeline and

connections).

Mercury project . This 8 MWe power plant consisting of a coke gas boiler and a steam

turbine in Walbrzych for WZK Victoria was constructed under a contract that expires in

2021. In 2006 PEP built a heat- and power-generating unit in cooperation with Victoria.

The electricity is sold either to Victoria or to the EnergiaPro distribution network. PEP

will be entitled to free carbon dioxide certificates by the end of 2012.

Previously PEP also operated the Wizow and Jeziorna projects (a 4.4 MWe electric

and 42 MWt thermal rated power CHP / coal-fired CHP plant of 95 MWt thermal and 6

MWe electric power respectively). However, the first project went bankrupt in 2006 and

the other was sold in December 2010. The latter was to be terminated in 2012 anyway,

not to mention project’s immaterial EBITDA / cash flow contribution in recent years - the

company has chosen to terminate the project two years earlier just to recover cash to be

invested in other high-yielding projects.

Puck wind farm

PEP’s first wind farm became operational in early 2007. Its total capacity of 22MW

should produce 47–50k MWh per year. Pricing remains crucial there since the operator

is receiving both ‘black’ energy and ‘green’ energy pricing. The wind farm’s green

energy output has been contracted to a local distribution company under a 15-year fixed

price EUR-denominated power purchase agreement.

The wind farm’s very low operational costs result in very high EBITDA margins (in the

region of 80%). A project of this kind needs few full-time employees and very limited

servicing (PEP has already agreed on a servicing fee related to the amount of MWhs

delivered by the project). However, the project’s high depreciation and the slow decline

in interest paid result in an EBIT margin cut to below 50% and a slow increase in

reported net profit.

Pellet production installations

The company’s acquisition of the GPBE North pellet production line in 2009 (30k tons of

pellet capacity p.a.) has almost reached its optimal capacity, while the newly built

production line (GPBE South, annual capacity of 60k tons) came online in late 2010.

These production lines provide pellets for biomass combustion in hard coal-fired power

units to Dalkia, EdF and GDF Suez under multi-year agreements.

PEP 1 April 2011

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Projects under construction

Lukaszow and Modlikowice wind farms

PEP started construction of these two wind farms, with respective capacities of 34MW

and 24MW, in 2010 and they are expected to be operational at the turn of 2011 and

2012. The CAPEX required comes in at PLN 232m and PLN 168m respectively. PEP

will receive a non-refundable grant of PLN 80m to help finance its construction.

354MW in operational wind farms

As we see this, PEP’s wind farm pipeline includes 280MW of projects to be built and

operated by the company. Construction of the first two wind farms, with a total capacity

of 70MW, is set to start in 2011, while the last project in the pipeline is scheduled to start

operations in late 2015.

Pellet production installation

The company’s third pellet production line (GPBE East) will be located in Zamosc. 100%

controlled by PEP, it will deliver pellets to GDF Suez, with a total annual capacity of 60k

tons. This production line is located in a Special Economic Zone, so it will enjoy tax relief

until 2020.

Pure biomass-burning power unit

PEP intends to build up to five 30–35MW biomass installations, but a contract for the

purchase of the electricity it will produce is still pending. Negotiations for this unit have

been ongoing with KGHM for almost year now, and PEP says that there are two other

parties interested in the project. We cautiously assume that PEP would build two

biomass-fired power units. Construction of the first one would kick off in 2012, but the

unit would not become operational earlier than 2014, and the other would start

production of electricity in mid-2017. PEP would retain 51% stake in the first unit, while

the other one would be 100% controlled by PEP.

PEP projects recapitulated

With the passage of time and with PEP’s strategic focus switched from outsourcing

projects to the renewable segment, unsurprisingly the variety of approaches to the latter

(wind development, biomass burning, pellet production) have made it the company’s key

valuation driver. Both future disposals of developed wind farm projects and the pipeline

for wholly owned wind farm projects provide 50% of PEP’s valuation. Other renewables

segment-related activities – pellet production lines and the pure biomass-burning

installation – jointly deliver another 16% of PEP’s valuation. Together the renewables

segment makes up a 66.1% share of the company’s valuation. The share of cooperation

with Mondi in the company’s total valuation has been reduced to below 23%.

PEP 1 April 2011

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Fig. 10. PEP: Valuation breakdown into projects

w ind operating30%

w ind disposal20%

biomass8%

Mondi22%

other projects1%

pellets7%

net cash12%


Shareholding structure

Fig. 11. PEP: Shareholding structure

Shares % of votes % of shares

Generali pension fund 3,165,056 16.03% 16.03%

Pioneer mutual fund 2,266,780 11.48% 11.48%

ING pension fund 1,077,259 5.46% 5.46%

Other 13,234,872 67.03% 67.03%

Total shares 19,743,967 100.0% 100.0%


Secondary Public Offering

Between March 22 and March 30 the company completed an accelerated bookbuilding

of 1.57m new shares, placed at PLN 28.5 per share. New shares were offered without

pre-emptive rights, but the current shareholders and these have enjoyed preferential

allocation. This offer structure saved time for the company, especially since it did not

require the time-consuming preparation of a company prospectus.

The final price settles at PLN 28.5 per share, which represents a 5.6% increase vs. the

minimum selling price set at PLN 27.0 per share. All in all, PEP’s gross inflow from SPO

amounted to PLN 44.7m, and net inflows amounted to PLN 42.4m. The cash inflow from

the SPO will partially finance the company’s CAPEX programme, including spending on

the development of 450MW of wind farm projects, construction of 70MW of wind farms,

construction of a pellet production line and a 30MW pure biomass-burning power unit.

PEP 1 April 2011

13

Financial results and forecasts An insight into PEP’s financials

PEP’s past activity could be represented in a simplified form as a simple heat and power

producer with additional sale- and lease-back-originated revenues. All its revenue /

EBITDA streams were predictable and lacked decent upside potential. The company’s

focus on the renewables segment has changed the entire picture – we expect PEP’s top

line and EBITDA for 2010-18 to grow at CAGRs of 19.5% and 21.3% respectively. A

look at Fig. 12 explains this miracle – multiplication of both wind and biomass projects

run by PEP on its own will be adding PLN 550m to the company’s revenues in late

years. In its early years (2010–14) the share of wind farm disposals comes in

respectively high (cash accumulation phase), but the assumption that wind farm

capacity will expand to 360MW implies more than PLN 350m of potential wind-

originated revenues as of 2016.

Fig. 12. PEP: Sales breakdown and EBITDA margin

0

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700

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2007

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30%

35%

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45%

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70%Wind operating Wind disposalBiomass PelletSaturn OtherEBITDA margin (rhs)


We can also see a direct relationship between the share of wind farms operated solely

by PEP and the EBITDA margin delivered. The company’s margin has never been shy,

primarily due to its massive energy alliance project, but wind’s 80% contribution to the

EBITDA margin makes the difference here by lifting PEP’s consolidated EBITDA

margins to a long-term contract-secured level of 58%.

This bright P&L outlook is somewhat worsened by PEP’s Balance Sheet outlook. An

unaware investor may be distressed by the company’s total debt peaking at PLN 1.8bn

in 2015, coming in twice as high as the value of PEP’s equity on that date. However,

wind farm financing specifics must be stressed – a high CAPEX implies a high debt load

– debt that remains perfectly secured with 15- to 20-year agreements for electricity

sales. There is, therefore, no room for an ‘unhedged’ debt position that investors may

feel uneasy about. It should be also noted that high amounts of debt are taken by PEP’s

subsidiaries, not the parent company itself. Should we witness an unfortunate case of

any project’s failure, PEP’s losses will be limited to equity paid – the company will not be

obliged to pay back subsidiary’s loans.

PEP 1 April 2011

14

Fig. 13. PEP: Balance sheet analysis

PLN in millions, unless otherwise stated

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EquityInterest-bearing libilitiesLease-back receivables


It should be also noted that part of PEP’s total debt remains collateralized by long- and

short-term receivables (both originating from the cooperation with Mondi expiring in

2022), thus trimming PEP’s 2010 year-end net debt position to PLN 56m. Moreover,

debt for new investments in wind or biomass is taken by PEP’s subsidiaries, not the

parent company – this implies PEP’s debt load is actually non-recourse one and the

hypothetical failure of a single project do not make PEP pay project’s debts back.

Fig. 14. PEP: Gearing ratios


0

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Once again - PEP’s long-term contracts, which guarantee its debt repayment,

differentiate this company from almost any other with respect to appropriate gearing

ratios. Although the ratio of total debt to EBITDA rallies from 2010’s 1.0x to an

unavoidable 5.6x in 2013, we still claim that this level represents no threat to the

company’s core business. Furthermore, PEP suffers from an almost two-year delay

between the initiation of a wind project and its operational start up (not to mention the

four-year period for biomass burning units). Interests paid are free of the last

shortcoming mentioned (these are not paid until the project’s operational start up), which

PEP 1 April 2011

15

results in much better readings (compared to the debt / EBITDA ratio) – interest

payments never exceed 41% of PEP’s annual operating profit for any given year.

Fig. 15. PEP: Free cash flow analysis


-750

-600

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2010

2011

E

2012

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-75%

-60%

-45%

-30%

-15%

0%

15%

30%

45%Operating FCF (lhs) CAPEX (lhs) Operating FCF/EV (rhs)

Source: Company data, DM BZ WBK estimates.

PEP’s ambitious wind-related plans will not make the company a cash cow before 2017.

Although Operating FCF remains healthy, massive CAPEX requirements will probably

not allow the company’s Operating plus Investing FCF to become positive any sooner.

However, the strong contribution from wind farms will allow PEP to deliver over PLN

300m in cash per annum – a stunning 50% of the company’s current valuation (30% p.a.

of company’s valuation at our Target Price).

Fig. 16. PEP: investment plans for 2011-2012 PLN in millions, unless otherwise stated

Wind Farm 1 Wind Farm 2 Pellet Plant

Wschod Biomass

Power Plant Wind Farms

development Total Share issue Own cash

Planned capacity [MW] 28 42 n.a. 30 326 n.a. n.a. n.a. Ownership 100% PEP 100% PEP 100% PEP 51% PEP 100% PEP n.a. n.a. n.a. Year of commissioning 2013 2013 2011 2014 - n.a. n.a. n.a. Project CAPEX 167 259 19 332 102 879 n.a. n.a. Equity 36 56 7 34 102 235 42 193 Debt 131 203 12 298* 0 644* n.a. n.a.

Source: Company data. * includes PLN 265m in biomass PP debt and PLN 33m of equity provided by minority partner in biomass PP.

The company assesses its 2011–12 CAPEX at PLN 879m, of which some PLN 235m in

cash is required for financing needs. The outlays on new wind farm developments

represent the highest share in these, especially since banks are not financing these

costs at all. However, not only will these costs be mostly recouped later on during

disposal of these projects, but these also represent a burden to the company’s Working

Capital (inventories), not to its Fixed Assets. We also believe that total outlays for the

biomass unit are a bit exaggerated – the unit’s start up in 2014 should allow for a delay

in part of its CAPEX until 2013 (its own equity input goes first, though – PEP will need

PLN 34m for its funding until 2012). It should be also noted that PEP has agreed for just

50% stake in its first biomass unit – the company is not capable of financing both wind

and biomass extensive investment programmes. In our view, PEP will need some PLN

105m of equity in 2011 (28MW wind farm, pellet production line, and most of its

development costs), while another PLN 130m should be used effectively in the following

PEP 1 April 2011

16

year. Last but not least, it is noticeable that the entire PLN 879m is to be spent on

various kind of renewable energy – PEP is clearly being serious about this segment.

Fig. 17. PEP: Wind / biomass CAPEX assumptions

PLN in millions

0

100

200

300

400

500

600

700

2011E 2012E 2013E 2014E 2015E 2016E 2017E

Wind CAPEX Biomass CAPEX

Source: DM BZ WBK estimates. 2011 includes outlays for 58MW projects’ completion.

Assuming the construction of all projects will start in a timely manner, we believe PEP

will require PLN 2.3bn in investment outlays for new projects in 2011–17 (unadjusted for

51% stake in its first biomass installation – true CAPEX for PEP settles PLN 0.2bn

lower). Wind farms and the biomass burning unit would represent almost 100% of this

amount, with the latter responsible for 30% (24% adjusted for minority stake) of PEP’s

seven-year investment outlays. These amounts seem huge in total, but PEP would

actually require only up to 20-25% of this (PLN 460-575m) in cash, while the remainder

will be financed externally. Furthermore, all these spending will be secured with new

long-term contracts for electricity deliveries – there will be no ‘unhedged’ debt in the

company. Maximum requirement of PLN 675m over seven years equals an average

annual burden of PLN 96m – the necessity to finance this burden represents the key

rationale behind: 1) the staged construction of investments (wind farms currently being

built will provide cash / financing for later ones); and 2) the need to cash in on some

developed wind farm projects via disposals.

PEP 1 April 2011

17

Wind mechanics in PEP Fig. 18. PEP: Wind farms development status

F – 42 MW

LMP, ED

E – 38 MW

LMP, ED

D – 102 MW

LMP, ED

Wind farm projects at advanced stages of development

Extension of Modlikowice/Łukaszów wind farms

Milestone reached:

LMP – Local master planED – Environmental decisionGCT – Grid connection terms

BP – Building permit

C – 28 MW

LMP, GCT

G – 50 MW

LMPA+B: 90-105 MW

LMP, ED, GCT

(105 MW)


PEP has developed 257MW in wind projects, of which it has sold 177MW. 22MW has

been operating since 2007 and the remaining 58MW remains under construction. While

the map above shows that PEP is searching for ideal locations all around Poland, it also

sheds light on the idea of developed wind projects. Projects of this kind require four

different decisions: a local master plan, an environmental decision, grid connection

terms and a building permit, none of which are easy or natural. Moreover, PEP has to

persuade landowners to allow wind farms on their property. Bearing all these factors in

mind, it is not surprising that a single wind project takes as much as two to three years

to reach ‘developed’ stage, and that PEP’s expertise remains so important. It is also

crucial to understand that, although PEP started its wind farm development in

cooperation with EPA, PEP now has its own wind development team – PEP’s long-term

dependence on EPA seems small in our view.

Fig. 19. PEP: Wind projects – development vs. dispo sals/construction

In MW

24 17

103

122

81

85

70

80

120

95

90

222 0 000

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204286

172

57

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PEP 1 April 2011

18

The company sells fully developed wind projects, or retains control over wind farms it

has constructed. Since these two activities require very different mechanics, we have

decided to discuss them separately.

Disposal of developed projects

So far the company has sold five wind projects, including two transactions in 2010. The

average net profit for these transactions was PLN 475k/MW. Further investigation,

including looking at the EUR/PLN exchange rate, reveals that the average price for each

MW sold come in at EUR 125k.

Fig. 20. PEP: Wind projects disposals PLN in millions, unless otherwise stated

Suwalki Tychowo Suwalki/Tychowo Jarogniew Jarogniew Wartkowo Pagow Average

9-Aug-07 26-Aug-08 30-Mar-09 9-Jan-09 6-Oct-09 8-Jun-10 20-Dec-10

Power [MW] 41 35 76 20 20 30 51

Stake sold 70% 70% 30% 70% 30% 100% 100%

Effective power sold [MW] 28.7 24.5 22.8 14.0 6.0 30.0 51.0

Net profit [PLNm] 12.6 9.0 9.7 8.9 3.7 10.1 25.6

Net/eff. power [PLNm/MW] 0.439 0.367 0.425 0.636 0.617 0.337 0.502 0.475

EURPLN exchange rate 3.5 3.2 4.0 4.6 4.3 4.1 4.0

Price in EURm / MW 0.125 0.115 0.106 0.138 0.143 0.082 0.126 0.125


The 2010 Wartkowo transaction requires some explanation since its low PLN- and EUR-

denominated pricing aroused concern over the long-term profitability of wind farm

development. This project was located far from the network, so that the investor had to

invest in a lengthy connection grid. These costs made PEP lower its price so as to

dispose of the projects – it had nothing to do with a lowered interest in Polish wind farms

in general.

We assume PEP will continue selling developed wind farms until 2015. Disposals in

2011, 2012 and 2013 (85MW, 80MW and 95MW respectively) should originate from

PEP’s cooperation with EPA. In calculating PEP’s net profits we used a decreasing

EUR-denominated price for one MW (from EUR 125k/MW in 2011 to EUR 114k/MW in

2013). This calculation yields net profits of PLN 40m in 2011, PLN 36m in 2012 and PLN

41m in 2013.

For 2014 we have assumed the disposal of all remaining wind projects and a cessation

of PEP’s cooperation with EPA – any projects sold will be developed by PEP’s own

team. As we see it, the reduction in costs (no payment to EPA) should be noticeable

and we assumed they will halve vs. current levels. Given this, we have changed our

calculation scheme – all projects sold at an average top line impact of PLN 759k/MW.

We arrive at 2014 net profit from disposals of PLN 115m, finalizing PEP’s developed

wind projects’ disposals.

Later on we conservatively assume there will be no other developed wind farms for sale,

although this assumption seems very weak in our opinion (see upsides’ section).

Windfarms under operations

PEP prefers to run its own wind farms than to dispose of it – that’s our key assumption.

It currently has only one 22MW wind farm running in Puck, but two others (total capacity

of 58MW) are under construction and slated to become operational at the turn of 2011

PEP 1 April 2011

19

and 2012. These projects are very safe once the agreement for electricity delivery is

signed with a partner – guaranteed cash flows are strong enough to repay the debt and

to provide the operator with a more than 15% return on capital. Below we present the

pipeline for PEP’s own wind farms, based on the company’s itinerary:

- 28MW wind farm – construction begins at the turn of 1H/2H’2011, project starts

contributing as of early 2013;

- 42MW wind farm – construction begins in early 2012, project starts contributing as

of late 2013;


contributing as of late 2014;


contributing as of late 2015.

These are our key assumptions for the projects under consideration:

- a flat electricity price of PLN 400 per MWh over the entire life of any wind farm (20

years);

- CAPEX at EUR 1.5m per MW, EURPLN exchange rate at 3.8x for all projects;

- PEP equity input at 25% of total CAPEX, no grants included;

- each project’s load factor at 28%, implying 2,453 working hours per annum per

MW;

- bank loans repaid over 15 years, which boosts the operator’s profits in the late

years.

Fig. 21. PEP: Wind projects running – financial con tribution


0

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Revenue EBITDA Net profit


We assume that the two projects currently under construction will become operational

as of January 2012, the next two projects (totalling 70MW) will start contribution, on

average, as of mid-2013. For each project after that electricity production will start up in

Nov/Dec of the year. This set of assumptions suggests revenues of PLN 350m as of

2016 (flat pricing implies a flat top line) and a targeted EBITDA of PLN 279m. The

segmental net profit would be affected by the inclusion of new projects and falling

interest payments, the latter resulting in continuous bottom line improvements. Should

PEP 1 April 2011

20

the company match our assumptions, its net profit resulting exclusively from operating

wind projects would reach PLN 100m already in 2020.

Pellet mechanics in PEP

PEP plans three pellet production facilities – GPBE South, East and North – with a total

capacity of 150k per annum. Sales are guaranteed via multi-year arrangements with the

owners of black generating units. The first pellet production unit (30k capacity) operated

throughout 2010, the second (60k greenfield) started up several months ago and the

completion of the third is scheduled for the end of 2011. The loss in 2009 resulted from

a late start up, while the nationwide floods in 2010 elevated crop prices above the

company’s assumptions. Last but not least, we assume that every new installation will

incur losses at the very beginning. With all capacities operational in 2012, we expect this

segment to be delivering solid results as of the following year.

It’s also worth mentioning that the contracts signed by PEP include an indexation of

price received for the growth in straw price the previous year. Hence, we perceive this

almost risk-free activity, with low early CAPEX requirements.

Fig. 22. PEP: Pellet contribution


-10

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10

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70

80

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100

2009

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2019

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2020

E

Revenue EBITDA Net profit


Motivation programme

Last year the company’s GSM approved a new motivation programme for management

and PEP’s other key employees totalling 770k shares for 2011–13. The program is

divided into sixteen tranches and employees will only receive them provided certain

requirements are met. These requirements relate to EPS, EBITDA per share, total

running capacity and PEP’s share price performance in relation to the WIG index. A

price of PLN 31.2 was set for all shares under consideration.

Should the company become an acquisition target, all these shares would be vested

immediately (with some cut to the total amount of shares vested depending on

acquisition timing), and almost the entire program relies on several fundamental Final

Conditions set for 2013:

- an EBITDA at PLN 264m or higher;

- a reported net profit of PLN 90m or higher;

PEP 1 April 2011

21

- an EBITDA per share above PLN 10.59;

- an EPS at PLN 3.62 or higher;

- total running capacity at year-end of 258MW or higher.

Below we present a quick insight into the workings of the motivation program.

Fig. 23. Motivation program breakdown No Number of shares Primary goal Est. outcome Vesting year 1 77,038 2010: E PS>2.89; 22MW delivered 2011 2 77,038 2011: EPS>3.11; 68MW delivered 2012 3 77,038 2012: EPS>3.27; 141MW delivered 2013 4 77,038 2013: EPS>3.62; 219MW delivered 2014

5 38,519 2010: EBITDA>4.64; 22MW delivered 2011

6 38,519 2011: EBITDA>5.87; 68MW failed failed 7 38,519 2012: EBITDA>7.96; 141MW failed failed 8 38,519 2013: EBITDA>10.58; 219MW failed failed 9 38,519 PEP 5% better than WIG in 2010 failed failed 10 38,519 PEP 5% better than WIG in 2011 delivered 2012 11 38,519 PEP 5% better than WIG in 2012 delivered 2013 12 38,519 PEP 5% better than WIG in 2013 delivered 2014 13 38,519 22MW in 2010 delivered 2011 14 38,519 80MW in 2011 delivered 2012 15 38,519 166MW in 2012 failed failed 16 38,519 258MW in 2013 delivered 2014

Source: Company data, DM BZ WBK estimates. ‘EBITDA’ refers to EBITDA per share. All figures in the third columns are in PLN except for those referring to MW (renewable capacity by year-end).

According to our model, we believe the conditions for five tranches will not be met. This

is particularly so for tranches based on the EBITDA-per-share ratio. A small delay to

PEP’s wind capacity programme and an increasing number of shares will not allow for

shares to be vested to the company’s employees. According to our model, the company

will deliver all of its 2013 goals except for reported EBITDA; we believe PEP will come in

PLN 76m short here, because one of its projects is delayed.

All in all, we believe PEP will fail to deliver on the conditions for tranches 6, 7, 8 and 15

and we believe these will not be vested at all, which will reduce the total amount of

shares vested by 2014 from 770k to 616k. Last but not least, tranches 9 to 12 all rely on

PEP’s share price performance vs. the WIG index. The company failed to deliver on

tranche 9 condition, but we believe its fundamentals will allow for a share price that

exceeds performance expectations as of mid-March 2011. Still, the vesting of 154k

shares (22.2% of the entire motivation programme) cannot be guaranteed. According to

our assumptions the number of shares vested should settle at 154k/193k/116k and 154k

respectively in years 2011–14.

We have one further remark with respect to the management option plan – in our view,

investors should keep their fingers crossed for all shares’ vesting. The total volume will

only be vested provided PEP delivers on its promises, with high capacity driving strong

results, and provided that the company’s share price outperforms the WIG index by a

minimum of 5% p.a. in the next three years. Finally, the price of PLN 31.2 per share

would result in a PLN 25m cash inflow (with all shares vested) – enough to self-finance

a 22MW wind project.

PEP 1 April 2011

22

Income statement forecasts

2010 results

In 2010 PEP reported its highest-ever set of financial results across the board, from the

top line through EBITDA and EBIT to net profit, for the fourth consecutive year. The

company’s net profit of PLN 61.6m represents a 31.4% increase y/y and a 23% of three-

year CAGR and a 45% of five-year CAGR respectively. Adjusted for the disposal of

developed wind farms, bottom line CAGR ratios are no less impressive at 15% (three

years) and 22% (five years).

Fig. 24. PEP: 2010 results segmental breakdown PLN in millions

Outsourcing -

operation Outsourcing -

production Wind farms

development Biomass

- Pellet Wind

energy Other Total Revenue 57.3 30.7 60.4 14.0 13.7 0.0 176.0 Gross profit 45.4 7.2 44.1 -0.5 6.5 0.0 102.6 CAPEX 0.1 0.2 110.0 14.8 0.0 0.3 125.5 Depreciation 0.4 4.3 0.0 1.2 5.1 0.0 10.9 Assets 389.8 97.5 185.0 32.6 95.4 11.8 812.1


Cooperation with Mondi represented a high share in both revenues and gross profit, at

32% and 44% respectively. This cooperation grew, with one new project running for the

whole of 2010 and higher volumes of renewable electricity produced. In 2010 PEP sold

two developed wind farm projects, with a total capacity of 81MW, for PLN 35.7m of net

profit. PEP’s wholly owned 22MW wind farm come in below expectations primarily due

to poor wind conditions in 2010. Finally, 2010 was the first year of PEP’s pellet

production expansion (one line was working for 12 months, while a new one was active

in December only), but floods in Poland made straw scarce and expensive. PEP’s gross

profit loss will be recouped via a price formula this year only. Last but not least, the

company’s annual performance was trimmed by PLN 5.1m of annual management

option costs.

PEP’s 2010 CAPEX was PLN 125m, which consisted primarily of investments in two

new wind farms (PLN 110m spent on 58MW projects to become operational at the turn

of 2011/12) and pellet production lines. The company’s adjusted net debt was PLN 56m,

including PLN 46m in cash, but this amount does not include a more than PLN 40m

payment for the Pagow developed wind farm project in late December.

2011–13 forecasts

We believe the company will continue its strong financial performance through 2011-13,

and that each year’s top line / EBITDA / EBIT and net profits will come in stronger y/y.

Multi-segment growth (primarily wind farms and the multiplication of current capacities in

pellet production lines) should see PEP’s EBITDA doubling by 2013 vs. 2010, with an

anticipated three-year net profit growth of 49% by 2013.

Given this, we expect 2011 to be the least thrilling year, with EBITDA improving 12.7%

y/y and the bottom line expanding by 8.2% y/y. While core performance should come in

slightly stronger y/y in 2011, annual growth is guaranteed thanks to the heaviest-ever

disposal of wind farm projects. We believe PEP will earn PLN 40.4m on these, an

almost PLN 5m improvement y/y, this amount being responsible for the full consolidated

bottom line improvement. While the oldest pellet production line should turn decisively

black, less-than-full capacity utilization of the second and inescapable initial losses on

the third will keep the pellet segment’s contribution to the bottom line in the red,

PEP 1 April 2011

23

regardless of EBITDA growth already reported in 2011. Finally, 2011 will be least

interesting due to the fact that we should see no new additions of wholly-owned

operating wind farms. Still, the completion of two ongoing wind farm projects (58MW),

the initiation of the construction of two new ones (70MW), the initiation of work on a pure

biomass-burning installation and the costs of project developments will drive PEP’s

2011 year-end adjusted net debt to PLN 300m.

Fig. 25. PEP: 2010-2013 EBITDA improvement in detai l PLN in millions

91 103

152

188

+1

+2 +1+6

+8

+4+6

+28

0

+1

-5

+46

60

80

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120

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EB

ITD

A


Contrary to 2011, current works on 58MW of wind farm capacity and completion of three

pellet production facilities will pave the way for decent growth in 2012. PLN 45m of

2012’s EBITDA contribution from new wind farms and pellet production capacities

operating at close to optimum will allow for the consolidation of PEP’s EBITDA to reach

PLN 152m, regardless of the fact that the disposal of developed wind farm projects will

deliver PLN 4m less y/y in 2012. 2012 will be yet another busy year for the company, as

the continued works on 70MW of new wind farm capacity (in addition to the existing

80MW by then) will be coupled with the company focusing on turning on its first

biomass-burning installation. This intensive CAPEX will be reflected in the expansion of

PEP’s net debt to a year-end figure of PLN 727m for 2012.

Fig. 26. PEP: 2010-2013 net profit improvement in d etail PLN in millions

62

67

77

92+1

+2+2

+1+5

+11 +5+7

+5

-4-2

-2

40

50

60

70

80

90

100

2010

Net

pro

fit

Win

d op

erat

ing

Win

d di

spos

al

Pel

let

Oth

er

2011

Net

pro

fit

Win

d op

erat

ing

Win

d di

spos

al

Pel

let

Oth

er

2012

Net

pro

fit

Win

d op

erat

ing

Win

d di

spos

al

Pel

let

Oth

er

2013

Net

pro

fit


PEP 1 April 2011

24

Finally, in 2013 investors will be pleased with the switch-on of two wind farm projects, a

28MW project to start in early 2013 and a 42MW project later that year. The large

number of disposals of developed wind farm projects (we expect 95MW to be sold that

year) will once again support annual EBITDA by PLN 41m, providing the cash

necessary to start construction of 120MW of new wind farm capacity and continued

works on biomass installations. These will boost the company’s net debt to PLN 1bn,

although this amount will be guaranteed with long-term contracts for wind farm

operations.

Fig. 27. PEP: Financial summary – adjusted figures PLN in millions, unless otherwise stated

2008 2009 2010 change 2011E change 2012E change 2013E change Sales 96.1 106.1 176.0 65.8% 195.6 11.2% 290.6 48.6% 342.5 17.9% COGS (incl. depreciation) 58.6 64.2 90.5 41.1% 103.2 14.1% 166.5 61.3% 193.1 15.9% EBITDA 48.3 50.3 91.3 81.5% 102.9 12.7% 152.2 47.9% 188.4 23.8% EBITDA margin (%) 50.3% 47.4% 51.9% 4.5 pp 52.6% 0.7 pp 52.4% -0.2 pp 55.0% 2.6 pp EBIT 39.1 40.4 80.4 98.7% 89.9 11.9% 121.6 35.3% 147.0 20.8% EBIT margin (%) 40.6% 38.1% 45.7% 7.6 pp 46.0% 0.3 pp 41.8% -4.1 pp 42.9% 1.1 pp Pre-tax profit 37.3 59.2 79.7 34.7% 82.4 3.3% 95.1 15.4% 114.5 20.4% Net profit 33.5 46.9 61.7 31.4% 66.6 8.0% 76.8 15.3% 91.9 19.6% Adjusted EBITDA* 37.1 23.0 47.2 105.2% 53.0 12.2% 107.3 102.3% 137.4 28.1% Adjusted EBIT* 27.9 13.1 36.3 176.3% 40.1 10.4% 76.7 91.5% 95.9 25.0% Adjusted net profit* 24.3 24.6 25.9 5.3% 26.3 1.5% 40.4 54.0% 50.5 25.0%

Source: Company data, DM BZ WBK estimates, *adjusted for impact of wind farm disposal

The power of management forecasting

PEP has a long history of annual management forecasts. These are commonly issued

either in January or in the preceding December, and in Fig. 28 we compare

management forecasts with reported results for the last four years.

Fig. 28. PEP: Management forecasts summary PLN in millions, unless otherwise stated

2007 2008 2009 2010

guidance deliverance difference guidance deliverance difference guidance deliverance difference guidance deliverance difference

Revenues 93.3 95.8 2.7% 104.6 99.5 -4.9% 123.7 106.1 -14.2% n.a. 176.0 -

EBITDA* 47.9 48.1 0.4% 53.2 51.7 -2.8% 70.3 71.8 2.1% 90.0 93.8 4.2%

Net profit** 29.8 29.7 -0.3% 35.6 36.1 1.4% 44.0 44.7 1.6% 56.0 62.1 10.9%

Source: Company data, *adjusted for payments for equity involved in Saturn, **adjusted for F/X differences

Changes in the top line are usually due to differences in the final number of developed

wind projects sold. However, in our opinion, both EBITDA and net profit lines deserve

special attention. Unique ‘negative’ surprises in the EBITDA line of 2.8% and very

precise net profit forecasts represent a track record no other WSE-listed company can

boast of. Given the aforementioned, investors should feel extremely comfortable with

both the 2010 forecasts (EBITDA of PLN 102m, net profit at PLN 67m) and the 2013

medium-term net profit target of PLN 90m.

PEP 1 April 2011

25

PEP’s risk-reward profile Below we list numerous factors affecting PEP’s financial performance and its market

perception. We are discussing and calculating upsides to the valuation every time we

believe the positive scenario comes more likely than the negative one – though,

investors should keep in mind that the negative course of actions would result in same-

size potential downsides to the company’s valuation.

Wind farm development pipeline

The company’s official strategy points to 1,019MW of developed wind projects by 2014.

We believe that PEP’s plans could exceed the 1GW threshold, especially since the

company has recently started its own wind project developments (the company will no

longer be dependant on its current partner in the development process). In our opinion

an additional 200MW of wind projects developed in 2015/16 seem like a reasonable

scenario.

Should this occur, the company could either sell these fully developed or add new

capacity to its wholly owned wind capacity. The disposal of an additional 200MW in

2016 would result in one-off annual revenues of PLN 149m, an EBITDA of PLN 128m

and a net profit of PLN 104m. All in all, selling this additional wind project would boost

PEP’s valuation by PLN 63m (discounted value), or PLN 2.9 per share (a 6.4% upside

to our valuation).

However, PEP would be much better off operating this 200MW of wind farm capacity on

its own. PLN 1.1bn of investment, with PLN 285m of equity inflow, could give rise to a

20-year flow of annual EBITDA at PLN 149m and net profit growing from PLN 40m in

the first year to PLN 200m in the last. The project’s discounted NPV would be PLN

118m, or PLN 5.6 per share (a 12.4% upside to our valuation).

Electricity pricing – multi-angle discussion

Pricing clearly represents the key risk and potential upside to the company’s valuation.

Below we have decided to test PEP’s valuation sensitivity to numerous possible

scenarios.

Growth in PEP’s total electricity price

Throughout our research we have applied a flat black+green electricity price of PLN

400/MWh for all wind farm projects operated by PEP, and PLN 425/MWh for pure

biomass-burning projects (the higher price reflects the advantages of biomass vs. wind).

We regard our assumptions as quite conservative – not only is 1) green electricity

currently indexed for the rate of inflation, but the 2) black electricity price is also set to

grow, 3) CO2 certificates are sure to boost the total electricity price and 4) our

assumptions are actually 17.5% below Poland’s current black+green mix at PLN

470/MWh.

Fig. 29. PEP: Valuation of wind+biomass portfolio PLN in millions, onless otherwise stated

growth rate p.a. 0.0% 0.5% 1.0% 1.5% 2.0%

Valuation 373 428 499 574 654 Upside - 55 126 201 281 Upside per share [PLN] 0.0 2.5 5.7 9.2 12.8


PEP 1 April 2011

26

We checked our PEP model for the impact of different potential growth rates on current

pricing. The outcomes are striking. The annual indexation for the rate of inflation boosts

2020’s total electricity price to PLN 469/MWh, and the valuation of all of PEP’s wind and

pure biomass-burning projects holds at PLN 654m (a PLN 12.8 per share upside). There

is no need for a growth rate as strong as 2.0% p.a. – a mediocre 1.0% p.a. would result

in a PLN 5.7 upside for PEP’s valuation.

Pure biomass-burning – increasing support from the State

It has recently been suggested that Poland’s current renewable support scheme will

change. While there has been a lack of clarity here, it seems likely that support for pure

biomass-burning installations will be the strongest, or at least stronger than for wind.

The most straightforward approach would be to change nothing except for the number

of green certificates granted to an installation – water electricity cut to 80%, wind

maintained unchanged and pure biomass installation receiving 20% more green

certificates is just one of many persistent rumours.

Our valuation of PEP’s pure biomass-burning installation was made at a flat electricity

price of PLN 425/MWh. If the company’s 30MW unit received 20% more green

certificates, the price in our model would amount to PLN 200/MWh (black price), PLN

240/MWh (discounted price of green certificate at PLN 200/MWh multiplied by 1.2x) and

a PLN 25/MWh premium for the lack of grid losses and no necessity for paying for

electricity ‘colours’. The implied flat electricity price of PLN 465/MWh would result in a

valuation for PEP’s installation of PLN 112m – a PLN 30m upside to the valuation and a

PLN 1.4 upside per share.

Application of European green electricity prices

Changes to renewable electricity support in Poland are widely discussed, but we have

not seen any detailed comparison of the systems valid in Poland and in other EU states.

We have done the research necessary, and our conclusions with respect to green

electricity pricing are summarized below.

Fig. 30. European green electricity prices

Germany Spain Czech France Italy Average Poland

EUR/MWh

Wind 97 73 160 82 96 102

Biomass 190 133 210 119 173 165

PLN/MWh

Wind 388 293 640 328 384 407 470

Biomass 759 533 840 476 691 660 470


It must be kept in mind that pricing mechanisms in Western Europe are widely

supported by all-kinds of subsidies (sometimes amounting to 25% to 50% of a project’s

cost) and tax incentives. Nonetheless, EU pricing does not seem excessively alarming

with regard to valuation, with the average zloty-denominated electricity price settling at

just above the PLN 400/MWh used in our model. German pricing for wind turns out to be

very similar to our assumptions, while we do not believe that Poland will apply Spanish

price levels. Spain has met much of its renewable electricity goal, so that renewables no

longer need strong promotion, which is definitely not the case in Poland.

PEP 1 April 2011

27

The worst-case scenario would be following the French model, which would trim wind

prices to PLN 328/MWh. The application of this to all of PEP’s wind projects, including

those set to go online at the turn of 2011/2012, would reduce the company’s valuation

by PLN 228m, or PLN 10.4 per share. However, we are certain that this cut to prices

would be matched with a growth in subsidies received by the interested parties. Last

year PEP received a PLN 80m non-refundable grant for its two wind farms with 58MW

of joint capacity, and we expect no more grants to the company. Low electricity pricing

would make grants of this kind a regular occurrence. PEP’s pending 280MW in the wind

pipeline could potentially inflict PLN 386m of non-refundable subsidies (PLN 17.6 per

share), far more than compensating for losses in pricing.

There is one more striking issue in Fig. 30 – the scale of biomass subsidies. We have

assumed that pricing for wind and biomass will remain barely changed, while in Europe

the respective pricings are vastly different, with the biomass average at PLN 660/MWh.

Should Poland follow the European model in this case, the NPV of PEP’s 30MW pure

biomass-fired unit would rally to PLN 260m, where a PLN 178m upside would imply a

PLN 8.1 upside per share.

All in all, the application of the aforementioned European averages for renewable

electricity would be very supportive to PEP – a tiny upside on wind would be supported

by a heavy upside in the biomass segment. The exclusion of the Czech Republic from

these calculations (wind support at PLN 348/MWh, biomass at PLN 615/MWh) reduce

the company’s valuation by PLN 78m (PLN 3.5 per share), but we believe the increased

subsidies availability would more than compensate for this loss – just one non-

refundable grant in the scale of the recent one awarded by PEP (PLN 80m for 58MW

projects) would nullify the downside.

Changes to PEP’s CAPEX – turbine costs and the exch ange rate

Regardless of our assumption about the company’s wind pipeline, its true CAPEX to be

spent remains uncertain. PEP’s CAPEX in the wind segment is a derivative of turbine

unit costs (currently assumed at EUR 1.5m/MW for all projects) and the EURPLN

exchange rate (our assumption is 4.06x for the first 70MW and 3.8x for all remaining

projects). Should either factor change, any single project may require both capital

investments and equity inflows that are different from our assumptions.

In our calculations we have not altered either CAPEX or equity requirements for the two

wind projects to be completed by year-end 2011 – turbines were purchased at a fixed

price and the projects were hedged against any changes in the exchange rate. Hence,

our calculations below refer only to changes in the 280MW of new capacity scheduled

for construction by 2015.

Fig. 31. PEP: Sensitivity to turbines’ unit pricing PLN in millions, onless otherwise stated

Win turbine [EURm/MW] 1.60 1.50 1.40 1.30 1.20 1.00

Valuation 243 291 340 388 437 534 Upside -49 0 49 97 146 243 Upside per share [PLN] -2.2 0.0 2.2 4.4 6.7 11.1


The reduction in wind turbine pricing continues. A few years ago EUR 1.7m per MW of

power would have been considered a fair price, but prices are clearly trending

downward. This trend is the result not only of lower demand for wind turbines in Western

PEP 1 April 2011

28

Europe, but also from technological progress. In the table above we find any price below

EUR 1.3m/MW unrealistic (as are persistent higher prices for turbines), but we regard it

as feasible that new technology could boost PEP’s valuation by PLN 2.2 per share.

Fig. 32. PEP: valuation of wind+biomass portfolio PLN in millions, onless otherwise stated

EUR/PLN rate 4.4 4.0 3.8 3.6 3.2

Valuation 241 338 390 435 533 Upside -132 -35 17 62 160 Upside per share [PLN] -6.0 -1.6 0.8 2.8 7.3


The exchange rate remains just as important as turbine prices and its volatility makes

the exchange rate one of PEP’s key medium-term valuation drivers. None of the

valuations should be excluded as unrealistic, although the widespread expectation of

the zloty strengthening against the euro in the long term suggests that an upside

remains far more likely than a downside. There is just one explanation for the table

above – downsides and upsides are not equal due to our conservative assumption of a

EUR–PLN exchange rate of 4.0x paid by the company for the two pending projects

totalling 70MW of capacity. Therefore, the application of a 4.0x exchange rate worsens

NPVs for only some projects.

Equity inflow requirements

We have assumed that PEP will have to provide 25% of any project’s CAPEX value,

while bans will provide the remaining 75%. However, this assumption proves incorrect

for either of the two new wind farms to be built in 2011 or for PEP’s pure biomass-

burning installation – wind farms are expected to require only 21.5% of PEP’s own

capital, while the biomass unit may require only 19.8%. These are still assumptions and

remain to be verified with the passage of time, but the change in the share of PEP’s own

equity required for the remaining 210MW in wind from 25% to 20% results in a PLN 10m

upside to valuation (PLN 0.3 per share).

This upside seems tiny and inconsequential, since we only looked at PEP’s known wind

pipeline. In fact, the reduction in equity requirement from 25% to 20% implies the same

amount of equity would allow PEP to build 25% larger wind farms. All in all, 25% for

210MW would be sufficient to cover the expenses of 20% of 263MW – or a 53MW wind

farm for free. Hence, it would support PEP’s valuation by another PLN 38m (NPV of

69MW-large wind project under full control), or PLN 1.8 per share.

One project vs. continued activity

Discussions of PEP’s operating wind farms or its pure biomass-burning unit, address

their NPVs as if these had been built, run for 20 to 30 years and then shut down. We

believe this is not a true assumption – in Western Europe the re-powering (replacement

of old renewable units with new ones) is becoming more and more important in the

renewable sector. In any case, with unchanged wind conditions and continued high

demand for carbon dioxide-free renewable power, it would be unwise to cease activity

after one lifecycle of a project.

The assumption of Terminal Value – new wind farms/biomass units built to replace

those switched off – adds 22% to every company’s project NPV. Therefore, the

assumption of continued operations would boost PEP valuation by PLN 78m, or PLN 3.5

per share.

PEP 1 April 2011

29

High gearing

As we mentioned above, the company’s reported net debt-to-EBITDA ratio will grow

from the current 1.0x to 5.6x in 2014. PEP’s activity – wind farm/biomass installation

construction – is both time- and CAPEX-intense and its cash inflows and schedule of

debt repayment is pre-defined for 15 to 20 years for each project under consideration.

Therefore, regardless of the company’s long-term agreement for electricity sales,

guarantees of debt repayment or the P/E ratio of 7.8 in 2012 and a P/E below 4.5 as of

2017, we are fairly certain that the issue of PEP’s reported very high indebtedness will

be brought to the public in coming years, representing risk to the company’s share price.

Mondi claim

The management of Mondi Świecie announced it would like to exercise its call option on

PEP’s key outsourced asset – all the heat and power facilities at Mondi. In order to do

this, it went to the Arbitration Court. Mondi would like to find out whether the old Mondi-

PEP call option remains in force. Should the Arbitration Court assessment come in

favourable to Mondi, it would like to acquire all power assets currently outsourced to

PEP for EUR 28.8m, or PLN 112m (additionally all debts would also be repaid).

According to PEP’s immediate communiqué, the ability of Mondi to exercise this option

under old conditions is legally dubious. PEP’s viewpoint is reportedly backed by several

authorities. PEP also says that Mondi’s claim is unfounded. PEP believes the transfer of

rights to its assets could take place, but the company found the price mentioned far too

low. Since the Arbitration Court case has no impact on current Mondi-PEP cooperation

conditions, PEP management has left its 2011 forecasts unchanged.

What is all the fuss about? The most important issue here is that Mondi has not

written a single word questioning the quality of services delivered by PEP. As we see it,

cooperation remains very mutually beneficial to the companies, with the scale of these

gains coming in far above Mondi’s original estimates. Money remains the issue here –

Mondi wants to keep all gains originating from power outsourcing for itself, while part of

these currently go directly to PEP. Mondi seems to be checking whether there is any

chance for it to retain all earnings in the power generation segment.

What has changed over the years? The details of the original Mondi-PEP agreement

were never disclosed, but its general intention was to share gains on addressing the

handling of energy/heat issues at Mondi. Some time ago only minor gains were

possible, but 1) two new sub-projects (in 2006 and 2010) have extended the scope of

PEP’s operations to all boilers running in Mondi, and 2) the implementation of red/green

certificates in Poland has multiplied gains on cooperation.

How big is the risk for PEP? In our model we have assumed the value of the PEP-

Mondi cooperation to be PLN 220m, which is PLN 110m (PLN 5.0 per share) higher

than the amount mentioned by Mondi. Hence, if the Arbitration Court made up its mind

immediately, and if it agreed with Mondi’s position in full, this worst-case scenario would

create a PLN 5.0 downside to PEP share price. PEP’s 2011 forecasts seem fairly safe

to us because: 1) the bulk of Mondi-PEP’s annual gains are recognized in 1Q; 2) the

court decision is unlikely to be instant, allowing for the next quarters of gains to be

recognised; and 3) PEP could easily make up the loss with the disposal of another small

wind project.

What will happen next? Cooperation between PEP and Mondi, and PEP’s delivery of

gains on it, should continue unchanged. We believe: 1) that the court case could take

years; 2) that PEP seems well-prepared and well-trenched for the case (the company

PEP 1 April 2011

30

may have been expecting Mondi’s actions); and 3) in our view, the odds of a mere PLN

112m being awarded to PEP are small due to the continued high efficiency of PEP-

operated Mondi boilers. Last but not least, PEP will have the right to appeal the verdict –

this court case is unlikely to come to an end anytime soon.

Support for renewables in Poland: insights into the government's view

On February 8, 2011 an interview with Mrs. Joanna Strzelec-Lobodzinska, deputy

Economy Minister, provided some insights into likely changes in support for renewable

sources. Below we present the key takeaways and a brief discussion. Our

understanding is that the changes to the current renewables support scheme should be

primarily perceived as risks for PEP.

Takeaways from the interview:

• The government sees the implementation of changes to the existing renewables

support scheme in Poland as necessary in order to soften its future impact on the

customer.

• The government wants to differentiate support for renewable sources based on: 1)

the source used (wind, water, biomass); 2) installation age; and 3) installation size.

• New installation are to receive full support (unknown value) for the full period of

average return on capital (not defined in the interview) for each technology used.

Support will decrease later on.

• All renewable installations both now and in the future will receive some support for

‘statistical purposes’ (direct quotation from Mrs. Strzelec-Lobodzinska).

• Biomass will receive the strongest support, followed by wind and biogas

technologies.

• The new support scheme (extra payments for renewable sources) will depend on

the price of black energy – strong growth in black energy would result in decreasing

pure ‘green’ subsidies.

• The government is still working on the potential inclusion of costs for connecting to

the grid into the renewable sources scheme – no final decision has yet been made.

• The deputy minister was not certain whether the new law could be implemented in

1H’2011 – major delays cannot be excluded.

• Wood and coal co-burning may receive additional support from the state – the

deputy minister argues that burning wood results in lower CO2 emissions.

Our perception of this interview:

1. Biomass will receive the strongest support, followe d by wind and biogas . The

biomass news is not a surprise and we are pleased to hear wind coming second.

However, it is important that the deputy minister did not mention strong support for

either wood co-burning or hydro installations. We expect support for these sectors

to be significantly reduced by the new law.

2. Age is important . Young installations will receive full support, but support for old

and very old (check for over 100-year-old hydro installations) will be cut

significantly. Another warning for hydro installations , especially since the deputy

PEP 1 April 2011

31

minister actually mentioned the abnormally high and unjustified profits at the

Wloclawek hydro power plant belonging to Energa.

3. ‘Green’ support will not be terminally added to the black energy price – instead, the

government has its eye on a total ‘black+green’ ele ctricity price . Hence, rapid

CO2-driven growth in electricity prices will result in a reduction in ‘green’ support.

4. It is still difficult to say when the new law may be passed and the deputy minister

sees delays as likely. Delays are certain in Poland when it comes to law legislation,

but we believe it is almost certain the new laws will come into force in early 2012 at

the latest – law changes must be applied before 2013, the most likely time period

for expensive CO2 certificates.

We have applied a flat ‘black+green’ price assumption for all projects under

consideration, so that all the aforementioned come in precisely inline with our

expectations. None of PEP’s projects are old, so PEP’s current gains on green energy

with its first wind farm are unlikely to be cut. There were share price-depressing rumours

that ‘green’ support will be cut in a few years, but now we see that this will most likely be

offset by rallying black electricity prices after the implementation of the CO2 certificate

scheme. We regard the official announcement of a flat ‘black+green’ price as strongly

supporting the company’s share price, unless its level is set significantly below PLN

400/MWh.

New share issue PEP’s development program remains uncertain with respect to the timeliness of certain

projects, either with respect to wind or biomass. Hence, we believe that under conditions

of acceleration of development in wind or biomass the company could find it reasonable

to apply for additional financing via new share issue.

However, we see this as hypothetical issue presently – we saw too many delays in

development process to make any strong statements. Otherwise – there might be new

share issue, but we feel very certain it will not come true before late 2013, and only

provided PEP will have very interesting projects at arm’s length.

For the lack of cash, in 2014 we assume PEP will sell its entire portfolio of developed

projects. Should the company get additional financing of PLN 80m then, the switch from

‘disposal’ into ‘operating own windfarm’ would boost PEP’s diluted valuation by PLN 1.5.

WACC / growth rate changes We are not discussing any changes to growth rate at all – our model assumes flat

prices, so that ‘g’ equals 0%, and changes to electricity prices are discussed above

(price indexation section). A 1pp change to WACC boosts / reduces our PEP valuation

by PLN 210m, or PLN 9.6 per share.

Still, we find our core WACC quite conservative one, and downside to WACC / upside to

valuation seems more likely in our view. Our 10.4% WACC is based on 58% of debt and

42% of equity. While this breakdown seems fine for the few first years, in the long term

PEP is repaying debt on each project, while the company’s equity keeps blossoming.

Therefore, the actual share of debt to equity over the life of wind project settles at 33% /

66% breakdown. Application of these would reduce WACC to 7.5%, at the same time

driving PEP’s valuation up by PLN 540m, or PLN 24.6 per share.

PEP 1 April 2011

32

Growth to renewable sector in Poland Fig. 33. Poland: Renewable energy capacity forecast s In MW

2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Hydro: 952 962 972 982 992 1,002 1,012 1,022 1,032 1,042 1,152

<1 MW 102 106 110 114 118 122 126 130 134 138 142 1 MW - 10 MW 178 184 190 196 202 208 214 220 226 232 238

>10 MW 672 672 672 672 672 672 672 672 672 672 772 of which pumping 0 0 0 0 0 0 0 0 0 0 0

Geothermal 0 0 0 0 0 0 0 0 0 0 0 Solar: 1 1 2 2 2 2 2 3 3 3 3

photovoltaic 1 1 2 2 2 2 2 3 3 3 3 concentrated solar power 0 0 0 0 0 0 0 0 0 0 0

Tide, wave, ocean 0 0 0 0 0 0 0 0 0 0 0 Wind: 1,100 1,550 2,010 2,520 3,030 3,540 4,060 4,580 5,100 5,620 6,650

onshore 1,100 1,550 2,000 2,450 2,900 3,350 3,800 4,250 4,700 5,150 5,600 offshore 0 0 0 0 0 0 0 0 0 0 500

small installations 0 0 10 70 130 190 260 330 400 470 550

Biomass: 380 450 720 940 1,180 1,530 1,630 1,780 1,930 2,230 2,530 solid 300 350 600 800 1,000 1,300 1,350 1,400 1,450 1,500 1,550

biogas 80 100 120 140 180 230 280 380 480 730 980 bioliquids 0 0 0 0 0 0 0 0 0 0 0

TOTAL 2,433 2,963 3,704 4,444 5,204 6,074 6,704 7,385 8,065 8,895 10,335 of which CHP 130 155 240 310 390 505 545 610 675 815 955

Source: Ministry of Economy

Fig. 34. Poland: Renewable energy output forecasts In GWh

2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Hydro: 2,279 2,311 2,343 2,375 2,407 2,439 2,471 2,503 2,535 2,567 2,969

<1 MW 357 371 385 399 413 427 441 455 469 483 497 1 MW - 10 MW 534 552 570 588 606 624 642 660 678 696 714

>10 MW 1,388 1,388 1,388 1,388 1,388 1,388 1,388 1,388 1,388 1,388 1,758 of which pumping 0 0 0 0 0 0 0 0 0 0 0

Geothermal 0 0 0 0 0 0 0 0 0 0 0 Solar: 1 2 2 2 2 2 2 3 3 3 3

photovoltaic 1 2 2 2 2 2 2 3 3 3 3 concentrated solar power 0 0 0 0 0 0 0 0 0 0 0

Tide, wave, ocean 0 0 0 0 0 0 0 0 0 0 0 Wind: 2,310 3,255 4,308 5,327 6,491 7,541 8,784 9,860 11,210 12,315 15,210

onshore 2,310 3,255 4,300 5,268 6,380 7,370 8,550 9,563 10,810 11,845 13,160 offshore 0 0 0 0 0 0 0 0 0 0 1,500

small installations 0 0 8 60 111 171 234 297 400 470 550

Biomass: 6,028 7,110 8,192 8,774 9,438 9,893 10,348 11,008 11,668 12,943 14,218 solid 5,700 6,700 7,700 8,200 8,700 8,950 9,200 9,450 9,700 9,950 10,200

biogas 328 410 492 574 738 943 1,148 1,558 1,968 2,993 4,018 bioliquids 0 0 0 0 0 0 0 0 0 0 0

TOTAL 10,618 12,678 14,845 16,478 18,338 19,875 21,605 23,374 25,416 27,828 32,400 of which CHP 1,874 2,215 2,556 2,747 2,979 3,157 3,334 3,614 3,894 4,482 5,069

Source: Ministry of Economy

PEP 1 April 2011

33

Financial statements and forecasts Fig. 35. PEP: P&L summary and forecasts PLN in millions, unless otherwise stated

2008 2009 2010 2011E 2012E 2013E Net sales 96.1 106.1 176.0 195.6 290.6 342.5 COGS 49.4 54.3 79.6 90.3 136.0 151.6 Depreciation 9.3 9.9 10.9 12.9 30.5 41.4 Gross profit 37.5 42.0 85.5 92.4 124.1 149.5 Other operating, net 1.6 -1.5 -5.1 -2.5 -2.5 -2.5 Operating profit 39.1 40.4 80.4 89.9 121.6 147.0 EBITDA 48.3 50.3 91.3 102.9 152.2 188.4 Financial income 16.1 12.4 13.7 11.8 10.2 9.4 Financial expense 18.1 14.4 19.2 19.4 36.7 41.8 F/X gains/losses 0.2 20.7 4.8 0.0 0.0 0.0 Profit before income tax 37.3 59.2 79.7 82.4 95.1 114.5 Income tax 3.8 12.3 18.0 15.7 18.3 22.7 Net profit 33.3 46.9 61.6 66.6 76.8 91.9


Fig. 36. PEP: Balance sheet summary and forecasts PLN in millions, unless otherwise stated

2008 2009 2010 2011E 2012E 2013E Current assets 104.2 167.4 234.7 273.7 282.0 232.5 cash and equivalents 11.6 58.3 46.3 79.2 42.1 38.9 accounts receivable 15.8 14.5 85.1 43.1 41.2 37.2 inventories 29.9 36.5 36.0 87.6 138.0 98.7 other assets 46.8 58.1 67.2 63.9 60.7 57.6

Fixed assets 427.6 496.6 575.7 885.5 1,361.9 1,757.3

PPE 170.4 163.9 277.4 625.5 1,120.8 1,546.8 long-term receivables 256.3 330.7 296.5 258.2 239.3 208.7

Total assets 564.2 665.0 812.1 1,160.9 1,645.6 1,991.5 Current liabilities 80.5 74.9 119.8 80.0 81.7 107.4 bank debt 52.4 47.0 62.0 29.4 29.6 54.3 accounts payable 19.7 13.9 21.7 25.0 26.5 27.5 other current liabilities 8.4 14.0 36.0 25.6 25.6 25.6

Long-term liabilities 302.3 354.7 388.1 662.7 1,031.1 1,255.8

bank debt 292.1 339.5 370.3 644.9 1,013.3 1,238.1 other long-term liabilities 10.3 15.2 17.7 17.7 17.7 17.7

Equity 180.5 234.3 303.2 417.0 499.9 595.3

share capital 37.6 38.5 39.5 42.9 43.3 43.6 capital reserves 109.5 149.0 202.2 307.5 379.7 459.9 net income 33.3 46.9 61.6 66.6 76.8 91.9

Total liabilities and equity 564.2 665.0 812.1 1,160.9 1,645.6 1,991.5


PEP 1 April 2011

34

Fig. 37. PEP: Cash flow statement summary and forec asts


2008 2009 2010 2011E 2012E 2013E Cash flow from operations 20.8 45.2 25.6 66.4 95.3 180.6 Net profit 33.3 46.9 61.6 66.6 76.8 91.9 Depreciation and amortisation 9.3 9.9 10.9 12.9 30.5 41.4 Changes in WC, o/w -0.6 -11.0 -62.4 -6.2 -47.0 44.2 inventories -19.9 -6.5 0.5 -51.6 -50.4 39.3 receivables 3.5 1.3 -70.6 42.1 1.9 4.0 payables 15.9 -5.7 7.8 3.3 1.5 1.0 Other, net -21.3 -0.7 15.4 -7.0 3.2 3.0

Cash flow from investment -110.5 -47.5 -90.8 -322.7 -506.9 -436.9 Additions to PPE -38.9 -3.4 -124.4 -361.1 -525.9 -467.4 Additions to intangibles 0.0 -1.1 0.1 0.0 0.0 0.0 Change in long-term investments -44.3 -74.4 34.2 38.3 19.0 30.5 Other, net -27.4 31.3 -0.7 0.0 0.0 0.0

Cash flow from financing 38.3 49.0 53.2 289.2 374.6 253.0 Change in long-term borrowing 11.0 47.4 30.8 274.6 368.4 224.7 Change in short-term borrowing 23.3 -5.5 15.1 -32.6 0.2 24.7 Change in equity and profit distribution 4.0 7.0 7.3 47.2 6.0 3.6 Dividends paid 0.0 0.0 0.0 0.0 0.0 0.0 Other, net 0.0 0.0 0.0 0.0 0.0 0.0

Net change in cash and equivalents -51.5 46.7 -12.0 32.9 -37.0 -3.2 Beginning cash and equivalents 63.1 11.6 58.3 46.3 79.2 42.1 Ending cash and equivalents 11.6 58.3 46.3 79.2 42.1 38.9


PEP 1 April 2011

35

Dom Maklerski BZ WBK SA Institutional Sales Department

5A Grzybowska St. 00-132 Warszawa

fax. (+48) 22 586 81 09

Equity Research

Pawel Puchalski, CFA, Head tel. (+48) 22 586 80 95 [email protected] Telecommunications, IT, Mining, Power

Maciej Barański tel. (+48) 22 586 81 00 [email protected] Banks Pawel Burzynski tel. (+48) 22 586 81 55 [email protected] Strategy, Oil & Gas, Chemicals, Biotechnology Tomasz Sokolowski tel. (+48) 22 586 82 36 [email protected] Pharma, Retail Zbigniew Porczyk tel. (+48) 22 534 16 10 [email protected] IT Distribution, Mining Machines Maciej Marcinowski tel. (+48) 22 586 82 33 [email protected] Lukasz Kosiarski, Research Associate tel. (+48) 22 586 82 25 [email protected]

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Bartek Godlewski, Head tel. (+48) 22 586 80 44 [email protected] Wojciech Wosko tel. (+48) 22 586 80 82 [email protected] Kamil Cislo tel. (+48) 22 586 80 90 [email protected] Pawel Szczepanski tel. (+48) 22 586 80 87 [email protected] Blazej Leskow tel. (+48) 22 586 81 57 [email protected] Marcin Kuciapski tel. (+48) 22 586 80 96 [email protected]

LIMITATION OF LIABILITY This material was produced by Dom Maklerski BZ WBK S.A. (DM BZ WBK S.A.), entity that is subject to the regulations of the Act on Trading in Financial Instruments dated July 29th 2005 (Journal of Laws of 2010, No.211 item 1384 - consolidated text, further amended), Act on Public Offering, Conditions Governing the Introduction of Financial Instruments to Organised Trading, and Public Companies dated July 29th 2005 (Journal of Laws of 2009, No.185 item 1439 - consolidated text, further amended), Act on Capital Market Supervision dated July 29th 2005 (Journal of Laws of 2005, No.183 item 1537 further amended). It is addressed to qualified investors and professional clients as defined under the above indicated regulations and to Clients of DM BZ WBK S.A. entitled to gain recommendations based on the brokerage services agreements. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of DM BZ WBK S.A. or entities belonging to BZ WBK. DM BZ WBK S.A. is an author of this document. DM BZ WBK S.A. may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. DM BZ WBK S.A. will not treat recipients of this report as its customers by virtue of their receiving this report. The investments and services contained or referred to in this report may not be suitable for particular investor and it is recommended to consult an independent investment advisor in case of doubts about such investments or investment services. Nothing in this report constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to investor’s individual circumstances, or otherwise constitutes a personal recommendation to particular investor. In the case where recommendation refers to several companies, the name “Issuer” will apply to all of them. Affiliates of DM BZ WBK S.A. may, from time to time, to the extent permitted by law, participate or invest in financing transactions with: Polish Energy Partners S.A. “Issuer”, perform services for or solicit business from such Issuer and/or have a position or effect transactions in the financial instruments issued by the Issuer (“financial instruments”). DM BZ WBK S.A. may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Financial instruments before this material is published to recipients. Unless otherwise permitted by law in the applicable jurisdiction, only authorised affiliates of DM BZ WBK S.A. will effect orders for Financial instruments from customers in such jurisdiction. This material may relate to investments or services of a person outside the United Kingdom or to other matters which are not regulated by the Financial Services Authority. Any further details as to where this may be the case are available upon request. DM BZ WBK S.A. emphasizes that this document is going to be updated at least once a year. This document remains in force for 12 months and no longer than the date of the issue of another recommendation. DM BZ WBK S.A. may have issued, and may in the future issue, other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them and DM BZ WBK is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report. Information and opinions contained herein have been compiled or gathered by DM BZ WBK S.A. from sources believed to be reliable, however DM BZ WBK S.A. and its affiliates shall have no responsibility or liability whatsoever in respect of any inaccuracy in or omission from this document prepared by DM BZ WBK S.A. or sent by DM BZ WBK S.A. to any person in connection with the offering of the Financial instruments and any such person shall be responsible for conducting his own investigation and analysis of the information contained or referred to in this document and of evaluating the merits and risks involved in the Financial instruments forming the subject matter of this or other such document. This statement shall be deemed to be incorporated in and form a term of any contract entered into by DM BZ WBK S.A. or its affiliates with any such person in respect of any transaction in Financial instruments. The information and opinions contained herein are subject to change without any notice. Dom Maklerski BZ WBK S.A. is not responsible for damages resulting from placing orders based on this document. THIS DOCUMENT DOES NOT CONSTITUTE AN OFFER OR INVITATION TO SUBSCRIBE FOR OR PURCHASE ANY FINANCIAL INSTRUMENTS AND SHALL NOT BE CONSIDERED AS AN OFFER TO SELL OR TO BUY ANY SECURITIES. THIS DOCUMENT IS FURNISHED AND PRESENTED TO YOU SOLELY FOR YOUR INFORMATION AND MAY NOT BE REPRODUCED OR REDISTRIBUTED TO ANY OTHER PERSON. THIS DOCUMENT NOR ANY COPY HEREOF SHALL NOT BE DISTRIBUTED DIRECTLY OR INDIRECTLY IN THE UNITED STATES, CANADA, AUSTRALIA OR JAPAN OR TO ANY CITIZEN OR RESIDENT OF THE UNITED STATES, CANADA, AUSTRALIA OR JAPAN WHERE ITS DISTRIBUTION MAY BE RESTRICTED BY LAW. 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PEP 1 April 2011

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REPORT NOR ANY COPY HEREOF MAY BE DISTRIBUTED IN ANY JURISDICTION OUTSIDE THE UK WHERE ITS DISTRIBUTION MAY BE RESTRICTED BY LAW. PERSONS WHO RECEIVE THIS DOCUMENT SHOULD MAKE THEMSELVES AWARE OF AND ADHERE TO ANY SUCH RESTRICTIONS. THIS DOCUMENT HAS NOT BEEN PREPARED BY OR IN CONJUNCTION WITH ISSUER. INFORMATION IN THIS DOCUMENT MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORISED OR APPROVED BY ISSUER. THE OPINIONS EXPRESSED HEREIN ARE SOLELY THOSE OF DM BZ WBK S.A DM BZ WBK S.A. INFORMS THAT INVESTING ASSETS IN FINANCIAL INSTRUMENTS IMPLIES THE RISK OF LOSING PART OR ALL THE INVESTED ASSETS. DM BZ WBK S.A. INDICATES THAT THE PRICE OF THE FINANCIAL INSTRUMENTS IS INFLUENCED BY LOTS OF DIFFERENT FACTORS, WHICH ARE OR CANNOT BE DEPENDENT FROM ISSUER AND ITS BUSINESS RESULTS. THESE ARE FACTORS SUCH AS CHANGING ECONOMICAL, LAW, POLITICAL OR TAX CONDITION. THE DECISION TO PURCHASE ANY OF THE FINANCIAL INSTRUMENTS SHOULD BE MADE ONLY ON THE BASIS OF THE PROSPECTUS, OFFERING CIRCULAR OR OTHER DOCUMENTS AND MATERIALS WHICH ARE PUBLISHED ON GENERAL RELEASE ON THE BASIS OF POLISH LAW. In preparing this document DM BZ WBK S.A. made use of the following valuation methods: 1) discounted cash flows ("DCF") 2) comparative. The DCF valuation method is based on expected future discounted cash flows. One advantage of the DCF valuation method is that it takes into account all cash streams reaching Issuer and the cost of money over time. Some disadvantages of the DCF valuation method are that a large number of parameters and assumptions need to be estimated; and the valuation is sensitive to changes in those parameters. The comparative valuation method is based on the economic rule of "one price". Some advantages of the comparative valuation method are that the analyst need only estimate a small number of parameters; the valuation is based on current market conditions; the relatively large accessibility of indicators for companies being compared; and that there is an extensive knowledge of the comparative method among investors. Some disadvantages of valuation by the comparative method are the considerable sensitivity of the results of the valuation on the choice of companies to the comparative group; the method can lead to a simplification of the picture of the company which in turn can lead to omitting certain important factors (e.g. growth dynamics, extra-operational assets, corporate governance, the repeatability of results, differences in applied accounting standards); and the uncertainty of the effectiveness of a market valuation of companies being compared. Explanations of special terminology used in the recommendation: EBIT – earnings before interest and tax EBITDA – earnings before interest, taxes, depreciation, and amortization P/E – price-earnings ratio EV – enterprise value (market capitalisation plus net debt) PEG - P/E to growth ratio EPS - earnings per share CPI – consumer price index WACC - weighted average cost of capital CAGR – cumulative average annual growth P/CE – price to cash earnings (net profit plus depreciation and amortisation) ratio NOPAT – net operational profit after taxation FCF - free cash flows BV – book value ROE – return on equity P/BV – price-book value Recommendation definitions: Buy - indicates a stock's total return to exceed more than 15% over the next twelve months. Hold - indicates a stock's total return to be in range of 0%-15% over the next twelve months. Sell - indicates a stock's total return to be less than 0% over the next twelve months. Over the last three months Dom Maklerski BZ WBK S.A. issued 8 Buy recommendation, 3 Hold recommendation and 0 Sell recommendation. The Issuer does not hold shares of DM BZ WBK S.A. Neither members of the Issuer’s authorities nor their relatives are members of the management board or supervisory board of DM BZ WBK S.A. No person engaged in preparing the report is a relative for the members of the Issuer’s authorities and none of those persons or their relatives are party to any agreement with the Issuer, which would be concluded on different basis than agreements between Issuer and consumers. Among those, who prepared this document, as well as among those who didn’t prepare it but had or might have had the access to it, there are such individuals who hold shares of the Issuer in the amount which does not exceed 5% of the share capital or financial instruments whose value is connected with the value of the financial instruments issued by the Issuer. During the last 12 months DM BZ WBK S.A. has been a party to agreements relating to the offering of financial instruments issued by Issuer and connected with the price of financial instruments issued by Issuer. During the last 12 months DM BZ WBK S.A. was not a member of syndicate for financial instruments issued by Issuer. DM BZ WBK S.A. did not buy or sell any financial instruments issued by the Issuer on its own account, in order to realize investment subissue or service agreements. DM BZ WBK S.A. acts as market maker, on principles specified in the Regulations of the Warsaw Stock Exchange, for the shares of Issuer. DM BZ WBK S.A. acts as issuer’s market maker, on principles specified in the Regulations of the Warsaw Stock Exchange, for the shares of Issuer. During the last 12 months DM BZ WBK S.A. has received remuneration for providing services for the Issuer. These services covered acting as issuer’s market maker, public offering of shares and managing the managerial options scheme. During the last 12 months Bank Zachodni WBK S.A. which is connected with Dom Maklerski BZ WBK S.A. has received remuneration for providing investment banking services for the Issuer. DM BZ WBK S.A. does not hold shares of the Issuer or any financial instruments of the Issuer being the subject of this document, exceeding 5% of the share capital. Bank Zachodni WBK S.A., which is connected with DM BZ WBK S.A., is not directly or indirectly connected with Issuer. DM BZ WBK S.A. does not rule out that in the period of preparing this document any Affiliate of DM BZ WBK S.A. might purchase shares of the Issuer or any financial instruments being the subject of this document which may cause exceeding 5% of the share capital. Subject to the above, the Issuer may be bound by other contractual relationship with DM BZ WBK S.A. DM BZ WBK S.A. does not, directly or indirectly, hold financial instruments issued by the Issuer or financial instruments whose value depends on the value of financial instruments issued by the Issuer (except on the basis of being market maker and issuer’s market maker). However, it cannot be ruled out that, in the period of the next twelve months or the period in which this document is in force, DM BZ WBK S.A. will submit an offer to provide services for the Issuer or will purchase or dispose of financial instruments issued by the Issuer or whose value depends on the value of financial instruments issued by the Issuer. Except for broker agreements with clients under which DM BZ WBK S.A. sells and buys the shares of the Issuer at the order of its clients, DM BZ WBK S.A. is not party to any agreement which would depend on the valuation of the financial instruments discussed in this document. Remuneration received by the persons who prepare this document may be dependent, in an indirect way, from financial results gained from investment banking transactions, related to financial instruments issued by the Issuer, made by DM BZ WBK S.A. or its Affiliates. In the opinion of DM BZ WBK S.A., this document has been prepared with all due diligence and excludes any conflict of interests which could influence its content. DM BZ WBK S.A. is not obliged to take any actions which could cause financial instruments that are the subject of the valuation contained in this document to be valued by the market in accordance with the valuation contained in this document. DM BZ WBK S.A. is subject to the supervision of the Financial Supervision Commission and this document has been prepared within the legal scope of the activity of DM BZ WBK SA. The date on the first page of this report is the date of preparation and publication of the document. ANY PERSON WHO ACCEPTS THIS DOCUMENT AGREES TO BE BOUND BY THE FOREGOING DISCLAIMER AND LIMITATIONS. Dom Maklerski BZ WBK S.A. with its registered office in Poznan, Pl. Wolności 15, 60 - 967 Poznan, registered by the District Court in Poznan – Nowe Miasto i Wilda, Division VIII Commercial of the National Court Register under the number KRS 0000006408, Taxpayer Identification No. 778-13-59-968, with share capital amounting to PLN 45 073 400 fully paid up .

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