The Hindu Business Line : Suzlon Energy: Invest at cut-off

INVESTORS not averse to risk can consider investing in the initial public offer of Suzlon Energy. The offer is being made at a price band of Rs 425 to Rs 510, at a multiple of 32 to 38 times its diluted FY05 earnings on an expanded equity base. The stock is expensive at the offer price, considering the average of about 30 times for other makers of conventional power equipment. Good demand prospects in the power sector coupled with government's emphasis on non-conventional forms of energy indicate bright business prospects for wind power. The established market leadership of Suzlon in India and the recent backward integration leading to cost competitiveness lend optimism to the company's earnings prospects and are the rationale for our recommendation.

Suzlon is a leading manufacturer of wind turbine generators and has carved a niche for itself in the wind energy segment in the country. The company, along with associates, combines consultancy, design, manufacturing, operation and maintenance services, thus providing total wind power solutions.

The proceeds of the issue are to be used to set up and expand manufacturing facilities in India, the US and China, invest in its marketing and research and development subsidiaries in Denmark and Germany; and redeem preference shares allotted to private equity investors.

Business prospects

Suzlon's expansion plans, once they happen, are likely to result in a wider range of products. It will also give the company control over its supply chain by facilitating in-house manufacture of key components such as rotor blade, which were so far outsourced. Setting up of new facilities in India, the US and China will broadbase manufacture and reduce freight costs involved in transporting unwieldy components.

The company's backward integration into manufacture of components such as tubular towers and generators, can be expected to lead to cost efficiency and provide a boost to the already healthy margins in March 2005.

The company's international tie-ups for technical inputs and the location of its international headquarters in Denmark — leaders in wind power technology — is likely to provide it the technological edge for international forays into the US and China.

The case for wind power and Suzlon's position

The country has a track record of perennial shortage of electricity with demand exceeding supply by 7.3 per cent in 2005. With the "power for all" mission of the government, the Ministry for Non-Conventional Energy Sources has estimated that by 2012, 10 per cent of the projected 2,40,000MW of the new capacity will come from renewable energy sources. Non-renewable power plants contribute about 70 per cent to India's installed capacity for power. With raw materials such as coal, naphtha and oil that are used in conventional generation methods facing supply constraints and steep price hikes, there appears to be tremendous potential for capacity addition through renewable sources.

Wind power has been traditionally disdained for its heavy capital investments and impediments in maintenance. Suzlon, with its globally competitive technology, provides complete solutions ranging from wind mapping, locating sites and developing wind farms to operation and maintenance. The high capital cost is further offset by the low variable cost and the fiscal incentives received by the user in the form of accelerated depreciation, tax holidays and loans from Indian Renewable Energy Development Agency.

Wind power provides an ideal alternative to costly grid power to corporates in the power intensive sectors. Companies such as Madras Cements and Maharashtra Seamless have wind farms which meet a portion of their captive requirements. Added to this, permit of carbon trading by the Kyoto Protocol has made this environment-friendly sector an attractive investment option for accumulating and trading carbon credits. With a proven track record and a dominant market share of 44 per cent in the country, and a place among the top ten in the world, Suzlon Energy appears to be well-placed to take advantage of the favourable industry environment.

Risk factors

The risks to Suzlon's business stem mainly from a possible reluctance to try out wind power. Wind power generation is subject to high risks. Consistent wind patterns remain a key to the success of this business. This risk is overcome to some extent by Suzlon's focus on wind study and mapping. Plant load factor in wind power, at 20-25 per cent, is one of the lowest in the energy sector.

Establishing wind power equipment also requires extensive land, which could call for large investments. Fiscal incentives have made wind power attractive for investors; Suzlon could face flagging demand if these incentives are removed or reduced.

About 50 per cent of the raw materials of Suzlon Energy are imported, thus making it susceptible to foreign exchange exposures. The business is working capital intensive with a significant lag in realisations from debtors.

Backed by strong financial performance

Over the past five years, the company has posted a compound growth rate of 44 per cent in profits. In 2004-05, Suzlon posted revenues of Rs.1900 crore — a 140 per cent increase over FY04; net profits were Rs.382 crore. Its operating margins stood at 24 per cent and have been in the 17-23 per cent range in the past five years. Income-tax and Customs duty concessions to the sector will ensure a sustained bottom line.

The book-building offer is open from September 23 to 29. JM Morgan Stanley and Enam Financial Consultants are lead managers to the issue.

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