The Hindu Business Line : Suzlon Energy: Hold

A rising market reach, a well-set backward integration strategy and a global demand for renewable sources of energy, driven by incentives, add visibility to the earnings growth of Suzlon Energy (Suzlon).

Investors can hold the stock with a one/two-year perspective.

At the current market price, the stock trades at 26 times its expected per share earnings for 2006-07 (excluding earnings from the recently-acquired Hansen Transmission) and is at a premium to a number of conventional domestic power equipment makers.

The rich valuation, however, appears justified on the back of the relatively high margins and medium-term growth visibility.

High growth trajectory

Suzlon's sales and net profits trebled in the quarter-ended June 2006. The top- and bottom-line have grown at over 60 per cent annually over the past four years.

While the significant orders won in China, the US and Australia will ensure exponential growth in volumes, the bottomline is likely to be slightly muted by the increased depreciation and finance charges.

Backward integration

To reduce costs and minimise supply-side risks, Suzlon is gradually moving towards in-house manufacturing of some of the key components. It already has a research, development and manufacturing facility for rotor blades. Its recent acquisition of Hansen Transmission, one of the leading wind energy and industrial gear box-makers, is a further move towards backward integration. .

Suzlon has achieved a greater level of vertical integration than its peers such as Vestas and Gamesa. This is reflected in its superior operating profit margin of 25 per cent against 13 per cent for Gamesa. We also expect the cost-efficiencies attained through the vertical integration to offset any margin dent caused by a hike in the prices of steel, which constitutes 70 per cent of the cost of towers.

Growing concerns of energy security have prompted a number of countries to diversify their fuel sources and also look at the renewable sources of energy.

Expanding market reach

In the US, the cut-off date for production tax credit has been extended for wind farms made operational before end-2007 from the earlier deadline of 2005. In China, the renewable energy sector has received a boost with the enactment of the Renewable Energy Law and wind power concessions that guarantee a 25-year power purchase agreement.

Suzlon is well-placed to capitalise on these export markets with orders already on hand and by setting up units in China and the US as also a dedicated export-facility in Karnataka.

In the domestic market, Suzlon enjoys about 50 per cent market share despite the entry of leading global players through joint ventures. End-to-end energy solutions, including wind mapping, site location to maintenance of wind farms give Suzlon an edge in the domestic market. Facilities closer to development sites also provide freight-cost advantage.

Risks

With rising demand, the industry is facing supply-side bottlenecks for some components, which could result in delivery hitches for Suzlon. This may impact its chances of repeat orders from new customers.

The Suzlon product range is limited in the 1.5-2 MW category compared to the offerings by Vestas and Enercon in the 3-4.5 MW range.

Suzlon may lose out in the European and American markets unless it rapidly moves to large-size turbines that can deliver power at lower unit cost. About 80 per cent of the order book of Rs 3,653.5 crore is tilted towards exports, exposing the company to foreign currency risks.

Further expansion of equity may also be possible on the back of approval to raise foreign currency bonds or depository receipts up to Rs 5,000 crore.

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