The Hindu Business Line : Suzlon Energy: Buy

The approval of the much-debated renewable energy production tax credit (PTC) by both the US Congress has brought renewed hope for the US wind energy market.

The renewal in PTC through December 2009 is a shot in the arm for global wind energy players. With an order book concentrated in the US, Suzlon Energy is likely to benefit from the tax credit renewal in the fastest growing wind energy market in the world.

Sound low-cost manufacturing bases in India and China and access to higher end technology through acquisitions have provided the right grounds for Suzlon’s take-off as a leading wind energy company. Globally too, the stage appears set for steady ramp up in renewable energy sources, what with several nations setting targets to generate a certain percentage of their energy needs from this source.

Investors with a three-five year perspective can consider investing in the stock of Suzlon Energy. At the current price of Rs 86, Suzlon trades at 5.7 times its projected FY-10 earnings. The stock price and its price-earnings multiple are at all-time lows, providing an attractive entry point.

However, given that the stock markets themselves appear short of any support, investors can consider adding the stock on declines linked to broad markets.

A long-term perspective on the stock is a pre-requisite as the benefits of synergies arising from the Hansen and REpower acquisitions would accrue only over time. Meanwhile, the company could also be burdened with short-term challenges such as high debt and muted profit margins as a result of acquisitions.

Key triggers

Two recent events provide greater impetus to the long-term earnings visibility of Suzlon. One, the renewal of PTC and investment tax credit in the US; this tax incentive package assumes significance as the US has traditionally seen drastic decline in wind installations on expiry of these credits and sharp pick up in volumes on extensions. Of Suzlon’s order book of 3,040 MW (valued at Rs 16,490 crore), as of the quarter ended June, a good 50 per cent is from the US. Concerns of a slowdown in order flows in the last quarter and the pending renewal of PTC have now eased. While we do not expect an immediate increase in order flows, medium-term prospects appear bright.

Two, Suzlon has managed to hike its stake in the Germany-based manufacturer of wind turbine generator, REpower, to 90 per cent by acquiring the stakes of Areva and Martifer in quick succession. This would not only provide a huge platform for Suzlon to tap the strong wind energy market in Europe but also bring it one step closer to sign a dominant agreement to have access to the high-end technology of REpower. REpower is a strong contender in the nascent off-shore WTG market in Europe.

Strong macro outlook

Suzlon has presence in all key markets that have actively provided policy support for renewable sources of energy. A number of States in the US and few other nations have initiated Renewable Portfolio Standard — a tool that facilitates countries to set targets to enhance their renewable energy portfolio. Similarly, the European Union has an aggressive target of generating 20 per cent of its energy needs through renewable sources by 2020 with major contribution expected to arise from wind power.

China too is looking to expand its wind power capacity to 1,00,000 MW by 2020. India’s planned targets and fiscal supports are also not any less when compared to these nations. With a global market share of 10.5 per cent, low cost bases in India and China and a local manufacturing centre for blades in the US, Suzlon appears well placed to tap these markets. Hansen’s gear box facility has provided an edge for Suzlon at a time when most global players are suffering from shortage in component supply.

Suzlon has also resorted to backward integration by setting up its own foundry, forging and machining units — key areas that cause supply disruption globally. And, now, with a majority stake in REpower, Suzlon can be expected to improve its presence in Europe and possibly access its high end technology at a later date.

Financials

Post its acquisition of Hansen, Suzlon had to deal with a cash-strapped company generating poor profit margins. Hence while the initial quarters of 2007-08 witnessed dip in operating profit margins, the end of FY08 saw the company’s OPMs at 13 per cent, still superior to industry averages. The sales realisation of the company’s wind business also improved to Rs 6.2 crore per MW in the first quarter of FY-09 from Rs 4.7 crore per MW a year ago.

In the coming years, Suzlon’s consolidated profitability could be further supported by REpower’s lucrative offshore wind farm segment. While the current depreciating rupee would favour the company’s export-tilted revenues, local base in countries such as the US may provide natural hedge to some extent against foreign currency fluctuations.

Concerns

Suzlon has planned a rights issue for Rs 1,800 crore to fund its stake acquisition from Martifer. Assuming it is at the current market price, the offer could lead to a 12-14 per cent expansion of equity base. While in a different market, the company would have typically resorted to debt, in a high interest and low liquidity scenario, the option of tapping the equity market and keeping leverage under check (given that Suzlon has traditionally remained highly leveraged) appears prudent. However, recent rights offers have faced hardships in the current challenging stock market conditions. Given this risk, Suzlon may have to look at alternative financing options as well. Interestingly, even in difficult times such as this, the company’s forging subsidiary has received Rs 400 crore through a 17 per cent stake sale to IDFC Private Equity, suggesting that the company’s business may yet have other funding channels.

Suzlon appears to have also cleaned up its quality issues on defective blades to some extent, by obtaining certification from Germanischer Lloyd, a certification body accredited to certify in accordance with relevant global wind energy standards. This may provide it an image boost especially in the US.

Suzlon has issued bonds convertible into equity at Rs 360-371. While this does pose a threat, given the stock’s current market price, its expiry date (2012), still a couple of years away, provides comfort on the conversion front.

Related Stories:
Price of Suzlon Energy rights issue in six weeks
Suzlon Energy considers rights issue to raise Rs 1,800 cr
Suzlon to buy out Martifer stake in REpower
Suzlon Energy (Rs 216.45): Sell

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