HSBC: Sell Suzlon target Rs 43

To hell and back. Suzlon’s acquisitions of Hansen, a Belgian gearbox maker, and
REpower (RPW), a German wind turbine manufacturer, gave it much-needed exposure to
new technology and markets but also a big pile of debt. The timing of the acquisitions
couldn’t have been worse as the company’s leverage peaked (QE Jun-09) around the time
of the trough of the credit crisis. The outlook has since improved, however. International
order flow is still thin but its Indian franchise remains strong with a market share of c50%
in a rapidly recovering market. RPW’s order book has also grown 67% y-o-y to 1.8x
FY10 sales. Most importantly, Suzlon has cut its net debt by c27% through fresh equity
issuance, working capital reduction and, ironically, the sale of a partial stake in Hansen.
But debt reduction and revival of order flow can’t prevent another year in the red.
We believe Suzlon can cut its net debt by 30% over the next 12 months through a mix of
initiatives, including recent rights issues, the sale of its residual stake in Hansen and
conversion of convertible bonds into equity. We estimate this would result in c32%
dilution. Order flow is likely to revive, driven by positive regulatory momentum and
projects in India and Brazil. Operating margins are also likely to inch up as sales mix
shifts towards the local market and SG&A expenses are controlled. While these initiatives
should slow the outflow of cash by end of FY12, profits will still be slow to recover due
to low pricing power and utilisation. We expect another loss in FY11.
Scale to drive profits at RPW but PBT breaks even only in FY12 – too early to buy.
With the RPW acquisition, Suzlon has gained exposure to the fast-growing offshore
segment where price pressures are less prevalent. On the negative side, integration with
RPW to get access to its cash flows is unlikely in the near term due to existing terms on
RPW’s credit lines. On the positive side, RPW’s increasing scale should help the group
generate positive PBT in FY12, provided Suzlon can execute its debt-reduction plan.
Given the execution risk, we think the risk-return trade-off is unfavourable. We also think
the consensus is overestimating the pace of Suzlon’s recovery. On our below-street
estimates, valuations are far from appealing relative to the rest of the sector.