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Suzlon Energy Ltd
▲ Overweight
Previous: Underweight
SUZL.BO, SUEL IN
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• Upgrade to OW, Dec-11 PT of Rs64: After 5 years, we estimate in FY12
India will once again be the primary market for Suzlon. The shift has
positives: (1) India wind additions @ 3-3.5GW/year likely given favorable
regulatory changes, pick-up in IPP investments in wind and positive steps
towards trading in renewable energy; (2) Suzlon remains the dominant
player in 1MW+ WTG market and has ~45% overall market share in India.
We forecast sales volume of 1.5GW from India; (3) Logistics-related
variable expenses could fall by ~Rs1-1.5mn/MW.
• Healthy operating leverage gains possible in FY12: We forecast a
domestic market-led recovery in sales volumes to 2250MW in FY12
(750MW overseas), coupled with stable fixed costs and flat employee
expenses. We forecast a capacity utilization-led EBITDA margin
improvement to ~12.8% in FY12- the street could be underestimating this,
in our view. We raise our FY12 estimates by ~30%.
• Oil slated to boil; renewable plays could be back in favor: Wind stocks
have strong positive correlation to oil prices (0.73x historically for Vestas
vs. Brent crude prices). J.P. Morgan Global Commodities Research expects
crude oil prices on a spot basis to breach US$100/bbl in 1H 2011 (up 35%
YoY) and to reach US$120 / bbl by end 2012.
• Risks to our contrarian call: (1) Little room for volume dip; ~490MW of
overseas inflows needed to meet FY12 overseas sales est. of 750MW; we
draw comfort from track record over FY08-10; (2) Famine of overseas
orders continues, only 330MW overseas over last 6 quarters, (3) Step up in
domestic competition, as global players want to set up shop in India.
• Revised SOTP based Dec-11 PT of Rs64 (vs. Mar-11 PT of Rs41 earlier):
PT includes- (1) ~Rs35 for wind business at 12x FY12 EPS, @35% discount
to Vestas' multiple, (2) Rs25.6 for REpower (RPW GR) stake at 20%
discount to current price (CP), (3) Rs3.3/share for Hansen (HSN LN) at 20%
discount to CP. Suzlon has underperformed Sensex by ~21% since
Aug'10. With a moratorium for debt repayment through FY12, and absence
of capex needs, we think Suzlon has time to mend operations.
Homeward bound, once again...
After a gap of almost 5 years India is set to become the primary market for Suzlon in
FY12 . This will mark a shift from developed markets like US and
Europe, and bring greater exposure to China and fast growing markets like Brazil, in
our view.
Given strong outlook for growth of wind investments in India, Suzlon’s leadership
position in 1MW+ segment in the domestic market and potential improvement in
operating profit margins - a shift in focus to India has positives in store for Suzlon in
our view.
India wind additions @ 3-3.5GW/year likely
The Indian wind market has potential to grow from ~2.2GW in FY11 to ~3-3.5GW
in FY12, in our view. Favorable regulatory changes, pick up in IPP investments in
wind and +ive steps towards trading in renewable energy all point to this. The
commencement of trading in RECs will be a key development, and is a step towards
a uniform 15% RPO for India, as originally envisioned in the NAPCC.
June 2008: National Action Plan for Climate Change (NAPCC)
NAPCC suggested that the target for renewable energy purchase be set at 5% of total
grid purchase in 2010, and the target be increased by 1% each year for 10 years. It
stipulated that SERCs could set a higher target than this minimum at any point of
time.
Under the plan, the Central and State governments were slated to set up verification
mechanisms to ensure that renewable energy is actually procured. The vision for
renewable energy certificates (RECs) was also outlined, to enable utilities falling
short to meet their RPS (Renewable Portfolio Standard). The plan allowed for
penalties to be levied, allowed under Electricity Act 2003, if utilities still fell short of
RPS target.
Total power generation from renewable sources (~15GW in FY10, assuming 25%
PLF) was ~4.1% of overall generation in FY10, as per our calculations. We est. that
to meet the vision of NAPCC, India would need to increase RE installed capacity to
~105GW by 2020 from 16.8GW as of Nov-10, a run-rate of ~9GW+ per annum (see
table 2 for calculation of renewable capacity required in 2020).
With assessed on-shore wind potential of 45GW in India, FY10 wind installed
capacity of 11.75GW (~75% of total RE), a capacity addition run rate of at least
3GW appears mandatory if India is to even reach near the 15% RPO by 2020.
Sep 2009: CERC guidelines for preferential tariff for renewable sector
CERC announced new guidelines to provide uniformity in setting up preferential
tariffs across states. CERC has fixed the RoE for wind investments at 19% (pre-tax)
for first 10 years, and pre-tax of 24% from 11th year onwards. The tariffs range from
Rs3.38/kwh to Rs5.07/kwh across classification of wind speeds.
November 2009: Generation Based Incentive (GBI) guidelines
GBI incentive of Rs0.50/kwh of renewable generation over and above PPA rates
introduced. This was to promote investments by IPPs as an alternative to accelerated
depreciation.
2010- RECs: A step towards a uniform 15% RPO
A framework for RECs was evolved by CERC. RECs shall be sold to obligated
entities (say SEBs) to enable them to meet their RPO. The certificates shall be issued
to the eligible entity on the basis of the units of electricity generated from renewable
energy sources and injected into the grid. Each certificate issued shall represent one
Megawatt hour of electricity generated from renewable energy source and injected
into the grid. The price of certificate shall be as discovered in the Power Exchange.
CERC in consultation with the Central Agency (NLDC) and Forum of Regulators
would set the floor price and forbearance price separately for solar and non-solar
certificates.
RECs could remove the roadblocks hampering enforceability of RPOs, in our view.
The current RPO regime has limitations as RE potential is not uniformly distributed
across states in India, inter-state sale or purchase of renewable energy is not allowed
and inter-state sale of RE is not economically viable under the present CERC open
access regulation. RE rich states like TN, Karnataka who can raise the RPS target are
reluctant to do so since they don’t have any incentive for absorbing the non-firm RE
power at preferential tariff into state grid.
The REC mechanism would allow for effective implementation of RPS, as it would
allow increased flexibility for participants, reduce transaction costs for RE
transactions, help to overcome geographical constraints and reduce risk for local
distribution companies by limiting its liability to only energy purchase.
Subsequent to CERC regulations on REC, some steps have been taken which make
commencement of trading in CY11 likely, in our view-
• NLDC has been appointed as the Central Agency to manage registration of
entities eligible to trade, issuing REC's and managing and settling accounts
in respect of RECs.
• 8 states have issued final regulations on REC, for 15 states regulations are at
draft level.
• 9 states have appointed a 'state agency' for managing REC issuance and
accounting
Pick up in IPP investments in wind, Suzlon track record in India in FY11 decent
According to management, a large proportion of wind investments in India have
come from retail and captive users until now, however in CY11, the majority of
investments will be IPP driven.
Suzlon reported 489MW in 1Q, 403MW in 2Q and ~318MW of orders since then- a
total of 1210MW YTD, a decent track record that we think makes our estimate of
1500MW in FY12 achievable. Among large IPP orders-
• 202MW - Kolkata based Techno Electric Group. Order is part of a major
new business agreement of 500 MW signed with Suzlon as the preferred
supplier. It is the single largest deal signed by an IPP customer in the wind
sector of India. The 1st phase of 101.4MW will be commissioned in the
state of Tamil Nadu by June 2011.The 2nd phase of 100.8MW will be
commissioned by Dec 2011.
• The Vedanta Group recently signed a ~USD 191mn agreement with Suzlon
for 150 MW wind projects in India. Projects will be completed in two
phases – first phase of 50 MW by March 2011, and the balance 100 MW
progressively by Sept-2011.
Suzlon remains the dominant player in India
Suzlon has a market share of ~45% of cumulative wind installed capacity of 11.7GW
at the end of FY10 (see table 4, ~48.7% in FY10). The #2 player Enercon has
supplied mainly 800kw WTG, making Suzlon the dominant player in the 1MW+
market. With excess capacity in India for both 1.5MW and 2.1MW models, Suzlon
has an opportunity to benefit from an up-tick in IPP investments. In our view
1500MW of sales volume is thus achievable from India alone
Healthy operating leverage gains likely in FY12
We forecast a domestic market-led recovery in sales volumes to 2250MW in FY12
(750MW overseas), coupled with stable fixed cost (~Rs15B) and flat employee
expenses.
We forecast a capacity utilization led EBITDA margin improvement to ~12.8% in
FY12 (see table 1)- the street could be underestimating this, in our view.
The improvement in EBITDA could be higher if Suzlon were to cut its overseas
employee workforce, in our view.
Operating performance is also likely to benefit from lower variable costs related to
logistics/transportation of WTG in India (~Rs0.8mn/MW in India vs. ~Rs2.5mn/MW
on a blended basis, based on discussions with the company). We estimate that if
Suzlon were to sell 100% in India, we estimate PAT breakeven for the wind business
at 1800MW
Oil slated to boil; renewable plays could be back in favor
Wind stocks have largely underperformed over the last 12months. We note that wind stocks have strong positive correlation to oil prices. See chart 1
depicting Vestas stock price and Brent Crude prices since 2006. There is 0.73x
correlation between the two
J.P. Morgan Global Commodities Research expects expect crude oil prices on a spot
basis to breach US$100/bbl in 1H 2011 (up 35% YoY) and to US$120 / bbl by end
2012. This is an added reason to believe that wind plays could be back in favor in
CY11.
Upgrade to Overweight, revised Dec-11 PT of Rs64
PT includes- (1) ~Rs35 for wind business at 12x FY12 EPS, @35% discount to
Vestas' multiple, (2) Rs25.6 for REpower (RPW GR) stake at 20% discount to
market price, (3) Rs3.3/share for Hansen (HSN LN) at 20% discount to market price
(see table 7). Suzlon has underperformed Sensex by ~21% since Aug'10.
Our old Mar-11 PT of Rs41 was based on- (1) Rs36/share, at 7.2 FY12E
EV/EBITDA (consolidated), a 5% discount to Vestas consensus estimate, (b)
Rs5/share for 26.28% stake in Hansen at its market price then. We used EV/EBITDA
as a valuation metric at that time as weak outlook on order inflows cast doubt on
Suzlon’s ability to service debt repayment/ interest. Now post retirement of promoter
debt (Rs11.75B) in 2Q, improved outlook on India order flows, we are more
confident of attributing an earnings based multiple for Suzlon’s wind business (but
still at a sharp discount to Vestas)
Key model revisions at consolidated level
We have reduced our loss number for FY11 to Rs6.1B from Rs8B earlier- based on
1H numbers, and track record of order in inflows, and 282bps improvement in
EBITDA margin. In FY12, we estimate overall wind business volumes at 2250MW
(vs. 2050MW earlier), improvement in EBITDA margin to 11% (consolidated) and
PAT of Rs8.47B, vs. Rs4.67B by consensus
Risks to our contrarian call
Of 25 recommendations (excluding J.P. Morgan) on the stock on Bloomberg there
are 9 sells, 12 holds and only 4 buys. We foresee the following risks to our contrarian
call
• Little room for volume dip; ~490MW of overseas inflows needed to meet
FY12 overseas sales estimate of 750MW; we draw comfort from track
record over FY08-10: Suzlon delivered 1336, 2041, and 773MW overseas
respectively over FY08-10.
• Famine of overseas orders continues till now, only 330MW overseas over
last 6 quarters
• Step up in domestic competition, global players want to set up shop/ expand
capacity in India: Gamesa and Siemens want to expand capacity in India.
Dongfang Electric recently signed a contract with KSK Energy Limited to
supply 166 units of 1.5 MW direct-drive wind turbines- marking the entry
of Chinese wind equipment in India for the first time.
Consolidated financial statements
With a moratorium for debt repayment thru FY12, and absence of capex needs over
next 15months at least, we think Suzlon has time to mend operations. See
consolidated P&L and Balance sheet in Table 12 and Table 13 respectively.
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