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Suzlon Energy Ltd (SUEL IN)
Upgrade to N(V): Turning around in next fiscal year
3Q results miss on REpower project delays & FX loss
But recent order momentum signals turnaround in FY12
driven by sales growth of 28%YoY & margin expansion
Upgrade to Neutral (V) with target of INR50 (from INR40); a
credible debt-reduction plan critical for re-rating
Bigger-than-expected loss, but silver lining in order flow: 3Q EPS of INR -1.43 missed
our estimate of INR -0.07 on under-performance by German subsidiary REpower and
notional FX losses (INR -0.23/share). REpower's underperformance was partly flagged
when it reduced its FY11 EBIT guidance by 37% on 22 December. Suzlon’s parent
EBITDA ex-REpower was 12% below our estimates too; however, there are signs of
recovery in recent order wins from Caparo, Vedanta (both India) and Martifer (Brazil).
Top-line growth & margin expansion to drive turn-around in FY12: We cut our
FY11-12 shipment forecasts for REpower by 21%; however, this is more than offset by
34% increase in Suzlon’s FY12 shipment to 2.1GW. The company’s recent order wins are
enough to achieve 45% of our shipment forecast and support a 28%YoY growth in sales
in FY12. In addition, margin expansion due to a shift to high-margin business in domestic
market is likely to help Suzlon quadruple its EBITDA and move into net profit in FY12.
Debt repayment in FY12 likely to require equity issuance: More than 85% of Suzlon’s
net debt is offset by the market value of its investments in REpower and Hansen –
solvency is not the issue, but liquidity is. Repayment of USD390m of convertible debt
(FCCB) in mid-2012 is likely to be preceded by the sale of stake in Hansen as well as
equity issuance. We factor in a 50% conversion of FCCB maturing in 2012 at a steep
discount; however, the company may pursue other avenues like fresh equity issuance or
sale of a strategic stake.
Worst behind but re-rating depends on debt reduction plan: Order-book momentum
and a potential turn-around in FY12 suggest that the worst may be over for Suzlon. A
44% increase in our FY12 OP estimate merits a higher PB multiple of 1.40x (1.13x
earlier) and a Neutral (V) rating. However, as we inch closer to the debt repayment
deadline in mid-2012, the company’s re-rating is likely to be postponed until it conveys a
transparent plan to reduce its debt or announces successful issuance of fresh equity.
Likely catalyst: Suzlon has lagged the local index by 40% over the last 12 months and we
believe that the shares are under-owned. As a result, any outperformance on order-flow,
profitability and, particularly, debt reduction may provide substantial outperformance.
Order-book rebound to reverse declining sales trend in FY12
We estimate that Suzlon’s consolidated order-book will grow by 57% YoY to over 4.4GW by the end of
FY11. This results in an increase of 6% in our FY12 shipment estimate, even though we cut our FY11
shipments by 10% due to underperformance by REpower. We now expect consolidated shipments and
sales to grow by 27% and 28%YoY respectively in FY12. Our revised sales forecasts factor a downward
revision of 21% in REpower’s shipment forecasts, which are more than offset by a 34% increase in
Suzlon’s (parent) FY12 shipments. The latter is driven by announcement of recent order wins in India and
Brazil (see table below), which account for 45% of our Suzlon’s shipment forecast of 2.1GW in FY12.
Sales mix changes positive for the margins
Suzlon’s gross margins have held relatively steady at 34% in last two fiscal years. We expect them to tick up
by 100bps in FY11 and 200bps in FY12. The increase in gross margins is largely due to higher sales and to
a shift in sales mix to higher margin equipment revenues from low-margin project revenues. The gross
margin improvement is already evident in a 300bps expansion in 9MFY11 gross margins compared to a
year before. We also expect Suzlon’s operating margins to benefit from lower operating expenses
(primarily, freight charges) required to serve the domestic market. More than three quarters of the
company’s shipments in FY11-12 are expected to be for the local market. Slower growth in opex vis-à-vis
revenue is expected to add 190bps to OP margin expansion in FY11 and another 240bps expansion in FY12.
Solvency not a concern – debt backed by investments
Suzlon’s high gearing and its ability to navigate out of the current indebtedness remains the key focus
area for the markets. In our view, the company’s solvency doesn’t appear to be of much concern. The
current market value of the company’s major investments, namely Hansen Transmission (HSN LN,
OW(V), current price 53.1p, target 85p) and Repower (RPW GR, Neutral, current price EUR120, target
EUR125), amounts to over 85% of its net debt (USD2.22bn). The fair value of these assets at HSBC’s
target prices for Hansen and Repower is over USD2bn. Around 90% of this investment value comes from
Suzlon’s 90.7% stake in Repower and implies a PE multiple of 16-17x FY12 EPS for Repower.
Asset sales & FCCB conversion likely before debt repayment
Suzlon’s ability to reduce its outstanding net debt of USD2.2bn is likely to remain the key investor
concern in the near term. In our view, the company is on track to shore-up enough funds in FY12 to repay
its USD390mn worth of foreign currency convertible bonds (FCCBs). We believe that it is likely to be in
a better shape to do so if (see chart below):
It is able to convince FCCB holders to convert to equity by offering them attractive entry point
(conversion price) as equity holders. We have assumed 50% conversion of FCCBs maturing in 2012
at INR30/share. This would result in issuance of 291m shares (16% of outstanding) for USD192mn.
It is able to raise cash at the parent level by selling capacity to its subsidiary in India & China. Note
that REpower has indicated that it plans to do so in the near future to control its costs and expand its
market reach to US, Australia and New Zealand.
Valuation & Risks
We value Suzlon using an average of Economic Value Added or EVA-based valuation and PB-based
relative valuation. Our assumptions for our EVA-based valuation are a cost of equity of 11%, a
sustainable return on equity of 14.1% (11.3% earlier, increased due to higher RoE forecasts for FY12-14)
over business cycles and a terminal growth rate for book value of 1% after FY14. The EVA-based
valuation implies a fair FY11 PB multiple of 1.45x (0.91x previously). We also look at the stock’s trading
range on trailing PB multiple since the end of 2008 (post crisis) and identify that Suzlon has traded near
the bottom of the sector trading range of 1-3x. On average, it has traded at a trailing PB of 1.35x. For our
target price, we use an average of the two valuation approaches, which results in a fair PB of 1.40x (1.13x
previously). This implies a target price of INR50 (INR 40 previously). Under HSBC’s rating system,
Indian stocks with a potential return between 1% and 21% and a volatility indicator fall in the Neutral
band. Since Suzlon’s potential return of 1% is within this band, we upgrade it to Neutral (V) from
Underweight (V) rating.
Risks
Key upside risks to our valuations are timely debt reduction leading to re-rating, higher than expected
ASP and profitability, decision to align capacity with demand, lower than expected interest costs, higher
than expected synergies with REpower and increase in feed-in tariffs/strict RPO implementation by
various Indian states to improve domestic turbine demand. Key downside risks to our valuations are a
delay in execution of the debt reduction plan, inability to acquire international orders, further de-rating of
the global wind sector, inability to reduce employee costs, or re-occurrence of quality issues.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Suzlon Energy Ltd (SUEL IN)
Upgrade to N(V): Turning around in next fiscal year
3Q results miss on REpower project delays & FX loss
But recent order momentum signals turnaround in FY12
driven by sales growth of 28%YoY & margin expansion
Upgrade to Neutral (V) with target of INR50 (from INR40); a
credible debt-reduction plan critical for re-rating
Bigger-than-expected loss, but silver lining in order flow: 3Q EPS of INR -1.43 missed
our estimate of INR -0.07 on under-performance by German subsidiary REpower and
notional FX losses (INR -0.23/share). REpower's underperformance was partly flagged
when it reduced its FY11 EBIT guidance by 37% on 22 December. Suzlon’s parent
EBITDA ex-REpower was 12% below our estimates too; however, there are signs of
recovery in recent order wins from Caparo, Vedanta (both India) and Martifer (Brazil).
Top-line growth & margin expansion to drive turn-around in FY12: We cut our
FY11-12 shipment forecasts for REpower by 21%; however, this is more than offset by
34% increase in Suzlon’s FY12 shipment to 2.1GW. The company’s recent order wins are
enough to achieve 45% of our shipment forecast and support a 28%YoY growth in sales
in FY12. In addition, margin expansion due to a shift to high-margin business in domestic
market is likely to help Suzlon quadruple its EBITDA and move into net profit in FY12.
Debt repayment in FY12 likely to require equity issuance: More than 85% of Suzlon’s
net debt is offset by the market value of its investments in REpower and Hansen –
solvency is not the issue, but liquidity is. Repayment of USD390m of convertible debt
(FCCB) in mid-2012 is likely to be preceded by the sale of stake in Hansen as well as
equity issuance. We factor in a 50% conversion of FCCB maturing in 2012 at a steep
discount; however, the company may pursue other avenues like fresh equity issuance or
sale of a strategic stake.
Worst behind but re-rating depends on debt reduction plan: Order-book momentum
and a potential turn-around in FY12 suggest that the worst may be over for Suzlon. A
44% increase in our FY12 OP estimate merits a higher PB multiple of 1.40x (1.13x
earlier) and a Neutral (V) rating. However, as we inch closer to the debt repayment
deadline in mid-2012, the company’s re-rating is likely to be postponed until it conveys a
transparent plan to reduce its debt or announces successful issuance of fresh equity.
Likely catalyst: Suzlon has lagged the local index by 40% over the last 12 months and we
believe that the shares are under-owned. As a result, any outperformance on order-flow,
profitability and, particularly, debt reduction may provide substantial outperformance.
Order-book rebound to reverse declining sales trend in FY12
We estimate that Suzlon’s consolidated order-book will grow by 57% YoY to over 4.4GW by the end of
FY11. This results in an increase of 6% in our FY12 shipment estimate, even though we cut our FY11
shipments by 10% due to underperformance by REpower. We now expect consolidated shipments and
sales to grow by 27% and 28%YoY respectively in FY12. Our revised sales forecasts factor a downward
revision of 21% in REpower’s shipment forecasts, which are more than offset by a 34% increase in
Suzlon’s (parent) FY12 shipments. The latter is driven by announcement of recent order wins in India and
Brazil (see table below), which account for 45% of our Suzlon’s shipment forecast of 2.1GW in FY12.
Sales mix changes positive for the margins
Suzlon’s gross margins have held relatively steady at 34% in last two fiscal years. We expect them to tick up
by 100bps in FY11 and 200bps in FY12. The increase in gross margins is largely due to higher sales and to
a shift in sales mix to higher margin equipment revenues from low-margin project revenues. The gross
margin improvement is already evident in a 300bps expansion in 9MFY11 gross margins compared to a
year before. We also expect Suzlon’s operating margins to benefit from lower operating expenses
(primarily, freight charges) required to serve the domestic market. More than three quarters of the
company’s shipments in FY11-12 are expected to be for the local market. Slower growth in opex vis-à-vis
revenue is expected to add 190bps to OP margin expansion in FY11 and another 240bps expansion in FY12.
Solvency not a concern – debt backed by investments
Suzlon’s high gearing and its ability to navigate out of the current indebtedness remains the key focus
area for the markets. In our view, the company’s solvency doesn’t appear to be of much concern. The
current market value of the company’s major investments, namely Hansen Transmission (HSN LN,
OW(V), current price 53.1p, target 85p) and Repower (RPW GR, Neutral, current price EUR120, target
EUR125), amounts to over 85% of its net debt (USD2.22bn). The fair value of these assets at HSBC’s
target prices for Hansen and Repower is over USD2bn. Around 90% of this investment value comes from
Suzlon’s 90.7% stake in Repower and implies a PE multiple of 16-17x FY12 EPS for Repower.
Asset sales & FCCB conversion likely before debt repayment
Suzlon’s ability to reduce its outstanding net debt of USD2.2bn is likely to remain the key investor
concern in the near term. In our view, the company is on track to shore-up enough funds in FY12 to repay
its USD390mn worth of foreign currency convertible bonds (FCCBs). We believe that it is likely to be in
a better shape to do so if (see chart below):
It is able to convince FCCB holders to convert to equity by offering them attractive entry point
(conversion price) as equity holders. We have assumed 50% conversion of FCCBs maturing in 2012
at INR30/share. This would result in issuance of 291m shares (16% of outstanding) for USD192mn.
It is able to raise cash at the parent level by selling capacity to its subsidiary in India & China. Note
that REpower has indicated that it plans to do so in the near future to control its costs and expand its
market reach to US, Australia and New Zealand.
Valuation & Risks
We value Suzlon using an average of Economic Value Added or EVA-based valuation and PB-based
relative valuation. Our assumptions for our EVA-based valuation are a cost of equity of 11%, a
sustainable return on equity of 14.1% (11.3% earlier, increased due to higher RoE forecasts for FY12-14)
over business cycles and a terminal growth rate for book value of 1% after FY14. The EVA-based
valuation implies a fair FY11 PB multiple of 1.45x (0.91x previously). We also look at the stock’s trading
range on trailing PB multiple since the end of 2008 (post crisis) and identify that Suzlon has traded near
the bottom of the sector trading range of 1-3x. On average, it has traded at a trailing PB of 1.35x. For our
target price, we use an average of the two valuation approaches, which results in a fair PB of 1.40x (1.13x
previously). This implies a target price of INR50 (INR 40 previously). Under HSBC’s rating system,
Indian stocks with a potential return between 1% and 21% and a volatility indicator fall in the Neutral
band. Since Suzlon’s potential return of 1% is within this band, we upgrade it to Neutral (V) from
Underweight (V) rating.
Risks
Key upside risks to our valuations are timely debt reduction leading to re-rating, higher than expected
ASP and profitability, decision to align capacity with demand, lower than expected interest costs, higher
than expected synergies with REpower and increase in feed-in tariffs/strict RPO implementation by
various Indian states to improve domestic turbine demand. Key downside risks to our valuations are a
delay in execution of the debt reduction plan, inability to acquire international orders, further de-rating of
the global wind sector, inability to reduce employee costs, or re-occurrence of quality issues.
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