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Strong domestic demand uptick offset by FCCB overhang; reiterating Hold
We find Suzlon's restructuring initiative beginning to show through as gross
debt:equity looks to be tapering off in FY12E. Also, thanks to a strong pickup in
wind power demand in India, Suzlon could see a turnaround. A positive operating
profit in FY12E and return to black after three years in FY13E are key positives
although recent data suggesting an industrial slowdown could create a sector
overhang, holding back the stock. We are also concerned about the FCCB
conversion. We reiterate Hold with a revised target price of INR51/share.
Indian wind market looks set for strong revival
Despite a significant rise in energy costs (i.e. crude oil and thermal coal prices), we
find that outside the emerging markets of China and India, growth in the US and
Europe remains a bit subdued. This is not a good news for Suzlon, which has a
9.8% global share in the wind market. However, unexpectedly, the Indian
government and the Central Electricity Regulator have come out with several
initiatives over the last six months to push up demand for wind power. With ~50%
market share in India, Suzlon Wind’s sales volume could touch 2,155MW in FY12E
(+54% yoy) and 2,865MW in FY13E (+33% yoy), higher than the break-even
volumes of ~2,200MW for the first time since FY09.
Our estimates factor in positive EBITDA in FY12E and positive PAT in FY13E
Despite revised demand surge in India, we now estimate that Suzlon could report
a positive consolidated EBITDA of INR10.6bn in FY12E and positive net income of
INR4.7bn in FY13E only v/s earlier expectations of a turnaround in FY11E, since
volume pick up in non-Indian markets is poor. Company has high operating
leverage as additional 100MW of sales at gives contribution of c. INR1.8bn
Our target price of INR51 is an average of P/B and DCF
Our 12m target price of INR51/sh is based on an average of P/B of INR32/sh and
DCF of INR70/sh, with a CoE of 15.8%. Key challenge us conversion of FCCB
(debt to equity) at INR76.68/sh to INR97.26/sh. Sales volume is a key risk; 10%
higher/lower volume could raise/cut FY12E EPS by 110%.
Investment thesis
Outlook
We rate Suzlon Energy a Hold with a target price of INR51/sh. A sharp pickup in Indian
demand for wind power has come as a surprise, with the Indian wind power equipment
market estimated to rise from 11.8GW in FY10 to 13.8GW in FY11E and 19.4GW in FY13E, a
volume CAGR (FY11E-13E) of 19%, much higher than the 16% seen over FY08-10. This is
clearly a result of government policies and regulatory support: 1) Given Suzlon’s ~50%
market share in India, such a demand surge gives us comfort that Suzlon should be able to
achieve overall break-even volume of c. 2200MW by FY12E and report a positive net income
by FY13E. 2) Following the debt restructuring, the company should not be too worried about
the pickup in global demand as the principal repayments are largely structured towards the
end of the maturity period i.e. FY14E-18E. 3) Despite this, we see some overhang in the
event the stock price does not cross INR97.26/sh by FY13E; that could put a strain on cash
flow as a result of FCCB redemption, unless the FCCB holders agree to bear some more
pain. 4) Suzlon still has a 26% stake in Hansen, valued at INR6.4bn at the current market
price, and a 91% stake in REpower at INR57.6bn, which could be used in a severe cash
crunch. With the stock at 85% of its peak, we find most of the negatives in the price, limiting
the downside.
Valuation
We have used an average of a three-stage DCF methodology and SOTP to arrive at our 12-
month target price of INR51/sh. (1) We use P/B on a consolidated book value, compared to
our earlier method of SOTP of value of standalone business on P/B ex. goodwill and market
values of stakes in Hansen and REpower. This change is on account of the change in
structure of the company, where REpower has become a subsidiary with 91% stake while
with only 26% stake, Hansen is no longer a subsidiary. Our P/B method gives a 12-month
target price of INR32/sh, using a price to book ratio of 1x, as we believe that the company
should be able to turn around from FY12E onwards. (2) Our DCF model follows a three-stage
cash flow forecast (highlighted in Figure 18), giving a 12-month target price of INR70/sh. The
explicit period is FY12E-13E and the semi-explicit period is FY13E-18E. We have assumed a
terminal growth rate of 2%. Our model uses a WACC of 11.7% based on a 11% cost of
debt, risk-free rate of 6.4%, 7.2% risk premium (both in line with Deutsche Bank estimates)
and beta of 1.3 (derived from Bloomberg Finance LP data for weekly stock returns).
Risks
Key downside risks are 1) a delay in demand pickup; 2) unsuccessful handling of poor grid
infrastructure in India; 3) slower-than-expected revival in key markets such as the US and
Europe; 4) hiccups in FCCB restructuring (if required); 5) potential sale of the remaining stake
in Hansen Transmission at depressed valuations; and 6) higher-than-expected increase in raw
material costs leading to margin pressures.
Key upside risks are 1) a sharp revival in demand in Suzlon's key markets i.e. India, the US,
Europe and China; 2) Suzlon converting FCCBs at the current strike price or negotiating
favourable terms to restructuring its debt; and 3) the sale of Hansen Transmission at a
premium to the current market price.
Our sensitivity analysis shows that a 10% higher-/lower-than-expected sales volume could
raise/cut FY12E EPS estimates by 110%. Similarly, a 100bps increase/decrease in RM/sales
could cut/raise FY12E EPS by 32%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Strong domestic demand uptick offset by FCCB overhang; reiterating Hold
We find Suzlon's restructuring initiative beginning to show through as gross
debt:equity looks to be tapering off in FY12E. Also, thanks to a strong pickup in
wind power demand in India, Suzlon could see a turnaround. A positive operating
profit in FY12E and return to black after three years in FY13E are key positives
although recent data suggesting an industrial slowdown could create a sector
overhang, holding back the stock. We are also concerned about the FCCB
conversion. We reiterate Hold with a revised target price of INR51/share.
Indian wind market looks set for strong revival
Despite a significant rise in energy costs (i.e. crude oil and thermal coal prices), we
find that outside the emerging markets of China and India, growth in the US and
Europe remains a bit subdued. This is not a good news for Suzlon, which has a
9.8% global share in the wind market. However, unexpectedly, the Indian
government and the Central Electricity Regulator have come out with several
initiatives over the last six months to push up demand for wind power. With ~50%
market share in India, Suzlon Wind’s sales volume could touch 2,155MW in FY12E
(+54% yoy) and 2,865MW in FY13E (+33% yoy), higher than the break-even
volumes of ~2,200MW for the first time since FY09.
Our estimates factor in positive EBITDA in FY12E and positive PAT in FY13E
Despite revised demand surge in India, we now estimate that Suzlon could report
a positive consolidated EBITDA of INR10.6bn in FY12E and positive net income of
INR4.7bn in FY13E only v/s earlier expectations of a turnaround in FY11E, since
volume pick up in non-Indian markets is poor. Company has high operating
leverage as additional 100MW of sales at gives contribution of c. INR1.8bn
Our target price of INR51 is an average of P/B and DCF
Our 12m target price of INR51/sh is based on an average of P/B of INR32/sh and
DCF of INR70/sh, with a CoE of 15.8%. Key challenge us conversion of FCCB
(debt to equity) at INR76.68/sh to INR97.26/sh. Sales volume is a key risk; 10%
higher/lower volume could raise/cut FY12E EPS by 110%.
Investment thesis
Outlook
We rate Suzlon Energy a Hold with a target price of INR51/sh. A sharp pickup in Indian
demand for wind power has come as a surprise, with the Indian wind power equipment
market estimated to rise from 11.8GW in FY10 to 13.8GW in FY11E and 19.4GW in FY13E, a
volume CAGR (FY11E-13E) of 19%, much higher than the 16% seen over FY08-10. This is
clearly a result of government policies and regulatory support: 1) Given Suzlon’s ~50%
market share in India, such a demand surge gives us comfort that Suzlon should be able to
achieve overall break-even volume of c. 2200MW by FY12E and report a positive net income
by FY13E. 2) Following the debt restructuring, the company should not be too worried about
the pickup in global demand as the principal repayments are largely structured towards the
end of the maturity period i.e. FY14E-18E. 3) Despite this, we see some overhang in the
event the stock price does not cross INR97.26/sh by FY13E; that could put a strain on cash
flow as a result of FCCB redemption, unless the FCCB holders agree to bear some more
pain. 4) Suzlon still has a 26% stake in Hansen, valued at INR6.4bn at the current market
price, and a 91% stake in REpower at INR57.6bn, which could be used in a severe cash
crunch. With the stock at 85% of its peak, we find most of the negatives in the price, limiting
the downside.
Valuation
We have used an average of a three-stage DCF methodology and SOTP to arrive at our 12-
month target price of INR51/sh. (1) We use P/B on a consolidated book value, compared to
our earlier method of SOTP of value of standalone business on P/B ex. goodwill and market
values of stakes in Hansen and REpower. This change is on account of the change in
structure of the company, where REpower has become a subsidiary with 91% stake while
with only 26% stake, Hansen is no longer a subsidiary. Our P/B method gives a 12-month
target price of INR32/sh, using a price to book ratio of 1x, as we believe that the company
should be able to turn around from FY12E onwards. (2) Our DCF model follows a three-stage
cash flow forecast (highlighted in Figure 18), giving a 12-month target price of INR70/sh. The
explicit period is FY12E-13E and the semi-explicit period is FY13E-18E. We have assumed a
terminal growth rate of 2%. Our model uses a WACC of 11.7% based on a 11% cost of
debt, risk-free rate of 6.4%, 7.2% risk premium (both in line with Deutsche Bank estimates)
and beta of 1.3 (derived from Bloomberg Finance LP data for weekly stock returns).
Risks
Key downside risks are 1) a delay in demand pickup; 2) unsuccessful handling of poor grid
infrastructure in India; 3) slower-than-expected revival in key markets such as the US and
Europe; 4) hiccups in FCCB restructuring (if required); 5) potential sale of the remaining stake
in Hansen Transmission at depressed valuations; and 6) higher-than-expected increase in raw
material costs leading to margin pressures.
Key upside risks are 1) a sharp revival in demand in Suzlon's key markets i.e. India, the US,
Europe and China; 2) Suzlon converting FCCBs at the current strike price or negotiating
favourable terms to restructuring its debt; and 3) the sale of Hansen Transmission at a
premium to the current market price.
Our sensitivity analysis shows that a 10% higher-/lower-than-expected sales volume could
raise/cut FY12E EPS estimates by 110%. Similarly, a 100bps increase/decrease in RM/sales
could cut/raise FY12E EPS by 32%.
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