Suzlon Energy - Wind powered

IPO REVIEW

Considering the tremendous growth opportunities in alternate energy segments like wind power where Suzlon operates, the stock valuations seem reasonable.

Suzlon Energy's IPO (opened on September 23, 2005) brings into focus two things. On the one hand the issue seems to be highly priced, with a valuation of 30 to 34 times based on earnings per share (EPS) for FY05. But it must be said in its favour that considering the huge influx in power infrastructure and the growing need for alternate energy systems, the company's future definitely looks attractive.

Analysts note that increasing environmental awareness augurs well for non-polluting sources of energy like wind power. Considering the fact that Suzlon is the market leader in the country in the wind power segment, the scope for future growth is unmistakable, say analysts.

The business
Suzlon is India's leading manufacturer of wind turbine generators (WTG), with a 42 per cent market share. It is also the world's sixth largest WTG manufacturer in terms of annualised installed capacity for 2004.

Besides manufacturing WTGs, the company is involved in wind resource mapping, identification of suitable sites and technical planning of wind power projects. The company recorded accumulated sales of 1126.60 mega watts (MW) as of March 31, 2005. In value terms, it clocked revenues of Rs 1942 crore.

A case for wind energy
The companies' success depends on the expected surge in global and domestic electricity demand going forward. The International Energy Agency (IEA) estimates that the world electricity demand will double between 2002 and 2030. As of now the wind energy constitutes only a miniscule per cent of total global energy production.

The IEA estimates that share of wind power (where Suzlon operates) will grow from 0.2 per cent in 2002 to 3 per cent by 2030 and will be the second-largest renewable source of electricity after hydroelectricity.

Analysts note that the power industry scenario in India has been characterised by energy shortages.

According to the Central Electricity Authority, India, demand for electricity in the country exceeded supply by an estimated 7.30 per cent in terms of total requirements and 11.70 per cent in terms of peak demand requirements.

At the end of FY05, India's power system had an installed generation capacity of approximately 115,544.8 MW. Of the installed capacity, thermal power plants powered by coal, gas, naphtha or oil accounted for approximately 69.40 per cent of total power capacity. Hydroelectric stations accounted for approximately 26.10 per cent and others (including nuclear stations and wind power) accounted for approximately 4.50 per cent.

According to BTM Consult ApS, India is making steady progress in the development of wind power. In 2004 was the third largest country in the world in terms of wind power installations with annual installations of 875 MW. The estimates are that the cumulative installed capacity for wind power in India will grow from 3000 MW in 2004 to 8,300 MW in 2009, a CAGR of 22.60 per cent.

The cumulative installed wind-generation capacity in India amounts to 3,595 MW. About 1,100 MW of this had been installed in FY05. This compares well with 615 MW of fresh capacity added in FY04 and 240 MW of capacity added during FY03.

Suzlon has the largest market share in this business, which stands at 42 per cent. The company's main competition in India comes from the Indian joint venture of Vestas Wind Systems A/S and NEG Micon A/S (market share "� 32 per cent) and Enercon GmbH (15.40 per cent). Suzlon's customers include Bajaj Auto, Ramco Group of companies, Godrej Industries and Maharashtra Seamless among others.

Analysts note that policy factors have a huge bearing on the companies like Suzlon. For example, in FY03, the company's revenues dropped by more than 50 per cent to Rs 260.56 crore compared to FY02, one of the main reasons being the uncertainty relating to announcements of new depreciation rates.

In recent years, governments in many countries, including India, have put in place policies that support the expansion of renewable energy sources, such as wind power, and such support has been a significant contributing factor in the growth of the wind power industry. As of now, industrial consumers can claim a depreciation of 80 per cent in the first year for all wind power expenses.

Analysts note that there could be a potential upside for wind energy in the future, since wind energy doesn't produce any carbon emissions. Wind energy is eligible for carbon credit benefits under the Kyoto Protocol for the period 2002-2012.

Financials
A key growth impetus for Suzlon has been rising cost of inputs such as coal in conventional power generating equipment and the resulting need for user industries to evaluate alternative energy sources.

Riding piggyback on this, the company's revenues grew 126.53 per cent to Rs 1942.48 crore and net profit grew 208.54 per cent to Rs 385.86 crore in FY05. Profit growth has exceeded income growth thanks to efficiencies realised in the southern part of the country from the setting up of a factory in Pondicherry.

Operating profit margin grew 714 basis points to 19.25 per cent in the previous financial year. During fiscal 2004 and fiscal 2005, income from India contributed 88 per cent and 99.70 per cent respectively, to Suzlon's total income.
 

Financials
In Rs crore	FY02	FY03	FY04	FY05	% change
Net sales	524.91	260.56	857.49	1942.48	126.53
Other income	8.44	9.14	17.36	23.43	34.97
Operating profit	115.75	13.57	103.85	373.92	260.06
OPM (%)	22.05	5.21	12.11	19.25	714 bps
Net profit	121.04	26.90	125.06	385.86	208.54
NPM (%)	23.06	10.32	14.58	19.86	528 bps
EPS (Rs )	5.50	2.51	5.70	15.03
P/E @ Rs 425    28.27 P/E @ Rs 510    33.93

Analysts expect that going forward, international revenues will contribute an increasing share of revenues. The company's debt to equity ratio as of FY05 stands at 0.39, while return on net worth amounted to 46 per cent. This is much better than its listed peers like ABB (24 per cent), BHEL (15.60 per cent) and Siemens (27.60 per cent).

According to an analyst from domestic securities firm, Motilal Oswal Securities, Suzlon's business model is robust and the company has strong growth prospects.

"I would expect the company to record a topline growth of 80 percent and a bottomline growth of 100 per cent in FY06. For FY07, the company should be able to clock a revenue growth of 30-40 per cent and a profit growth of 35 per cent," he says.

Concerns
The main concerns are on government policy issues. Analysts note that if the government decides to reduce the incentives for wind energy industry, it will have a negative impact on the company.

Senior company management highlighted that alternative energy sources are now cost-effective thanks to advances in technology and the importance of fiscal and tax benefits has been declining. Another important factor is that the capacity utilisation factor for wind energy is pretty low at 22-32 per cent.

Also wind farms requires large tracts of land (20 acres/MW on an average) to run a smooth operation. Another worry is the raw material costs. In FY04 and FY05, imported raw materials and components accounted for 54.5 per cent and 50.2 per cent of Suzlon's raw material cost. A devaluation or depreciation in the value of the rupee is bound to increase the total costs of such imports, there by squeezing margins.

Valuations
Based on a FY05 EPS of Rs 15.03, Suzlon is valued at 28 times at the lower end of the price band (Rs 425) and nearly 34 at the upper end (Rs 510). But compared to other players in the power industry such as ABB (42x), Siemens (38x) and BHEL (24x), the valuations seem reasonable, say analysts. On Friday, when the issue opened for subscription, the issue was oversubscibed by 15 times.

"The issue has already been oversubscribed, So I would advise investors to buy the issue at Rs 510 levels," says an analyst. If Suzlon is able to keep up the fast pace of growth that it has managed in the past couple of years, the stock would look reasonably priced on forward PE multiple basis.

Janish Shah, analyst with Networth Stock Broking says that the stock looks attractive from a medium to long term perspective. "Traditional power sector companies like ABB and Siemens command forward valuations of 18-20 times. Suzlon is expected to clock a growth rate of 40-45 per cent going forward. So valuations are not unreasonable," says Shah.

Issue closes: September 26, 2005
Issue size: Rs 1222 cr - Rs 1466 cr