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Suzlon Energy: Look beyond the quarter - Views on News from Equitymaster

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Suzlon Energy: Look beyond the quarter
Oct 27, 2006

Performance summary
The increased focus on renewable energy and its consequent impact on Suzlon Energy is clearly visible from its the first half performance. It has to be remembered that the financials are not necessarily comparable because of the integration of its Belgium acquisition in the current fiscal year. Excluding this, operating margins have slightly weakend in 2QFY07 and 1HFY07, which is largely on account of additional overheads towards capacity expansion (in India and outside) that are yet to reflect at the topline level. The fact that the company is able to negotiate higher prices for newer contracts in India and outside, highlight the underlying strength in the business.

Consolidated financials…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Sales 11,230 20,870 85.8% 14,341 31,559 120.1%
Expenditure 8,705 17,270 98.4% 11,154 26,101 134.0%
Operating profit (EBDIT) 2,525 3,600 42.6% 3,187 5,458 71.3%
Operating profit margin (%) 22.5% 17.3%   22.2% 17.3%  
Other income 69 87 25.5% 129 248 91.5%
Interest 148 547 269.0% 263 913 247.7%
Depreciation 143 428 198.7% 276 776 181.2%
Profit before tax 2,302 2,711 17.7% 2,777 4,017 44.6%
Tax 236 340 44.0% 265 686 159.0%
Profit after tax 2,066 2,371 14.7% 2,512 3,331 32.6%
Minority interest 11 (17) - 18 (25) -
Net income 2,077 2,354 13.3% 2,530 3,306 30.7%
Net profit margin (%) 18.4% 11.4%   17.5% 10.6%  
No. of shares 260.7 287.7   260.7 287.5  
Diluted earnings per share (Rs)*         33.1  
P/E ratio (x)*         39.5  
*On a trailing 12-months basis            

What is the company's business?
Suzlon Energy (Suzlon) is Asia’s leading manufacturer of wind turbine generators (WTGs) having around 53% share of India’s domestic installations in 2005. On a cumulative basis, Suzlon has installed around 36% of India’s total wind power capacity of 5,150 MW. At the end of 2005, the company was among the five largest manufacturers of WTGs globally in terms of annual installed capacity. It is the first Asian company to manufacture WTGs, which have MW and multi-MW capabilities. The products manufactured by Suzlon include rotor blades, control panels, nacelle cover and tubular towers. The company had recently acquired the Belgian Hansen Transmissions, which is one of the three major multi-MW gearbox suppliers in the world. During the period between FY02 and FY06, Suzlon has grown its revenues and net profits at compounded rates of 65% and 61% respectively.

What has influenced performance in 2QFY07?
Installations jumps: Hansen currently has a capacity of 3,300 MW, which is fully booked for the next three years and the company is in the process of expanding the capacity to 5,800 MW. This will be done in phases and the full expansion will be in place in another 18 months. As far as the pricing environment is concerned, the company expects blended prices to increase by 3% to 5%, depending on the nature of the order going forward. We continue to have a very positive outlook on Suzlon's topline growth prospects over the next two to three years. As against the industry estimates of around 20% CAGR in windpower capacity, given the increased interest in the global markets, it is likely to be surpassed.

Costs running ahead of revenues: The decline in operating margins in 2QFY07 and in 1HFY07 should not be a major cause for concern, as the numbers are not comparable because of the Hansen integration. Also, the orderbook is seasonal in nature i.e., close to 65% of the company's revenues is booked in the second half of the fiscal year. Nevertheless, there were two major reasons for the decline in EBDITA margin i.e., employee and raw material costs. Higher staff cost during the quarter (17.8% of sales in 2QFY07 as against 15.0% in 2QFY06) is due to capacity expansion in China and US, both of which started operations in September 2006. Secondly, 88 MW of orders are currently in transit, the costs for which are already booked whereas the revenues are not. To that extent, overheads are front ended. As against the addition of around 4,000 MW to the global wind energy in 9mCY05, the industry added 7,500 MW in 9mCY06, thus taking the cumulative world installations to close to 67,000 MW (12% increase as compared to January 2006). In India, close to 650 MW of wind energy was added in the first six months of the fiscal year and Suzlon continues to maintain a 50% market share. As of 1HFY07, the total orderbook (excluding Hansen, the Belgium acquisition) stood at Rs 66.4 bn, which is commendable (87% of this orderbook is international in nature).

Segmental snapshot…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Wind turbine 11,024 16,087 45.9% 14,110 23,604 67.3%
% margin 23.5% 18.4%   22.8% 18.5%  
             
Gear Box - 4,368 - - 7,520 -
% margin - 10.8%   - 13.2%  
Others 207 418 101.8% 234 441 88.3%
% margin 22.8% 26.5%   18.4% 16.5%  
Overall PBIT margin 23.5% 17.0%   22.7% 17.2%  

On the raw material costs front, last year, there was an increase in customs duty to the tune of 4% on certain components. This, combined with higher commodity prices and the change in product mix has impacted margins in 2QFY07. The company is venturing into the manufacture of 60 kW windpower plants that typically accounts for around 20% to 25% of domestic demand. Towards this, raw material costs have increased whereas volumes are yet to gain scale. Overall, the company expects EBDITA margins to be in the range of 21% to 22% for FY07. We have a stable to positive view on margins going forward, given the underlying supply-related constraints with respect to gear boxes in the global market (Hansen is one of the major producers of this product).

Higher capex leads to higher charges: Suzlon is investing Rs 7.5 bn towards setting up of a integrated turbine facility in Karnataka, which will have a capacity of 1,500 MW (slated for completion in July 2007). Also, another Rs 7.5 bn is earmarked towards its forging and foundry manufacturing facilites in India besides the capacity expansion in Belgium. Given the aggressive growth plans, the rise in depreciation and interest charges in 1HFY07 is not surprising. While the consolidated effective tax rate has increased in 2QFY07, that of standalone is more or less on similar lines.

What to expect?
The stock trades at Rs 1,305 implying a price to earnings multiple of 39 times trailing twelve month earnings (price to sales of 4.1 times our FY07 revenue estimates). While valuations looks high, in our view, the industry is poised for robust growth rates over the next three to five years with clear visibility in income streams. The capacity expansion at Hansen will propel topline growth to even higher levels (planned expansion of 75% of existing levels). In this context, we maintain our HOLD recommendation on the stock from a long-term standpoint.

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