>SUZLON ENERGY LIMITED (EQUTY RESEARCH)

■ A black hole: It goes without saying that an investor would do well to steer clear of a bad business. A business that sacrifices profitability for growth, over leverages its balance sheet for making acquisitions, whose customers are constantly complaining about product quality, comes within striking distance of breaching its debt covenants and has an extremely volatile record of earnings. All characteristics that have become closely associated with Suzlon, the wind turbine major that until recently seemed to be growing at an astonishing rate.

We last recommended the stock in November 2006, when the company held a lot of promise by virtue of its good track record prior to that and the fact that it was present in a sunrise industry with great potential for growth. And we have been maintaining caution after the stock hit our target price subsequently. Now, a series of decisions made by its management has completely ruined not only the company’s business reputation and its balance sheet, but also out faith in the management's competencies and intentions.

It has now left us with a situation where many of the factors surrounding the company, as discussed in more detail though the rest of the report, make it an extremely tough and unreliable job to project any kind of earnings going forward. A big lack of clarity on what decisions the management will take going forward makes it even more difficult to estimate its performance. And its past track record on this front makes us only further queasy to say the least. As such, while the stock might appear cheap on some valuation standards, we do not see Suzlon being a part of any long term investors’ core portfolio. Thereby, we recommend a ‘Sell’ on the same.

■ Embroiled in several controversies: The past few years has seen Suzlon getting embroiled in a number of controversies relating to the performance and quality of its wind turbines. In India, Essel Mining, a Birla company, filed a lawsuit on the company seeking damages over technical problems experienced by the wind mills set up by it for the company. They are presently trying to settle out of court. Essel is seeking damages over under performance of the wind mill set up by Suzlon in Maharashtra.

In the US too, the company has faced a number of problems when the blades of wind turbines supplied by it developed cracks. This led to the company announcing a recall and retrofit program that is still in not completed. Further, other problems relating to the equipment not producing enough power to meet Suzlon’s sales contracts, and delays in providing technical support and service have kept cropping up for the company. All this has led to the company making a lot of unexpected provisions and heft extraordinary costs, bring in major instability and volatility as far as its earnings are concerned. To the extent that Suzlon, in one of our meetings with the company, had clearly indicated that all such charges and provisions have been made in FY08 itself, and there would be no impact on its FY09 numbers. That did not turn out to be the case, and the problems on this front continue to haunt the company

■ Sacrificing stability and profitability for growth: In a bid to grow aggressively, Suzlon has made two large acquisitions in the past few years. The first one was Hansen Transmission, a Belgium based gearbox manufacturing company. And the second was Repower Systems, a Germany based WTG maker who is mainly into the assembly of large capacity wind turbines.

■ Over reliance on regulatory climate: Apart from the inherent potential, one of the major factors aiding the growth of wind power industry in India and globally is the legislations and government policies that support the expansion of renewable energy sources like wind power. Support for investments in this sector is typically provided through fiscal incentive schemes or public grants to the owners of wind power systems. An example of incentives is preferential tariffs and tax breaks on power generated through the use of wind.

Globally, one of the best examples of such incentives is the Production Tax Credit (PTC), which is extended to wind power producers in the US. As per the PTC, wind power generators are granted tax credit at a base rate of 1.5 cents (US$ 0.015) per unit (kWh, of kilowatt hour) of electricity produced. Such has been the effect of the PTC scheme in the US that the country has witnessed a boom and bust cycle in the wind power sector in line with the extension and expiry of the scheme.

To see full report: SUZLON ENERGY