>SUZLON ENERGY(MACQUARIE RESEARCH)

Hanging by a thread

Underperform, with a target price of Rs79
We transfer coverage of Suzlon to Inderjeetsingh Bhatia, with an Underperform rating and a target price of Rs79. The Street has been primarily focused on balance sheet issues. We believe the bigger concern should be the core business fundamentals, which are expected to remain weak despite the building economic recovery. The company is projected to deliver 18% earnings CAGR over FY09–12, primarily driven by subsidiaries (Hansen and REpower).

• Valuations are rich at 10–30% premium to market: Suzlon is trading at 9.2x FY11 EV/EBITDA as against 7.1–8.1x for other global WTMs. These valuations are even more demanding, given Suzlon’s recent serious quality issues, the impact for which is still not known or built into numbers.

• Target price of Rs77 based on SOTP: Our target price is based on 9x FY11E Suzlon Wind EV/EBITDA, which is a 20% premium to global average and 10% holding company discount to Hansen and Repower, which are listed subsidiaries. Although the long-term average EV/EBITDA multiple has been around 12x, we do not expect the stocks to re-rate again to those levels due to much more moderate growth projections over next few years.

Balance sheet overhang on the way to being addressed
Suzlon has seen a sharp correction on concerns regarding its ability to meet its debt obligations. However, we believe that the company will be able to pull out of these issues through dilutions, renegotiations on covenants and very likely the sale of its stake in Hansen, which could yield almost US$900m at current price.

• There are near-term concerns on the test of covenants in September, when annualised consolidated EBITDA needs to be 4x net debt. If volume remains weak, Suzlon would be required to undertake further debt restructuring.

Business fundamentals to remain weak over medium term
Wind turbine manufacturers (WTM) are facing severe demand/supply mismatch, as huge capacity has been added in the past 12 months. Even with the most bullish industry estimates, which suggest a CAGR of 14% for the industry over the next three years, the overcapacity situation is likely to persist over the next three to four years, leading to pricing pressure. Please refer to our global wind energy team’s report, A shift in power, dated 1 May 2009, for detailed analysis on global demand supply dynamics.

• A quarter of the global market is effectively closed to Suzlon: The Chinese market (almost 25% of annual installation) is practically open only to local manufacturers. Suzlon would thus be unable to participate in a huge growth opportunity beyond the 10% of its capacity based in China. Even in India, medium-term demand may suffer, as the tax arbitrage window is closing.

• Near-term assumptions are below guidance: The company has guided for 2400–2600MW of revenues in Suzlon’s Wind business for FY10 (213MW in 1Q FY10). We believe that despite early signs of recovery in 2H FY10, the company will miss its guidance by 10%, leading to EBITDA margins of 10% in FY10 vs guidance of 12–14%.

To see full report: SUZLON ENERGY