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What’s unconventional, growing every year by over 30% globally, and has the promise to change the world in under 10 years? The answer, my friend, is wind energy. Starting off as the humble windmill that dotted the landscape of countries like Holland and Denmark, wind power has doubled in terms of global installations in the past three years and seems to be the only serious alternative to thermal power today. Driven by a combination of tax and energy incentives around the globe, wind power is now the clear leader in alternative power generation technology.
Companies like Suzlon have generated terrific returns for their investors (the stock is up 187% from its offer price of Rs 100 in October 2005). Plus there is a decent returns on investment (RoI) for direct investors in windmills, driven mostly by tax benefits. Here Suzlon offers an end-to-end management contract under which it supplies equipment, constructs and manages coowned wind farms. The beauty of wind power is that, like solar energy, it has negligible operating cost. So there is terrific operating leverage as you generate higher volumes, and as your cumulative generation crosses a threshold.
Of course there is a technological limit to how much power you can generate with a particular wind turbine given a certain wind speed. Also, the wind at your location may not always follow its long-term average as closely as you might have hoped.
If capital costs are kept low (via soft interest rates and modern design innovations), wind power can deliver a decent RoI. With generous tax sops and power purchase rates mandated by governments from the US, China, Spain and India, wind farms are serious business for investors and owners alike. Business is assured, as most governments are keen to mandate the use of power generated from non-conventional resources.
By all counts, 2007 was a landmark year in the global history of wind power. Global capacity hit 94 GW (1 GW = 1,000 MW), driven by sales of 20 GW (up 30% from 15 GW in 2006). The year also saw the US emerging as the largest wind energy market with over 5 GW of wind power being added.
In terms of total installed capacity, Germany still leads the tally with over 22 GW, followed by the US with almost 17 GW, while India is fifth in the global sweepstakes with over 8 GW of wind energy having been installed so far. This is going to change soon, as China and the US are expected to lead the incremental demand for the next decade.
Indian challenger Suzlon completed the acquisition of offshore and highcapacity turbine maker RE Power. Large windmill sizes of the kind that RE Power makes (beyond 2 MW), generally result in cheaper costs per MW, but the technology is difficult to master especially for offshore wind turbines. This acquisition fits nicely into Suzlon’s business mix which is already integrated by the addition of Hansen, a leader in gearboxes. Gearboxes are in critically short supply in the wind power industry. Suzlon has posted its initial growth by importing and stabilising European wind power technology into India, but its future clearly lies outside the country (overseas order book is six times the Indian order book). Incremental growth will now come from the US and China, both countries where it has a bulging order book but strong competition to contend with. Plus the Hansen and RE Power acquisitions will help it gain a foothold in Europe, the traditional wind energy market.
Recent performance has not been inspiring on the profitability front. Suzlon’s earnings before interest, taxes, depreciation and amortisation (EBITDA) margin fell to 12.7% in the period April-December, 2007 against 15.8% a year ago. On the other hand, its topline growth of 72% reflected the industry bull case more than adequately at Rs 8,756 crore. The lack of operating leverage in spite of such a large jump in revenues is worrisome.
The two big acquisitions so far have been mostly debt financed, and after two foreign currency convertible bonds (FCCBs)—convertible at Rs 360 and Rs 372—the company’s debt to equity ratio might also look somewhat stretched at approximately 1.3 in its March 2008 balance sheet. Future promise is strong, with both Hansen and RE Power due for several rounds of margin expansions in the foreseeable future.
On the operating front, 417 wind turbines of 2.1 MW supplied by Suzlon have undergone a blade retrofit programme starting in the third quarter of 2007-8. The total cost involved is Rs 100 crore against the nine months’ consolidated EBITDA of over Rs 1,150 crore. The concern here is more than immediate profits. Will the rapidly growing order book slow down in the face of this negative development? Seems unlikely, as the company announced yet another major order win in China recently in the 1.5 MW category.
My guess is that Suzlon’s management will find the going tough over the next two years, with commodity (mostly steel) prices weighing against them. With a 300% jump in the critical gearbox capacity at Hansen, a doubling of Suzlon’s own capacity and an almost 50% jump in RE Power’s high-range sea and wind turbine range, Suzlon will have its hands full expanding across locations in India, Belgium and China.
And if the FCCBs do convert, fully diluted equity will rise to over Rs 310 crore (155 crore shares at Rs 2 face value). But servicing this should not be a problem for Suzlon, because by 2009-10 the consolidated revenues could cross Rs 25,000 crore, three times up from under Rs 8,000 crore in 2006-7. If Suzlon maintains a net margin of 10-11% on this, we might well see it earn close to Rs 2,500 crore (or a shade under Rs 17 per share) in profits.
As a fund manager of other people’s money, I missed out on a great chance to invest again in Suzlon at Rs 210 during the recent crash.
Dipen Sheth is Head of Research, Wealth Management Advisory Services. He can be reached at dipen@wealthmanager.ws
