For FY09, Suzlon Energy Ltd. (SEL) reported a strong set of numbers. The net sales of the company increased by 85.3% y-o-y to Rs 91.2 billion, primarily due to the merger of REpower Systems AG (REpower) with the company and a 34.2% y-o-y WTG sales volume growth.
However, the EBITDA margin declined to 8%, as compared to 17.5% in Q4’08, due to the sharp increase in other operating expenses. (Other operating expenses increased to 21.4%, as a % of sales, as compared to 11.3% in Q4’08.)
Looking ahead, we expect the topline to remain under pressure, given the order visibility of just 2-3 quarters.
The company’s order book has been declining since Q4’08 and remains a cause for concern. As on June 2009, SEL’s outstanding order book stands at 1,463 MW (Rs79 billion), which represents a revenue visibility of 2-3 quarters only.
This decline is primarily attributable to the slowdown in global economies. Nevertheless, most of these economies have begun showing the early signs of recovery. (IMF has upgraded its world GDP forecast for FY10.)
A recovery in the global economies and improving credit availability should provide some respite to the company. SEL’s management expects new orders of around 2,400–2,600 MW in FY10.
However, we expect lower utilisation rates in the coming quarters, as the average age of these projects will generally be about 1-2 years.
Additionally, the short-term revenue visibility of the company’s existing order book will add to the lower utilisation rates. Accordingly, we expect a ~10% decline in net sales in FY10.
In FY09, the other operating expenses of the Company have increased significantly on account of the Blade Retrofit programme, higher consultancy charges, and other one-offs. The Company’s Retrofit programme is expected to complete in August 2009.
Further, other one-off costs are also expected to decline, which should result in an improvement in SEL’s margins. Additionally, during the first half of FY09, the Company experienced significant pressure on its operating margins due to the rising commodity prices.
However, the commodity prices have now declined from their peak levels in July 2008. A fall in commodity prices, such as steel and copper, is likely to ease the margin pressures. These commodities account for ~30% of the total cost of materials.
We expect the EBITDA margins of the Company to increase to ~11.9% and 12.3% in FY10 and FY11, respectively, as compared to 10.1% in FY09.
At Rs 86.4, SEL’s stock is trading at a forward P/E of 19.9x and 11.3x for FY10E and FY11E earnings, respectively. Based on our DCF valuation, we have arrived at a target price of Rs. 92 (assuming a 12% WACC and a 5% terminal growth rate).
The target price does not provide any significant upside potential from the CMP. Thus, we give a Hold rating to the stock.
As the DCF valuation is sensitive to the changes in the WACC and terminal growth rate, we have performed a sensitivity analysis of the same.