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Is it a bubble?(The Economic Times (India) Via Thomson Dialog NewsEdge)Amidst the dazzle of 2005's stock market stars, the Suzlon stock has been a stand-out performer. After a high-profile IPO debut, the company now has a market cap in excess of Rs 30,000 crore. The basic story is simple and hence highly appealing. Not only is there a huge power shortage in India, the situation is likely to get much worse before getting better. According to the government's estimates, in seven years between FY05 and FY12, we need to add another 85,000 MW to 'meet' demand. But the government's demand estimates are invariably calculated on an available supply-plus basis. Logically speaking, in the absence of supply constraints, demand could well be significantly higher. In other words, if power were available freely, it would create additional demand. Whichever way you slice the data, there is no getting away from the fact that India needs massive investments in power generation capacity. The second key driver is the rising cost of oil and other fossil fuels. In parallel, costs of alternate technologies like wind and solar power follow a long-term falling trend line, sustained by technological innovation. Looking at lifetime costs (including operations), the gap between thermal and non-conventional energy sources is gradually diminishing. In some countries (including India), government incentives make wind power a fairly attractive investment for those with extra cash and large tax liabilities. The third factor driving demand for wind (or non-polluting) power is the largely 'un-quantifiable' environmental costs, which keep rising with increasing global concern for the environment. Given the three strong trends working in favour of wind energy; investors have been drawn to the Suzlon stock, as a clear play on the rising global demand for alternate energy sources. In the wind power space, Suzlon is India's largest player with a 43% market share in FY05 (reportedly 60% in the first nine months of FY06), and the world's sixth largest. The company offers 'integrated' solutions spanning the entire value chain: wind resource mapping, identification of suitable sites, technical planning, after-sale O&M services, acquisition of sites, installation and implementation of turbines and connection to power grids. In other words, if you have the cash, Suzlon can not only set up the plant from scratch, but even run it for you. Little wonder that the company has grown more than thirteen times in the last 5 years. So what is the problem? As always for an investor, it is the price we pay! In recent days, Suzlon's market cap has hovered above Rs 30,000 crore, making it India's 15th most valuable listed company. The company is worth more than L&T, Tata Steel, Tata Motors, GAIL, Gujarat Ambuja, HPCL, BPCL, Ranbaxy, Hindalco, Maruti! Now, think about this for a while. You could sell Suzlon, buy both BPCL and HPCL, throw in a Biocon, and still have a few thousand crores of loose change left over. Or leaving aside SBI, the next five public sector banks would be worth less than Suzlon! Sadly, analyst reports and media hype focus exclusively on EPS and P/E numbers. During the 9 months ended December 2005, Suzlon posted 141% and 328% growth in revenues and bottom line respectively. Given that most analysts are projecting annual growth rates of between 50% and 100% till 2008, it's easy to conclude that P/E levels based on FY08 earnings are not out of line with other high-growth stocks. But we all know that earnings can be extremely deceptive. And all the popular ratios like P/E and EV/EBITDA can conveniently obscure the true picture by ignoring the quality of earnings. Ultimately, the price you pay is the market cap, which is the value of the company. And Suzlon's market cap is more than 8 times FY06 sales estimates (between Rs 3,500 to Rs 3,800 crore), and more than three times some pretty optimistic FY08 sales estimates. Now, this is even more expensive than the valuations given to brand or IP driven product companies, even those with first-rate corporate governance. Driven by exciting earnings and growth numbers, investors have ignored some disquieting numbers in the balance sheet. Working capital needs are extremely high, and constitute an estimated 70-75% of total capital employed. Most of this is held in inventories and debtors. Moreover, in each the last five financial years, the company has provided negative free cash flows. And on top of everything else, a maze of intra-group transactions make it extremely difficult to figure out the quality of the reported bottom-line numbers, as Suzlon lends to, buys from, sells to, owes money to and is owed money by a large bunch of subsidiaries and associate companies. A group company (SRL) acquires/leases land for wind farm projects, for Suzlon or its customers. Suzlon loans them money for this, even while SRL is guaranteed a return calculated on a cost-plus basis. Similarly, another group company (SDL) provides services for erection, installation and commissioning of the wind power projects, and also receives loans and a remuneration calculated on a cost-plus basis. Another one (SWSL) is the management contractor and operates and maintains the power plants. Another bunch of related companies such as Samiran Udaipur Windfarms Pvt. Ltd., Samiran Jodhpur Windfarms Pvt. Ltd., Samiran Jaipur Windfarms Pvt. Ltd., Samiran Jaisalmer Windfarms Pvt. Ltd., Sarjan Realities Ltd. and Suzlon Developers Ltd. are collectively known as 'Windfarm Developers'. Their job is to get 'allocation' of wind farm projects from local governments, and then transfer these to Suzlon. Naturally, the company will pay for these services as well as fund the Windfarm Developers via loans. Other overseas subsidiaries such as SEG, AERT and AERH sell various 'technical' services to Suzlon. Apart from a bewildering array of subsidiaries, Suzlon's prospectus mentions at least 20-odd companies owned by the promoter family. From what I could gather, a large chunk of these associates and group companies had significant financial dealings with Suzlon. While there is nothing wrong in theory, this makes for a completely non-transparent set of business dealings. I would not like to impute any negative motives on the part of promoters, but surely the lack of transparency and possible issues of corporate governance imply unusually high levels of risk for any rational investor? Especially given the current stupendous valuations! e-mail: [email protected] |