The Street is betting big on these two energy stocks. Should you?

Are they headed for more upswing or is this a temporary high?

Inox Wind & Suzlon: Dalal Street is betting big on these 2 stocksAI-generated image

dhanak हिंदी में भी पढ़ें read-in-hindi

Long before power generation, wind was harnessed for many purposes - to propel sailing ships, pump water and grind grains with a grindstone. As renewable energy took centre stage in sustainability conversations, the modern-day application of wind turbines to generate electricity came into existence. In India, wind turbine manufacturers (OEMs) like Inox Wind and Suzlon Energy were among the frontrunners as they moved to capitalise on growing calls for adoption of renewable energy.

The industry ascended on the country's priority list, leading to tight government regulation and high intervention. The long-term nature of projects further makes the business working capital intensive, resulting in little profitability.

However, in the last year, stocks of Inox Wind and Suzlon Energy have become the Street's favourites. The S&P BSE Energy index reported a staggering 64 per cent growth (as of April 8, 2024) amid steadily growing bullish sentiment towards renewable energy.

The run up piqued our interest, forcing us to look into what's behind this outperformance. Here's what we found:

The return to profitability

After years of losses, both Inox and Suzlon managed to break the streak recently. Inox reported two straight quarterly profits (Q3 and Q4 FY24) after it was last profitable in 2017. Suzlon Energy, too, turned profitable for the entire year (FY23) after a gap of six years.

Behind the turnaround is the strengthening of their order books due to the growing demand for wind energy.

In Q3 FY24, Inox's order book jumped over 100 per cent. While it has maintained a large order book of above 1000 MW over the years, note that this included a letter of intent for a 502 MW-order between FY20 and Q2 FY24.

Suzlon Energy's order book also grew impressively, leaping to 3157 MW (as of January 2024) from 652 MW in FY23. This was supported by its deleveraging efforts. The company, plagued by high debt for years, managed to reduce its debt of Rs 12,000 crore in FY18 to just Rs 120 crore- a 100 times decline! This was primarily done through conversion of debt into equity and raising fresh equity capital through promoters and a rights issue.

The easing of the debt burden and the growing order book helped Suzlon grow its revenue by 26 per cent per annum in the last three years.

Should you bet on the duo, then?

There is no doubt that the re-strengthening of the order books has breathed life into the once bleak growth prospects and the share prices of the two companies. However, a granular look at their books reveals glaring issues:

  • The industry grapples with high trade receivables and a high cash conversion cycle. Take for instance, Inox Wind's working capital cycle of 505 days in FY23, among the worst in the industry.
  • Weak operating metrics plague leading players

    In terms of five-year averages

    Suzlon Energy Inox Wind
    Trade receivable days 133 557
    Trade payable days 247 758
    Inventory Days 199 456
    Trade receivable as a % of sales (%) 32 144
    Cash conversion cycle (in days) 85 256
    Note: Data as of FY23
  • Wind OEMs generally take 12-18 months to execute purchase power agreements. Due to a lack of pricing power, they are unable to pass on high raw material prices. This dents their profit margins.
  • Inox Wind is entirely dependent on its technology partner ASMC to design its turbines. With zero spending on R&D, it does not design turbines on its own.

    Additionally, its bonus share issue (3:1) seems strange at a time when it has just turned profitable. It should instead reinvest every additional penny into the business.
  • Steep fixed costs are common in the industry. Suzlon Energy's operating leverage has traditionally been above 30 per cent!

    Notwithstanding the recent demand pick-up, Suzlon has historically been highly volatile both in terms of its earnings and price.

    Even after giving over 5 times returns in the past year, it still trades at over 90 per cent discount to its highest price of 2008 (Rs 417).
  • With the recent rally, valuations are now steeply expensive. Suzlon trades at a P/E of 80 times. Inox Wind (still loss-making on a TTM basis) trades at a m-cap to sales multiple of over 10 times.

The volatile and highly regulated nature of the industry, and the poor working capital metrics of the two companies call into question the sustainability of their recent outperformance.

Additionally, the high valuations do not justify themselves given the long-term outlook is ambiguous.

Also read: Three quality mid caps available at attractive valuations

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