Suzlon Energy: A Trap or a Big Wealth Creation Opportunity? 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

Now, there are a lot of qualities that differentiate a successful investor from a failed one.

But there's one quality that often gets ignored.

I believe this quality is the most important of all.

One cannot become a successful investor unless one masters this quality.

This quality is the ability to separate investment from speculation.

Successful investors know how to differentiate between investment and speculation. In fact, they know this better than most other investors.

And this is not all. They build this huge wall between investment and speculation and rarely jump over and go to the speculative zone.

On most occasions, they stay well within the investment side and get heavily rewarded for it.

This is not the case for most of us.

First, our lines between investment and speculation are blurred at best.

And even where we know what investment is and what is speculation, we lack self-control.

We often turn greedy and end up speculating more than we should. Or we are so fearful that even when a stock becomes an attractive investment, we deem it to be speculative and stay away from it.

So, how exactly do we correct this mistake? How do we differentiate between an investment and a speculation? And once we do so, how do we ensure we always stay on the right side of investment?

Let's try and understand this with the help of a case study on Suzlon Energy Ltd.

The stock is a hot property these days. It is up a huge 14x since the lows of March 2020 and as per experts, there could be still a lot of upside to come.

But please note that it was not always like this. In fact, pre 2020, the stock had been one of the biggest wealth destroyers in the Indian stock market.

Just to put things in perspective, despite the stock going up a huge 14x in the last three and a half years, it is still down a huge 93% from its October 2007 highs.

Put differently, for someone who would have invested back in October 2007, his loss is still more than 90% despite the 14-bagger return since March 2020.

But why has the stock lost so much since 2007. Well, it is thanks to a brutal combination of demand destruction, a highly leveraged balance sheet as well as regulatory flip-flops. All these factors had turned the stock into one of the biggest wealth destroyers.

For e.g. between FY13 and FY22, the company has been profitable in only one year. Its net worth has gone into the negative since FY14.

So, while the business is still struggling, the stock price has done really well.

As I highlighted, it has multiplied more than 14x since the lows of March 2020.

It has more than tripled in the last one year.

To be honest, this is not the first time the stock has attempted to make a comeback. It has tried doing it few times in the past as well.

But to me this appears to be the stock's strongest comeback bid. It looks like the fundamentals are finally changing for the better.

In fact, the commentary from the management at the end of FY23 results was quite encouraging.

Here are the key positives...

• Consolidated FY23 PAT before any exceptional items turned positive after six years.
• Substantial reduction in net finance costs from Rs 7.1 bn in FY22 to Rs 4 bn in FY23.
• Net debt to EBITDA (pre-forex) is 1.4x vs 7x for FY22.
• Costs came under control as the economy and commodity prices stabilized.

So, as you can see, profits have received a big boost. Both debt as well as interest costs have also come down a lot. The order book and hence the revenue visibility, is also looking stronger than ever.

So has the risk-reward equation finally turned in favour of the investors after the improvement in fundamentals that we just saw?

I'm not so sure.

You see, as per sensible investing principles, one needs to have some understanding of the intrinsic value of the stock so that we can consider buying it at a discount to intrinsic value. So if the intrinsic value is Rs 100, buying it at Rs 70 or lower is a great thing to do.

However, we are not in a position to value the stock right now because we don't know the earnings the stock is capable of achieving on a sustainable basis.

Both, its losses as well as profits have been all over the place over the last few years, making it difficult to value the company on a PE basis.

We can try to take the future earnings into account. However, we need some kind of assurance about the profit it can achieve on a sustainable basis.

We don't think we will be following good investing principles if we value the company on just on its future earnings.

This way, any loss-making company can claim to have any market value it likes. This is a dangerous path that we don't like to follow.

Valuing the company based on book value is another option. However, the company's less than Re 1 book value per share versus the current price of Rs 14 per share, makes this exercise meaningless.

The company's book value is in rebuilding phase. Therefore, it doesn't make sense to value company on its current book value.

Besides difficulty in valuing the company, there's also the issue of debt which continues to remain higher than equity.

There is always a risk it can spiral out of control given the working capital-intensive nature of the business.

I'm of the firm belief that every investor should have his or her criteria of investment versus speculation.

The most successful investors are the ones who know the boundary that separate investment from speculation and have the discipline to invest within that boundary.

They rarely venture outside these boundaries.

My idea of an investment is a stock with a good balance sheet and decent, if not the best track record.

Unfortunately, Suzlon, despite strong signs of a turnaround and concrete plans for de-leveraging, falls outside my boundary.

It hasn't turned consistently profitable yet and still has high debt.

So, I may still not call it an 'investment'.

At best, it could be termed as an 'intelligent speculation' based on how I define my own boundary.

And intelligent speculation is something that you do with only a small part of your portfolio. You never make it your core holding.

Core holdings are meant for businesses that are within your boundaries and where your understanding of the earnings power of the business and its intrinsic value is quite reliable.

Now this doesn't have to be the case for you. Maybe Suzlon's business is well within your investment boundary.

But if you're confused whether to invest in the stock or not, then perhaps you don't know your boundaries well enough.

So, it would be best to sort that out first.

Only then take a call on Suzlon based on whether it falls outside or inside your boundary of investment.

That's all from me today. Good bye and happy investing.