Verdict: Skip it

IPO Snapshot:

Sterling and Wilson Solar has entered the primary market on Tuesday 6^th August 2019, to raise Rs. 3,125 crore via an offer for sale (OFS) of equity shares of Re. 1 each by both the promoters, in the price band of Rs. 775 to Rs. 780 per share. 75% of the issue is reserved for institutional investors, 15% for HNIs and only 10% for retail. Issue represents 25% of the post issue paid-up share capital and closes on Thursday 8^th August, with listing likely on 20 August.

Company Background:

Having commenced operations in 2011, Sterling and Wilson Solar is the world’s largest pure-play solar engineering, procurement and construction (EPC) company with 4.6% global market share, and also the largest in each of India (17% market share), Africa (37%) and Middle East (40%). Part of the Shapoorji Pallonji (SP) Group, which owns 2/3^rd stake in the company, balance 1/3^rd stake is owned by Promoter Chairman Mr. Khurshed Daruvala. To de-risk operations, company has spread presence across 26 countries. However, top 2 customers accounted for 37% and top 5 contributed to 54% of FY19 revenue of Rs. 8,240 crore. As of 31-3-19, company’s order book stood at Rs. 3,832 crore plus letter of intent of Rs. 3,908 crore (of which, Rs. 2,196 crore converted to definitive contracts). Thus, firm order book stands at Rs. 6,028 crore, representing 73% of FY19 revenues.

Objects of Issue and Shareholding:

The issue is 100% OFS, with both shareholders offering shares to public in 2:1 ratio, mirroring their ownership in the company. SP Group’s shareholding will shrink to 50% from current 67%, while Mr. Khurshed Daruvala will own 25%, down from current 33%.

Company was formed out of de-merger (effective 14May18) of Sterling and Wilson Private Ltd (SWPL)’s solar EPC business. In the process of taking over all assets and liabilities of SWPL’s solar EPC business, loans to related parties (3 fellow subsidiaries) of Rs. 1,935 crore came on company’s balance sheet, as of 31-3-19, on the asset side against a corresponding low-cost short term borrowing on the liability side. This loan amount to fellow subsidiaries stood at Rs. 1,715 crore, as of 31-12-18, as per DRHP, indicating rise of Rs. 220 crore between Jan-Mar 2019. The RHP assures investors that both the promoters will utilise part of IPO proceeds to fully repay these loans within 90 days from listing. Thus, while the company will not directly receive any proceeds from the offer, its debt of nearly Rs. 2,000 crore (debt equity ratio of 2.1:1) will stand eliminated as an outcome of the IPO. In essence, the IPO is facilitating correcting the anomaly on the balance sheet, which if not attended to, can raise potential corporate governance questions.

Financials:

FY19 revenue of Rs. 8,240 crore rose 20% YoY, with Middle East and Africa being the largest geography accounting for 48% revenue share, followed by India at 30%. Since material and direct project costs average 88% of revenues, EBITDA (excluding other income) came at Rs. 642 crore, translating into EBITDA margin of 7.8%, same as of FY18. If one were to adjust the finance cost of Rs. 60 crore incurred effectively for unsecured loans taken for fellow subsidiaries (which was not there in FY18), adjusted EBITDA for FY19 stands at Rs. 582 crore, indicating 7.1% EBITDA margin for FY19, which is 76 bps drop YoY, in the year, when topline grew at 20%.

In FY19, company’s bad debts have also spiked, with write-offs and provisions aggregating Rs. 24 crore in FY19 and were also as high as Rs. 29 crore in FY17. Thanks to other income of Rs. 210 crore (one-off for FY19, as mainly interest on loans to related corporate entities, which should dis-continue from H2FY20) and overseas tax sops (sustainable in future), effective tax rate is 15-17%, leading to FY19 PAT of Rs. 638 crore and EPS of Rs. 39.85 for FY19, on an equity of Rs.16.04 crore. FV was split to Re. 1 each on 11^th Jan 19 from Rs.10 earlier.

Based on the stage of project execution, revenue and profitability are not steady and fluctuate significantly YoY and QoQ, as depicted in the financial extract below:

^derived from 9MFY financials presented in DRHP

Company’s FY17 revenue fell 40% YoY to Rs. 1,640 crore from Rs. 2,740 crore in FY16, due to lack of new international EPC projects that year, adversely affecting margins. FY17 EBITDA fell sharply to Rs. 55 crore (3.3% margin) from Rs. 189 crore (6.9% margin) in FY16. Similar fluctuations was witnessed in Q4FY19 revenue, which contracted 36% YoY to Rs. 2,325 crore, as 1.2 GWp Abu Dhabi project commenced in Q3FY18 lead to surge in Q4FY18 revenues and a matching order was not present in Q4FY19. What is most surprising is, despite lower volumes margins in Q4FY19 spiked to levels never recorded in company’s history – EBITDA of 14.3% (as material and direct project cost dropped to 81% vs 88-89% historically), which look unsustainable, and raise question marks due to it coinciding immediately prior to the IPO. 

Since company follows an asset-light business model, its FY19 RoE came at 62% on net worth (31-3-19) of Rs. 841 crore. Working capital needs are low as customer contracts are short duration, with advance payment for some deliverables, while supplier payment cycles are longer (4 months). Despite this, however, outstanding debtors were not abysmally low, both as of 31-3-19 (2.8 months) and as of 31-3-18 (3.2 months). 

Business Risks: 

1. Company undertakes solar EPC projects on fixed price basis over short term, for which PV modules are sourced from third party suppliers, bearing product quality risks. Company guarantees project completion within timelines and provides for maintaining specified plant performance ratio generally for up to 2 years post commissioning. While it has not paid for any damages in FY18 and 19 towards performance ratios, between May-July 2019, company received claims from Abu Dhabi project for Rs 6 crore for faulty equipment supplied by a supplier, for which recourse may/may not be successful. It has also faced project delays in Argentina, Namibia, Morocco and Zambia in the past which may harm reputation and financials.
2. Global operations, although fetching higher margins, are difficult to execute and subject to very high geographic, political and economic risk. History has enough examples of domestic companies across sectors (consumer, commodity, construction, energy) struggling overseas, especially in Africa and Latin America. So far, company’s presence is largely across Middle East and Africa, as along with India, these 2 geographies accounted for 90% of revenue in FY18 and FY19. As company expands deeper into South East Asia and Americas, the ride ahead may be full of learnings and challenges.
3. Since international geographies account for a large share of revenue (70% in FY19), current trend of strengthening rupee also does not bode well for margins.

Valuation:

At Rs. 780, market cap will stand at Rs. 12,508 crore, which discounts FY19 earnings by a PE multiple of 19.6x, which is quite stretched for an EPC company operating on single digit core margins. Few other pointers making the pricing aggressive are:

1. On Re. 1 face value, issue price of Rs. 780 appears high
2. While there are no listed peers, India’s largest construction company L&T with 10x the size of Sterling and Wilson and diversified presence across sectors and geographies, is ruling at PE multiple of 18x.
3. Poor track record in terms of returns generated by the solar sector for investors
4. Infra sector is not well-received on the bourses currently.

While company’s topline may continue to rise due to size of global opportunity at USD 15 billion and solar energy getting competitive due to drop in prices of PV modules, its margin expansion may be challenging, as seen in FY19 and hence operating margins need to be monitored closely. Also, investors do no receive steep fluctuations in quarterly performance well, as was the case in Q4FY19 highlighted above. While Shapoorji Pallonji tag helps company source clients globally and is also a well-respected name in India, past financial transactions keep us in a wait-and-watch mode.

Conclusion:

Fluctuating margins, weak investor sentiments, especially towards infra sector, and aggressive pricing make this issue best avoided.

Grey Market Premium (GMP) of Sterling and Wilson: Grey Market Premium of Sterling and Wilson is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in Pathshala column.

Disclosure: No Interest.