ReNew Energy: Potentially Differentiated Offerings, Not Investment Grade Just Yet (RNW)

Funding Briefing

Vitality suppliers are ripe to catch a bid as we tide by numerous macroeconomic elements, every having implications to the price and profitability of vitality provide. Renewables are the wild card within the combine, providing potential differentiation from standard vitality purveyors by way of pricing and core choices. ReNew Vitality (NASDAQ:RNW) has emerged as one such title, extra so with its footprint within the Indian market.

RNW is a supplier of renewable vitality to the Indian market. Its clear vitality portfolio is without doubt one of the largest globally. It at present stands at ~13.7 GW of capability as of June this 12 months. RNW additionally provides storage and trades in carbon markets. The corporate listed on the NASDAQ in 2021, and since, it is fairness efficiency hasn’t lived as much as the hype, regardless of discovering a backside earlier within the 12 months (see: Determine 1).

This report will unpack all the shifting components within the RNW funding debate and hyperlink this again to why I imagine it is a maintain for now. While there are compelling arguments for the corporate’s aggressive place, I am not seeing this pull by to the economics to say it is a screaming purchase. Web-net, fee maintain.

Determine 1.

Dive into Indian renewables market

India’s renewable vitality market has undergone exceptional development and transformation over the past decade, pushed by a number of crucial elements, together with (i) authorities insurance policies, (ii) its world local weather commitments, and (iii) financial dynamics. India had set formidable targets of attaining 450GW of renewable vitality capability by 2030, specializing in photo voltaic, wind, and hydroelectric energy. It is projected to develop at CAGR 7.3% into 2028.

Major renewables sources

1. Solar energy has emerged because the main renewable vitality supply, contributing considerably to the nation’s whole renewable vitality capability. India is a sunny place, and the ample daylight, coupled with declining photo voltaic panel prices, has accelerated the adoption of photo voltaic vitality. Each utility-scale and rooftop photovoltaic initiatives are capturing funding.
2. India also has a well-established wind vitality sector, and the nation is among the many largest wind vitality producers worldwide. Technological developments in wind generators and supportive insurance policies have inspired additional growth. Coastal areas are additionally exploring offshore wind initiatives as a result of their potential.
3. Given India’s various geography, hydroelectric energy performs an important function within the nation’s renewable vitality combine. The federal government has put its concentrate on enhancing hydroelectric effectivity and is exploring pumped hydro storage.

Economics and funding flows

The price of photo voltaic and wind vitality applied sciences is lowering, making them more and more aggressive with standard fossil fuels. In India, this has resulted in record-low tariffs in photo voltaic and wind auctions, driving funding to the sector.

Authorities initiatives resembling ‘Make in India’ and ‘Atmanirbhar Bharat‘ have additionally promoted home manufacturing. So the bottom is there for its renewables business to develop competitively for my part.

Essential insights from funding information sample

Q1 FY’24 takeouts

[Note: as a reminder, RNW reported its first quarter fiscal ’24 results. This corresponds to Q2 CY 2023. For simplicity and consistency, I’ll talk in terms of 2024 from here. As a further reminder, all figures are quoted in USD, at the cross rate at the time of RNW’s reporting].

In its Q1 FY’24, RNW clipped whole income of ~$300mm, which decreased from $305mm final 12 months It pulled this to adj. EBITDA of $227mm on earnings of c. $36mm, in comparison with a internet lack of $ 1mm in Q1 ’23.

As to the unit economics, notice the next:

• RNW offered ~5.1Bn kWh of electrical energy through the quarter, a lower of 1.4% YoY.
• Concerning the cut up, gross sales of electrical energy from wind property decreased by 8.8% YoY, whereas the gross sales of electrical energy from photo voltaic property elevated by ~9%.
• Electrical energy gross sales from hydro property decreased by ~9% YoY.

Determine 2.

A degree to think about is that RNW’s working portfolio has grown considerably since ’22. It reached 8.4 GW in Q1, a rise of 47% in comparison with its Q1 ’22. Put in capability has additionally elevated 10% from 7.6 GW to eight.4 GW within the final 12 months. On the finish of June, RNW’s portfolio comprised 13.7 GWs, with round 8.4 GWs of this commissioned and the remaining 5.3 GWs firmly dedicated.

Determine 3.

Wanting forward, RNW plans to fee between 1.3—1.7 GW of initiatives through the the rest of the fiscal 12 months. The corporate’s Peak Energy and RTC initiatives are anticipated to be important contributors to development, and administration initiatives EBITDA development of >35% in its fiscal ’25, and it goals to succeed in goal commissioning steerage of 1.75—2.25 GW by the tip of FY’24.

Evaluation of financial efficiency

Within the utilities sector, particularly in vitality, lack of differentiation is a significant problem. Suppliers battle to face out by way of price, product choices, and branding, leaving few obvious client benefits for suppliers. Most suppliers are topic to comparable pricing mechanisms and are indistinguishable given they’re all promoting vitality and so forth. That is much like commodity producers, the place there is no such thing as a price differentiation/price management, so the important thing insulators are elements of manufacturing and effectivity. Consequently, the financial traits of every firm develop into essential in figuring out these with the aggressive place.

Renewables present a possible antidote to this conundrum. The interaction of tendering and offtakes is totally different to the normal vitality sector, so there’s scope to see larger post-tax margins together with capital turnover, probably rising the aggressive benefits of the sector.

Determine 4 depicts RNW’s money conversion cycle (“CCC”) and days gross sales excellent (“DSO”) on a rolling TTM foundation since ’21. The corporate listed in that 12 months, however we’ve knowledge courting again to FY’20. Critically, the trailing CCC has tightened by ~150 days from 2022 to ’23, coming in at 51 days throughout RNW’s Q1 on DSO of 102 days. At this fee of conversion, it might flip over its NWC 6.3x a 12 months given the common of the final 2 quarters (assuming a 365 day 12 months).

The speed of return produced on RNW’s capital investments is what I am most enthusiastic about. In Determine 5 you may see it had put $8.2Bn or $22.30/share in danger within the enterprise by Q1. This produced $509mm or ~$1.40/share in trailing post-tax earnings, solely 6.2% return on funding, in step with historic averages. The returns on new capital deployed aren’t a saviour right here, down 6% within the TTM, and simply 3% within the December interval.

However there is a key takeout right here, and it pertains to what I used to be speaking about with differentiation and so forth:

1. RNW’s post-tax margins are remarkably excessive, coming in at 54% within the TTM. On the similar time, capital turnover is statistically low, at 0.11x of gross sales continually.
2. This squares off with the economics of the enterprise for my part. For one, renewables usually are not but broadly adopted. So it is unlikely to see capital behaving effectively. Relatedly, alternative models have not been referred to as for on current placements at crucial mass.
3. However what’s intriguing is the marginal distinction in renewable vitality provide and standard vitality provide. Examine this to ONE Fuel (OGS) for instance, a reputation I lately lined. It’s working ~12% post-tax margins, ~0.4x capital turnover, ~4–5% return on capital. The distinction on the margin is staggering right here, elevating the query—does RNW take pleasure in client benefits with its choices? Extra possible for my part, is the price differentiation issue, in that renewables are merely dearer proper now than standard vitality provide, feeding extra down the P&L for RNW. Nonetheless, these are very compelling economics, ought to the corporate enhance its capital effectivity numbers.

As talked about earlier, I am tasked with benchmarking firms towards their propensity to compound capital at above-market charges of return. We take into account this 12% in our fairness holdings, reflecting long-term market averages. So RNW is producing a sequence of financial losses utilizing this conference. Determine 6 outlines this in granular element. At an $8.2Bn funding, the TTM post-tax earnings it will want to supply at a 12% cost is $991.4mm, whereas it did $509mm in Q1. The following financial loss per share was $1.30. Financial earnings are undoubtedly preferable.

Expectations at steady-state operations

RNW’s working drivers since 2020 are famous in Determine 7. As talked about, we’ve knowledge going again to 2020 for the corporate. Revenues have compounded at 3.8% on very enticing working margins. Naturally, the majority of capital allocation has been towards fastened capital, whereas NWC necessities have narrowed. For each new $1 in gross sales, RNW invested $8.30 in direction of its fastened asset base.

Carrying these assumptions ahead is sort of telling. Administration are projecting ~$2Bn in CapEx for its FY’24. If it maintained the regular state proven above, it will fall brief by ~$500mm. To hit that degree of funding both must both:

(i). Enhance income development and preserve the identical fee of fastened capital funding, or

(ii). Up the capital allocation in direction of fastened property regardless.

Determine 8 reveals the capital necessities at a continuing 4.5% income development fee, not far forward of consensus estimates. Right here it will want to speculate ~$2Bn for the 12 months into its CapEx applications, ~$350–$420mm per quarter, equating to ~60% of the trailing NOPAT every rolling interval, or >100% of the potential FCF every interval.

Valuation and conclusion

The inventory sells at 15x ahead EBIT and has solely created $1.80 in market worth for each $1 in internet asset worth to this point. As you may see in Determine 9, it trades at a reduction to capital invested. In different phrases, the market does not worth RNW’s property very extremely in any respect, by way of their earnings energy shifting ahead. In reality, contemplating the capital productiveness, it could be the market has RNW priced appropriately at its present marks.

Compounding the agency’s fairness worth on the numbers proven in Determine 8, because the perform of its ROIC and reinvestment fee, I get to $7.28/share in implied fairness worth for the corporate. This degree is supported in technical research as properly, as seen within the P&F examine in Determine 11. In proportion phrases, that is 28% potential worth hole. However in actuality, it is $1.60 in capital appreciation per share, so a big place dimension can be required to take this on for my part, one thing I am not dedicated to with the chance profile at play.

Determine 11.

In brief, there are compelling arguments to make within the funding debate for RNW. Chief amongst these are the core choices in renewables. Second to this are the excessive post-tax margins it produces on ~$8.5Bn of capital in danger, opposite to conventional vitality suppliers. It is going to be investing closely for development going ahead, too. However the flip aspect is capital productiveness is low for RNW. This can be a high-margin, low capital turnover enterprise, that has tremendously excessive reinvestment necessities to keep up its aggressive place. I’ve estimated it wants to speculate $8 for each $1 in new gross sales at a 4.5% income development fee to keep up aggressive and hit its inside CapEx targets. Hassle is, the follow-through on earnings from that is unattractive, throwing off 6–7% charges of return on a rolling TTM foundation. Cash might be compounded at extra enticing charges elsewhere at this cut-off date, with a lot decrease danger for my part. Web-net, fee maintain.