Is Bhel the best proxy play for Modi govt?

Bharat Heavy Electricals Limited (Bhel) is at a point where we can differentiate all that went wrong with the company and the power sector over the last several years and a future which holds a lot of promise.

The June quarter numbers of the company are a culmination of low order book built up over the years and a weak execution cycle where the customer was in no hurry to commercialise its operations on account of low demand.

For the first time in 12 years, Bhel posted an operating loss on account of weak sales growth and falling margins. This was on the back of an already low base. As a result, Bhel posted 16% lower revenue, negative earnings before interest depreciation tax and amortisation (EBIDTA) of 4.9% and an 83% drop in profit.

In a post-result analyst call, Bhel’s management said that execution was impacted by stranded projects, which remain around Rs 24,000 crore or around 24% of its power segment order book.

Broking firm Barclays says that while execution will remain weak in the near term, it is largely a manifestation of weak order inflows in the past few years and no change to the slow-moving order book position. Execution trends in the near term remain sluggish and a pick-up is expected only from third quarter.

Slow moving projects are still at 10GW amounting to Rs 25,000 crore, with little clarity on when things will move on, says the Barclays note. There is Rs 3,300 crore of receivables on account for these projects.

Bhel has been carrying the negative baggage for some years now and has been at the receiving end of slowdown in order flow from public sector companies. But that seems to be changing fast.

During the current fiscal, orders for 20 Giga Watts (GW) is expected to be awarded in India. Kotak Securities says Bhel can win nearly half of these orders. The company has already bagged 4.1 GW of orders it the first quarter and is a L1 in around 5 GW of orders.

Interestingly, private players have complained against this sharp increase in order book position of Bhel. In a recent letter to the Minister of State for Coal, Power and Renewable Energy Piyush Goyal, industry body FICCI complained that few state power utilities are awarding power plant EPC contracts to CPSUs (central public-sector undertakings) on nomination basis rather than on tendering basis.

Bhel, on the other hand, says that it has been receiving negotiated orders for the last three years which accounted for nearly 18% of the order book. If a customer wants early finalisation of order and to facilitate early generation they enter into such negotiated deals, says Bhel’s management.  Prices of such negotiated orders are benchmarked to other recent orders finalised on an international competitive bidding basis. Bhel, because of its high capacity of 20 GW, is in a position to aggressively bid and offer liberal terms as compared to other players in the industry.

But going forward, Bhel will no longer be a power sector story. The company has augmented its strength in other sectors of the Indian economy that are expected to do well. The company is betting on railways and defence for its future growth.

Barclays says that the company has bid for 15 high speed trains in collaboration with Kawasaki and Toshiba (likely to be finalised by FY16 end). In Defence, the company has participated in the submarine tender and expect naval gun orders to be finalised this year.

The company is also preparing itself to capitalise on order flow in the solar power sector. Kotak Securities says the company is looking at an EPC contract of 100 MW in FY16 which is set up double in FY17.

Bhel has positioned itself well to capitalise on all the sectors of the economy which are expected to do well. Apart from a passing footnote most of the analysts have not taken numbers from sectors other than power in their calculations. Bhel can spring a surprise in the near future after all it is present in sectors which have the most performing ministers.