While the economic environment is seen improving which augurs well for L&T and BHEL, valuations aren’t cheap.
The country’s two largest capital goods and engineering majors, BHEL and Larsen & Toubro’s (L&T), performance for the September 2009 quarter was a mixed bag. While revenue growth was not exciting, operating profit margins were better than expected. In terms of order inflows, the trend was mixed. While BHEL’s order inflow was the lowest in 11 quarters, L&T reported a surge. Notably, order inflows are likely to remain healthy going ahead – BHEL has maintained its order inflow guidance of Rs 55,000 crore while L&T has upped its target for order book growth for 2009-10 to 30 per cent as against 25 per cent earlier. With industrial production showing signs of a recovery, the electronics (for L&T) and machinery and industrial products businesses (for both) should do well in the coming quarters.
Topline growth slows…
For the September 2009 quarter, L&T reported a mere 3 per cent growth in standalone revenues, which was below Rs 8,300-8,900 crore the Street was expecting. But, adjusting for the sale of its ready-mix concrete business, which accounted for roughly Rs 275 crore of revenues last year, the growth was a bit higher at 6 per cent. In the core businesses, subdued demand in the local and overseas markets pulled down the performance of L&T’s electrical & electronics (E&E) and machinery & industrial products (MIP) businesses, which reported a decline in revenues year-on-year. However, the last two quarters of 2008-09 were not good hence, the two numbers in the second half should be better and help close the year with flattish revenues. The company’s biggest division (engineering and construction; E&C), which accounted for 80 per cent of revenues, reported a 32 per cent jump in export revenues as L&T had received a good amount of orders last year. But, since there were delays project orders, domestic revenues were up just 7 per cent.
For BHEL though, its topline growth at 24 per cent was good, but far lower than 46 per cent in March 2009 quarter and about 30 per cent in June 2009 quarter. Its industrial division, which accounts for about a quarter of sales, was the culprit with revenues growing by about seven per cent – power division sales were up 23 per cent. Going ahead, the power division should continue to dominate even as the prospects for the industrial division improves.
…but margins up
The positive surprise came on the margin front. Lower commodity prices helped both companies report an improvement in operating profit margins. For L&T, better product mix in the E&E business (about 9 per cent of revenues) pushed up the division’s EBIDTA margins by 400 basis points to 17.1 per cent compared to the previous year quarter. In its E&C business, margins were however down by 20 basis points to 11.3 per cent on a y-o-y basis. The company says that the quarterly performance could see some fluctuations due to the nature of the project-related business – a yearly trend in margins gives a better picture. For September 2009 quarter, L&T’s overall EBIDTA margins were higher aided by cost efficiencies across expenditure heads which the management expects to sustain. At the net level, excluding exceptional income, net profit was up 24 per cent at Rs 568 crore and was boosted by a surge in other income. L&T earned more from treasury operations and also received export incentive arrears.
BHEL’s margins also got a boost due to the decline in commodity prices. Going ahead, analysts expect BHEL to close 2009-10 with margins of 17.5-18 per cent, with 50 bps rise in 2010-11.
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Trend in orders
The trend in orders for the two companies was however, starkly different. While L&T secured new orders worth Rs 18,365 crore representing an increase of 47 per cent y-o-y – almost double the amount of orders received in the June 2009 quarter, BHEL’s new order inflow at Rs 8,000 crore was down 46 per cent y-o-y. In case of L&T, since the company announces the big order wins as they are secured the markets were not surprised. The company had secured big projects during the quarter, including one from ONGC worth Rs 5,400 crore and two power equipment orders worth Rs 1,800-2,000 crore each. Thus, as on end-September 2009, its order book (unexecuted orders) was up 30 per cent to Rs 81,623 crore, which provides healthy revenue visibility.
For BHEL, the company has stated that post-results it has secured an Rs 5,600 crore order for supercritical power equipment which provides comfort. For companies like L&T and BHEL, a delay in some larger orders can lead to a fluctuation in the quarterly trends, which is not unusual. The broader trend, however looks comfortable.
Going ahead, L&T believes that firm crude oil prices should encourage investments in the hydrocarbon sector and infrastructure projects in West Asia. Notably, since power projects entail huge investments and given the increasing investments, L&T’s order book (power-related) is expected to increase going ahead. For now, it expects FY10 order book to end with a 30 per cent rise, as against earlier estimates of 25 per cent.
| HEALTHY GROWTH PROSPECTS | ||||||||
| in Rs crore | BHEL | Larsen & Toubro | ||||||
| FY09 | Q2FY10 | % Chg | FY10E | FY09 | Q2FY10 | % Chg | FY10E | |
| Net sales | 26,234.0 | 6,625.0 | 24.0 | 34,111.0 | 33,647.0 | 7,866.0 | 6.2 | 39,375.0 |
| OPM (%) | 16.9 | 18.6 | 338 bps | 17.8 | 11.6 | 10.6 | 140 bps | 11.3 |
| Other income | 788.0 | 196.0 | -4.7 | – | 739.0 | 218.0 | 63.9 | – |
| Net profit | 3,138 | 858.0 | 39.3 | 4,533.0 | 2,709.0 | 580.0 | 26.1 | 3,167.0 |
| EPS (Rs) | 64.1 | – | – | 92.6 | 46.3 | – | – | 58.8 |
| PE (x) | 34.6 | – | – | 23.9 | 34.1 | – | – | 26.7 |
| % change is year-on-year; % change in Q2 Net sales for L&T is adjusted for sale of RMC business L&T's net profit for FY09 and FY10 are excluding extra-ordinary items E: Estimates Source: Company, analysts reports | ||||||||
Given that NTPC has called for tenders for 11 units of 660 MW each of supercritical power equipment (expected to close by March 2010) and another 4-5 units of 800 mw each expected by the end of the current fiscal, it is good news for players like BHEL and L&T – the former has managed to secure a majority of NTPC’s orders in the past. Notably, analysts indicate that BHEL has also been able to secure a large number of orders from the private sector as well. And given its integrated operations, depreciated plant, technology tie-ups and economies of scale, they expect BHEL to secure a good number of the new orders.
Conclusion
The improving economic environment augurs well for both the companies, which are expected to witness healthy topline and profit growth as well as new order inflows over the next two years. However, given that their stocks are quoting at a PE of over 23 times their respective 2009-10 estimated earnings, valuations are not cheap and leave little room for upside in the near-term.