BHEL stock powers up on improved prospects for growth, new orders

Many analysts though are bearish due to state-owned firm's muted financials and likely low valuation

The announcement that Bharat Heavy Electricals (BHEL) had bagged a new order worth Rs 4,000 crore led to a spike in the share price to a multi-year high. The order is from Mahan Energen (erstwhile Essar Power MP), a wholly-owned subsidiary of Adani Power, for supplying equipment and supervising the erection and commissioning of a 2x800 MW supercritical thermal project at Bandhaura, Madhya Pradesh.

This is one of several large orders the engineering public sector undertaking (PSU) has received. They include an order of Rs 2,240 crore from NHPC for a project in Roing, Arunachal Pradesh, and orders from the Railways for the 80 Vande Bharat sets (in joint venture with Titagarh Wagons) as well as orders from the Indian Navy for electrical systems for guns.

In the calendar year 2023, BHEL has received approximately Rs 21,800 crore worth of new orders. The order book stands at over Rs 1 trillion, which is over 4x the FY23 revenues, indicating assured growth through the next few years if order execution is up to par.

Nevertheless, many analysts are pessimistic about BHEL with “sell” or “reduce” ratings even though the stock has been hitting new highs, indicating valuation mismatch. The demand outlook for fresh orders seems robust due to capex across conventional and renewable power generation segments, as well as power T&D (transmission and distribution), defence-related orders, and the Railways. In addition, there’s demand from new areas such as data centres, the EV (electric vehicle) ecosystem, and green hydrogen. Much of the demand is led by government policy but there’s also private sector capex.

The EPC (engineering, procurement and construction) and BTG (boiler, turbine and generator) markets for thermal power equipment are effectively duopolies with only Larsen & Toubro and BHEL in contention for most orders. It’s likely that BHEL’s order book will continue to swell through FY24 and FY25, given the policy trend and apparent recovery in private sector activity. At least 5-6 GW of thermal tenders could be on offer annually for the next several years, since 25GW of thermal capacity expansion is on the cards by 2030.  

The negative attitude of analysts is because earnings estimates for FY24 are weak, and a pickup in EPS growth is not expected till the second half of FY25. Some analysts have even cut earnings before interest, taxes, depreciation, and amortisation (Ebitda estimates) for FY24 to factor in delayed order execution and inflows and weak gross margins. The nature of the capital goods business leads to very high working capital requirements and high interest costs, leading to negative cash flows.

BHEL also has very high receivables. The company had negative operating cash flow (OCF) with outflow of Rs 740 crore in FY23 vs positive OCF of Rs 660 crore in FY22. Apart from poor gross margins at 30 per cent vs pre-pandemic levels of 40 per cent, there’s been a rise in total debtors to Rs 36,300 crore. The receivables are a key area of concern.

The financial stress is one reason why valuations are likely to be low for BHEL. Whether the metric is enterprise value/Ebitda or price-to-earnings ratios, the stock would be reckoned over-valued at current levels by conservative analysts, after its big run up. The optimists are betting on better-than-expected improvement in the receivables situation and faster order execution.