The stock of Bharat Heavy Electricals (BHEL) is likely to come under pressure on Monday, since it has disappointed on order inflow. Although operational performance for the December quarter (announced on Friday evening) was largely in line with Street expectations, the disappointment was the negative order inflow of roughly Rs 1,800 crore, due to cancellations and changes in scope of some projects (worth Rs 5,847 crore). But, execution was robust and helped net revenue increase 19 per cent year on year to Rs 10,743 crore during the quarter.
The stock had risen 19 per cent in the past month and closed down by 2.8 per cent to Rs 274 on Friday, even as the Sensex ended up marginally (0.9 per cent) and the Bombay Stock Exchange’s capital goods index jumped 1.8 per cent, led by Larsen and Toubro.
Weak order inflows in the nine months (totalling Rs 15,273 crore) to December has led to its order book also declining 7.3 per cent year-on-year and nine per cent sequentially to Rs 1,46,500 crore. The weak inflow trend has put a question on the long-term outlook, which the market has been sensing—it is reflected in the stock’s historically low valuation of 9.8 times (sub-10 times) 2012-13 estimated earnings, after the correction of 39 per cent in the past one year.
Says Amit Mahawar, analyst, Edelweiss Securities, “We continue to remain concerned over BHEL’s overall business profitability in the long term, given the high base coupled with increasing domestic competition and pricing pressures in the power equipment space.” Additional pressure could come from the follow-on offer, expected before the end of 2011-12.
| Q3: L&T better off | ||
| In Rs crore | Qtr ended Dec' 11 | |
| L&T | BHEL | |
| Net sales | 13,999 | 10,743 |
| % chg (y-o-y) | 23.0 | 19.0 |
| Operating profit | 1,344 | 2,080 |
| % chg (y-o-y) | 9.5 | 0.4 |
| Net profit | 992 | 1,433 |
| % chg (y-o-y) | 23.0 | 2.1 |
| E: Estimates. Source: Company, Analysts estimates | ||
Meanwhile, in the infrastructure sector, even as Larsen and Toubro (L&T) trades at a huge premium versus BHEL, analysts prefer L&T. It looks relatively better positioned on order inflows and the headwinds are not structural but led by the deteriorating macroeconomic environment, which appears temporary.
Q3: BHEL vs L&T
L&T has scored over BHEL on all the parameters, namely, growth in order book, order inflows, sales and both, operating as well as net profit margins. In contrast to expectations, BHEL’s overall revenue growth was driven by the power division, as revenues jumped 58 per cent to Rs 8,711 crore (79 per cent of sales). The sharp jump can also be attributed to the low base — the year-ago quarter had seen revenue decline by around four per cent compared to the December 2009 quarter. On the other hand, the industry division disappointed with a 37 per cent drop in revenue to Rs 2,367 crore. Though the macro environment has been weak, the decline is also due to the high base (revenues more than doubled in the corresponding period in the previous year).
Also, the company’s operating profit margin declined 360 basis points (bps), the biggest in the past 13 quarters, to 19.4 per cent due to high raw material and other expenditure.
In contrast, despite a high base, L&T’s sales growth of 23 per cent was not only better than expected, but the net profit margin was stable at around seven per cent, though the operating profit margin disappointed (down about 117 basis points year-on-year).
Going ahead, analysts suggest investors monitor performance of the industry division (railways, defence, transportation, telecommunications and renewable energy) in the coming quarters, as they are sceptical of BHEL’s new ventures and the power equipment industry’s profile has deteriorated in recent years, thanks to entry of private and foreign players. Says Mahawar of Edelweiss, “BHEL will find it difficult to build its non-BTG (boiler-turbine-generator) revenue base and, thus, will not be able to effectively utilise its unlevered balance sheet.”
Outlook
Both the events—negative order inflow and decline in order book—has happened for the first time in BHEL’s history. The outlook continues to be bearish, as competitive intensity has heightened and order pipeline is limited.
Analysts, though, have turned positive about L&T since the interest rate cycle is expected to soon reverse and the company would be the biggest beneficiary. Accordingly the stock is up 34 per cent in a month and trades at 17 times 2012-13’s estimated earnings.
Says Shailesh Kanani, analyst, Angel Broking, “We maintain L&T as our top pick in the E&C (engineering and construction) space, due to comfortable leverage position, strong order book position (Rs 145,768 crore, up 27 per cent in Q3), superior return ratios and less dependence on capital markets for raising equity for funding projects. On the other hand, we continue to maintain our negative stance on BHEL, owing to structural issues like heightened competition, margin erosion and slowing of order inflows.”
Adds Venkatesh Balasu-bramaniam, analyst, Citigroup Global Markets, “L&T remains our top industrial pick. Its diversity/strong balance sheet allows it to withstand an extended slowdown and the shares should move up if the rate cut cycle starts.”
More so, as analysts expect BHEL’s sales, operating profit and net profit to grow at a compounded annual growth rate of 10, three and five per cent, respectively, between 2010-11 and 2012-13, while the same for L&T is estimated at 19 per cent, 12 per cent and 14 per cent, respectively. Thus, they expect the valuation gap between L&T and BHEL to stay, if not widen.
