BHEL: Results in line, but outlook remains bleak

BHEL's quarterly and annual results for the period ended March were in line with expectations but analysts are worried over slow execution, pressure on margins and lack of fresh orders. That apart, falling order book, high proportion (20-25 per cent) of slow moving orders, increase in working capital, especially receivables, are other key concerns, which continue to reflect in the financials of the company.

"We believe the power equipment order cycle will remain weak in FY14. The impact of a weak cycle should reflect through revenue growth declines in FY14; however, a sharp margin decline is likely only from the second half of FY15, when weak margin orders start to get recognised," said Venugopal Garre, who tracks the company at Barclays Capital.

In the light of these issues, analysts continue to ascribe lower valuations to the stock. Analysts are expecting BHEL's earnings per share (EPS) to fall from Rs 27.35 in FY13 to about Rs 19.5 in FY15. In this scenario, they believe there is little scope of re-rating of valuations. At the current market price of Rs 196, the stock valuations appear reasonable at 7.2 times FY13 earning, but the PE works out to 10 times if FY15 numbers are considered.

  During the quarter ended March 2013, the company reported 4.2 per cent decline in net profit to Rs 3,237 crore, largely on account of a 113 basis points drop in operating profit margins to 24.7 per cent. During the quarter, revenues declined 2.2 per cent, which was largely the result of slow growth in industrial segments as the power segment reported flat growth in revenues.

On an annual basis as well though BHEL's revenues grew a mere one per cent, profits declined 5.6 per cent as a result of lower margins. Declining margins is an industry wide phenomena, the result of higher competition, high capacity (availability) and lower demand. "Pricing in BHEL's recent orders is at Rs 2.5-2.6 crore per Mw, which our channel checks indicate is the break-even level for BHEL. Hence, we expect margins to contract to 14 per cent by FY15 from 21 per cent in FY12," said Bhavin Vithlani, who tracks the company at Axis Capital, in a recent note.

This decline in margins (estimated to fall by 750 basis points) over the three-year period will have a huge impact on earnings, given that sales are also expected to fall as a result of slow execution. What's also worrying is the trend in orders. In FY13, though order inflow growth at 43 per cent looks good, it was aided by a low base of FY12 and secondly, was lower than expectations, mainly due to industry segment (22 per cent of the revenue), which reported 53 per cent decline in new orders. On the other hand, the order book (orders pending execution) continues to decline. This has fallen from Rs 1,34,700 crore in FY12 to Rs 1,15,200 crore in FY13. It is further expected to dip to around Rs 1,10,000 crore in FY14. The current order book is around 2.4 times its FY13 revenue, which is much lower than almost four times seen in recent years.

While lack of revenue and earnings visibility for BHEL are issues, increase in new orders is also critical for any improvement in sentiments which isn't likely anytime soon.