Equipped to grow

POUND WISE

Strong order book position and healthy industry outlook make BHEL a compelling investment

The share price of India's largest power equipment manufacturer BHEL has corrected significantly in the last eight months, to some extent led by the correction in the broader equity market.

Among other reasons for the fall is the de-rating of capital goods sector on account of an expected slow down in India Inc's capital expenditure as well as the pressure of margins.

Concerns pertaining to company's rising employee cost and higher competition from the domestic and overseas players in the power equipment (raising worries over sustainable growth in earnings) have also impacted negatively.

While some of the concerns may be partly true, the stock has fallen 53 per cent since its peak in November 2007 to Rs 1,380 currently, and offers a good investment opportunity.

Stable growth
The company continues to get orders from power utilities and captive power generation companies resulting in strong order book of Rs 91,400 crore, which is over four times its FY08 turnover (in last three months, BHEL has received new orders worth about Rs 10,400 crore).

The strong revenue visibility along with better industry outlook is the indication of stable growth in the future, as well.

Also, the capacity addition undertaken by BHEL will lead to higher operating leverage and faster execution of orders-long delivery periods tend to act as a hindrance and at times lead to potential customers seeking alternatives to BHEL.

As far as competition is concerned, even after the stiff competition from Chinese players, the company has bagged orders. Analysts believe that the company scores high on the quality and service parameters, which plays in its favour.

"Some of the BHEL's equipments, which are established at NTPC's power plants, are operating at 90-95 per cent PLF (plant load factor) as compared to the Chinese equipments, which are suitable for 60-65 per cent PLF. Also, BHEL being a domestic player can give better service,'' says an analyst tracking the power sector.

The competition from domestic players (most in joint venture with foreign players) like L&T among others could be one concern. However, it will take a long time for them to bring up new capacities, which in any case are considered to be small given the huge opportunity in the power equipments business.

Margin 'al' impact
On the margin front, the company is certainly under pressure given the rising cost of steel and other materials required along with higher provisioning of the employee cost.

However, the company is able to manage since about 50 per cent of its orders are having price variation clauses. While for the balance, BHEL has adopted a strategy whereby, it orders for the raw material in advance where it has emerged a L1 winner.

Also, with the full impact of the recent expansion, the economies of scale will work in favour of the company, thereby helping it sustain margins. According to the management, manpower cost, which used to be 18 per cent of sales, has declined to about 13 per cent.
 

ORDER BOOST
Rs crore	FY08	FY09E	FY10E
Net sales	19,365.00	25,175.00	33,231.00
OPM (%)	17.40	17.00	17.00
Net profit	2,859.00	3,726.00	4,918.00
EPS (Rs)	58.41	76.12	100.47
P/E (x)	23.60	18.10	13.70
E: Estimates

A bigger opportunity
BHEL manufactures over 180 engineering products having different applications mainly in power generation, transmission and transportation. The company is a key beneficiary of the ongoing investment in the power sector.

According to estimates, out of the total capacity addition of 78,000 in the 11th Five Year Plan, orders for about 70-75 per cent have been placed. The orders for the remaining are expected to flow till the December 2009, translating into more opportunities for the company.

The capital outlay for EPC work (equipments and the balance of plant work) for the remaining capacities could be in the range of Rs 55,000-60,000 crore.

Higher visibility
Not only this, as the orders for the 12th Five Year Plan (capacity addition of 82,000 mw) has started to flow in, the company is expecting new orders to the tune of Rs 40,000-50,000 crore in FY09.

Analysts also expect that over the next 12 months, the projects of about 18,000 mw based on the super critical technology will be announced, where BHEL has scaled up its capabilities and hence, stands a good chance to secure some of these.

Besides, demand from the captive industrial power segment continues to grow "" orders booked during FY08 were at an all time high at Rs 7,850 crore. BHEL has recently bagged few prestigious orders from the Hindustan Zinc and Mittal Refinery.

Analysts estimate that the company could end FY09 with total outstanding orders of about Rs 128,000 crore, which is about six times its FY08 revenue.

This also provides higher visibility in revenue and earnings (till FY11). On the back of higher order book and commissioning of new capacities, the company is estimated to witness revenue growth of about 30 per cent in FY09, and about 25 per cent in the FY10.

Augmenting capacity
Considering the piling order book and higher demand for power equipments, the company is gradually raising its capacities and upgrading technologies.

BHEL has introduced the 800 mw thermal sets with supercritical parameters suited to Indian conditions (both, Indian and imported coal can be used as input).

Also, the company is extending its capability for higher rating (mw) hydro sets and advanced class Gas turbines to cater to upcoming market requirements. Meanwhile, the company increased its manufacturing capacity from 6,000 mw to 10,000 mw in December 2007, which is now fully operational.

Under the second phase of expansion, the company is adding another 5,000 mw of capacity, which will start contributing in phases from December 2009.

Additionally, the acquisition of BHPV (Bharat Heavy Plates and Vessels) will help increase the execution capability of BHEL by about five per cent in FY09 and by 10-12 per cent in the later years. BHEL's joint venture with NTPC will also enhance its execution capabilities.

Valuations
The current stock price of BHEL has excessively built in concerns over its outlook and a probable slow down. However, considering the strong current order book and healthy long-term outlook on the back of strong demand for power equipment, the stock should see an upward re-rating.

Also, as the company is making its efforts to scale up its other businesses (such as transportation) and diversification in the oil rigs will further boost growth rates.

Nevertheless, the valuations are compelling. At Rs 1,380, the stock is trading at 18 times its estimated earnings in FY09 and 13 times its FY10 earnings. Investors with lower appetite for risk can invest in the stock for healthy gains in the long term.