The government has shortlisted 15 public sector companies for disinvestment this financial year. In a series beginning today, we analyse the top seven companies, and give an insight into what investors should do
Despite stock valuations near their all-time lows and talk of imposition of import duty on power equipment, Bharat Heavy Electricals Ltd’s proposed follow-on public offer (FPO) might not evoke a resounding response. The government plans to sell five per cent of BHEL’s equity, the second largest company in terms of market capitalisation among the 15 public sector units (after NMDC) listed for divestment.
The Indian boiler-turbine-generator (BTG) industry is going through challenging times and BHEL, the country’s largest power equipment manufacturer, has witnessed rising competition, both from local and global players, over recent years. Analysts expect the financial performance to come under further pressure in the coming years if the sector’s prospects do not improve. Hence, despite trading at a historically low valuation of 8.6 times FY13 estimated earnings, most of them are not bullish on the stock, currently at Rs 220.45.
Says Rahul Kaul, analyst, Angel Broking, “A reducing order backlog weighs heavily on BHEL’s long-term growth trajectory. Hence, the attractive valuation is largely overshadowed.”
| NO SPARK | |||
| In Rs crore | FY12 | FY13E | FY14E |
| Revenues | 47,979 | 50,064 | 52,961 |
| % change y-o-y | 13.6 | 4.3 | 5.8 |
| Operating profit | 9,889 | 9,036 | 9,034 |
| % change y-o-y | 15.2 | -8.6 | 0.0 |
| Net profit | 7,040 | 6,217 | 6,179 |
| % change y-o-y | 17.1 | -11.7 | -0.6 |
| EPS (Rs) | 28.8 | 25.4 | 25.2 |
| P/E (x) | 7.7 | 8.7 | 8.8 |
| E: Analysts’ estimates Source: Company, Analyst reports | |||
| DECLINING VISIBILITY | ||||||
| In Rs crore | 10-Dec | 11-Mar | 11-Jun | 11-Sep | 11-Dec | 12-Mar |
| Order book | 158,000 | 164,100 | 159,600 | 161,000 | 146,500 | 134,700 |
| % change y-o-y | 17.9 | 14.0 | 7.8 | 4.5 | -7.3 | -17.9 |
| Order inflows | 12,200 | 23,500 | 2,771 | 14,300 | -1,800 | 6,829 |
| % change y-o-y | -23.8 | 4.0 | -74.4 | 5.9 | -114.8 | -70.9 |
| Quarterly figures Source: Company | ||||||
Adds Satyam Agarwal, analyst, Motilal Oswal Securities (MOSL), “BHEL’s valuations will remain under pressure due to de-rating catalysts like possible downside to our order intake assumptions in FY13/14 on account of a worsening external environment in the power sector and downside risk to FY13/FY14 earnings estimates due to execution constraints and deteriorating working capital.”
Bloomberg says of the 10 analysts’ ratings in the month of June, five have a sell/underweight call and four a neutral/hold, with price targets ranging from Rs 182 to Rs 224—only one analyst has a buy call, with a price target of Rs 264.
Pain not abating
The company has been able to maintain its profitability in most of the past several quarters because of the orders procured three to four years earlier, when power generation capacity addition started gaining pace, competition was low and the company’s hold in the industry was strong. However, a lot has changed and analysts expect BHEL’s sales and profits to come under pressure (see table), as the sector dynamics have slowed due to execution bottlenecks, increase in competition (domestic as well as foreign) and lower pricing power (witnessed in the NTPC bulk tender). Some of the pressure could be offset by the company’s efficient raw material management and stable employee cost.
Though it is venturing into other areas like transport (metro, railways), water, renewable energy, transmission and distribution, oil and gas, these will take time to meaningfully contribute to order inflows, order book and financial performance. Says Amit Mahawar, analyst, Edelweiss Securities, “We do not see any material contribution from the non-thermal revenue base over the next two-three years. We remain concerned on profitability of the industrial business, given the limited business pipeline and sustained pricing pressure.”
However, B P Rao chairman and managing director of BHEL, begs to differ. He said in the post-result conference call (last month), “If you look at the segment-wise results, including the current (March 2012) quarter, the industry segment which consists of all the above mentioned areas has better profitability than even the power segment.”
Declining visibility
The company’s order book (orders pending execution) at Rs 1,34,700 crore as on end-March 2012 was lower by 18 per cent year-on-year (first annual decline since FY99), as order inflows tanked by 64 per cent to Rs 22,100 crore. As a result, revenue visibility (order book to sales) came down significantly from 3.9 times in FY11 (peak of 4-4.5 times in FY09) to 2.8 times in FY12.
Says Agarwal of MOSL, “Given the execution period of 3.5 to four years for several power sector projects, the ratio is now in an uncomfortable zone and would constrain revenue growth.” Adds Siji A Philip, analyst, HDFC Securities (Retail Research), “If the stagnation in new order intake witnessed in FY12 continues, the performance of BHEL is likely to be affected in FY14 and beyond.”
That looks probable, as the order pipeline has dried and orders for the 12th five-year Plan have been already placed. There is still time for awarding of 13th Plan orders. The company has said it expects order inflow of 14,000-15,000 Mw in FY13 (2,820 Mw in FY12), mainly due to the spillover from FY12 and the NTPC bulk tender (6,500 Mw). But, analysts feel this is optimistic, as the company had witnessed cancellations of orders in the third quarter.
Says Kaul of Angel Broking, “The current economic landscape is still not conducive for sustained inflows, on account of multiple challenges.” Adds Siji of HDFC Securities, “The BTG segment is in a relatively long downturn cycle, similar to that witnessed in 1999-2003. It will take some time to revive, owing to fuel supply and power pricing issues.”
However, Rao, in the conference call, had said BHEL did not see any other cancellation issues. He said, “We have no indications from anybody of further cancellation of orders.”
Valuations
Meanwhile, the stock touched a 52-week low of Rs 197.8 on May 18 and is trading way below the five-year historic average of 20 times. While imposition of import duty on power equipment could help companies like BHEL to some extent in the medium term, any significant gain is likely only after power equipment ordering for the 13th Plan begins. There, too, it will depend on BHEL’s ability to secure a larger share at reasonable profit margins. In this backdrop, unless there is a marked improvement in fundamental outlook of BHEL or if the FPO is priced at a reasonable discount to the market price, subscription is unlikely to yield returns.
Among the few silver linings in all the pessimism is the high dividend yield of 2.9 per cent, and the company’s huge cash position (Rs 6,672 crore as on March 2012).
