HSBC: BHEL- Deceleration in growth- Downgrade to SELL

BHEL- Deceleration in growth
 Order execution to pick up in interim (c22% in FY12e vs. c19% in
FY10), but order inflows to decelerate to c6% in FY11-17e
 Earnings growth to slow to c5% in FY13-17e from c30% in FY07-
12e; competition from domestic and foreign suppliers to increase
 Downgrade to UW from OW; lower our TP to INR2,300 from
INR2,850


Investment summary
Execution remains key as order growth slows
and competition kicks in
While we expect significant capacity additions in
the power sector over the next 5-10 years, we
expect the yearly run-rate of capacity addition to
stabilize at c17GW per annum. This, in our
opinion, will depress the y-o-y growth in BHEL’s
power equipment orders relative to the growth
seen in the last five years (order intake has gone
up from c3.4GW in FY06 to c16.5GW in FY10).
Hence, in the near term (i.e. over the next 2
years), we believe that the execution of its
currently sizeable order book will remain key for
BHEL to achieve the expected earnings growth.
Additionally, in the longer term, we expect
competition to kick in and pose an incremental
challenge to BHEL as some of the new entrants to
the BTG segment, such as L&T (4GW) and
Thermax (3GW), are currently adding a
significant amount of capacity and will compete
with BHEL as suppliers of power equipment.
Hence, although the outlook for the power sector,
including both utilities and suppliers, remains
robust, the future of BHEL will depend a lot on its
ability to step-up in terms of execution, especially as
the competition is lurking just around the corner.
Currently, our FY11-12 estimates assume that
BHEL will indeed ramp up its order execution
rate to 12-13GW of BTG equipments over the
next two years compared to c5.2GW
commissioned in FY10. However, we remain
cautious on FY13e, where we are c6-7% below
consensus on sales and EPS. We note that
historically, power capacity addition in any fiveyear
plan has always been back-end loaded and
we expect this trend to persist going forward.
Hence at BHEL, we expect a downward step
change in order execution and the annual
deliveries during FY13 and FY14 (i.e. for the first
two years of the 12th five-year plan), before the
momentum picks up again in FY15-17.