BHEL:Positive results;concerns on margins, competition: Kotak Sec

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Bharat Heavy Electricals (BHEL)
Industrials
Positive results; however, highlight concerns on margins, competition. BHEL
reported strong results (revenues up 25.7%, margin expansion of 70 bps) ahead of
estimates. But margins are likely to remain under pressure given recent commodity price
rise (even in 2Q contribution margins contracted by 230 bps). Other concerns relate to
likely preference of Chinese vendors by large utilities, and increased competition in
NTPC’s boiler tender. Backlog remains strong at over Rs1 tn. Reiterate REDUCE.

Strong results; management confident of near-term growth; margins likely to be under pressure
BHEL reported a strong revenue growth of 25.7% yoy to Rs83.3, slightly ahead of our estimates
(by 4%). EBITDA margin at 17.7%, up 70 bps yoy, were also ahead of our estimate of 17%. The
slightly higher-than-expected revenues as well as EBITDA led to a net PAT of Rs11.4 bn in 2QFY11,
up 33% yoy and about 11% ahead of our estimate of Rs10.3 bn. The margins were likely
supported by one-off gains in other expenses, while contribution margin has in fact declined by
230 bps yoy. We believe that margins are likely to come under pressure in the near led by higher
commodity prices. The management is confident of near-term revenue growth on the back of
execution of the existing large backlog - cites a target of Rs500 bn revenues for FY2012E.


Concerns on larger customers preferring Chinese vendors, increased competition in bulk tender
We highlight several concerns related to (1) larger customers (Adani, Sterlite, RPower) have been
displaying preference towards Chinese vendors while smaller utilities like DB Power and Visa
power are displaying preference towards BHEL, (2) boiler tender may be a negative catalyst in the
near term as two out of four bidders may get eliminated, increasing competition, and (3) some
order might have been booked which may not be financially closed (India Bulls-Phase II).

Other highlights: Strong backlog and inflows, exploring options to expand industrials
Other highlights include (1) BHEL reported a strong 1HFY11-end order backlog of Rs1,540 bn and
inflows of Rs147 bn in 2QFY10; NTPC bulk tender and JVs with state utilities likely to drive inflows
- excluding JV orders private sector dominate inflows, (2) Exploring various options in
transportation and T&D to expand scope and scale of industrials and exports segments, (3) has
incurred capex of Rs5.3 bn so far – on track for full-year capex expectation of about Rs15-16 bn.

Retain REDUCE as inflows peak; competitors gain foothold; other segments likely remain small

We have revised our earnings estimates to Rs115.5 and Rs138.6 from Rs114.3 and Rs135.5 for
FY2011E and FY2012E. We retain REDUCE (TP: Rs2,675) as (1) BHEL may face headwind in inflows
as bulk of the XIIth plan capacity ordering completes slowing incremental ordering, (2) more
competitors gain foothold, (3) other segments unlikely to scale up. Lower inflows would reduce
visibility and revenue growth post FY2013E despite assuming stronger execution.