Buy BHEL - Case Strengthens; Target Rs 3,030:: Emkay

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BHEL

Case Strengthens; Retain BUY

BUY

CMP: Rs 2,218                                       Target Price: Rs 3,030

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n     Adjusting for One-Offs, BHEL performance meets expectations – APAT growth at 25% yoy to Rs13.4 bn

n     Subdued order inflows in Q3FY11 (down 21% yoy to Rs122 bn) – but not concerning as Q4FY11E asking rate is undemanding at Rs241 bn (-1% yoy). Order backlog at Rs1576 bn

n     Bursting all popular myths and notions, BHEL hinted at substantial operating leverage in business operations, which could fructify beginning FY12E

n     Maintain earnings estimates of FY11E (Rs110.6/Share) and FY12E (Rs129.0/Share). Reiterate BUY with target price of Rs3,030/Share

Despite all confusion, BHEL delivers strong operational performance in

Q3FY11 – despite adjusting one-offs

BHEL reported strong performance in Q3FY11– key highlights are (1) Net sales grew

25% yoy to Rs88.5 bn (2) EBITDA margins expanded 130 bps yoy to 21.4% (3) EBITDA

growth of 32% yoy to Rs19.0 bn and (4) APAT growth of 31% yoy to Rs14.0 bn. Even

after adjusting for the one-off - APAT growth at 25% yoy to Rs13.4 bn meets

expectation (impact on net profit at Rs0.6 bn). (One-off linked to modification of

mismatch in recognition of revenue and creation of provision of contractual obligation at

2.5%)

Order backlog at Rs1576 bn; Order inflows decline 21% yoy

BHEL witnessed subdued order inflows during the quarter - order inflows declined 21%

yoy and 16% qoq to Rs122 bn (or 7.8 GW) – attributed to delays and postponements in

order finalization. Major orders bagged were (1) Indiabulls Power – (a) 5x270 MW Nasik

TPP – Rs28.75 bn (b) Elina TPP, Amravati – Rs28.83 bn (2) APGENCO – 1x600 MW

Rayalseema – Rs14.45 bn. The order backlog has increased 18% yoy and 3% qoq to

Rs1576 bn.

But not an area of concern - Q4 implied growth rate -1% yoy

Despite subdued order inflows in Q3FY11, BHEL reiterates to meet its FY11E target

order inflows of Rs600 bn – on the back of a robust order bid pipeline. We believe BHEL

appears to be on track to achieve its stated guidance – given the undemanding asking

rate in Q4FY11E at Rs241 bn (or -1% yoy).

BHEL Result Update

BHEL hints at substantial operating leverage in operations, could fructify in

ensuing years

Bursting all popular myths and notions, BHEL hinted at substantial operating leverage in

business operations, which could fructify beginning FY12E. Key areas for operating

leverage identified (1) Employee Costs - indicated employee addition of 4000 Nos every

year for next three years and exit of 10000 employees in same time period, thus keep

headcount unchanged at 50,000 Nos (2) various operational initiatives undertaken to

reduce material intensity and costs (3) efforts to drive efficiencies from brownfield

expansion, wherein installed capacity doubles from 10,000 MW to 20,000 MW.

Nonetheless, BHEL would gain additional muscle to combat competition in future order

bidding. There is scope for operating leverage, but remains un-factored in EMKAY and

Consensus earnings - building case for future earning upgrades.

Retain earnings estimates of Rs110.6/Share and Rs129.0/Share for FY11E

and FY12E respectively

BHEL cuts noise and delivers a satisfactory performance in 9MFY11. Also, BHEL reiterates

the order inflow guidance for FY11E at Rs600 bn, reasonably confident to deliver the same.

Citing initiatives undertaken to optimize costs, drive efficiencies, reduce material intensity

etc and probable gains from brownfield expansion and ceiling on headcount, probability of

earnings upgrades has emerged. But, until then we retain our earnings estimates of

Rs110.6/Share and Rs129/Share for FY11E and FY12E respectively. BHEL is trading at

attractive valuations of PER of 17X FY12E earnings. We maintain BUY rating with price

target of Rs3030/Share.