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BHEL
RECOMMENDATION: BUY
TARGET PRICE: RS.2632
FY12E P/E: 15.6X
Upgrade purely based on valuations
BHEL third quarter numbers are ahead of our expectations. Revenue growth
driven by order execution as well as ramping up of expanded capacity.
Margins came in sharply higher due to a combination of operating leverage
and change the method of accounting for contractual obligations.
While the order backlog is strong at Rs 1580 bn, its revenue visibility has
been trending downwards as revenue growth is outpacing rise in order
intake.
Stock's underperformance is partly explained by investor skepticism on
growth beyond 2012-13 (as order intake is showing signs of plateauing) and
vulnerability of margins due to product mix changes and higher
competition. The BHEL management has taken steps to address some of
these concerns.
However, the underperformance in past quarters has made valuations
attractive. Stock is trading at a discount to L&T and Thermax. The current
price provides an upside of 19% to our target price. We revise rating to BUY
in view of adequate upside from current levels to our target price of Rs 2632
(Rs 2600 earlier).
Concerns include recent firming of material prices, delay in land acquisition
resulting in prolonged order finalization cycle, new entrants resorting to
lower product pricing to gain a market foothold and rupee depreciation
resulting in higher cost of imports.
Result Highlights
Momentum in execution progress maintained
n Revenues for the quarter rose 25.0% yoy to Rs 88.5 bn mainly driven by higher
execution of power sector orders. The company had received large orders in
FY08 and FY09, which have crossed critical milestones for revenue booking and
hence the robust revenue growth.
n The company's Trichy based boiler mfg operations had delivered 0.5 mn tons in
FY10 and is on track to dispatch 0.68 mn tons and 0.8 mn tons in FY11 and
FY12 respectively.
n BHEL has increased its thermal power capacity to 10000 MW, which is also driving
higher output. The company plans to deliver 16-17000 MW of power project
in the current fiscal.
n The industry sector segment mainly constitutes captive power projects, T&D
equipments and railways business. The execution cycle in this segment is shorter
compared to the power segment. A significant share of industrial sector's order
book is contributed by the private sector for captive power projects
Margins expansion primarily led by lower material costs:
n EBITDA margins expanded 140 bps to 23.4% mainly due to lower material costs.
The management indicated value engineering and smart sourcing of materials as
the main contributor of lower material expenses.
n Employee costs have grown at a moderate pace of 9.9% yoy, which is line with
expectations. In the previous quarter, the management had indicated that arrears
related to wage revision provision have been completely provided in FY10.
Hence wage increases were expected to fall to the normalized rate of 8-10%
pa. For the fiscal, the management indicated that employee costs are estimated
to be in the range of Rs 56-57 bn, which is line with our estimate.
n During the quarter, the company changed the method of calculating the percentage
completion to remove the mismatch in recognition of revenue and creation
of provision for contractual obligation (at 2.5% of the contract revenue on
completion of trial operation). The impact due to this on revenues, PBT and PAT
was Rs 4.4 bn, Rs 800 mn and Rs 600 mn respectively. The costs associated with
this change have been booked under various heads.
Visibility remains strong but order intake appears to have plateaued
n Order backlog at Rs 1580 bn is highest ever and translates into a revenue visibility
of 51 months of trailing four quarter revenues.
n Major orders won during the quarter were 5x270 MW from IndiaBulls Power,
5x270 MW from Elena Power and 600 MW from APGenco.
n Company expects to win roughly 16000 MW of thermal power orders. The company
expects to win couple of orders from JVs it has signed with state utilities.
BHEL is also assured of boilers for 5-6 sets of 660 MW when NTPC opens the
tender for bulk ordering of supercritical sets in February 2011.
n The company reiterated its guidance of Rs 600 bn of new orders in the current
fiscal thus requiring the company to win orders worth Rs 270 bn in the fourth
quarter. The company categorically indicated that it does not see any peaking of
annual order intake in the foreseeable future.
n BHEL has emerged L2 in the bulk tender for supply of Turbine Generators comprising
of 11 units of 660 MW each. BHEL gets to supply 4 units provided it is
able to match the L1 price. BHEL is also L1 in two orders worth 2x660 MW each
from Rajasthan SEB, which will be booked in the current quarter.
n Management is confident of maintaining order intake in the range of Rs 550-600
bn in FY11. The project pipeline is strong for order intake in FY12 (the bulk tender
for 9x800 MW is also expected to be finalized in FY12).
n New growth verticals that the company is targeting are HV T&D equipments, Rail
locos-including metro, nuclear and gas based power, solar power, wind power,
flue gas desulphurization systems and water desalination
Concerns on erosion in market share and peaking order intake
behind significant underperformance
BHEL has probably the highest revenue visibility among listed equipment manufacturers.
The street pays a premium on higher revenue visibility and a discount to revenue
uncertainty. However, in BHEL's case, street is concerned with order intake
which has slowed down considerably. This implies that slackening order accretion
would eventually pull down the robust revenue growth. This scenario could manifest
itself from FY14 onwards.
BHEL's initiatives to address concerns
n BHEL has hiked its R&D spend to increase optimization of its equipment manufacturing
and also reduce the import content on supercritical sets
n The company plans to indigenize sourcing of CRGO steel in tie-up with SAIL.
n The company has outlined areas including water treatment, solar power, railways
and power transmission to offset the moderation in growth of power generation
market.
Stock Outlook: Stock's underperformance makes valuations attractive
n Order intake grew from a level of Rs 187 bn in FY06 to Rs 600 bn in FY10 and
has been the key rerating driver for the stock. However, we see order intake
settling at a moderate growth trajectory going forward on account of 1) bulk of
12th plan order intake has been ordered 2) increased competition from private
sector and Chinese players. Taking this into cognizance, the company's valuation
multiples have contracted vis-à-vis other engineering company.
n We also need to monitor the likely impact on margins as more of supercritical
orders (higher import content) are converted into revenues. We do believe there
could be downside to margins.
Valuation and Target Price
BHEL is currently trading at 18.6x and 15.6x FY11 and FY12 earnings respectively. In
view of the strong numbers and upside of 19% from current levels, we upgrade the
stock to BUY with a DCF based target price of Rs 2632.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
BHEL
RECOMMENDATION: BUY
TARGET PRICE: RS.2632
FY12E P/E: 15.6X
Upgrade purely based on valuations
BHEL third quarter numbers are ahead of our expectations. Revenue growth
driven by order execution as well as ramping up of expanded capacity.
Margins came in sharply higher due to a combination of operating leverage
and change the method of accounting for contractual obligations.
While the order backlog is strong at Rs 1580 bn, its revenue visibility has
been trending downwards as revenue growth is outpacing rise in order
intake.
Stock's underperformance is partly explained by investor skepticism on
growth beyond 2012-13 (as order intake is showing signs of plateauing) and
vulnerability of margins due to product mix changes and higher
competition. The BHEL management has taken steps to address some of
these concerns.
However, the underperformance in past quarters has made valuations
attractive. Stock is trading at a discount to L&T and Thermax. The current
price provides an upside of 19% to our target price. We revise rating to BUY
in view of adequate upside from current levels to our target price of Rs 2632
(Rs 2600 earlier).
Concerns include recent firming of material prices, delay in land acquisition
resulting in prolonged order finalization cycle, new entrants resorting to
lower product pricing to gain a market foothold and rupee depreciation
resulting in higher cost of imports.
Result Highlights
Momentum in execution progress maintained
n Revenues for the quarter rose 25.0% yoy to Rs 88.5 bn mainly driven by higher
execution of power sector orders. The company had received large orders in
FY08 and FY09, which have crossed critical milestones for revenue booking and
hence the robust revenue growth.
n The company's Trichy based boiler mfg operations had delivered 0.5 mn tons in
FY10 and is on track to dispatch 0.68 mn tons and 0.8 mn tons in FY11 and
FY12 respectively.
n BHEL has increased its thermal power capacity to 10000 MW, which is also driving
higher output. The company plans to deliver 16-17000 MW of power project
in the current fiscal.
n The industry sector segment mainly constitutes captive power projects, T&D
equipments and railways business. The execution cycle in this segment is shorter
compared to the power segment. A significant share of industrial sector's order
book is contributed by the private sector for captive power projects
Margins expansion primarily led by lower material costs:
n EBITDA margins expanded 140 bps to 23.4% mainly due to lower material costs.
The management indicated value engineering and smart sourcing of materials as
the main contributor of lower material expenses.
n Employee costs have grown at a moderate pace of 9.9% yoy, which is line with
expectations. In the previous quarter, the management had indicated that arrears
related to wage revision provision have been completely provided in FY10.
Hence wage increases were expected to fall to the normalized rate of 8-10%
pa. For the fiscal, the management indicated that employee costs are estimated
to be in the range of Rs 56-57 bn, which is line with our estimate.
n During the quarter, the company changed the method of calculating the percentage
completion to remove the mismatch in recognition of revenue and creation
of provision for contractual obligation (at 2.5% of the contract revenue on
completion of trial operation). The impact due to this on revenues, PBT and PAT
was Rs 4.4 bn, Rs 800 mn and Rs 600 mn respectively. The costs associated with
this change have been booked under various heads.
Visibility remains strong but order intake appears to have plateaued
n Order backlog at Rs 1580 bn is highest ever and translates into a revenue visibility
of 51 months of trailing four quarter revenues.
n Major orders won during the quarter were 5x270 MW from IndiaBulls Power,
5x270 MW from Elena Power and 600 MW from APGenco.
n Company expects to win roughly 16000 MW of thermal power orders. The company
expects to win couple of orders from JVs it has signed with state utilities.
BHEL is also assured of boilers for 5-6 sets of 660 MW when NTPC opens the
tender for bulk ordering of supercritical sets in February 2011.
n The company reiterated its guidance of Rs 600 bn of new orders in the current
fiscal thus requiring the company to win orders worth Rs 270 bn in the fourth
quarter. The company categorically indicated that it does not see any peaking of
annual order intake in the foreseeable future.
n BHEL has emerged L2 in the bulk tender for supply of Turbine Generators comprising
of 11 units of 660 MW each. BHEL gets to supply 4 units provided it is
able to match the L1 price. BHEL is also L1 in two orders worth 2x660 MW each
from Rajasthan SEB, which will be booked in the current quarter.
n Management is confident of maintaining order intake in the range of Rs 550-600
bn in FY11. The project pipeline is strong for order intake in FY12 (the bulk tender
for 9x800 MW is also expected to be finalized in FY12).
n New growth verticals that the company is targeting are HV T&D equipments, Rail
locos-including metro, nuclear and gas based power, solar power, wind power,
flue gas desulphurization systems and water desalination
Concerns on erosion in market share and peaking order intake
behind significant underperformance
BHEL has probably the highest revenue visibility among listed equipment manufacturers.
The street pays a premium on higher revenue visibility and a discount to revenue
uncertainty. However, in BHEL's case, street is concerned with order intake
which has slowed down considerably. This implies that slackening order accretion
would eventually pull down the robust revenue growth. This scenario could manifest
itself from FY14 onwards.
BHEL's initiatives to address concerns
n BHEL has hiked its R&D spend to increase optimization of its equipment manufacturing
and also reduce the import content on supercritical sets
n The company plans to indigenize sourcing of CRGO steel in tie-up with SAIL.
n The company has outlined areas including water treatment, solar power, railways
and power transmission to offset the moderation in growth of power generation
market.
Stock Outlook: Stock's underperformance makes valuations attractive
n Order intake grew from a level of Rs 187 bn in FY06 to Rs 600 bn in FY10 and
has been the key rerating driver for the stock. However, we see order intake
settling at a moderate growth trajectory going forward on account of 1) bulk of
12th plan order intake has been ordered 2) increased competition from private
sector and Chinese players. Taking this into cognizance, the company's valuation
multiples have contracted vis-à-vis other engineering company.
n We also need to monitor the likely impact on margins as more of supercritical
orders (higher import content) are converted into revenues. We do believe there
could be downside to margins.
Valuation and Target Price
BHEL is currently trading at 18.6x and 15.6x FY11 and FY12 earnings respectively. In
view of the strong numbers and upside of 19% from current levels, we upgrade the
stock to BUY with a DCF based target price of Rs 2632.
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