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Bharat Heavy Electricals
Cross-border deal to shake up things
Event
ƒ Alstom & Shanghai Electric have announced to merge their respective boiler
businesses. Post the call by Alstom management, we believe JV is very keen
on Indian market and would emerge as a serious threat to domestic players.
ƒ We do not rule out a legal tussle regarding IPR issues between BHEL and the
Alstom combine, which adds to uncertainty. Competitive environment in India
should continue to worsen and current operating margins of ~20% seem
unsustainable. We cut our price target to Rs2,147 based on 16x AVG FY12 &
FY13 earnings which is based on a 15% discount to long term PE ratio.
Impact
ƒ JV has potential to emerge as a serious player in India: This JV has the
potential to address two of the biggest concerns regarding Chinese equipment:
⇒ After sales support possible from India facility: JV with a
manufacturing base in India which can be used for after sales support
and service which none of the Chinese companies had created till date.
⇒ Alstom technology could address concerns on lifecycle costs: JV
would have access to best in class technology. Incidentally, BHEL
supercritical boilers are based on Alstom technology.
ƒ JV very keen on India market: Alstom management was very clear in the
conference call that the JV would be very keen to sell in India despite certain
disagreements which it would look to iron out with BHEL. But since Shanghai
Electric already is present in India, it would continue to be present in India.
ƒ BHEL does not hold the aces in a potential long drawn legal tussle:
Though BHEL claims that Alstom cannot sell in India till 2020, we believe
there is a potential legal tussle on the cards as Alstom is keen on selling in
India. Moreover, BHEL is heavily dependant on Alstom for supercritical boiler
technology transfer, which if stalled would impact ability of BHEL to bid for
future projects in India. Further, BHEL was looking to partner Alstom in many
areas like nuclear, railways which would come into question.
Earnings and target price revision
ƒ We cut our PT to Rs2,147 based on 16x average FY12 & FY13 earnings
Price catalyst
ƒ 12-month price target: Rs2,147.00 based on a PER methodology.
ƒ Catalyst: Pricing in the boiler bulk tender expected in Q1FY12
Action and recommendation
ƒ Negative newsflow on BHEL to continue: Consensus is still sanguine about
margins while we believe that equipment pricing will trend downwards over
the medium term with more competition emerging. Margin decline in the near
term would be more led by higher proportion of super-critical and EPC
revenues. Further, order inflow scenario remains challenging. We reduce our
target price to Rs2,147 and maintain Neutral.
Alstom Shanghai Boilers Co to create a formidable combine
ƒ Structure of the deal: Alstom (ALO FP, €44.08, N, TP: €34) and Shanghai have agreed to merge
their respective boiler businesses which would include all facilities across the globe. Turnkey
projects would be kept out of the scope of this combine.
ƒ Combine to bring together best of technology and cost advantage: Alstom clearly holds the
edge in terms of R&D, technology and global sales footprint. Shanghai Electric on the other hand
has significant cost advantage with large manufacturing presence in China. Shanghai Electric also
has large market share in China which still remains one of the largest demand centres for thermal
based power equipment.
ƒ India Presence of JV adds to the concern for Indian market: Alstom has a presence in India
through facilities in Durgapur, West Bengal. It claims to manufacture coal fired boilers and Heat
recovery steam generators (HRSG). Key concern on the Chinese equipment regarding higher life
cycle costs would be addressed by Alstom technology, while lack of after sales service can be
taken care by existing presence in India.
BHEL – Alstom relationship to get complicated after this deal
ƒ BHEL claims exclusivity in India: As per BHEL management, it will be not affected by the new
alignment, as Alstom cannot sell in India till 2020. We are not absolutely clear on this issue, as
BHEL was competing with Alstom for the recently awarded 1,980MW Lalitpur power project.
ƒ But BHEL depends on Alstom for technology transfer for super-critical boiler: BHEL’s all
bids for super-critical boilers are explicity based on Alstom technology. BHEL cannot force issue
too much which might create issues in the technology transfer and jeopardise all bids for power
projects. Straining of relationship with Alstom might create issues regarding further relationships in
other areas.
ƒ Further, BHEL relationship with Alstom spans a number of other areas: BHEL has recently
tied up with Alstom for taking projects in the nuclear space. It is also looking to tie-up with Alstom
for locomotives factory.
Fig 1 BHEL Alstom relationship in various areas
Segment Nature of relationship
Super-critical boilers Technology transfer
Nuclear Project level partnerships
Locomotives Possible JV
Source: Company data, Macquarie Research, April 2011
ƒ Shanghai Electric has existing contracts in India: Shanghai Electric has been present in India
for some time now with large contracts already awarded. It would be extremely difficult to enforce
BHEL’s rights in these circumstances. Further, it does not make sense for Shanghai Electric to
enter into this JV if one of the key overseas markets is out of reach for the next 10 years or so.
ƒ Alstom management keen on sales in India: In the conference call hosted by Alstom, the
management appeared to be extremely keen on continuing to sell in India. A logic for the deal
seems to be the opportunity in large emerging markets like India. Alstom management was
upfront in accepting that there are outstanding issues with BHEL and that it is working on resolving
them. Yet, it was clear that excluding India from sales was pretty much out of the question.
Margin risk completely under-estimated
ƒ Contribution from super-critical projects: We believe revenue contribution from super-critical
would be around 10% in FY12 with a further increase in future. Margin contribution in the initial
years would be very limited as bulk of the components would be imported.
ƒ Higher EPC contribution: BHEL’s order inflow in FY11 achieved guidance, but aided significantly
by EPC contracts which was not the case in the previous three years. Margin contribution from
EPC contracts would be naturally lower due to much higher outsourcing content.
ƒ Limited scope for operating leverage from staff costs: We believe BHEL has exhausted the
operating leverage in staff costs. BHEL’s employee productivity (revenue / employee) in FY11 now
matches that of many global companies like ABB, Siemens and Indian peers like L&T, Cummins.
ƒ Bulk of the raw material efficiency behind us: BHEL has seen around 500bps margin
expansion from FY09-11 primarily driven by 360bps improvement in the raw material costs.
Valuations – Cut price target on worsening competitive environment
ƒ Earnings downgrades still on the cards: We believe consensus earnings are still very sanguine
about margins. Even revenue growth incrementally would come under pressure as environment
on coal shortages, environmental clearances, financial closure could worsen. Recently,
environment minister commented that 100GW capacity addition target in 12
th
five year plan is
ecologically impossible to achieve. Issues like these could derail execution.
ƒ Order inflow pressures to worsen: BHEL order inflows have remained flat over the last three
years. Even order inflows in FY11 were assisted by large EPC contracts. We have still not
witnessed domestic competition on a large scale.
ƒ Increasing competition, slower order inflows to lead de-rating, reducing price target to
Rs2,147: We have cut our target price to Rs 2,147 from Rs 2,337 earlier. Revised target price is
based on 16x average of FY12 and FY13 earnings as against earlier 18x FY12 earnings. Our
target multiple is now based on 15% discount to longer term average multiple of 18.7x. We have
assigned a discount to the longer term multiple as order inflow would be significantly slower in the
next five years with potential pressures on margins. Order inflow in the trailing 5 years has grown
at 26% CAGR, while we project the growth in next 5 years would be in single digits.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Bharat Heavy Electricals
Cross-border deal to shake up things
Event
ƒ Alstom & Shanghai Electric have announced to merge their respective boiler
businesses. Post the call by Alstom management, we believe JV is very keen
on Indian market and would emerge as a serious threat to domestic players.
ƒ We do not rule out a legal tussle regarding IPR issues between BHEL and the
Alstom combine, which adds to uncertainty. Competitive environment in India
should continue to worsen and current operating margins of ~20% seem
unsustainable. We cut our price target to Rs2,147 based on 16x AVG FY12 &
FY13 earnings which is based on a 15% discount to long term PE ratio.
Impact
ƒ JV has potential to emerge as a serious player in India: This JV has the
potential to address two of the biggest concerns regarding Chinese equipment:
⇒ After sales support possible from India facility: JV with a
manufacturing base in India which can be used for after sales support
and service which none of the Chinese companies had created till date.
⇒ Alstom technology could address concerns on lifecycle costs: JV
would have access to best in class technology. Incidentally, BHEL
supercritical boilers are based on Alstom technology.
ƒ JV very keen on India market: Alstom management was very clear in the
conference call that the JV would be very keen to sell in India despite certain
disagreements which it would look to iron out with BHEL. But since Shanghai
Electric already is present in India, it would continue to be present in India.
ƒ BHEL does not hold the aces in a potential long drawn legal tussle:
Though BHEL claims that Alstom cannot sell in India till 2020, we believe
there is a potential legal tussle on the cards as Alstom is keen on selling in
India. Moreover, BHEL is heavily dependant on Alstom for supercritical boiler
technology transfer, which if stalled would impact ability of BHEL to bid for
future projects in India. Further, BHEL was looking to partner Alstom in many
areas like nuclear, railways which would come into question.
Earnings and target price revision
ƒ We cut our PT to Rs2,147 based on 16x average FY12 & FY13 earnings
Price catalyst
ƒ 12-month price target: Rs2,147.00 based on a PER methodology.
ƒ Catalyst: Pricing in the boiler bulk tender expected in Q1FY12
Action and recommendation
ƒ Negative newsflow on BHEL to continue: Consensus is still sanguine about
margins while we believe that equipment pricing will trend downwards over
the medium term with more competition emerging. Margin decline in the near
term would be more led by higher proportion of super-critical and EPC
revenues. Further, order inflow scenario remains challenging. We reduce our
target price to Rs2,147 and maintain Neutral.
Alstom Shanghai Boilers Co to create a formidable combine
ƒ Structure of the deal: Alstom (ALO FP, €44.08, N, TP: €34) and Shanghai have agreed to merge
their respective boiler businesses which would include all facilities across the globe. Turnkey
projects would be kept out of the scope of this combine.
ƒ Combine to bring together best of technology and cost advantage: Alstom clearly holds the
edge in terms of R&D, technology and global sales footprint. Shanghai Electric on the other hand
has significant cost advantage with large manufacturing presence in China. Shanghai Electric also
has large market share in China which still remains one of the largest demand centres for thermal
based power equipment.
ƒ India Presence of JV adds to the concern for Indian market: Alstom has a presence in India
through facilities in Durgapur, West Bengal. It claims to manufacture coal fired boilers and Heat
recovery steam generators (HRSG). Key concern on the Chinese equipment regarding higher life
cycle costs would be addressed by Alstom technology, while lack of after sales service can be
taken care by existing presence in India.
BHEL – Alstom relationship to get complicated after this deal
ƒ BHEL claims exclusivity in India: As per BHEL management, it will be not affected by the new
alignment, as Alstom cannot sell in India till 2020. We are not absolutely clear on this issue, as
BHEL was competing with Alstom for the recently awarded 1,980MW Lalitpur power project.
ƒ But BHEL depends on Alstom for technology transfer for super-critical boiler: BHEL’s all
bids for super-critical boilers are explicity based on Alstom technology. BHEL cannot force issue
too much which might create issues in the technology transfer and jeopardise all bids for power
projects. Straining of relationship with Alstom might create issues regarding further relationships in
other areas.
ƒ Further, BHEL relationship with Alstom spans a number of other areas: BHEL has recently
tied up with Alstom for taking projects in the nuclear space. It is also looking to tie-up with Alstom
for locomotives factory.
Fig 1 BHEL Alstom relationship in various areas
Segment Nature of relationship
Super-critical boilers Technology transfer
Nuclear Project level partnerships
Locomotives Possible JV
Source: Company data, Macquarie Research, April 2011
ƒ Shanghai Electric has existing contracts in India: Shanghai Electric has been present in India
for some time now with large contracts already awarded. It would be extremely difficult to enforce
BHEL’s rights in these circumstances. Further, it does not make sense for Shanghai Electric to
enter into this JV if one of the key overseas markets is out of reach for the next 10 years or so.
ƒ Alstom management keen on sales in India: In the conference call hosted by Alstom, the
management appeared to be extremely keen on continuing to sell in India. A logic for the deal
seems to be the opportunity in large emerging markets like India. Alstom management was
upfront in accepting that there are outstanding issues with BHEL and that it is working on resolving
them. Yet, it was clear that excluding India from sales was pretty much out of the question.
Margin risk completely under-estimated
ƒ Contribution from super-critical projects: We believe revenue contribution from super-critical
would be around 10% in FY12 with a further increase in future. Margin contribution in the initial
years would be very limited as bulk of the components would be imported.
ƒ Higher EPC contribution: BHEL’s order inflow in FY11 achieved guidance, but aided significantly
by EPC contracts which was not the case in the previous three years. Margin contribution from
EPC contracts would be naturally lower due to much higher outsourcing content.
ƒ Limited scope for operating leverage from staff costs: We believe BHEL has exhausted the
operating leverage in staff costs. BHEL’s employee productivity (revenue / employee) in FY11 now
matches that of many global companies like ABB, Siemens and Indian peers like L&T, Cummins.
ƒ Bulk of the raw material efficiency behind us: BHEL has seen around 500bps margin
expansion from FY09-11 primarily driven by 360bps improvement in the raw material costs.
Valuations – Cut price target on worsening competitive environment
ƒ Earnings downgrades still on the cards: We believe consensus earnings are still very sanguine
about margins. Even revenue growth incrementally would come under pressure as environment
on coal shortages, environmental clearances, financial closure could worsen. Recently,
environment minister commented that 100GW capacity addition target in 12
th
five year plan is
ecologically impossible to achieve. Issues like these could derail execution.
ƒ Order inflow pressures to worsen: BHEL order inflows have remained flat over the last three
years. Even order inflows in FY11 were assisted by large EPC contracts. We have still not
witnessed domestic competition on a large scale.
ƒ Increasing competition, slower order inflows to lead de-rating, reducing price target to
Rs2,147: We have cut our target price to Rs 2,147 from Rs 2,337 earlier. Revised target price is
based on 16x average of FY12 and FY13 earnings as against earlier 18x FY12 earnings. Our
target multiple is now based on 15% discount to longer term average multiple of 18.7x. We have
assigned a discount to the longer term multiple as order inflow would be significantly slower in the
next five years with potential pressures on margins. Order inflow in the trailing 5 years has grown
at 26% CAGR, while we project the growth in next 5 years would be in single digits.
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