Bharat Heavy Electricals- Order inflow under serious risk:: Macquarie Research

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Bharat Heavy Electricals
Order inflow under serious risk
Event
 We revisit our investment thesis on BHEL as problems continue to compound
for the power sector. BHEL’s order inflow growth is under severe risk and
desperation for new orders likely to impact pricing. We reduce our target price
to Rs1,852 based on 14x avg of FY12/13 EPS(from Rs2,100 earlier) as we
are getting incrementally bearish on medium term growth. We have cut our
FY14E earnings estimates as impact of lower pricing in next few quarters
would be visible with a lag. Retain Neutral rating with a cautious stance.
Impact
 Order inflow at serious risk: Uncertainty on fuel, land and financing has
slowed down new power sector awards. BHEL’s expectation of clocking 10%
inflow growth in FY12E is clearly at severe risk especially after a washout in
Apr-Aug 2011. Our current projection of flat order inflows is contingent on both
the bulk awards from NTPC and 2,640MW of Rajasthan orders going through.
We are more concerned with order inflow growth in FY13E: With
100GW of 12th plan already awarded, growth now hinges on ordering for
13th plan which are facing coal linkage and clearance issues.
Revising our order inflow forecasts: We reduce our order inflow growth
estimates for FY12E and FY13E to 1.5% and -6.5% from 8.5% and 7.5%
earlier. Our FY12E forecast is below company’s guidance of 10% growth.
 Severe competition for orders to drive down prices and margins: We
continue to highlight that equipment capacity at ~35,000MW p.a. would
outstrip annual thermal demand at ~15,000MW. Payback of 4-5 years for new
players even at 10% margin provides significant downside risks to BHEL’s
margins of 18-20%. We are building in margin decline of 170bps over FY11-
14 from 19.4% to 17.7%.
 Revenue growth would come under pressure from FY13E onwards: We
expect revenue growth rate to slow down from 18% in FY11 to 8% in FY14E
as we expect funding, clearances and fuel linkage issues to slowdown
execution especially of newer private sector orders won in FY11. However,
our revenue growth estimates build in improvement in execution rate from
27.5% in FY11 to 30.5% in FY14E, due to an increase in BHEL’s capacity.
Earnings and target price revision
 We increase our FY12-13E EPS by 1% but cut FY14E EPS by 9%.We cut our
target price to Rs1,852 (14x average FY12-13E EPS) from Rs2,100 earlier.
Price catalyst
 12-month price target: Rs1,852.00 based on a PER methodology.
 Catalyst: decline in order inflow and further fall in margins
Action and recommendation
 Earnings growth over FY12-14E can potentially turn negative: With
slowing revenue growth and falling margins, we expect earnings CAGR to be
8% over FY11-14E. We reduce our target multiple to 14x average FY12-13E
EPS (20% discount to long term averages). We decrease our target price to
Rs1,852 (from Rs2,100 earlier). Retain Neutral with cautious stance.
 View of BHEL as defensive may come under question with slowing order
inflows: BHEL is seen as defensive due to near term earnings support.
However, shortfall in orders, potential pressure on pricing and upcoming FPO
could keep upside limited in the stock.