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Order cancellation: Isn’t that priced in?
Adjusted 3QFY12 results in line
but no order is sentimentally
negative; Buy on correction
Action: No new orders and some cancellation of previous orders
could impact stock near-term; Buy on such a decline
BHEL’s 3QFY12 results were in line with expectations after adjusting for
INR2.28bn of additional provisions created during the quarter and reflected
under the “other” expense line-item. Most other cost items and revenue
growth, too, were slightly better than expected, though no new orders during
the quarter and an order cancellation of INR58bn are potential dampeners
for the stock price in the near term. We, however, note that:
Our assumptions already classify ~INR230bn of the existing order book
as slow moving and/or at the risk of cancellation/deferment, and our
interactions with investors suggest a similar assumption by the bulk of the
Street, as well. As such, the official statement of order cancellation of
INR58bn is not new information but merely a confirmation of Street fears.
While no new order is a negative surprise, this is mainly due to
continued postponement of some larger orders by customers. For
example, whether the NTPC bulk tender is finalised in FY12 or FY13
hardly makes any difference to BHEL valuation, as per our estimates.
Catalysts: Orders, results, macro and policy action
Softening commodity prices and policy reforms are key upside triggers.
Valuation: At 9.6x FY13F EPS, stock prices in adverse sector fortune
At 9.6x FY13F EPS, we estimate the stock is now pricing in a negative
terminal growth rate and/or substantial reduction in sustainable ROE
(down to low-teens vs. ~30% in FY12F). While we do not rule out nearterm
numbers to mirror such a trend, extrapolating such assumptions until
perpetuity is unjustified, in our view. We reiterate our Buy rating.
3QFY12 results were in-line with expectations adjusted for
higher provisioning
ABOVE OR BELOW EXPECTATIONS?
BHEL’s 3QFY12 reported earnings results were 5-8% below Nomura and consensus
estimates, mainly due to sharply higher other expenses reported by the company.
However, adjusted for higher provisions relating to liquidated damages and contractual
obligations, the results were in line with estimates.
WHAT DOES THE RESULT MEAN?
• Revenue was in line with expectations, and most other cost items (including raw
material costs and staff costs) were lower than expectations.
• Had it not been for higher other expenses (due to high provisions, as explained above),
results would have been a positive surprise.
• Order inflows have surprised negatively though – according to management, there
have no new orders in the power segment this quarter. a 9MFY12 order inflow is down
~60% y-y facing difficulties in all segments. Moreover, management disclosed order
cancellation and/or reduction in scope of work for some orders totalling to ~INR 58bn
and will be likely dampener for the stock in the near term, in our view.
LIKELY STOCK REACTION:
The stock was down ~3% on the day its results were announced, and we expect it to
remain weak in the near term. However, much of the bad news on the order inflow
slowdown is in the price, in our view, and hence we recommend further accumulation in
case of any weakness in the stock.
What drives our Buy rating on BHEL?
Incrementally positive newsflow in the power sector
Tariff hike is now a reality at most SEBs
While tariff hikes have been a contentious issue for most states, we now see evidence of
progressive action being taken by state distribution companies over the past few months.
Our banking analyst’s interaction with Power Finance Corporation (POWF IN) also
suggests that, incrementally, SEBs’ condition has started to improve and stricter
enforcement by banking agencies will likely yield further results.
Below we note some key takeaways from this meeting:
• The state power ministers’ conference in July 2011 adopted 14 resolutions to improve
SEBs’ discipline. These include computerization of accounts, regular filing of tariff
revision petitions, timely payment of subsidies by state governments, and bringing
down AT&C losses to 15%, among others.
• Based on these resolutions, the finance and the power ministry are jointly expected to
come up with a list of conditions necessary for further disbursal of short-term loans by
SEB lenders.
• Since August 2011, all lenders have stopped short-term lending to weak SEBs, and
some action on this front is expected soon.
• The outlook on state electricity boards is definitely looking brighter with the recent spate
of tariff hikes and the appellate tribunal's judgement directing state electricity
commissions to ensure the timely determination of tariffs.
• The Tamil Nadu Electricity Board (TNEB, the weakest SEB) had recently sought the
regulator’s approval to hike tariffs by 38%, and this will likely add INR110bn to its
revenue next year, or around 50% of current revenue. This implies a cash-positive
scenario conducive to regular debt servicing within two years.
• The Appellate Tribunal for Electricity in India has ruled that all state distribution
companies in the country will have to file their tariff revision petitions by April 1 every
year, and failure to do so within a month of the specified time would empower
respective state power regulators to suo motto begin the exercise on behalf of the
distribution companies (‘Tribunal orders annual hike in power tariffs to avoid big shock
once in years’, The Economic Times, November 22, 2011). Further, such a decision by
the state regulator would be binding on the state discoms.
• PFC expects at least 5-10% increase in tariffs from all SEBs which haven't recently
raised tariffs in response to the appellate tribunal's directive. The only exception would
be Uttar Pradesh, which has declined to raise tariffs until after the state elections in
CY12. However, Uttar Pradesh has been servicing its debts regularly, and even the
Oct-11 payments have been on time.
• Under the modified conditionality that PFC is enforcing on all projects since Apr-11,
PFC won't make disbursals until the power purchase agreement and fuel supply
agreement are in place compared with the earlier condition of getting PPA done within
12 months and having the Letter of Assurance (LoA) for fuel linkage.
• The Shunglu committee report is expected to be ready by end Dec-11 and it would try
to address transparency and timeliness issues with SEB accounting.
Environment clearance for projects picks up pace
Land and environment clearances have delayed proposed infrastructure projects.
However, here too we see incrementally positive news flow emerging for the sector as
the government has been relaxing norms to accommodate industry proposals. For
example, as per media articles, the environment ministry has now relaxed environment
clearance norms for projects requiring forest land (‘Environment Minister Jayanthi
Natarajan relaxes environmental clearance norms for projects requiring forest land’, The
Economic Times, Sep 13, 2011).
Similarly, approvals on some of the long-pending projects have now been hastened. We
note the environmental clearance for Lavasa hill city as a case in point (‘Lavasa gets
conditional environmental clearance’, Live Mint, Nov 9, 2011).
While we have still a long way to go in terms of environmental approval reforms and are
still far from what could be termed as a 100% industry-friendly model, we note that
increasingly positive developments will, nevertheless, boost investor and developer
confidence in the infrastructure sector in general.
However, coal availability for new projects in the near term remains uncertain;
partial relief for long-term from imports
Even as we witness positive developments relating to other issues plaguing the power
sector, coal availability remains a practical problem for which a near-term solution is yet
to be determined.
In our April 12, 2011 report, Structural bottlenecks ahead, we had highlighted that
domestic coal availability (from Coal India and subs and captive coal blocks) could
increase from the current 365mn ton p.a. to 630mn tons p.a. by FY17 in a best-case
scenario. This would imply enough coal availability for an incremental power capacity
~50-55GW p.a. by the end of FY17. In contrast, the actual power capacity addition
envisaged during the same period is much more (>100 GW), suggesting that coal
availability will remain a medium-term concern.
What could mitigate the problem partially, in our view, is imported coal from mines that
Indian corporates have acquired over the past few years. Despite the potential of coal
imports, what remains a key concern for the sector is whether the discoms would be in a
position to pay up for the higher power cost owing to imported coal (which is more
expensive compared with domestic coal). Continuing with our argument on positive
traction on SEB reforms, we believe in the long-term discoms should be in a position to
gradually accept more power based on imported coal as their own financial health
improves. Below we list out some of the large coal mine acquisitions made by Indian
corporates in recent times, which could likely add to India’s coal supply.
Chinese competition is expected to ease though domestic competition remains a
long-term threat
While we have been concerned about rising competition in the sector, we note that
competition from China and Korea will likely ease. This is mainly on account of: 1) the
proposed import duty on imported power equipment, and 2) ~20% depreciation of INR
vs. CNY that will make Chinese imports expensive and hence uncompetitive.
While stability of the currency exchange rates cannot be forecast, we believe at this
moment Chinese imports are ~25% more expensive compared to their earlier prices.
Based on our channel checks, the historical difference between BHEL and Chinese
imports has been around 10-15% and as such in the current situation, it is unlikely that
Chinese equipment will find buyers in the Indian market.
However, we remain concerned that competition from domestic operators could pose a
long-term threat to BHEL’s market share. In our view, the only possible solution to
domestic competition will be a genuine uptick in demand for equipment that could fill up
capacity for all operators concerned.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Order cancellation: Isn’t that priced in?
Adjusted 3QFY12 results in line
but no order is sentimentally
negative; Buy on correction
Action: No new orders and some cancellation of previous orders
could impact stock near-term; Buy on such a decline
BHEL’s 3QFY12 results were in line with expectations after adjusting for
INR2.28bn of additional provisions created during the quarter and reflected
under the “other” expense line-item. Most other cost items and revenue
growth, too, were slightly better than expected, though no new orders during
the quarter and an order cancellation of INR58bn are potential dampeners
for the stock price in the near term. We, however, note that:
Our assumptions already classify ~INR230bn of the existing order book
as slow moving and/or at the risk of cancellation/deferment, and our
interactions with investors suggest a similar assumption by the bulk of the
Street, as well. As such, the official statement of order cancellation of
INR58bn is not new information but merely a confirmation of Street fears.
While no new order is a negative surprise, this is mainly due to
continued postponement of some larger orders by customers. For
example, whether the NTPC bulk tender is finalised in FY12 or FY13
hardly makes any difference to BHEL valuation, as per our estimates.
Catalysts: Orders, results, macro and policy action
Softening commodity prices and policy reforms are key upside triggers.
Valuation: At 9.6x FY13F EPS, stock prices in adverse sector fortune
At 9.6x FY13F EPS, we estimate the stock is now pricing in a negative
terminal growth rate and/or substantial reduction in sustainable ROE
(down to low-teens vs. ~30% in FY12F). While we do not rule out nearterm
numbers to mirror such a trend, extrapolating such assumptions until
perpetuity is unjustified, in our view. We reiterate our Buy rating.
3QFY12 results were in-line with expectations adjusted for
higher provisioning
ABOVE OR BELOW EXPECTATIONS?
BHEL’s 3QFY12 reported earnings results were 5-8% below Nomura and consensus
estimates, mainly due to sharply higher other expenses reported by the company.
However, adjusted for higher provisions relating to liquidated damages and contractual
obligations, the results were in line with estimates.
WHAT DOES THE RESULT MEAN?
• Revenue was in line with expectations, and most other cost items (including raw
material costs and staff costs) were lower than expectations.
• Had it not been for higher other expenses (due to high provisions, as explained above),
results would have been a positive surprise.
• Order inflows have surprised negatively though – according to management, there
have no new orders in the power segment this quarter. a 9MFY12 order inflow is down
~60% y-y facing difficulties in all segments. Moreover, management disclosed order
cancellation and/or reduction in scope of work for some orders totalling to ~INR 58bn
and will be likely dampener for the stock in the near term, in our view.
LIKELY STOCK REACTION:
The stock was down ~3% on the day its results were announced, and we expect it to
remain weak in the near term. However, much of the bad news on the order inflow
slowdown is in the price, in our view, and hence we recommend further accumulation in
case of any weakness in the stock.
What drives our Buy rating on BHEL?
Incrementally positive newsflow in the power sector
Tariff hike is now a reality at most SEBs
While tariff hikes have been a contentious issue for most states, we now see evidence of
progressive action being taken by state distribution companies over the past few months.
Our banking analyst’s interaction with Power Finance Corporation (POWF IN) also
suggests that, incrementally, SEBs’ condition has started to improve and stricter
enforcement by banking agencies will likely yield further results.
Below we note some key takeaways from this meeting:
• The state power ministers’ conference in July 2011 adopted 14 resolutions to improve
SEBs’ discipline. These include computerization of accounts, regular filing of tariff
revision petitions, timely payment of subsidies by state governments, and bringing
down AT&C losses to 15%, among others.
• Based on these resolutions, the finance and the power ministry are jointly expected to
come up with a list of conditions necessary for further disbursal of short-term loans by
SEB lenders.
• Since August 2011, all lenders have stopped short-term lending to weak SEBs, and
some action on this front is expected soon.
• The outlook on state electricity boards is definitely looking brighter with the recent spate
of tariff hikes and the appellate tribunal's judgement directing state electricity
commissions to ensure the timely determination of tariffs.
• The Tamil Nadu Electricity Board (TNEB, the weakest SEB) had recently sought the
regulator’s approval to hike tariffs by 38%, and this will likely add INR110bn to its
revenue next year, or around 50% of current revenue. This implies a cash-positive
scenario conducive to regular debt servicing within two years.
• The Appellate Tribunal for Electricity in India has ruled that all state distribution
companies in the country will have to file their tariff revision petitions by April 1 every
year, and failure to do so within a month of the specified time would empower
respective state power regulators to suo motto begin the exercise on behalf of the
distribution companies (‘Tribunal orders annual hike in power tariffs to avoid big shock
once in years’, The Economic Times, November 22, 2011). Further, such a decision by
the state regulator would be binding on the state discoms.
• PFC expects at least 5-10% increase in tariffs from all SEBs which haven't recently
raised tariffs in response to the appellate tribunal's directive. The only exception would
be Uttar Pradesh, which has declined to raise tariffs until after the state elections in
CY12. However, Uttar Pradesh has been servicing its debts regularly, and even the
Oct-11 payments have been on time.
• Under the modified conditionality that PFC is enforcing on all projects since Apr-11,
PFC won't make disbursals until the power purchase agreement and fuel supply
agreement are in place compared with the earlier condition of getting PPA done within
12 months and having the Letter of Assurance (LoA) for fuel linkage.
• The Shunglu committee report is expected to be ready by end Dec-11 and it would try
to address transparency and timeliness issues with SEB accounting.
Environment clearance for projects picks up pace
Land and environment clearances have delayed proposed infrastructure projects.
However, here too we see incrementally positive news flow emerging for the sector as
the government has been relaxing norms to accommodate industry proposals. For
example, as per media articles, the environment ministry has now relaxed environment
clearance norms for projects requiring forest land (‘Environment Minister Jayanthi
Natarajan relaxes environmental clearance norms for projects requiring forest land’, The
Economic Times, Sep 13, 2011).
Similarly, approvals on some of the long-pending projects have now been hastened. We
note the environmental clearance for Lavasa hill city as a case in point (‘Lavasa gets
conditional environmental clearance’, Live Mint, Nov 9, 2011).
While we have still a long way to go in terms of environmental approval reforms and are
still far from what could be termed as a 100% industry-friendly model, we note that
increasingly positive developments will, nevertheless, boost investor and developer
confidence in the infrastructure sector in general.
However, coal availability for new projects in the near term remains uncertain;
partial relief for long-term from imports
Even as we witness positive developments relating to other issues plaguing the power
sector, coal availability remains a practical problem for which a near-term solution is yet
to be determined.
In our April 12, 2011 report, Structural bottlenecks ahead, we had highlighted that
domestic coal availability (from Coal India and subs and captive coal blocks) could
increase from the current 365mn ton p.a. to 630mn tons p.a. by FY17 in a best-case
scenario. This would imply enough coal availability for an incremental power capacity
~50-55GW p.a. by the end of FY17. In contrast, the actual power capacity addition
envisaged during the same period is much more (>100 GW), suggesting that coal
availability will remain a medium-term concern.
What could mitigate the problem partially, in our view, is imported coal from mines that
Indian corporates have acquired over the past few years. Despite the potential of coal
imports, what remains a key concern for the sector is whether the discoms would be in a
position to pay up for the higher power cost owing to imported coal (which is more
expensive compared with domestic coal). Continuing with our argument on positive
traction on SEB reforms, we believe in the long-term discoms should be in a position to
gradually accept more power based on imported coal as their own financial health
improves. Below we list out some of the large coal mine acquisitions made by Indian
corporates in recent times, which could likely add to India’s coal supply.
Chinese competition is expected to ease though domestic competition remains a
long-term threat
While we have been concerned about rising competition in the sector, we note that
competition from China and Korea will likely ease. This is mainly on account of: 1) the
proposed import duty on imported power equipment, and 2) ~20% depreciation of INR
vs. CNY that will make Chinese imports expensive and hence uncompetitive.
While stability of the currency exchange rates cannot be forecast, we believe at this
moment Chinese imports are ~25% more expensive compared to their earlier prices.
Based on our channel checks, the historical difference between BHEL and Chinese
imports has been around 10-15% and as such in the current situation, it is unlikely that
Chinese equipment will find buyers in the Indian market.
However, we remain concerned that competition from domestic operators could pose a
long-term threat to BHEL’s market share. In our view, the only possible solution to
domestic competition will be a genuine uptick in demand for equipment that could fill up
capacity for all operators concerned.
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