>BHEL (MOTILAL OSWAL)

Operating leverage to have limited earnings impact
In FY09, BHEL provided prior period wage arrears/gratuity arrears of Rs6.7b (total arrears at Rs17.3b). Adjusting for prior period arrears, BHEL’s FY09 EBITDA margin is 18.9%. In FY11, we expect BHEL’s EBITDA margin to expand 260bp to 21.5%, indicating operating leverage. However, EBITDA CAGR of 31% translates into PAT CAGR of only 25% due to decline in other income from Rs7.9b in FY09 to Rs4.5b in FY11E. Decline in other income is mainly due to fall in cash balance from Rs96.2b in FY09 to Rs46.7b in FY11E. Cash balance is expected to fall due to: (1) Lower customer advances on the back of stagnation / marginal decline in annual order intake, (2) Faster unwinding of customer advances due to strong execution, (3) capex of Rs42.1b during FY10 &FY11 and (4) actual cash payments of Rs20b+ towards wage arrears bhmentioned above.

Stagnation in annual order intake to impact working capital and thus cash levels: Order intake and customer advances for the same had increased substantially during FY06-FY09. Annual order intake witnessed exponential increase from 3.4GW in FY06 to 17GW during FY09, up 400% in 3 years. This resulted in balance sheet cash increase from Rs41.3b in FY06 to Rs96b in FY09, an increase of 132%. During FY09-FY11 we expect stagnant order intake leading to fall in cash balance to Rs46.7b by FY11. This cash reduction will be accentuated by increase of cash requirement in faster execution (revenue CAGR of 23% during FY09-FY11). Also, BHEL will entail cash outflow of Rs20b during 1QFY10 for the wage provisions made during FY09.

Capex plan of Rs100b+ to increase capacity to 20GW by FY12: BHEL plans to increase its power equipment manufacturing capacity from 10GW to 15GW by March 2010 and to 20GW by March 2012. BHEL plans to spend Rs100b+ for this expansion plan During FY09, company spent only Rs11b, indicating that the majority of capex would happen during FY10-FY12.

Valuation and view: We expect FY09-11E revenue CAGR of 23% and EPS CAGR of 25%. The stock currently trades at a P/E of 23.2x FY10E and 18x FY11E. We maintain Neutral with a price target of Rs2,033/sh (18x FY11E earnings).

To see full report: BHEL