>BHEL (EDELWEISS)

■ Lower commodity prices aid margins; execution remains strong: Bharat Heavy Electricals’ (BHEL) Q2FY10 earnings, at INR 8.57 bn (up 39% Y-o- Y), were ahead of our estimates on better-than-expected execution (revenues 4% higher than estimates) and lower commodity costs. EBITDA margins improved 340bps Y-o-Y, to 18.3%, on lower material costs (56.4% in Q2FY10 vis-à-vis 58.4% in Q2FY09, a 200bps improvement). Q2 revenues were up 24% Y-o-Y, to INR 67.2 bn, propelled by a strong quarter for the power segment (revenues up 23% Y-o-Y).

■ Order backlog at INR 1.26 tn; intake slower in Q2: Q2 order intake at INR 80 bn, down 40% Y-o-Y might look disappointing but in our view too much should not be read into the same. in our view. Management remains confident of achieving its INR 500-550 bn target and closing a few pending private orders in H2FY10. Q2FY10 order backlog stood at INR 1.26 tn.

Lower commodity prices aid margin

■ Capacity expansion on track: Capacity expansion, to 15 GW, is expected to fully complete by December 2009- March 2010, while the second phase of capacity expansion (from 15 GW to 20 GW) has already commenced. The company expects to complete ordering for the second phase of capacity expansion by end of FY10, while the capacity expansion itself will be complete by December 2011.

■ NTPC bulk tendering in FY11 to determine competitive landscape: NTPC bulk tendering orders of 11x660 MW is likely to be finalised in FY11. As per the terms, BHEL is likely to get orders for six boilers sets and five turbine sets, provided it matches the L1 bid. We believe, the outcome is important as it will provide competitive insight. In our view, margins for BHEL could suffer during the initial phase of indigenisation (super critical) and aggressive bidding by new entrants like L&T.

■ Outlook and valuations: Introducing FY12; maintain ‘HOLD’: We are introducing our FY12 estimates, charting 33% CAGR revenue growth over FY10-12E, driven by lumpy delivery schedule in FY11 and FY12. Despite its steep valuation (P/E of 21x and 17.2x FY11E and FY12E, respectively) BHEL remains our preferred pick as in our view competitive intensity is likely to pick up in the Twelfth Plan. However, near-term upsides continue to be limited, in our view. We maintain ‘HOLD’ and ‘Sector underperformer’ on the stock.

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