>BHARAT HEAVY ELECTRICALS LIMITED (GOLDMAN SACHS)

What's changed
Larsen & Toubro (L&T) today announced an EPC order win valued at Rs69bn from Maha Genco (Maharashtra State electricity company) for a 3X660MW Supercritical Power plant.

The price for this order is about 25% lower than the average pricing we have seen for new orders in the Indian power equipment sector until now.

Implications
We believe this trend of intense competition (as seen in the order win for L&T today) will only scale up as new players with domestic manufacturing capabilities continue to ramp-up operations. We believe this will result in a loss of pricing power and market share for BHEL, leading to declining blended returns and margins. We estimate return on capital for the company will be under pressure for all incremental orders and look for a decline of 320bps over next three years.

Price war in power equipment market is on; reiterate Conviction Sell

Our Sell rating (Conviction List) on BHEL is predicated on the thesis of structural changes in the Indian power equipment market which we believe are negative for the company: 1) increasing competition leading to pricing pressure, 2) lower margins on all supercritical category orders (technology sharing payments), and 3) average delivery periods staying high in spite of increased capacity (regional vendor network difficult to expand).

Valuation
Our 12-month P/B-based target price implies 39% downside potential from current levels. The stock is currently trading at 7.0X 12-month fwd BVPS and 27X 12-month fwd EPS (premiums of 18% and 30% respectively to its own 5-year median), which we believe doesn’t price in the structural headwinds outlined above.

Key risks
Favourable regulatory changes such as import duties on equipment; steel price volatility impacting margins as orders for steel are placed in advance.

To read the full report: BHEL