>BHARAT HEAVY ELECTRICALS LIMITED: Introducing CIRA's new rating system

■ Downgrade to Sell — We resume coverage on BHEL with a Sell rating and a target
price of Rs250. Severe coal/ gas shortages, high international coal prices, poor SEB
financials and land acquisition/ environmental delays have shrunk the India BTG
market. Over the last 5-6 years BHEL has faced competition from Chinese suppliers.


■ ….. and the problem has been compounded — The rise of domestic equipment suppliers, such as L&T-MHI, Toshiba-JSW, Bharat Forge-Alstom, BGR-Hitachi, shows the Indian power BTG market is just like any other industry: an incumbent making super normal profits attracts new competitors, leading to overcapacity/ pricing collapse.


■ Barriers and pricing are falling — Once BHEL gets the last of the reserved bulk orders in FY13, every incremental order should be a hard-fought battle. Import duties can perhaps provide a sentiment +ve, but we wonder if it will make any difference as: (1) XIIth Plan (FY13E-17E) ordering is over and (2) lack of fuel visibility implies XIIIth Plan (FY18E-22E) ordering will not start in a hurry. BGR-Hitachi’s winning bids in the recently concluded bulk tender are not too far off vis-à-vis Chinese pricing. 


■ Target price Rs250 — Based on P/E of 10x Sep13E and set at ~ 30% discount to
 historical average ~14x given BHEL’s (1) declining backlog ,(2) EPS CAGR of -4% over FY12E-14E and (3) RoEs falling from FY11 - 31% to FY15E - 17%. Our EPS estimates are not conservative as they assume (over next three years) (1) inflows of Rs400bn/year, (2) gross margins contracting only 66bps, (3) execution speed improving from 30% to 48% on expanded capacity and (4) maintenance capex Rs3bn/year.


■ Introducing CIRA's new rating system — In Oct 11 CIRA announced its new stock rating system. CIRA's investment ratings are Buy, Neutral and Sell. Our ratings are a function of analyst expectations of expected total return and risk. Risk rating takes into account price volatility and fundamental criteria. Stocks will either have no risk rating or a High risk rating. The sidebar and table on this page show our new rating, target price, and estimates for BHEL. See “Guide to CIRA Fundamental Research Investment Ratings” in the Important Disclosures section of Appendix A1 of this report for a description of our rating system.


To read report in detail: BHEL
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