>BHEL: Coalgate, fake orders and then some more

Action: Execution outlook worsens, while stock seems fairly valued 

Recent news flow regarding several private sector power producers being implicated in the ‘coalgate’ scandal, some of which are BHEL’s existing customers, has negative implications for BHEL’s execution outlook. We estimate that ~28% of BHEL’s existing order book is at risk now (compared to ~19% earlier) and this drives our earnings cuts over the next few years. Simultaneously, several other private power developers have allegedly placed fake orders with power equipment companies in order to boost their chances of securing coal mines in India. Such issues question the credibility of the 115GW equipment orders placed in the system and raise the possibility that post clean-up of some of these orders (through cancellation/forfeiture), new order activity could revive sooner than earlier expected, albeit likely to be in 2-3 years, in our view. In the medium term, we believe the outlook remains highly uncertain as the clean-up of existing orders will bring accompanying pain for the incumbents.

Catalysts: Orders, results and sector concerns Execution and order inflow/cancellation clarity are key stock catalysts.

Valuation: Cut FY13F-14F earnings estimates 1-8% and TP to INR199 We continue to value BHEL based on a DCF methodology (Ke 13.5% and terminal growth of 4%). Our TP of INR199/share factors in deteriorating margins (down to 12-14% levels post FY14 and 8% post FY17) and 6GW p.a. coal-based order inflow over the medium term. Given ~0.5% potential upside from current levels, we maintain our NEUTRAL rating.

To read report in detail: BHEL