Monday, July 30, 2012


Performance Likely To Moderate 

Bharat Heavy Electricals (BHEL) reported revenue of Rs83.3bn for 1QFY13, up 16.9% YoY and 9.5%/6.4% higher than our/Bloomberg consensus estimates, respectively. However, we believe the pace of order execution may not sustain in the coming quarters with a declining order book, subdued order placement activity and possible delay from the clients’ side owing to structural issues in the power sector. Consequently, we maintain our revenue estimates for FY13E/FY14E. Driven by higher revenue, EBITDA/PAT were higher than our estimates by 7.9%/8.6%, respectively, but margins were largely in line with our estimates. EBITDA grew 17.8% YoY to Rs10.9bn, translating to an operating margin of 13.1%, 20bps lower than our estimate of 13.3%. PAT registered 12.9% YoY growth at Rs9.2bn, resulting in a net profit margin of 11.1%, in line with our estimate. Consequently, we maintain our view of sharp erosion in profitability for BHEL over FY12-14E. We retain our Hold rating on the stock with a target price of Rs221 based on 9xFY14E EPS. 

Order intake to remain weak: Procedural delays on account of land acquisition, fuel linkage and environment/forest clearance continued to hamper order placement activity in the power sector. For the quarter, BHEL reported order inflow of only Rs56bn (weak order intake in four out of the past five quarters) leading to order backlog of Rs1,329bn, 13.3% lower YoY. BHEL is yet to be awarded orders worth Rs93.8bn by NTPC through its bulk tenders. Although the management reiterated its order inflow guidance of Rs600bn for FY13E, we are factoring in order inflow assumption of Rs450bn as we expect the policy paralysis in the power sector to continue. 

Margin compression likely: We expect a sharp erosion in profitability for BHEL over FY12-14E due to pricing pressure in the BTG (boiler, turbine and generator) space owing to dual impact of oversupply and weak demand. The industry segment is also beginning to witness softening margins as it registered a 160bps YoY decline in operating margin to 21% for the quarter. Consequently, we expect BHEL’s operating margin to fall 160bps/150bps YoY in FY13E/FY14E to 17.7%/16.2%, respectively. 

Outlook and Valuation: BHEL is unlikely to sustain its revenue growth traction on such a high base, considering the subdued order placement activity. Also, compression in operating margin is likely to lead to earnings CAGR decline of 7.9% over FY12-14E. However, we believe the recent correction in its stock price factors in these negatives. At Rs212, BHEL trades at 8.0x/8.6x FY13E/FY14E earnings, respectively, compared to average PE of 16x over the past 10 years and least PE of 7.9x/6.5x over the past 6/10 years, respectively. We value the stock at 9xFY14E EPS of Rs24.6 with a target price of Rs221 and retain our Hold rating on it.