'Sell' BHEL shares, target price Rs 140: Order backlog is shrinking

Written by Citi | Updated: Aug 12 2013, 20:06pm hrs
BHEL shares, target price Rs 140: Q1 answers the questions that Q4 created: Stronger than expected Q4FY13 sales and 290 days of receivables had made us wonder if there was an element of advancement of future sales to meet FY13 MoU (memorandum of understanding) targets. Q1FY14 sales declining 24% year-on-year perhaps corroborates this. This implies that reality lies somewhere between the stronger than expected Q4FY13 and weaker than expected Q1FY14.

But no improvement in receivables is worrying: Given the above explanation for Bharat Heavy Electricals Ltd (BHEL) sales decline, we would have expected receivables to improve quarter-on-quarter. But they have increased to just R410 bn, which is worrying.

Profits collapse: All the cost items in Bhels Q1 results are inline with expectations. Only thing amiss is sales, which are down 24% y-o-y, which led to a PAT (profit after tax) of R4.7 bn, down 49% y-o-y. Net of forex gain on receivables PAT is down 82% y-o-y.

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Not many new orders to speak of: Bhel won R14.7 bn of orders in Q1. Unfortunately R12 bn of orders from Iraq (won in FY11) were cancelled, leading to net addition of only R2.5 bn to the backlog. The backlog at R1,086 bn is down 18% y-o-y.

Maintain Sell: If inflows are less than sales, the backlog

will decline. A declining backlog (-18% y-o-y in FY12 and -15% y-o-y in FY13) will lead to sales decline. This in turn would lead to negative operating leverage, which would lead to decline in margins, RoEs (returns on equity) and RoCEs (returns on capital employed). Given the Indian coal scenario, we dont know when ordering would begin in earnest again and pull inflows above sales.

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Target price cut to R140: We cut our target price to R140 (from R185 earlier) to factor in (i) cut in target P/E to 7x (from 8x earlier) and (ii) 3-12% cut in EPS (earnings per share). Our EPS cuts over FY14e-16e (estimates) factor in 8-17% lower inflows, 4-7% lower sales and new Ebitda (earnings before interest, taxes, depreciation and amortisation) margin assumptions.

More than a particular stock price level, investors should be looking for signs of business revival to get constructive.

Without the same the stock could very well decline more and remain at those levels for long periods of time.

Investment strategy: Severe coal/ gas shortages, high international coal prices, poor SEB (state electricity board) financials and land acquisition/environmental delays have shrunk the opportunity pie for Bhel. Over the last five-six years Bhel faced competition from Chinese suppliers. The problem has

been compounded by the rise of domestic equipment suppliers like L&T-MHI, Toshiba-JSW, Bharat Forge-Alstom, BGR-Hitachi, Doosan, Thermax-Babcock Wilcox, Cethar Vessels and GB Engineering-Ansaldo. Indian power BTG (boiler, turbine, generator) market is just like any other industry, where the incumbent making super-normal profits attracts a host of new competitors, leading to overcapacity.

Once Bhel gets the last of reserved bulk orders in FY13, every incremental order should be a hard-fought battle. Import duties can perhaps provide a sentiment positive, but we wonder if it will make any difference as: (i) Plan-XII (FY13-17) ordering is over and (ii) lack of fuel visibility implies Plan-XIII (FY18-22) ordering will not start in a hurry.