What do we do when a stock gives 15% returns on the day of its result? Prudence suggests waiting for a correction. Maybe that’s right, but we beg to differ. Why? BHEL is a beaten down under-owned stock and a potential turnaround candidate. Current quarter numbers once again suggest that this is happening at multiple places. First and foremost, debtors compressed by R6 bn, despite turnover increasing 28% y-o-y, a big positive. Second, a big cost reduction is seen in other expenses, which lowers break-even points. Third, visibility of new orders is becoming ripe for execution. Finally, with free cash flow yield of 5/23% for FY17/18e, even on estimates below consensus, we find the stock as amongst best value picks in the entire infra basket. Maintain buy.
What’s special about the results?
There was nothing much on P/L side. In fact, order inflow at Rs 36 bn was weak and below estimates. Net sales, at Rs 56 bn (up 29% y-o-y), should be seen on a base which is depressed. Raw material to sales (RM/sales) at 63% is on the higher side. But, for us, cash and balance sheet, and accounting policy are far more important. Debtor reduction, historical provisions done at 100% of receivables for >3 years is far superior than peers, who do it on judgmental basis. Results show that a PSU management can effect cost reductions at multiple levels, a phenomenon seen earlier in Coal India.
Where do we go from here?
Unlike many PSUs who lost market share to private sector, BHEL has maintained its position and appears well placed to benefit as more projects kick-start their execution. Working with lower fixed costs/faster timelines can lower RM/sales; though it is early days to say this, it can be watched out for. However, cash generation is on the cards and our estimates factor in FCF of Rs 20 bn in FY17, jumping to Rs 88 bn in FY18e.
Outlook and valuations: Recovery in sight
While we retain our thesis on BHEL that balance sheet revival is in sight, we believe the company is on course to see substantial cash flow over next 2-3 years. For us, key monitorable remains sequential reduction in debtors and closure of key orders, imparting the much-needed revenue visibility. Maintain buy/so with a DCF based target price of R185.
BHEL is the largest heavy engineering and manufacturing enterprise in India in the energy-related/infrastructure sector. It manufactures over 180 products under 30 major product groups and caters to core sectors of the Indian economy viz., power generation & transmission, industry, transportation, telecommunications, and renewable energy.