Bhel reported Ebitda loss of Rs 4.7 bn in Q2FY16 (vs our expectation of a profit of Rs 3.2 bn), as gross margin at 34.2% (down 990bps y-o-y) was 10.3ppts lower than our estimate. This was led by aggressive pricing in recent orders and higher share of imported components for the super-critical projects under Joint Deed Undertaking (JDU).
Consequently, Ebitda margin declined to a record low of -8% (vs our estimate of +5.5% and Q2FY15 of +4.7%). Order inflow declined 81% y-o-y, as there were no major power sector orders in Q2. Due to a sharp decline in Ebitda margin, we cut our FY16/FY17 Ebitda estimate by 55%/52% and TP (target price) by 5% to Rs 122/share. We remain Sellers given our structural concerns on the BTG industry and Bhel’s inability to diversify. The stock is trading at 49.8x FY17e P/E and 1.7x FY17e P/B (price-to-book ratio) , a premium of ~300% to its cross-cycle P/E.
Standalone results overview: Revenue at Rs 59.4 bn declined 3% y-o-y led by a 15% y-o-y decline in the industry business. Power revenue grew merely by 2% y-o-y to Rs 48.5 bn. Weak revenue growth despite a 19% y-o-y increase in the opening order book as on July 2015 could be due to slow-moving and yet-to-start orders at Rs 370 bn.
Gross margin declined sharply by 990bps y-o-y to 34.2% due to: (a) increase in share of imported components in execution under the Joint Deed Undertaking (JDU); and (b) aggressive pricing under the recent orders. Higher other expenses (up 24% y-o-y) along with a decline in revenue meant that the Ebitda margin declined further by 12.7ppts to a record low of -8.0%. Consequently, Ebitda declined from profit of Rs 2.9 bn in Q2FY15 to a loss of Rs 4.7 bn (vs our expectation of profit of Rs 3.2 bn). Higher other income (up 90% y-o-y) meant that loss before tax stood at Rs 3.3 bn (lower than Ebitda loss of Rs 4.7bn) vs a profit of Rs 2.1 bn in Q2FY15. Tax reversal meant that loss after tax stood at Rs 2.0 bn vs profit of Rs 1.2 bn in Q2FY15 and our estimate of profit of Rs 2.3 bn.
Key takeaways from the conference call
* Gross margin to remain under pressure from hereon: Gross margin in Q2FY16 declined 990bps y-o-y to 34.2% due to higher proportion of orders underexecution which were taken under the Joint Deed Undertaking (JDU) with the foreign technology partner. As Bhel does not have material execution track record of super-critical boilers on its own, customers (NTPC and all major central and state utilities) ask for execution guarantee from Bhel’s foreign technology partner. In return for the guarantee (under JDU), Bhel has to buy a high portion of BTG components from the technology partner rather than manufacturing inhouse (management refrained from giving the proportion) which impacts the gross margin. The share of JDU orders under-execution has increased from 30-40% in FY13-14 and 55% in FY15 to 65% in 1HFY16.
Impractical price bidding by Bhel for the sake of market share: Another reason for gross margin contraction in 2QFY16 is the weak pricing under the recent orders. The management highlighted its new strategy of improving market share to 80% from ~72% currently by making aggressive bids. We believe the margin pressure could steepen further, as the execution in the recent orders which were taken at record lows is yet to commence.
* Bhel is L1 in 8.3GW orders (all from public sector): The management guided for industry order intake of 22GW in FY16 led by SEBs and public sector utilities. Bhel expects order wins of ~17GW in FY16, out of which it has already won 4.1GW of order in 1HFY16 and another 1.6GW in October 2015 .
* No major order taken during the quarter: Order inflow at ~R24bn in Q2FY16 declined 81% y-o-y, as there were no major order inflows in the power sector. However, order book at R1.12tn increased 19% y-o-y due to the 6GW Telangana order of R277 bn taken in 4QFY15 and 1QFY16.
Consequent to the Ebitda miss, we cut our FY16/FY17 Ebitda estimate by 55%/52%. The cut in Ebitda is primarily led by a 300bps/350bps cut in Ebitda margin in FY16/FY17. We remain SELLers on Bhel, as we have the following concerns:
* Pricing unlikely to improve: Pricing is under a lot of pressure; Bhel took the Telangana EPC order at R46m per MW vs R50m per MW earlier. Pricing is likely to improve only if the ordering size increases to >20GW in FY16 vs ~10GW in FY14 and FY15.
* Increase in coal production a negative catalyst for Bhel: Even with a peak demand of 141GW in FY15 and installed capacity of 270GW, India had a peak deficit of 7GW. This is because of shortage of coal (average PLF declined to 66% in FY15 vs 79% in FY08). If the Power and Coal minister’s guidance of 1bn tonne coal production by FY19 (implying tripling of production over FY14-19) is met then clearly India’s average PLF would improve substantially, fully eliminating the power deficit.
* Feeder separation a negative catalyst for Bhel: Assuming that India’s AT&C losses are reduced by 9% points to 16% then the incremental supply can be 7GW which would be sufficient to eliminate current peak deficit of 7GW. A positive step towards reduction in AT&C losses has already been taken by the Government through allocation of Rs 430 bn for the feeder separation scheme on a pan-India basis. The feeder scheme in Gujarat led to reduction of AT&C losses from 26% in FY06 to 16% in FY11. If the power deficit declines to nil then power demand would increase by only 6-7GW per annum (elasticity of power to GDP is 0.9x).