Investors with an exposure of at least two to three years can buy into Bharat Heavy Electricals Ltd. A significant share in the thermal business in the 11th Five-Year Plan, solid capacity expansion, greater earnings visibility, continued encouraging performance, and strategic tie-ups, would strengthen the company’s position in the engineering sector, thereby making it a lucrative investment proposition

Business

BHEL is an engineering company catering to the power and infrastructure sectors. It manufactures over 180 products for industries like power generation and distribution, transportation, telecommunications, and renewable energy.

The company’s operations are organised around two major business segments – power (74% of 1HFY08 revenues) and other industries (26%). The company has around 42,000 employees and 14 manufacturing units. BHEL built sets account for over 80,000 MW, or almost 65% of India’s power generation capacity of 130,000 MW.

Investment rationale

a) Drivers

India is a power-deficit country. The gap between demand and supply has been increasing. The peak deficit varies from 5.8% of peak demand requirements in the southern region to 26.5% of peak demand requirements in the western region.

BHEL built sets account for around 85,000 MW, or 65%, of India’s power generation capacity of 1,15,000 MW at present. And with the government clearing a blueprint to add another 80,000 MW of generation capacity by the year 2012, the company has a strong potential to grow, while going forward.

Acceleration of the reforms process, corporatisation of SEBs and the Electricity Act of 2003 would all offer good growth prospects for BHEL, which has been consistently upgrading its product profile to cater to the changing demand of the industry.

b) Orders

BHEL’s order backlog stood at Rs 72600 crore at the end of September 2007. This was more than four times the company’s sales in the whole of FY07, thus indicating strong visibility into the future.

While the high order book does raise concerns of timely execution, BHEL’s capacity expansion plan to 15,000 MW by 2010, which appears to be running on schedule, is expected to take care of the large backlog. The company also has an in-principle approval from the government for further expansion through acquisition of small-sized units.

c) Capacity expansion

BHEL has embarked on a plan of enhancing its manufacturing capacity to 15,000 MW per annum by the end of 2009, at a total investment of Rs 32 billion. The company has already expanded its manufacturing capacity from 6,000 MW to 10,000 MW (in December 2007). With these expanded capacities, the company would be able to execute significantly larger sized projects over the next five years.

d) JVs

BHEL has signed a joint venture agreement with NTPC for manufacturing power generation and related equipment, in addition to executing power and other infrastructure projects. It has recently made its foray into the execution of supercritical thermal power projects. The company signed a MoU with the Tamil Nadu Electricity Board (TNEB) to float a JV company for setting up the first 1,600 MW supercritical power project in the southern state. The project, with a total capital outlay of around Rs 8500 crore (Rs 5.3 crore per MW).

Concerns

BHEL has seen delays on orders in the past. One reason for this has been a huge order book and the unavailability of adequate resources to execute the same on time. The power ministry has now called for the company to work on extra shifts to complete its order backlog, which is crucial, considering the government’s target of setting up almost 78,000 MW during the eleventh plan period (2007-12).

Financials & valuations

BHEL has posted a 15.6% rise in net profit, at Rs 772 crore, for the quarter ended December 31, 2007, as compared to Rs 668 crore for the same quarter last year on the back of robust growth in its equipment business.

Its income from operations has also increased by 17.3% to Rs 5,529 crore in the third quarter from Rs 4,710 crore for the third quarter of last year.

Its income from power business rose by 18% at 4,204 crore from Rs 3,538 crore in the same period last year. At Rs 2019.90, the stock is trailing 34.11(x) on earnings of Rs 59.21.