Sell rating at BHEL; FY16 provisional results show no respite is in sight for BHEL

FY2016 provisional result—weakness continues: BHEL’s Q4FY16 execution and profitability were sharply below estimate. Order inflow was strong this year (includes a very large order where no advance was received and no EC is in place, so far), but incremental near-term ordering potential continues to be weak. Given that significant variability is likely in near-and medium-term earnings on several known unknowns (execution, margin, inflow, WC), we remain SELLers.

FY2016 provisional result: weakness continues
* Sharp decline in revenues: BHEL reported provisional financial results with FY2016 gross revenues of R267 bn (5.3% below estimates, down 13.7% y-o-y). These results imply Q4FY16 revenues of R105 bn (12.6% below estimates, down 19.5% y-o-y compared to 9.5% decline in 9MFY16). The company has reported y-o-y revenue decline in all quarters of this financial year, indicating a persistent weakness in execution. The company cited subdued business environment and stranded projects as key reasons for the weakness in execution.
* Implied Ebitda turns positive in Q4FY16: The company reported a PBT loss of R14.4 bn in FY2016 (35.2% below estimates, down 167% y-o-y). Assuming estimates for other income, interest costs and depreciation are used judiciously Ebitda loss is R15 bn. Full year Ebitda has been supported by back-ended execution in Q4FY16. Q4 revenues constitute 39% of FY2016 revenues and imply a positive Ebitda of R8 bn versus Ebitda loss of R23 bn in 9MFY16. In our view, the results indicate that raw material costs have remained at elevated levels of 63% of sales on account of Joint Deed of Undertaking (JDU) related costs for supercritical technology.
* Order inflows marginally ahead of estimates: The company reported an order inflow of R437 bn (4% above estimates, up 42% y-o-y) in FY2016, the highest in the past five years. The order backlog at R1.1 tn was in line with estimates and up 9% y-o-y. Improved order backlog should set the stage for growth, provided bottlenecks are removed in stranded projects.
* Three key variables to watch out for incrementally are:
(i) Potential reduction in JDU related costs, (ii) resolution of issues affecting stranded projects and (iii) competitive intensity. All these will have a bearing on gross margin and overall profitability.
* Other key highlights: (i) the company retained its volume leadership with a high market share of 74%, (ii) it spent 3.34% of sales on R&D activities in FY2016, (iii) increased focus on cash realization has resulted in arresting the rising trend of debtors.
* Revise estimates; retain SELL: We revise our estimates to Rs 4.3 and Rs 9.8 from Rs 5 and Rs 10.3 EPS in 2017e and 2018e led by changes to execution and margins estimate.