BHEL - Recent optimism unfounded; outlook remains hazy - Antique

We believe that optimism around Bharat Heavy Electricals Limited's (BHEL) growth outlook in past few months, on the back of likely power sector reforms and SEB debt restructuring, is unfounded. In our opinion, reforms are aimed at speedy implementation of ongoing power projects, improving operating environment for power utilities and making coal sector viable. We believe that any meaningful pick up in BTG ordering is at least two years away. Given declining BTB, pressure on margins, and deteriorating working capital, FY14-15e earnings will be under severe pressure. Maintain SELL.

Demand outlook deteriorating; order inflow at new normal

BHEL's annual order inflow has declined by 63%, from INR605bn in FY11 to INR220bn in FY12, and has remained weak after that. BHEL enjoyed strong order inflow in FY08-11 with average annual inflow of INR573bn which is expected to shift to significantly lower at ~INR287bn per year over the next few years. We believe that order book will decline to INR1tn in FY13e, down 37% from INR1.64tn in FY11. BTB will fall to around 2.4x TTM sales in FY13e, from peak of 4x, thereby adversely impacting revenue visibility. Also, BHEL is executing over 25GW of private sector power projects, the progress on many of these may be delayed, thereby meaningfully impacting BHEL's FY14-15e revenue growth.

EBITDA under pressure; FY14e EPS to drop by 26%

We believe that pricing environment in the domestic BTG manufacturing industry will significant worsen due to excess capacity. Poor operating leverage on account of declining sales will also have a meaningful impact on EBITDA margins going forward. In our view, EBITDA margin will decline by 247bps in FY14e, leading to over 26% YoY fall in earnings to INR20.5. Given the ordering environment, FY15e appears equally uncertain.

Deteriorating working capital; RoE to fall to lowest since FY03

As at FY12, the company's receivables (including retention money) stood at historic high of 263 days of sales, resulting into cash on books declining to INR66bn in FY12 from INR100bn in FY10. We believe that working capital environment will remain challenging. Declining earnings coupled with adverse working capital will drive down RoE to 15% in FY14e (lowest since FY03).

Valuation and outlook

We believe that the current crisis in India's coal sector is meaningfully negative for BHEL. In our opinion, many of the private sector power projects that BHEL is executing, may go slow in the backdrop of growing uncertainty around fuel availability. This will adversely impact BHEL's earnings growth for FY14e and beyond. At 11.8x FY14e earnings, the stock is not cheap given worsening external environment in the coal sector and downside risk to FY14-15e earnings estimates due to execution constraints and deteriorating working capital. We maintain SELL.

Source : Equity Bulls

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