BHEL - Structural issues unlikely to abate - ICICI Securities

The BHEL stock price has run up close to 40% from its lows in August on the back of positive newsflow as regards to: a) domestic sourcing of BTG equipments for UMPPs (Ultra Mega power Projects), b) notification of standard bidding document (SBD) for case-2 bids with fuel cost as pass-through, and c) approval of the coal block auction policy by the government. While these policies would have been a harbinger of capex in the sector, we believe their impact on BHEL's growth prospects could be delayed/muted given the sector dynamics (competition, current untied capacity in the space, and delay in development of coal blocks).

Further, in light of execution slowdown, weakening working capital cycle (recent legal action against customer overdues to the extent of Rs170bn) and limited opportunities (except in UMPPs), we expect a period of negative operating leverage and reducing margins. Reiterate SELL with a price target of Rs120/share (unchanged), based on 10x FY15E EPS.

Positive newsflow, yet not so positive:

- Domestic sourcing of BTG equipments for UMPPs – While foreign competition may not be a threat, domestic players have already queered the pitch as ~30-35GW of BTG capacity is already awaiting fresh orders. Further, incremental ordering is likely to be sparse, unless current issues see resolution.

- SBD for Case-2 bids – This is more positive for the power sector as it is likely to followed by SBD for case-1 bids as well. However, with much untied capacity already waiting to sign PPAs and muted power demand (3.3% growth in YTD FY14, PLFs at multi-year low), players may not be hurrying to set up fresh capacities.

- Coal block auction – With at least 4-5 years lag between mine win and production, players would rather wait for visibility on mining/exploration/clearances before ordering for equipment.

Current issues see no signs of abatement: Faced with a depleting orderbook, stretched working capital and execution slowdown (due to client side issues such as funding and clearances), BHEL is likely to bear the brunt of negative operating leverage. Consequently, we expect BHEL to see EBITDA margin decline of 770bps between FY13 and FY15. While there have been talks of BHEL taking over troubled projects, the same could be counter-productive in alleviating balance sheet pains.

Reiterate SELL with target price of Rs 120/sh: Our earnings estimates factor revenues and earnings degrowth CAGR of 16.9% and 33.1% over FY13-15, leading to a sharp decline in RoE (from 21.7% in FY13 to 8.3% in FY15E). Key risks to our call are: order wins at healthy margins, and profitable diversification in new segments.

Source : Equity Bulls

Keywords