BHEL (BHEL IN) Weak execution unable to absorb wage revision

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1 INSTITUTIONAL EQUITY RESEARCH BHEL (BHEL IN) Weak execution unable to absorb wage revision INDIA CAPITAL GOODS Quarterly Update Top takeaways from 1QFY18 BHEL reported a recurring loss of Rs 785mn vs. Rs 512mn profit yoy (our/consensus estimate: Rs 2.2bn profit). Loss was due to: (1) lower than expected revenues, which were unable to absorb the wage revision provision of Rs 2.5bn, and (2) higher finance costs (Rs 657mn vs. Rs 57mn yoy) due to unwinding of provision for contractual and long term obligations. Order inflows (Rs 18bn, 14% yoy) were weak on delay in conclusion of L1 orders (5GW). Receivables stood at Rs 324bn (vs. Rs 319bn in 4QFY17) of which Rs 190bn were deferred receivables (due on completion of certain milestones). BHEL has entered into a technical collaboration agreement with Kawasaki Heavy Industries (KHI) for manufacturing stainless steel coaches and bogies for metros. Key highlights: Revenue (Rs 55bn, 2% yoy) was 13%/9% below our/consensus estimates. Power revenues (77% of sales) were flat yoy while EBIT grew 41% yoy led by a 296bps yoy improvement in margins to 10.1% vs. 7.2%. Industry revenues (23% of sales) fell 8% yoy while margins were flat at 6.3%. PAT was up 4% yoy on Rs 2.1bn foreign exchange gains. Conference call takeaways Of its Rs 1,014bn order book, Rs 618bn of orders are clear/executable (61% vs. 63% in 4QFY17). Further, three projects will add to its executable order book: (1) 4GW Yadadri project (Rs 180bn, 18% of order book), (2) 400MW Maheshwar hydro project as PFC has taken over, and (3) a private sector project as SBI has taken over the project. BHEL is likely to remove 8% or Rs 79bn worth of projects from its order book Rs 54bn Nasik and Amravati phase 2 projects of Rattan Power, Rs 25bn Visa Power project. It is L1 in 5GW (>Rs 250bn) of projects, which includes 2.4GW Pataratu, 1.32GW Udangadi (under litigation), 660MW Bhusawal, and 660MW Panki (EC received). Additionally, it highlighted 4GW of projects are under tendering. BHEL has received Rs 7.5bn orders for boiler modification to control NOx emissions and expects another Rs 15bn of orders in FY18 from under construction projects. It is also a major beneficiary of the FGD tenders floated by NTPC and Neyveli. It is targeting Rs 40 50bn of orders from spares and services as against Rs 27bn in FY17. BHEL will incur Rs 3bn of capex and Rs 9bn for R&D spending during FY18. Announced bonus issue of 1:2 equity shares. Outlook and valuation: We expect the share of slow moving orders in BHEL s orderbook to reduce to 20% over the next few quarters from 39% currently, thus increasing the visibility of our FY18 revenue estimates. However, we cut our FY18/19 earnings by 26%/11% on lower revenues/margins (to factor in weak 1QFY18 results and higher finance costs). We have kept our target price at Rs 130 as we roll forward our target multiple of 15x PE to June 2019 (March 2019 earlier). We maintain our Neutral rating as we find it difficult to justify current valuations (16x FY19 PE) for single digit RoEs and no material business diversification. Key things to monitor margins in FY18; share of low margin contracts should decline, but wage impact could negate gains. 11 August 2017 Neutral (Maintain) CMP RS 127 / TARGET RS 130 (+3%) COMPANY DATA O/S SHARES (MN) : 2448 MARKET CAP (RSBN) : 330 MARKET CAP (USDBN) : WK HI/LO (RS) : 183 / 116 LIQUIDITY 3M (USDMN) : 12.5 PAR VALUE (RS) : 2 SHARE HOLDING PATTERN, % Jun 17 Mar 17 Dec 16 PROMOTERS : FII / NRI : FI / MF : NON PRO : PUBLIC & OTHERS : KEY FINANCIALS Rs mn FY17 FY18E FY19E Net Sales 2,82,222 3,05,572 3,36,381 EBIDTA 17,749 18,613 28,947 Net Profit 10,294 11,072 18,991 EPS, Rs PER, x EV/EBIDTA, x P/BV, x ROE, % Debt/Equity (%) CHANGE IN ESTIMATES Revised Est. % Revision Rs bn FY18E FY19E FY18E FY19E Revenue % 1.0% EBITDA % 1.5% Core PAT % 10.5% EPS (Rs) % 10.5% Jonas Bhutta ( ) jbhutta@phillipcapital.in Vikram Rawat ( ) vrawat@phillipcapital.in (Rs mn) Q1FY18 Q1FY17 Change yoy vs. expectations Comments Order book 10,13,800 10,80, % Order inflows 18,000 32, % Delay in conclusion of L1 (5GW) orders Sales 55,056 56, % 13% Due to weak Industrial segments revenues Gross margin (%) 40.1% 36.8% 335 bps 214 bps Change in sales mix (lower JDU project) EBITDA (883) % 142% Impacted by provision for wage revision EBITDA margin (%) 1.6% 1.3% 287 bps 495 bps Recurring PAT (785) % 150% Reported PAT % 48% Due to weak operating result and higher interest costs Recurring EPS (Rs) (0.3) % 150% Page 1 PHILLIPCAPITAL INDIA RESEARCH

2 BHEL: Quarterly results Rs mn Q1FY18 Q1FY17 Change yoy Sales 55,056 56, % Raw material 32,954 35, % % of sales 60% 63% 335 bps Gross profit 22,102 20, % Gross margin (%) 40.1% 36.8% 335 bps Employee cost 14,088 14, % % of sales 26% 26% 1 bps Other expenses 8,897 5, % % of sales 16% 10% 622 bps EBITDA (883) % EBITDA margin (%) 1.6% 1.3% 287 bps Depreciation 2,001 2, % EBIT (2,884) (1,471) 96.0% EBIT margin (%) 5% 3% 262 bps Interest % Other Income 2,492 2, % PBT (1,050) % Tax (265) % Effective Tax rate (%) 25.2% 19.4% 580 bps Recurring PAT (785) % Recurring PAT margin (%) 1% 1% 234 bps Exceptional 1, % Reported PAT % Recurring EPS (Rs) (0.3) % Source: Company, PhillipCapital India Research BHEL: Segmental results Rs mn Q1FY18 Q1FY17 Change yoy Segment Revenue Power 43,356 43, % Industrial 12,714 13, % Gross Sales 56,070 57, % Excise & service tax (2,264) (2,091) 8.3% Other operating income 1, % Total Operating Income 55,056 56, % Segment EBIT Power 4,386 3, % Industrial % Segment EBIT 5,187 3, % Unallocated (8,072) (5,420) 48.9% EBIT as per P&L (2,884) (1,471) 96.0% EBIT margin (%) Power 10.1% 7.2% 296 bps Industrial 6.3% 6.1% 19 bps Segment EBIT 9.3% 6.9% 235 bps Unallocated % of Total operating income 14.7% 9.7% 500 bps EBIT margin 5.2% 2.6% 262 bps Source: Company, PhillipCapital India Research Estimates Page 2 PHILLIPCAPITAL INDIA RESEARCH

3 Financials Income Statement Y/E Mar, Rs mn FY17 FY18e FY19e FY20e Net sales 2,82,222 3,05,572 3,36,381 3,64,553 Growth, % Other income Total income 2,82,222 3,05,572 3,36,381 3,64,553 Raw material expenses 1,71,100 1,80,506 1,99,722 2,15,980 Employee expenses 53,999 55,811 66,338 65,295 Other Operating expenses 39,374 50,641 41,375 44,840 EBITDA (Core) 17,749 18,613 28,947 38,438 Growth, % (229.9) Margin, % Depreciation 8,488 8,645 8,996 9,517 EBIT 9,260 9,968 19,951 28,921 Growth, % (140.2) Margin, % Interest paid 3,506 2,959 2,933 2,863 Other Non Operating Income 1,091 1,106 1,121 1,137 Pre tax profit 13,018 14,763 25,321 34,774 Tax provided 2,724 3,691 6,330 8,694 Net Profit 10,294 11,072 18,991 26,081 Growth, % (245.1) Net Profit (adjusted) 10,294 11,072 18,991 26,081 Unadj. shares (m) 2,448 2,448 2,448 2,448 Wtd avg shares (m) 2,448 2,448 2,448 2,448 Balance Sheet Y/E Mar, Rs mn FY17 FY18e FY19e FY20e Cash & bank 1,04,918 1,16,700 1,22,694 1,29,972 Debtors 3,18,633 3,28,251 3,52,131 3,81,623 Inventory 73,724 79,823 87,871 95,231 Loans & advances 30,188 33,487 36,864 39,951 Other current assets 2,170 2,170 2,170 2,170 Total current assets 5,29,632 5,60,432 6,01,730 6,48,946 Investments 6,614 6,664 6,714 6,764 Gross fixed assets 1,37,795 1,41,073 1,44,507 1,48,337 Less: Depreciation 1,01,836 1,10,481 1,19,477 1,28,994 Add: Capital WIP 1,683 1,405 1,472 1,641 Net fixed assets 37,642 31,997 26,502 20,984 Total assets 6,12,302 6,37,507 6,73,360 7,15,108 Current liabilities 1,96,533 2,12,531 2,30,147 2,50,789 Provisions 91,929 91,163 95,746 98,772 Total current liabilities 2,88,462 3,03,694 3,25,893 3,49,560 Non current liabilities Total liabilities 2,89,358 3,04,589 3,26,789 3,50,456 Paid up capital 4,895 4,895 4,895 4,895 Reserves & surplus 3,18,049 3,28,022 3,41,676 3,59,757 Shareholders equity 3,22,944 3,32,918 3,46,571 3,64,652 Total equity & liabilities 6,12,302 6,37,507 6,73,360 7,15,108 Cash Flow Y/E Mar, Rs mn FY17 FY18e FY19e FY20e Pre tax profit 13,018 14,763 25,321 34,774 Depreciation 8,488 8,645 8,996 9,517 Chg in working capital 76 3,786 13,105 16,271 Total tax paid 4,546 3,691 6,330 8,694 Cash flow from operating activities 13,128 11,136 9,511 13,473 Capital expenditure 3,327 3,000 3,500 4,000 Chg in investments Cash flow from investing activities 1,371 6,302 4,753 4,667 Free cash flow 11,757 17,438 14,264 18,140 Debt raised/(repaid) Dividend (incl. tax) 4,654 5,337 8,000 10,987 Cash flow from financing activities 7,699 5,656 8,270 10,863 Net chg in cash 4,058 11,782 5,994 7,277 Valuation Ratios FY17 FY18e FY19e FY20e Per Share data EPS (INR) Growth, % (245.1) Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) DPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital/sales (x) Working capital days Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) n/a n/a n/a n/a Dividend cover (x) Total debt/equity (%) Net debt/equity (%) (32.2) (34.8) (35.1) (35.4) Valuation PER (x) Price/Book (x) Yield (%) EV/Net sales (x) EV/EBITDA (x) EV/EBIT (x) Source: Company, PhillipCapital India Research Estimates Page 3 PHILLIPCAPITAL INDIA RESEARCH

4 Stock Price, Price Target and Rating History B (TP 270) N (TP 250) N (TP 240) N (TP 245) N (TP 240) N (TP 207) 100 N (TP 100) S (TP 105) S (TP 120) S (TP 120) N (TP 135) N (TP 130) 0 J 14 J 14 S 14 O 14D 14 J 15 M 15A 15 J 15 J 15 S 15 O 15D 15 J 16 F 16 A 16M 16 J 16 A 16 O 16N 16 J 17 F 17 A 17M 17 J 17 Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL 15% > to < +15% Target price is less than +15% but more than 15% SELL <= 15% Target price is less than or equal to 15%. Page 4 PHILLIPCAPITAL INDIA RESEARCH

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