BHARAT HEAVY ELECTRICALS LIMITED RESEARCH

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1 RESULTS REVIEW Bharat Heavy Electricals Limited Hold Share Data Market Cap Rs bn Price Rs. 1, BSE Sensex 13, Reuters BHEL.BO Bloomberg BHEL IN Avg. Volume (52 Week) 0.26 mn 52-Week High/Low Rs. 2,930 / 1, Shares Outstanding mn Valuation Ratios Year to 31 March 2009E 2010E EPS (Rs.) /- (%) 26.5% 34.2% PER (x) 21.6x 16.1x EV/ Sales (x) 3.1x 2.4x EV/ EBITDA (x) 14.9x 11.0x Shareholding Pattern (%) Promoters 68 FIIs 16 Institutions 10 Public & Others 6 Relative Performance 3,500 2,800 2,100 1, Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 BHEL Rebased BSE Index Riding on increased order book Bharat Heavy Electricals Limited (BHEL) s net profit for Q1 09 jumped 33.1% yoy as the Company booked higher revenues on the back of additional capacity of 4,000 MW per annum. However, a higher wage provisioning due to the Sixth Pay Commission s recommendations exerted pressure on the margins. We remain upbeat about the Company s near term growth because of the following factors: Sizeable order book to fuel growth: Order inflow during the quarter shot up 29% yoy. The robust order book worth Rs. 950 bn provides a healthy revenue visibility over the next 4-5 years. We believe that there could be a slowdown in the order inflow growth rate in FY10 as orders for the XIth five-year plan would already have been placed and the orders for XIIth five-year plan would not have commenced. However, with its operations spread across 70 countries and the aim to double its exports by 2012, we expect BHEL to reap benefits from the overseas orders during that period. No major worries on capacity: BHEL increased its capacity to 10,000 MW per annum in December 2007, which helped Q1 09 net sales to jump 33.9% yoy. The Company plans to further increase its capacity to 15,000 MW per annum by December Furthermore, the Company s imported raw material (especially forgings) capacity Key Figures Quarterly Data Q1'08 Q4'08 Q1'09 YoY% QoQ% (Figures in Rs mn, except per share data) Net Sales 32,339 72,020 43, % (39.9%) EBITDA 3,107 13,633 3, % (72.6%) Adj Net Profit 2,889 11,109 3, % (65.4%) Margins(%) EBITDA 9.6% 18.9% 8.6% NPM 8.9% 15.4% 8.9% Per Share Data (Rs.) Adj EPS % (65.4%) Please see the end of the report for disclaimer and disclosures. -1-

2 crunch is expected to ease out through advance orders and build up of own manufacturing facility. New avenues for business: BHEL has inked an MOU with Nuclear Power Corporation of India Limited (NPCIL) to explore and evaluate various technology options available to manufacture steam turbine generation sets of 700 MWe rating and above. This joint venture will also enable BHEL to design and manufacture steam generation sets to meet the needs of the upcoming nuclear power projects. This move should open up new avenues for BHEL. Incremental growth in margins: Almost 50% of the Company s current orders are based on premium pricing, while the remaining orders contain the price escalation clause. Meanwhile, orders for a significant portion of the required raw materials were placed on a fixed-price basis at the time of the bids. Moreover, management indicated that it has made adequate provisions to account for the increase in the wage costs. We believe that these positives will more than compensate for any increase in the cost of other raw materials. Thus, we expect short term margins to improve nominally. Valuation At the current market price (CMP), the stock is trading at a forward revised P/E of 21.6x and 16.1x for FY09E and FY10E earnings, respectively. Based on our DCF valuation and assuming a WACC of 16.7% and a terminal growth rate of 5%, we have arrived at a target price of Rs. 1,790, which is 12.4% more than the CMP. As a result, we downgrade our rating to Hold. Result Highlights Strong revenue booking BHEL s Q1 09 net sales jumped 33.9% yoy as 4,000 MW of new capacity got stabilized, resulting in faster revenue booking. The Power segment s revenue increased 28.2% yoy to Rs bn, while the Industry Please see the end of the report for disclaimer and disclosures. -2-

3 segment s revenue surged 39.7% yoy to Rs bn and contributed 27.3% to the total revenues. Order inflow grew 29% yoy to Rs. 145 bn, while the order book swelled 52.2% yoy to Rs. 950 bn. EBITDA margin under pressure Despite an impressive hike in the net sales, EBITDA margin dipped 97bps yoy to 8.6% due to the higher wage provisioning. The management has highlighted that it has already provided 40% hike for the employees and 50% of DA (Dearness Allowance) to accommodate the expected wage hike for the coming months, as per the Sixth Pay Commission s recommendations. Therefore, the wage cost-to-total revenue ratio is expected to come down. On a separate note, 50% of BHEL s current orders include a price escalation clause. For the remaining orders, the Company has already placed orders for most of the raw materials at a fixed price. Therefore, we expect nominal improvement in the margins. Segmental snapshot (in Rs. mn) 60,000 50,000 40,000 30,000 20,000 10, % 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Q2'07 Q3'07 Q4'07 Q1'08 Q2'08 Q3'08 Q4'08 Q1'09 Pow er Industry Pow er EBIT Margin Industry EBIT Margin Source: Company data, Indiabulls research For the quarter, net profit grew 33.1% yoy to Rs. 3.8 bn on the back of a higher other income, while net profit margin remained almost flat at 8.9%. Please see the end of the report for disclaimer and disclosures. -3-

4 Key Events BHEL bagged massive orders in Q1 09. Some of them are: A Rs. 35 bn turnkey contract for the Pragati III Combined Cycle Power Plant to manufacture four advanced class Frame 9FA gas turbines to be installed at Bawana, Delhi A Rs. 22 bn contract to install two units of 500 MW each at the upcoming Marwa thermal power project of the Chhattisgarh State Electricity Board (CSEB) A Rs. 22 bn EPC contract to manufacture a 600 MW thermal set for TNEB, North Chennai A Rs. 21 bn turnkey contract to set up a 400 MW thermal power plant in Syria A Rs. 18 bn turnkey contract from DVC to set up a 500 MW unit at Bokaro TPS. Key Risks The following factors can pose a threat to our rating: Increased competition (especially from Chinese manufacturers) Delays in the execution of projects A more-than-expected increase in the prices of raw materials Any failure of projects involving super critical technology (considering BHEL s relative inexperience in this field) Outlook Focusing on the sustainable energy need We believe that BHEL would be able to further accelerate its order execution process on the back of the capacity expansion programme, higher capacity utilization, self-manufacturing of forgings, and BHPV s additional capacity. BHEL is presently working on an extended capacity of 10,000 MW per annum and is scheduled to increase it to 15,000 MW per annum by December The Company is also planning a joint venture for manufacturing castings and forgings in order to solve the critical Please see the end of the report for disclaimer and disclosures. -4-

5 component shortage problem. Moreover, it has inked a JV with NPCIL to carry out EPC activities for nuclear power plants. At the CMP, the stock trades at a forward P/E of 21.6x and 16.1x for the revised earnings of FY09E and FY10E, respectively. We have used DCF valuation to value the stock, assuming a WACC of 16.7% and a terminal growth rate of 5%. Our target price of Rs. 1,790 is 12.4% more than the CMP. Based on our valuation, we believe that the favorable performance during the quarter has already been factored in the stock price. Hence, we downgrade our rating to Hold. Key Figures Year to March FY06 FY07 FY08 FY09E FY10E CAGR (%) (Figures in Rs mn, except per share data) (FY08-10E) Net Sales 133, , , , , % EBITDA 25,986 36,053 38,051 48,546 65, % Adj Net Profit 16,779 24,277 28,593 36,163 48, % Margins(%) EBITDA 19.4% 20.9% 19.6% 20.6% 21.6% NPM 12.5% 14.1% 14.8% 15.4% 15.9% Per Share Data (Rs.) Adj EPS % PER (x) 11.2x 22.7x 19.4x 21.6x 16.1x Please see the end of the report for disclaimer and disclosures. -5-

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