BHEL (BHEL IN) Weak execution and margins lead to the miss in earnings

INSTITUTIONAL EQUITY RESEARCH BHEL (BHEL IN) Weak execution and margins lead to the miss in earnings INDIA CAPITAL GOODS Quarterly Update 26 October 2018 Top takeaways from 2QFY19 BHEL s reported earnings (Rs 1.85bn; +60% yoy) were materially lower than our and consensus estimates. If we were to adjust for forex gains and reversal of prior period depreciation, the company in fact incurred a net loss, partly due to elevated provisions. Order inflows (Rs 51.6bn) were driven by Rs 29bn of orders in the power segment for emission control equipment. Order book at Rs 1.15tn (+19% yoy) stood at 3.9x book tobill of TTM sales. Working capital intensity increased further (NWC 233 vs. 174 days 4QFY18) with increase in receivables (481 vs. 448 days) and inventory (96 vs. 79 days). BHEL announced a buyback of 189.3mn shares accounting for 5.2% of outstanding capital at the price of Rs 86/share (23% premium to CMP) leading to a cash outgo of Rs 16.3bn. Key highlights: Revenues (Rs 68bn, +5% yoy) were marginally (3%/2%) below our/consensus due to muted power segment revenues (78% of sales, +2%) though supported by strong growth in industrial revenues (+32%) on a weak base. Reported EBITDA was up 41% yoy (Rs 2.4bn vs. Rs 1.7bn yoy) on 90bps yoy expansion in EBITDA margins (3.6% vs. 2.6% yoy). Margins were supported by gross margins (41.4% vs. 40.8%) even as employee costs were up 9% qoq. However, if we were to adjust for the forex gain of Rs 2.7bn, BHEL would have reported an EBITDA loss of Rs 332mn (vs. Rs 149mn yoy). Segmentally, operating profitability was supported by Industrial segment EBIT (Rs 696mn vs. Rs 18mn yoy) while Power EBIT declined 36% because of cost provisions. Conference call takeaways Changing sales mix in favour of SEB orders coupled with elongated payment terms and zero advances on certain orders should lead to an increase in working capital. SEBs account for 53% of receivables as of September 2018 against 37% in March 2018; the share of central utilities (29% vs. 37%) and private sector (13% vs. 15%) clients has reduced. The company hopes to offset this pressure on cash flows by imputing a higher margin at the time of bidding. BHEL is well placed in Rs 250bn of orders across power (Rs 205bn), industrial (Rs 15bn), international (Rs 20bn), and spares and services (Rs 15bn). These orders include Talcher TPP (1.3GW), Sagardighi (660MW), Adilabad (800MW), emission control equipment (more than Rs 30bn), and a project in Tanzania. In addition, the management expects to submit bids for 5.7GW of projects. Outlook and valuation With healthy share of executable orders, visibility on FY19 20 revenues has materially improved, though visibility on margins is still hazy. However, we cut our FY19/20 earnings estimates by 7%/4% to factor in impact higher working capital cycle and share buyback. We revise our target price to Rs 65 (Rs 80 earlier) based on 12x FY20 PE. We maintain our Neutral rating, as we find it difficult to justify current valuations (13x FY20 PE) for single digit RoEs and no material business diversification and stretched working capital. Neutral (Maintain) CMP RS 70 / TARGET RS 65 ( 7%) COMPANY DATA O/S SHARES (MN) : 3671 MARKET CAP (RSBN) : 274 MARKET CAP (USDBN) : 3.7 52 WK HI/LO (RS) : 108 / 65 LIQUIDITY 3M (USDMN) : 10.1 PAR VALUE (RS) : 2 SHARE HOLDING PATTERN, % Sep 18 Jun 18 Mar 18 PROMOTERS : 63.1 63.1 63.1 FII / NRI : 13.6 13.0 13.0 FI / MF : 17.8 18.2 18.5 NON PRO : 0.5 0.6 0.5 PUBLIC & OTHERS : 5.1 5.2 4.9 KEY FINANCIALS Rs bn FY18 FY19E FY20E Net Sales 288.13 316.60 374.18 EBIDTA 14.13 24.96 35.33 Net Profit 4.69 14.32 19.21 EPS, Rs 1.3 4.1 5.5 PER, x 55.0 17.1 12.7 EV/EBIDTA, x 10.3 7.6 5.8 P/BV, x 0.8 0.8 0.7 ROE, % 1.4 4.4 5.9 Debt/Equity (%) 0.3 2.3 2.3 CHANGE IN ESTIMATES Revised Est. % Revision Rs bn FY19E FY20E FY19E FY20E Revenue 316.60 374.18 1.2% 0.2% EBITDA 24.96 35.33 5.7% 4.8% Core PAT 14.32 19.21 7.3% 3.6% EPS (Rs) 4.1 5.5 2.3% 1.6% Jonas Bhutta (+ 9122 6246 4119) jbhutta@phillipcapital.in Vikram Rawat (+ 9122 6246 4120) vrawat@phillipcapital.in (Rs mn) Q2FY19 Q2FY18 Change yoy vs. expectations Comments Order book 11,53,300 9,70,900 18.8% 3% Order inflows 51,590 18,740 175.3% 150% Led by Rs 29bn order for emission control equipment on low base Sales 67,799 64,632 4.9% 3% Muted power segments sales partly supported by strong growth in Industrials Gross margin (%) 41.4% 40.8% 54 bps 164 bps EBITDA (332) (149) 123.4% 108% Impacted by elevated employee costs and costs provisions EBITDA margin (%) 0.5% 0.2% 26 bps 680 bps Recurring PAT (772) (304) 153.8% 129% Reported PAT 1,852 1,154 60.4% 30% Supported by forex gain and depreciation reversal due to change in estimate life Recurring EPS (Rs) (0.2) (0.1) 153.8% 129% Page 1 PHILLIPCAPITAL INDIA RESEARCH

BHEL: Quarterly results Rs mn Q2FY19 Q2FY18 Change yoy Order book 11,53,300 9,70,900 18.8% Order inflows 51,590 18,740 175.3% Sales 67,799 64,632 4.9% Raw material 39,757 38,252 3.9% % of sales 59% 59% 54 bps Gross profit 28,042 26,380 6.3% Gross margin (%) 41.4% 40.8% 54 bps Employee cost 15,398 13,988 10.1% % of sales 23% 22% 107 bps Other expenses 12,976 12,541 3.5% % of sales 19% 19% 27 bps EBITDA (332) (149) 123.4% EBITDA margin (%) 0.5% 0.2% 26 bps Depreciation 1,610 1,872 14.0% EBIT (1,942) (2,020) 3.9% EBIT margin (%) 3% 3% 26 bps Interest 689 552 24.7% Other Income 1,517 2,185 30.6% PBT (1,114) (388) 187.6% Tax (343) (83) 310.8% Effective Tax rate (%) 30.8% 21.5% 923 bps Recurring PAT (772) (304) 153.8% Recurring PAT margin (%) 1.1% 0.5% 67 bps Exceptional 2,623 1,458 79.9% Reported PAT 1,852 1,154 60.4% Recurring EPS (Rs) (0.2) (0.1) 153.8% Source: Company, PhillipCapital India Research BHEL: Segmental results Rs mn Q2FY19 Q2FY18 Change yoy Segment Revenue Power 51,532 50,647 1.7% Industrial 14,538 11,037 31.7% Gross Sales 66,069 61,684 7.1% Excise & service tax 879 100.0% Other operating income 1,730 2,069 16.4% Total Operating Income 67,799 64,632 4.9% Segment EBIT Power 4,257 6,691 36.4% Industrial 696 18 3810.1% Segment EBIT 4,953 6,708 26.2% Unallocated (6,895) (8,729) 21.0% EBIT as per P&L (1,942) (2,020) 3.9% EBIT margin (%) Power 8.3% 13.2% 495 bps Industrial 4.8% 0.2% 463 bps Segment EBIT 7.5% 10.9% 338 bps Unallocated % of Sales 10.2% 13.5% 334 bps EBIT margin 2.9% 3.1% 26 bps Source: Company, PhillipCapital India Research Estimates Page 2 PHILLIPCAPITAL INDIA RESEARCH

BHEL: Segmental results Rs mn Q2FY19 Q4FY18 Q2FY18 Equity share capital 7,343 7,343 4,895 Reserves & Surplus 3,18,770 3,18,668 3,17,752 Networth 3,26,113 3,26,011 3,22,648 Borrowings 7,170 572 778 Deferred tax liabilities, net (35,482) (36,259) (39,936) Non current liabilities (28,312) (35,687) (39,158) Networth & Liabilities 2,97,800 2,90,324 2,83,490 Fixed Assets incl CWIP 31,337 32,716 34,441 Non current investments 6,738 6,907 7,359 Current investments 5,802 Investments 6,738 6,907 13,161 Non current assets 38,075 39,623 47,603 Inventories 77,466 62,588 66,682 Trade receivables 3,89,926 3,54,935 3,29,982 Cash & bank balances 70,998 1,12,912 96,443 Other assets 32,884 31,575 38,152 Current Assets 5,71,274 5,62,009 5,31,259 Trade payables 1,10,796 1,10,659 86,744 Other liabilities 1,13,860 1,13,591 1,13,121 Provisions 86,892 87,059 95,506 Current Liabilities 3,11,548 3,11,309 2,95,372 Net Current Assets 2,59,726 2,50,700 2,35,887 Total Assets 2,97,800 2,90,324 2,83,490 Working capital analysis Net working capital ex cash 1,88,728 1,37,789 1,39,444 NWC ex cash % of sales 64% 48% 50% NWC ex cash days 233 174 181 Inventory days 96 79 86 Receivable days 481 448 428 Other assets days 41 40 49 Gross working capital days 618 567 564 Trade payable days 137 140 112 Other liability days 141 143 147 Provision days 107 110 124 Current liability days 385 393 383 Net WC Days 233 174 181 Source: Company, PhillipCapital India Research Estimates Page 3 PHILLIPCAPITAL INDIA RESEARCH

Financials Income Statement Y/E Mar, Rs mn FY17 FY18 FY19e FY20e Net sales 285,995 288,130 316,597 374,180 Growth, % 11 1 10 18 Total income 285,995 288,130 316,597 374,180 Raw material expenses 175,356 165,292 179,855 212,567 Employee expenses 53,946 60,265 59,614 58,988 Other Operating expenses 36,642 48,442 52,167 67,293 EBITDA (Core) 20,051 14,131 24,961 35,333 Growth, % (246.7) (29.5) 76.6 41.6 Margin, % 7.0 4.9 7.9 9.4 Depreciation 8,488 7,864 6,932 7,294 EBIT 11,562 6,267 18,029 28,039 Growth, % (150.2) (45.8) 187.7 55.5 Margin, % 4.0 2.2 5.7 7.5 Interest paid 3,506 2,546 2,616 3,364 Other Non Operating Income 7,659 6,931 6,287 4,438 Pre tax profit 15,715 10,652 21,699 29,113 Tax provided 4,437 5,965 7,378 9,899 Net Profit (adjusted) 11,278 4,688 14,321 19,215 Growth, % (200.9) (58.4) 205.5 34.2 Net Profit 4,959 8,066 16,798 19,215 Unadj. shares (m) 3,671 3,671 3,482 3,482 Wtd avg shares (m) 3,671 3,671 3,482 3,482 Balance Sheet Y/E Mar, Rs mn FY17 FY18 FY19e FY20e Cash & bank 1,04,918 1,12,912 62,200 48,574 Debtors 3,18,633 3,54,935 3,94,662 4,51,067 Inventory 73,724 62,588 73,913 87,356 Loans & advances 0 0 0 0 Other current assets 32,357 31,575 34,461 40,048 Total current assets 5,29,632 5,62,009 5,65,236 6,27,045 Investments 6,614 6,907 6,907 6,907 Gross fixed assets 53,725 56,261 59,278 62,285 Less: Depreciation 17,766 25,573 32,505 39,799 Add: Capital WIP 1,683 2,028 2,011 2,004 Net fixed assets 37,642 32,716 28,784 24,490 Total assets 6,12,302 6,37,892 6,37,186 6,94,701 Current liabilities 1,95,870 2,23,793 2,19,902 2,54,075 Provisions 91,929 87,059 87,735 99,951 Total current liabilities 2,87,799 3,10,852 3,07,638 3,54,026 Non current liabilities 1,558 1,029 7,529 7,529 Total liabilities 2,89,358 3,11,881 3,15,166 3,61,554 Paid up capital 4,895 7,343 6,964 6,964 Reserves & surplus 3,18,049 3,18,668 3,15,055 3,26,183 Shareholders equity 3,22,944 3,26,011 3,22,019 3,33,147 Total equity & liabilities 6,12,302 6,37,892 6,37,186 6,94,701 Source: Company, PhillipCapital India Research Estimates Cash Flow Y/E Mar, Rs mn FY17 FY18 FY19e FY20e Pre tax profit 15,715 10,652 21,699 29,113 Depreciation 8,488 7,864 6,932 7,294 Chg in working capital 101 1,331 57,153 29,047 Total tax paid 6,259 3,810 7,378 9,899 Cash flow from operating activities 5,620 9,941 39,570 3,612 Capital expenditure 3,327 2,938 3,000 3,000 Chg in investments 27 293 0 0 Cash flow from investing activities 5,659 9,607 5,764 1,438 Free cash flow 40 19,548 33,806 2,174 Debt raised/(repaid) 544 530 6,500 0 Dividend (incl. tax) 4,655 8,042 8,087 9,250 Cash flow from financing activities 4,697 6,710 16,906 11,451 Net chg in cash 4,737 12,838 50,712 13,625 Valuation Ratios FY17 FY18 FY19e FY20e Per Share data EPS (INR) 3.1 1.3 4.1 5.5 Growth, % (200.9) (58.4) 222.1 34.2 Book NAV/share (INR) 88.0 88.8 92.5 95.7 FDEPS (INR) 3.1 1.3 4.1 5.5 CEPS (INR) 5.4 3.4 6.1 7.6 CFPS (INR) 4.7 3.4 (10.5) (0.9) DPS (INR) 1.1 1.8 1.9 2.2 Return ratios Return on assets (%) 2.1 1.0 2.5 3.2 Return on equity (%) 3.5 1.4 4.4 5.9 Return on capital employed (%) 4.8 2.0 5.5 7.2 Turnover ratios Asset turnover (x) 1.0 1.1 1.1 1.1 Sales/Total assets (x) 0.5 0.5 0.5 0.6 Sales/Net FA (x) 7.1 8.2 10.3 14.0 Working capital/sales (x) 0.8 0.8 0.9 0.9 Working capital days 292.1 285.4 326.4 316.4 Liquidity ratios Current ratio (x) 2.7 2.5 2.6 2.5 Quick ratio (x) 2.3 2.2 2.2 2.1 Interest cover (x) n/a n/a n/a n/a Dividend cover (x) 2.9 0.7 2.1 2.5 Total debt/equity (%) 0.5 0.3 2.3 2.3 Net debt/equity (%) (32.0) (34.3) (17.0) (12.3) Valuation PER (x) 22.9 55.0 17.1 12.7 Price/Book (x) 0.8 0.8 0.8 0.7 Yield (%) 1.5 2.6 2.7 3.1 EV/Net sales (x) 0.5 0.5 0.6 0.5 EV/EBITDA (x) 7.7 10.3 7.6 5.8 EV/EBIT (x) 13.4 23.3 10.5 7.3 Page 4 PHILLIPCAPITAL INDIA RESEARCH

Stock Price, Price Target and Rating History 200 150 N (TP 207) 100 50 N (TP 100) S (TP 105) S (TP 120) S (TP 120) N (TP 135) N (TP 130) N (TP 130) N (TP 100) B (TP 103) N (TP 80) 0 A 15 O 15N 15 J 16 F 16 A 16M 16 J 16 A 16 S 16 N 16D 16 F 17M 17M 17 J 17 A 17 S 17 N 17D 17 J 18 M 18A 18 J 18 J 18 S 18 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 5 PHILLIPCAPITAL INDIA RESEARCH

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