Stock Review: BHEL

India's largest power equipment manufacturer and engineering major, BHEL, reported last Friday (during market hours) a mixed set of numbers for the June quarter. Since the broader picture continues to suggest growth rates should be pretty healthy, most analysts continue to be positive on the stock, which was up 1.8 per cent since last Thursday's close against the Sensex's 0.5 per cent decline.

June quarter, a mixed bag

BHEL's revenues grew by a modest 16.6 per cent year-on-year, which were slightly below analysts' expectations as well as the 25 per cent growth recorded for the quarter and year ended March. Positively, significant savings in input costs (due to low-cost inventory) helped earnings before interest, taxes, depreciation and amortisation (Ebitda) margins jump 380 basis points to 13 per cent.

This, even as employee costs grew faster consequent to new recruitments to support the expanded capacities as well as wage revisions effected earlier. A relatively lower rise in tax outgo saw net profits surge 42 per cent, which were ahead of Street estimates.

Unexciting order inflows

Consequent to the muted top line growth in the June quarter, analysts have marginally scaled down their revenue growth projections (21-23 per cent) for the current year.

However, they are hopeful that BHEL would report improved margins, led by gains on the raw material front and operating leverage and, hence, maintain their earnings estimate for the current year.

The medium-term concern, however, stems from the fact that order inflows are showing signs of plateauing. For the June quarter, while order inflows were lower by about 12 per cent year-on-year at Rs 10,800 crore, they were according to analysts expectations. Although order backlog (pending orders for execution) was higher by 19.4 per cent at Rs 148,000 crore (the highest in BHEL's history) at end-June and provided a revenue visibility of three-four years, the stagnation in inflow of orders is worrying analysts.

BHEL's management has guided for an order inflow of about Rs 60,000 crore in 2010-11, which is almost equal to the order inflow seen in 2008-09 and 2009-10.

IIFL's analysts wrote in a post-results note: "While the current order book provides visibility for the next three years, stagnant order inflows and management comments about difficulty in maintaining growth rates on an expanding base suggest growth would decelerate over the medium term."

The road ahead

On the back of planned investments in the power sector, BHEL's growth prospects over two years look good even as the demand in the industrial equipment business is still subdued.

Analysts expect BHEL to clock revenue growth of over 20 per cent and earnings growth of 29 per cent for 201011; they expect earnings growth to be lower at 16-21 per cent in 2011-12.

They say the stagnation in order inflows, if continued, could impact growth beyond 2012-13. Worries on this front, not surprisingly, have led to the BHEL stock under-performing its closest peer (L&T) and the BSE Capital Goods index in the last one year as well as year-todate.

At Rs 2,461.45, the stock is trading at about 22 times estimated 2010-11 earnings and aptly reflects these concerns. Analysts believe there is limited upside from current levels and have one year price target ranging Rs 2,400-2,700.