Stock Review: Bharat Heavy Electricals (BHEL)

UNLIKE most peers, Bharat Heavy Electricals (BHEL) has been a laggard on the bourses in the past four months. While its financial performance has remained stellar, what concerns analysts is the growing competition from Chinese companies.

   BHEL's stock has fallen by 4% in the past four months, as against the 6% gains of the BSE Capital Goods. Due to the fall in valuations, the public sector company now trades at a discount to its peers.

   Recently, BHEL had lost a few bulk orders to Chinese and private Indian competitors. China-based Dongfang Electric, for instance, bagged Abhijeet Group's . 11,300-crore order for 600 MW supercritical coal burning units. In another instance, Reliance Power placed orders worth around . 37,700 crore with Shanghai Electric for coal-fired power generators.

   The order loss, however, would not impact BHEL's near-term growth, since it had orders worth . 154,000 crore till Septemberend — its biggest order book ever and nearly four times its revenues for the trailing 12 months. But increasing competition from Chinese vendors raises concerns about BHEL's long-term growth prospects.

   Rising competition in the boiler, turbine, and generator (BTG) segments is also expected to put pressure on the company's margins. Its peers L&T and Thermax operate at 17% and 11% margins, respectively. At 22%, BHEL's margins are superior. Increasing competition may reduce BHEL's margin dominance.

   Rising raw material costs could also impact margins. Prices of steel and copper, its key raw materials, rose steadily in the first half of FY11, with copper prices hitting all-time highs. As a result, during the first half of the current fiscal, the company witnessed raw material costs rise faster than its top line.

   What could offer some relief to investors is that order flow in the medium-sized projects segment has not dwindled. After adding orders worth about . 6,000 crore during the September 2010 quarter, the company recently bagged an order of . 3,700 crore for setting up a 700 megawatt coal-fired power unit at Bellary in Karnataka.

   BHEL's stock trades at a price-earnings multiple (P/ E) of 24. This is at a discount to its peers, L&T (P/E of 35) and Thermax (39). BHEL's near-term growth looks intact given its strong order book. But that may not be sufficient to improve its valuations. The company needs to demonstrate its competitive edge in winning larger orders in the coming quarters.