Stock Review: Bharat Heavy Electricals Limited (BHEL)

 

Negative business sentiment mostly explains why BHEL is trailing Sensex despite sizzling sales numbers and a decent margin play. But order flow and strategic collaborations may just save the day

 

   CAPITAL goods major Bharat Heavy Electricals Limited (BHEL) has underperformed the Sensex over the past 1 year despite a robust growth in sales and operating margins. The decline in stock price seems to be driven by the negative sentiment prevailing in the sector amid a slowdown in investment growth. The company, which recently announced its flash results for financial year 2010-11, looks set for a strong growth track. Beating its own guidance of order inflow of 60,000 crore for the year, Bhel secured orders worth 60,507 crore. Its total outstanding orders at the year end were 1,64,130 crore, which is nearly four times its provisional FY11 turnover, giving it a reasonable revenue visibility over the next few years. The company also entered into various strategic tie-ups during the year, including a manufacturing co-operation agreement with GE India Industrial Private, a pact with Abengoa, Spain, to develop state-of-the-art Concentrated Solar Power Projects in India and a collaboration agreement with Nuovo Pignone for manufacturing of centrifugal compressors. It has also formed a joint venture with the government of Kerala to manufacture alternators and other products like LT motors and traction equipment for Indian Railways.

FINANCIALS:

BHEL's revenues grew about 25% y-o-y while net profits were up 37% for the trailing 12 months (TTM) ended December 2010, which is quite impressive. While the dent on interest expense is clearly evident as the same has risen by about 77% during the period on account of hardening interest rates, the same does not have a significant impact on the financials in absolute terms. Given its extremely low debt equity ratio of about 0.01, BHEL is relatively less sensitive to interest rate movement vis-àvis peers. Raw material, the major cost item, grew by about 18%, which is justified, given the rise in commodity prices. The company is, however, relatively insulated to the rising material costs as it maintains an average inventory pileup of about two quarters.

VALUATIONS:

BHEL is currently trading at TTM price earning multiple (P/E) of 21, which is quite reasonable in the current market scenario, especially when compared with peers. Weakness in the capital goods sector has already pulled down the stock price which was trading at a TTM P/E of 30 a year ago. The company's strong financials — as reflected by the flash results — the robust order book and a revenue visibility for the next 3-4 years make it a good buy at the current levels.

Key factors


Positives


• Strong order book. Outstanding orders in hand for execution in 2011-12 and beyond stand at 164,130 crore

• Several new strategic business tie-ups been entered into last year

• Impressive sales growth and steady operating margins despite bottlenecks such as hardening interest rates and rising raw material costs

Negatives


• Slowdown in the investment activity in the capital goods space - environmental clearances being one of the major issues

• Cautious outlook for company's international business as many companies, especially in the oil & gas sector, have announced cutbacks in the capital spending

• Threat from Chinese suppliers and easier Chinese financing