Quick Take

BHEL - BUY Capital Goods 24 Mar 2009

Execution improving but constraints remain CMP Rs1410 Price performance (%)
We visited a fast-track thermal power project site where BHEL Market cap (US$ m) 13,680
1M 3M 1Y
is a BTG vendor. Our visit highlighted that issues bedevilling BHEL 3.6 4.3 -24.7
Rel. to Sensex -3.2 5.8 13.7
BHEL’s execution are easing but there still exist constraints for Bloomberg BHEL IN
L&T -3.2 -21.0 -58.8
acceleration in execution. Given continuing constraints on Alstom Projects -18.3 17.0 -43.7
execution, the yearly MOU to be signed with the Ministry for 52Wk High/Low (Rs) 2111/981 Thermax 3.0 -10.4 -68.3
FY10 is likely to be lower than consensus estimates. On the Diluted o/s shares (m) 490
other hand, FY10 employee costs could provide a positive Daily volume (US$ m) 42.8 Stock movement
surprise, notwithstanding increased gratuity provisions. BHEL Dividend yield FY09ii (%) 1.2 Volume Price (Rs)
still provides the best earnings visibility in the Indian capital- Free float (%) 32.3 10.0 Shares (m) 2540
8.0 2040
goods universe, but recent outperformance and execution Shareholding pattern (%) 6.0 1540
issues could weigh on stock performance. Promoters 67.7
4.0 1040
FII 16.0
Visit to a fast-track thermal power project to assess progress Domestic MF/Insurance 9.5 2.0 540

Others 6.7
• We revisited a fast-track thermal power project where BHEL is a
0.0 40

Jun-08

Jan-09
Mar-08

Apr-08

Jul-08

Sep-08

Oct-08

Dec-08

Mar-09
BTG vendor to assess the progress made since our last visit six
months ago. We came away with the impression that timely
completion of the project would be a tough challenge.
Financial summary
• The physical targets set for FY09 would be missed by 12-13%.
FY07A FY08A FY09ii FY10ii FY11ii
Y/e 31 Mar
• The key reason for the delay in execution is a 4-month delay in Revenues (Rs m) 171,431 192,632 248,748 317,639 386,474
handing over the project site to BHEL. EBITDA margins (%) 19.4 17.7 14.6 18.0 18.4
• BHEL’s attempts to expedite the project were stymied by delays in Reported PAT (Rs m) 24,147 26,092 29,089 42,495 51,003
procurement of critical pressure parts, which are sourced from EPS (Rs) 49.3 53.3 59.4 86.8 104.2
overseas vendors. Glitches in the pressure-part supply chain have Growth (%) 43.8 8.1 11.5 46.1 20.0
still not been fully ironed out. PER (x) 28.6 26.5 23.7 16.2 13.5

• Domestic supply chain bottlenecks have eased significantly, with the ROE (%) 30.0 26.7 24.9 30.4 29.5
Trichy plant able to meet most requirements of domestically-sourced EV/EBITDA (x) 19.0 17.8 17.2 10.9 8.8
boiler assemblies well ahead of schedule. Price/Book (x) 7.9 6.4 5.5 4.5 3.6
Source: Company, IIFL Research. Price as on 23 March 2009
• Improvements in material management and project management
through enhanced recruitment had a positive impact on execution.
Gopal Ritolia Anupam Gupta
• Overall, BHEL’s efforts towards improving execution are bearing gopal.ritolia@iiflcap.com anupam.gupta@iiflcap.com
results, but it is still early to factor in significant acceleration in (91 22) 6620 6651 (91 22) 6620 6641
execution rates.
 BHEL - BUY

Figure 1: First unit has just started execution during our visit six months ago Figure 3: Work has started on the second and third unit as well

Source: Company, IIFL Research

Source: Company, IIFL Research

Figure 2: Considerable progress has been achieved in completion of first unit Figure 4: Boiler assembly execution could have expedited but for critical pressure parts

Source: Company, IIFL Research

Source: Company, IIFL Research

gopal. rit olia@iif lcap.com 2

 BHEL - BUY

Figure 5: Domestic supply chain is able to keep pace with execution
• With the negotiations still pending, final decision on wage hikes
the increase in salary cost estimates. Our channel checks had
suggested that government was not sanguine about the hikes
proposed and was considering a lower payout than what the
provisions implied. In our view, this could have been due to: i)
management expectation of final wage settlement settling at higher
levels after negotiations, or ii) increased gratuity payment
provisions.
would be taken by the new government post the elections. In our
view, a new government would be less amenable to larger hikes.
Hence, there exists possibility of a roll-back in provisions already
made, increased gratuity provisions notwithstanding.

Strong order book provides visibility in an uncertain environment

• After 46% YoY growth in order book, the book-to-bill ratio of 4.96x
as at end-3QFY09 is at its all-time high, providing unmatched
earnings visibility well into FY12.

Source: Company, IIFL Research

• Against order inflow guidance of Rs400bn given at the start of the
year, the management expects to end the year with order intake of
Rs600bn—a strong 20% YoY growth in an environment where other
FY10 revenue guidance could be lower than estimates E&C companies are finding it difficult to sustain order books.
• Our on-the-ground assessment of execution issues and interaction Figure 6: Existing order book provides growth visibility till FY11
with BHEL management suggests that FY10 revenue targets set for
BHEL as per the MOU to be signed with the Ministry would translate Rs bn Order book Revenues
1,200
into ~20% growth, which is 5-6% lower than 25-26% growth
factored in consensus estimates. 1,000
• In FY08, BHEL’s revenues were in line with the MOU signed with the 800
Ministry. In FY09, BHEL is unlikely to outperform the MOU, given the
600
execution slippage in 3Q. Hence, FY10 consensus revenue estimates
could be revised downwards. 400

200
FY10 employee cost estimates could be revised downwards
-
• On the 3QFY09 earnings call, the management increased the FY09 Current 4QFY09 FY10 FY11 Balance
employee cost estimates to Rs43bn-Rs45bn. We were surprised by
Source: Company, IIFL Research

gopal. rit olia@iif lcap.com 3

 BHEL - BUY

Key to our recommendation structure

BUY - Absolute - Stock expected to give a positive return of over 20% over a 1-year horizon.
SELL - Absolute - Stock expected to fall by more than 10% over a 1-year horizon.

In addition, Add and Reduce recommendations are based on expected returns relative to a hurdle rate. Investment horizon for Add and Reduce recommendations is up to a year. We
assume the current hurdle rate at 10%, this being the average return on a debt instrument available for investment.

Add - Stock expected to give a return of 0-10% over the hurdle rate, ie a positive return of 10%+.
Reduce - Stock expected to return less than the hurdle rate, ie return of less than 10%.

Published in 2009. © India Infoline Ltd 2009

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gopal. rit olia@iif lcap.com 4