Initiating Coverage

BHEL
CMP: `1,930
Key Financials Total Revenue Growth % EBITDA EBITDA % Net Profit EPS (In `) CEPS (In `) EV/EBITDA EV/Sales RoE % ROCE %

India Equity Capital Good

Target: `2,167
FY10 334 24.8 59.2 17.7 43.0 88 97 12.3 2.6 27.0 27.0 FY11 422 26.6 87.0 20.6 60.1 123 134 9.1 2.1 29.8 29.8 FY12E 462 9.4 97.7 21.2 67.6 138 152 7.8 1.8 26.6 26.7

Upside: 12%
(` bn)
FY13E 512 10.8 107.0 20.9 74.1 151 167 6.8 1.5 23.8 23.8

Rating: ADD

14 July 2011

We find value in BHEL, despite the decline in revenue visibility as: (1) the companys current underperformance compared to Sensex over the last three quarters is overdone, (2) revenue visibility is the highest among its peers, (3) growth potential of the industrial and international orders remains untapped, and (4) despite pricing pressure, BHEL will continue to show positive margin surprises due to multiple operating and financial levers. In our view, the current underperformance has been priced in all the near-term negatives concerning growth. The stock is trading at its lowest 2-year forward P/E of 12.6x FY13E EPS of `152. We feel the stock warrants value at this price for its business and financial strength. We initiate our coverage with an ADD rating with a target price of `2167. Investment Rationale Visibility is down but still the highest among its peers: Despite negative sectoral headwinds of the power equipment sector, at 3.7xFY11 revenues, BHEL still holds the highest visibility in the sector. Given the order quality, we feel the current order book yields strong revenue CAGR of 9% in FY11-FY14E. Considering the revenue base, (~10% of the countrys infrastructure spent) we feel the growth is commendable. Pick up in industrial capex to see gradual shift from power to industry segment: We expect stagnation of incremental thermal power capacity post-FY17E. Increase in BTG capacities by new players would challenge BHELs dominance in power space. But the proven technological base of BHEL will stand out well in providing good order traction from the industry, which is undergoing a declining phase. We expect the industry segment to report 49% revenue in FY17E against 25% in FY11. Still have margin levers to play out well in competition: Despite competition from Chinese manufacturers, margin threat for BHEL is limited. With increasing backward integration (at 67% currently) and wage cost settled until FY17, BHEL holds operating levers to protect margins despite a potential compromise due to competition. Lower operational capex and higher R&D expense (2.5% of the turnover) to yield financial levers in sustaining healthy margin at the net level. Valuation is at two-year low, attractive for business strength. Initiate with an ADD rating: Sectoral headwinds like (1) poor availability of domestic coal and rising international coal prices, (2) poor availability of gas, and (3) poor health of SEBs are leading to the possible project deferment for BHEL. Nevertheless, at two-year low valuation on the back of three quarters of underperformance has put BHEL a good value play at the CMP of `1,930. We initiate with an ADD rating with a target price of `2,167.

Stock Info Face Value (`) Shares O/S (mn) Market Cap (` bn) 52-Week Range(H/L) 1-Year Avg Vol (mn) Nifty Bloomberg Code Year End 10 490 944.4 2695 / 1871.55 0.8 5,581 BHEL IN Mar

Shareholding Pattern (%) Foreign Institutions Corporate Holding Promoters Public & Others

(June' 11) 13.2 12.7 4.2 67.7 2.2

Relative Price Performance

SBICAP Securities Limited 2nd Floor, A Wing, Mafatlal Chambers, Lower Parel, Mumbai - 400013 E-mail: sbicapresearch@sbicapsec.com (For Private circulation only)

Rabindra Nath Nayak Securities Research 91-22-42273310 rabindra.nayak@sbicapsec.com

Alok Ramachandran Nirav Vasa Securities Research Securities Research 91-22-42273478 91-22-42273460 alok.ramachandran@sbicapsec.com nirav.vasa@sbicapsec.com Please refer to our disclaimer given at the back cover page

BHEL

SBICAP Securities Ltd

Table of Contents
Investment Rationale ....................................................................................................................3 Valuation .........................................................................................................................................8 Financial Analysis ........................................................................................................................12 Industry Snapshot ........................................................................................................................15 Summary .......................................................................................................................................16 Industry Concern..........................................................................................................................17 Company Profile...........................................................................................................................17 Financial Statements ....................................................................................................................19

Please refer to our disclaimer give at the last page

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SBICAP Securities Ltd

BHEL

INVESTMENT RATIONALE
The 2-year forward P/E has contracted from 20x in FY09 to 13x in FY11. Despite decline in order visibility, the revenue visibility is highest among its peers We understand that the valuation of BHEL has contracted due to decline in visibility of order inflows. The 2-year forward P/E has contracted from 20x in FY09 to 13x in FY11. Fuel-related concerns are leading to deferment of power projects by the customers; thus, impacting the valuation of BHELs power business. However, BHELs current order backlog has the highest visibility among its peers (the book-tobill ratio of 3.7x). The current order book presents a revenue visibility until FY14. Visibility is set to decline with flat growth in order book, but
2,000 1,500 1,000 2 500 0 1 0 5 4 3

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

FY14E

FY15E

FY16E

Revenues in Rs Bn Total Inflow in Rs Bn

Source: SBICAP Securities Research

Total Orderbook in Rs Bn Visibility (Total Orderbook/Revenue)

the current visibility is still the highest among its peers

Order backlog (Rs bn) Thermax Crompton Greaves ABB L&T Siemens India
Source: SBICAP Securities Research

Book-to-bill (x) 1.6 0.7 1.3 2.7 1.5

72 71 84 1149 151

We have incorporated the bulk tendering of NTPC and the order inflows of the super-critical projects from its JVs with states into our estimates.

Power segment orders to stagnate and visibility to decline Currently, power sector constitutes 70% of the total revenues of BHEL. Going ahead, the growth in thermal generation projects in India is expected to stagnate. The new BTG manufacturers would be aggressively bid to capture market share, despite a lull in the generation capex in the country. These companies will find little potential in export business in the initial years of manufacturing. On this backdrop, we understand that the order inflows in the power segment will decline. We have incorporated the bulk tendering of NTPC and the order inflows of the super-critical projects from its JVs with states into our estimates. Through this, BHEL will continue to maintain satisfactory order inflows during the next two years.

Securities Research

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FY17E

BHEL Power segment revenue visibility is declining

48 36 24

SBICAP Securities Ltd

4.8 3.6 2.4

12 0 -12 1.2 0.0

FY12E

FY13E

FY14E

FY15E

FY16E

Power Segment Visibility YoY Revenue Growth (Power,LHS)

Source: SBICAP Securities Research

Industry Segment Visibility YoY Revenue Growth (Industry,LHS)

BHEL commands 100% share in the repairs and maintenance (R&M) works of the thermal power plants. We expect the R&M and after sales service businesses to grow as the company commissions projects. Sales after sales (SAS) revenue to see good traction in the power segment
500 375 250 125 0 18 14 9 5 0

FY12E

FY13E

FY14E

FY15E

FY16E

SAS order Inflow in Rs Bn (LHS) Total Order Inflow in The Power Segment in Rs Bn(LHS) SAS % in total Power Segment Order (RHS)

Source: SBICAP Securities Research

During FY10, BHELs secured orders were worth `135bn, a rise of 31% YoY.

but industry and international segments to see traction leading to healthy revenue Currently, BHELs industry and international segments contribute 25% of its revenues. The industrial capex is in a declining phase from 1QFY11 due to de-growth in the industrial GDP growth of the country. During FY10, BHELs secured orders were worth `135bn, a rise of 31% YoY. However, it suffered 15% decline in order inflows in FY11 due to slowdown in the industrial capex. We expect the industrial capex cycle to reverse by the end of FY12 leading to a traction of order inflows in this segment.
250,000 200,000 150,000 40 30 20 10 100,000 50,000 0 0 -10 -20

Industrial GDP declined leading to decreased order inflows

16

12

(%)

FY12E

FY13E

FY14E

FY15E

FY16E

Q1FY10

Q3FY10

Q1FY11
Industrial GDP

Q3FY11

Order Inflow (Rs Mn)

Growth in % (RHS)

Source: SBICAP Securities Research

Please refer to our disclaimer give at the last page

Securities Research

FY17E

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY17E

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY17E

FY05

FY06

FY07

FY08

FY09

FY10

FY11

SBICAP Securities Ltd

BHEL The reform process for the power distribution is very much in the agenda of the government. Considering the transportation constraints of fuel in the country, we expect power transmission will get prominence in the power sector going ahead. The government has plans to take up the inter-state transmission capacity from 27GW to 40GW in the next three years. Power Grid is planning to invest `1trn during the 12th Plan, which is ~2 times its capex of the 11th Plan. The investments by Power Grid also see increase in capex by the state transmission companies leading to pick up in transmission equipments in the country. We expect the strong competition from the Chinese players in the transmission equipment segment will be one-two years away. We understand that BHEL has good presence in the Gulf countries. With rising crude prices, the order will increase from the Gulf countries. We expect the international orders to rise at a 10% CAGR over FY11-FY17E. Pace of project execution to drive increase revenue growth in power segment, but industry segment to remain consistent
0.50 0.40 0.30 0.20 0.10 75 74 74 76 79 80 81 82 81 80 79 77 30 0 25 26 26 24 21 20 19 18 19 20 21 23 120 90 60

Power Grid is planning to invest `1trn during the 12th Plan, which is ~2 times its capex of the 11th Plan.

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

FY14E

FY15E

FY16E

Power Segment Contribution (%) Power Segment Execution

Industry Segment Contribution (%) Industry Segment Execution

Source: SBICAP Securities Research

Power segment revenue to decline, as contribution from industry segment to rise

100 75 50 25 0 600 450 300 150 0 140 105 70 35 0

FY12E

FY13E

FY14E

FY17E

FY15E

FY16E

FY12E FY13E

FY14E FY15E

FY16E

Power Segment(in Rs Bn) Power Segment(%)

Source: SBICAP Securities Research

Industry Segment (in Rs Bn) Industry Segment(%)

FY17E

Export in Rs Bn

Industry in Rs Bn

Good product quality and dedicated after sales service will drive the utilities to repose faith in BHELs equipments in future.

BHEL still left with some margin levers, to play out well in competition We understand that the pricing pressure will definitely be there for BHEL, particularly with the presence of competition from Chinese players in the country. However, despite the strong competition over the last five years, BHEL has successfully maintained its margins. Good product quality and dedicated after sales service will drive the utilities to repose faith in BHELs equipments in future. Thus, we expect BHEL will be able to sustain its margin in future.

Securities Research

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FY17E

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY02 FY03

FY04 FY05

FY06

FY07 FY08

FY09 FY10

FY11

FY11

BHEL

SBICAP Securities Ltd

Chinese equipment import is healthy, but BHELs margins are superior; BHEL can compete on pricing 24
400,000 300,000 200,000 100,000 0 120 90 60 30 0

18 12 6 0 Dong Fang Revenue in bn $ SEC PBT % BHEL PAT %

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

In Rs Mn

Growth

Source: SBICAP Securities Research, SEC: Shanghai Electric Corporation (China), Dong Fang: Dong Fang Electric (China) & Ministry of Commerce

Our interaction with NTPCs management suggests that the progress and quality of BHELs equipment is better than the Stage 1 project of Barh

Currently, BHEL manufactures 67% of its components from its own manufacturing base. It is also taking effective steps to indigenise the super-critical technology gradually. The company is in the process of setting up 660MW super-critical plants for NTPC in the phase II of its Barh project. Our interaction with NTPCs management suggests that the progress and quality of BHELs equipment is better than the Stage 1 project of Barh (set up by Power Machines of Russia). We believe with more in-house manufacturing, the company could reduce the raw material (RM) cost as a percentage of sales. We have not considered any reduction in our estimates.

Reduction in RM and sub-contracting cost as a % of sales could be positive margin surprises for BHEL
100% 95% 75% 70% 50% 25% 0% 45% 20% -5% 140 120 100 80 60 40 20 0

FY12E

FY13E

FY14E

FY15E

FY11E FY16E FY17E

FY01

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

FY 10

FY11

Ferous Meterial Cost Cost of Components

Source: SBICAP Securities Research

Non Ferous Other Material Cost Cost of Stores and Spares

RM Cost (%) SG&A Cost(%) Operating EBITDA (%)

We have estimated net additions of 2,000 employees until FY17E.

BHEL has reached a wage settlement with the employees until FY17E. So we believe the company could reduce the employee cost as a percentage of sales with the rise in turnover until FY17E. We have estimated net additions of 2,000 employees until FY17E.

Please refer to our disclaimer give at the last page

FY01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY11 FY12E FY13E FY14E FY15E FY16E FY17E

Employee Cost(%) Provisions (%)

Core EBITDA in Rs Bn (RHS)

Securities Research

SBICAP Securities Ltd Wage cost settled till FY17E, could surprise on margins
60,000 45,000 30,000 15,000 0 4,000 2,000 0 (2,000) (4,000)
1,800 1,350 900 450 0

BHEL

FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY11 FY12E FY13E FY14E FY15E FY16E FY17E

FY12E

FY13E

FY14E

FY15E
24 18 12 6 0

FY16E

Number of Employee

Net Addition/Reduction

Average Wage Cost /Employee in Rs Thousand

Source: SBICAP Securities Research

...adjusted wage cost as a percentage of revenues to be stable

100 75 50 25 0

FY11

FY12E

FY13E

FY14E

FY15E

FY16E

Adjusted Wage Cost in Rs Bn

Source: SBICAP Securities Research

Adj Wage Cost as % of Revenue

BHEL has reduced its tax provision as a percentage of sales and PBT during FY11 compared to FY10.

BHEL spends 2.5% of revenue on R&D and enjoys a tax deduction of 200%. BHEL has reduced its tax provision as a percentage of sales and PBT during FY11 compared to FY10. Going forward, the reduction in tax rate will provide good financial levers during competition to sustain its profitability. Three quarters of underperformance has sweetened the valuation, initiate with an ADD rating BHEL has underperformed the Sensex since 3QFY11. It should be noted that this has been despite strong order inflows during 3QFY11 and 4QFY11. Following are the key reasons for the underperformance of the BHEL: 1) the listing of Coal India in 3QFY11, which led to negative guidance (by Coal India) on the long-term coal availability in the country 2) leading to rising dependence on imported coal and in 4QFY11 rise in coal prices in the international market after the flooding in New Castle 3) significant deteriorating gas production by Reliance Industries in 1QFY12 These events confirm the possibility of the near- to medium-term deferment of projects leading to the chance of reduction in profitability growth. The underperformance has further widened with the announcement of disinvestment program by the government. In our view, the current underperformance has been priced in all the near-term negatives concerning to growth. The stock is trading at its lowest 2-year forward P/E of 12.6x FY13E EPS of `152. We feel the stock warrant value at this price for its business and financial strength. We initiate our coverage on BHEL with an ADD rating.

The stock is trading at its lowest 2-year forward P/E of 12.6x FY13E EPS of `152.

Securities Research

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FY17E

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

FY 10

FY17E

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

FY 10

FY11

BHEL

SBICAP Securities Ltd BHEL has underperformed the Sensex since 2QFY11 despite consistency in profitability and order inflow
24,000 21,000 18,000 15,000 12,000 2,900 2,550 2,200 1,850 1,500

Dec-09

Dec-10

Jun-10

Aug-10

Apr-10

Oct-10

BSE_SENSEX
Source: SBICAP Securities Research

BHEL

has underperformed by 20% w.r.t 2 - year Index

Source: SBICAP Securities Research

VALUATION
We initiate our coverage on BHEL with an ADD rating with a target price of `2,167. Our target price is based on an average price derived after considering DCF, 2-year forward looking P/E multiples and EV/EBITDA multiple of BHEL. Primary reason for undertaking multiple valuation techniques would be to capture the valuation strengths and weakness from the short and long-term point of view.
Description of valuation Method 17xFY11 EPS 10x FY 11EV/EBITDA DCF Average Fair Value 2,574 2,268 1,661 2,167 Characteristics of Two Year forward Valuation multiples Max PE 21 12 Median 18.0 10.3 Minimum 12.6 6.5

Cost of Capital-12%, Terminal GR- 3%

Source: SBICAP Securities Research

Apr-11

Feb-10

Feb-11

Jun-11

Please refer to our disclaimer give at the last page

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SBICAP Securities Ltd

BHEL P/E multiple based price discovery We have given a P/E of 17x FY13E EPS of `151.4. Based on this, we have derived a target price of `2,574. The P/E of 17x is derived at a discount of 100bps to its median 2-year forward looking P/E multiple. We believe the major events, which have negative impact on power sector like delay in coal linkages and delays in clearances are fully factored in the downward rally. With the improvement in power sector, we expect a positive impact of the same to influence BHELs stock price.

The P/E of 17x is derived at a discount of 100bps to its median 2-year forward looking P/E multiple.

2Year forward PE Band Movement

4,000 3,200 2,400 1,600 800 0
23

20 17 14 11

Aug-05

Aug-06

Aug-07

Aug-08

Aug-09

Aug-10

Aug-11

Feb-05

Feb-06

Feb-07

Feb-08

Feb-09

Feb-10

Feb-11

Source: SBICAP Securities Research

We do not foresee any major fall in the companys EBITDA margins in the near-term

EV/EBITDA based price justified We have given EV/EBITDA multiple of 10x FY13E EBITDA of `116.3bn. The multiple of 10x is justified as the stocks median EV/EBITDA multiple for the last two years has been 10x. We do not foresee any major fall in the companys EBITDA margins in the near-term as orders currently under execution were bagged with steady margins. Any fall in prices, if undertaken by BHEL, would help in increasing the competitive intensity on Chinese and Korean players. 2Year forward EV/EBITDA Movement
4,000 3,000 2,000 1,000 0
Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12

18 15 13 12 8 5

Source: SBICAP Securities Research

Securities Research

Please refer to our disclaimer give at the last page

Feb-12

BHEL DCF-based valuation to capture long-term growth potential

DCF Table Year Net Sales Growth (%) EBIT EBIT Margin Tax Rate EBIT (1-Tax Rate) Depreciation NOPAT Capital Expenditure Investment in Working Capital FCFF Discounted FCFF Terminal Growth Rate (%) Terminal Value Net Debt Total Value of Equity O/S shares Value per Share
Source: SBICAP Securities Research

SBICAP Securities Ltd

5-year CAGR of 6% FY11 27 90,604 20 35 58,893 5,441 64,334 17,623 22,182 24,529 26,098 FY12E 9 21 31 64,466 6,874 71,340 16,482 3,600 51,258 48,616 FY13E 18 21 31 70,636 7,556 78,192 3,600 19,449 55,143 46,609 FY14E 18 21 31 76,024 8,176 84,200 2,800 13,517 67,883 51,149 FY15E 10 22 31 76,397 8,166 84,564 6,000 14,648 63,916 42,932 FY16E 10 21 31 79,075 9,016 88,091 6,000 21,833 60,259 36,082 FY17E 10 21 31 78,004 9,436 87,440 6,000 20,341 61,100 32,604

5-year CAGR of 8% FY18E 10 21 31 68,985 10,146 79,132 10,146 2,838 66,148 31,467 FY19E 10 17 31 75,884 10,910 86,794 10,910 3,122 72,762 30,856 FY20E 10 17 31 83,472 11,731 11,731 3,434 80,039 30,257 FY21E 10 17 31 91,819 12,614 12,614 4,532 87,287 29,397 379,971 3 336,436 (96,623) 813,030 490 1,661

422,282 462,078 512,079 540,532 561,597 575,929 567,546 624,301 686,731 755,404 830,945 99,178 108,671 116,960 117,535 121,654 120,007 106,131 116,744 128,419 141,261

95,203 104,434

Sum of Discounted Cashflow of Visible Period

We expect the companys revenues to grow by a CAGR of 7% during FY11-FY21E. We have divided the period under consideration in two phases. We expect the EBIT margin to remain steady at 20% over FY12E-FY19E. WACC for the period under consideration is at 12%, which is derived after considering the following conditions: WACC calculation basis:
Risk Free Rate (10 year Govt Bond Yeild) Risk Premium Beta (BSE) Cost of Debt Cost of Equity Equity(%) Debt (%) WACC
Source: SBICAP Securities Research

8.31 4.67 0.81 12 12.1 99 1.1 12.1

10

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Securities Research

SBICAP Securities Ltd Comparison with global peers:

P/E Copmany Name Dong Fang Electric Corporation Harbin Power Shanghai Electric Corporation Mitsubshi Heavy Electric Doosan Heavy Electric ABB Seimens
Source: SBICAP Securities Research

BHEL

EV/EBITDA CY11E 10.5 1.6 13.2 11.9 13.0 9.5 7.5 CY12E 9.2 1.5 11.3 10.7 10.5 8.2 7.2 12.6 10.2 11.7 6.8 10.9 14.1 11.4

Price/Sales CY11E 1.2 0.3 1.1 0.2 0.9 1.6 1.2 CY12E 1.1 0.3 1.0 0.2 0.8 1.4 1.1

Price/Book Value CY11E 3.3 1.0 1.4 1.1 1.8 3.4 2.5 CY12E 2.7 0.9 1.3 0.9 1.6 3.0 2.2

Country China China China Japan Korea Switzerland Germany

CY11E 14.7 11.5 13.1 8.0 15.0 16.5 11.6

CY12E

Comparison with Indian peers in the power sector:

P/E Copmany Name BHEL Crompton Greaves L&T ABB Areva Seimens
Source: SBICAP Securities Research

EV/EBITDA FY13E 12.7 13.4 18.2 36.1 18.8 25.6 FY12E 7.6 10.1 13.4 32.1 13.0 19.0 FY13E 6.6 8.8 11.5 23.2 10.5 15.8

Price/Sales FY12E 2.0 1.4 1.8 2.5 1.3 2.7 FY13E 1.8 1.2 1.5 2.2 1.1 2.2

Price/Book Value FY12E 3.7 3.8 4.0 6.8 5.1 7.6 FY13E 3.0 3.1 3.4 5.8 4.2 6.1

Country India India India India India India

FY12E 14.0 15.4 21.5 49.6 25.4 30.5

Securities Research

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11

BHEL

SBICAP Securities Ltd

FINANCIAL ANALYSIS

Order backlog to increase by a CAGR of 4% over FY11-FY17E:BHELsmarketshare in the 11th Plan was 49%.The company would beable to maintain the same in the 12th Plan despite increase in competition from players originating from low cost countries(LCCs). Market share of BHEL in the 11th and 12th Plans
Non Chinese players, 22% BHEL, 49% Chinese players, 29%
Source: SBICAP Securities Research

Non Chinese players, 27% BHEL, 50% Chinese players, 23%

We expect BHELs industry segement revenue to grow by a CAGR of 7% over FY11FY17E.

Thecompanyscurrentorderbacklogis`1.6trn,representingthebooktobillratioof 4.7x FY11 sales. BHEL would be able to maintain its booktobill ratio at above 3x overFY11FY17E,asweexpecttheindustrialcapextoreviveinFY12E. Revenues to increase by a CAGR of 7% over FY11FY21E We expext BHELs revenues from power segment to grow at a CAGR of 4% over FY11FY17E. The major growth in order inflows is expected from industrial power and international segements as utility capex is expected to rationalise in the country. We expect BHELs industry segement revenue to grow by a CAGR of 7% over FY11FY17E. Order inflows are expected from industry and international segments and would account for 55% of the order inflows in FY17E against 75% in FY11. Order inflows of BHEL
13 8 20 37 13 26 1 22 3 23 25 18 5 17 5 15 5 17 6 23 6 19 7 23 8 25 8 28 9 30 10 32 10

35

72 50

61

77

74

78 57

80

79

71

75

70

67

64

61

58

55

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

FY14E

FY15E

FY16E

Power Segment
Source: SBICAP Securities Research

Industrial Sector

International

12

Please refer to our disclaimer give at the last page

Securities Research

FY17E

SBICAP Securities Ltd

BHEL EBITDA margins to remain steady as incremental revenues to come with lower manpower requirement We do not expect any major increase in manpower requirement for BHEL in future, due to increased mechanisation with the incremental capacity addition. Increase in wages of employees in absolute terms is also ruled out as the negotiaitions for the sixth pay commission will be applicable until FY17E.

EBITDA and segmental EBIT trend

28 21 14 13.0 7 0 5.0 29.0

21.0

FY12E

FY13E

FY14E

FY15E

FY16E

FY12E

FY13E

FY14E

FY15E

FY16E

FY17E

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

EBIT(Power) in%

EBIT(Industry) in%

Total EBIT Margin in%

Core EBITDA (%)

EBITDA (%)

Source: SBICAP Securities Research

The quantum of these noncore income is strong enough to increase its EBITDA profits by 200bps

Non-core income to increase, as pace of project execution faces strong headwinds BHEL receives an advance of 13% of an order value before it starts work on the order. As a result, the company is able to receive interest on the same. The quantum of these non-core income is strong enough to increase its EBITDA profits by 200bps. We expect this trend to continue as the pace of project execution gets delayed due to sectoral headwinds such as fuel linkages issues, delays in receiving environmental clearances and other logistical issues.

Non-core income slated to rise

FY16E FY14E FY12E FY 10 FY 08 FY 06 FY 02 -18.0 -13.0 -8.0 -3.0 2.0 7.0 12.0 17.0 FY 04

72 54 36 18 0

Non Core Income (in Rs Bn)

Cash used in Capex and Opex (in Rs Bn)

Source: SBICAP Securities Research

Securities Research

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FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11E FY12E FY13E FY14E FY15E FY16E FY17E

Non Core Income (in Rs Bn) Advances as % of Orderbacklog Advances as % of Sales

FY17E 48 36 24 12 0

FY01

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

FY 10

FY11

13

BHEL Least impacted due to stretched working capital

SBICAP Securities Ltd

Compared to its peers in the capital goods industry, we expect minimum impact of stretched working capital requirements on the company due to the size, scale and complexity of projects undertaken. Capability to undertake orders for power plants on turnkey basis would also support passing the impact of stretched working capital requirements from customers to its vendors and sub-contractors. BHEL reported ROCE of 45% and ROE of 30% in FY11. Return ratios to decline, we estimate 5% CAGR in EPS over FY11-FY17E We expect the companys return ratios to remain as a benchmark for the capital goods industry in future. BHEL reported ROCE of 45% and ROE of 30% in FY11. The probability of an increase in return ratios from the existing levels seems to be difficult and is expected to head southwards in the near-term as business dynamics change.
1000 200 150 100 50 0

Margins to remain stable

24
750

18
500

12
250

6
0

FY12E

FY13E

FY14E

FY15E

FY16E

FY 11E

FY17E

FY 01

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

FY 10

NetSalesinRsBn EPSinRs(RHSandInfigures)

NPM
Source: SBICAP Securities Research

EBIT Margin

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FY01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY11 FY12E FY13E FY14E FY15E FY16E FY17E

NetProfitinRsBn

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SBICAP Securities Ltd

BHEL

INDUSTRY SNAPSHOT
The government intends to add 100GW of power capacity in the 12th Plan. However, considering the existing pace of project execution and previous track record of capacity addition, we expect only 75GW addition. Of this, 60GW will come from thermal power, while the remaining 15GW will come from hydro, nuclear, biomass and wind segments. The near-term trigger for the power equipment and ancillary suppliers would be the finalisation of NTPCs 660MW bulk tender expected in CY11. Post-finalisation, the pace of finalisation of 9x800MW across four locations of bulk tendering will provide order inflows to BTG manufacturers in India. . Capacity planned versus capacity addition Thermal power addition
120,000 90,000
Capacity addition in GW

16 12 8 4 0
FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013E FY2014E FY2015E FY2016E FY2017E

MW

60,000 30,000 0

2002-2007

2007-2012

Target

Achievement

Source: SBICAP Securities Research

Fuel linkages and not rise in interest rates to impact project execution The main reason for the delay in pace of project execution and lack of robust order inflows from private players would be structural issues like lack of fuel linkages, delays in receiving environmental approvals and increase in fuel costs. The rise in interest rates has a limited impact on the incremental capacity addition led by: a) the linkage of borrowing rates to prime lending rates of banks and b) multidecade loan repayment periods. Thus, borrowers also gain from lower interest rates. Increase in the pace of capacity addition can be expected once these structural issues are sorted out, which are expected to be solved in the near-term. The cycle of rising interest rates is expected to peak by CY11 for a brief period at higher levels. Lower interest rates would also play an important role in increasing the pace of project execution of the existing projects. Thus, increasing the utilisation levels of power equipment and ancillary suppliers. Demandsupply mismatch to provide impetus for capacity addition: We expect demand for power in India to grow by a CAGR of 8% over the 12th Plan. The major impetus for power demand is expected to come from domestic consumption, which is mainly discretionary consumption demand. For the 12th Plan, we expect overall capacity addition to grow by a CAGR of 6%, while the demand is expected to outpace supply and increase by 8%. Demand for power from commercial sector is expected to grow by a CAGR of 9.5% followed by residential demand at 9.25%. Agricultural demand for power is expected to grow by a CAGR of 4%. Concentration of power consumption areas in metro cities would also result in higher peak hour demands.

For the 12th Plan, we expect overall capacity addition to grow by a CAGR of 6%, while the demand is expected to outpace supply and increase by 8%.

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2012E-2017E

1961-66

69-74

74-79

80-85

85-90

92-97

97-02

15

BHEL In FY11, eight states in India have revised the power tariffs in the range of 8-14%.

SBICAP Securities Ltd Revision of power tariffs to lead the way for sectoral reforms Losses in T&D segment and irrational tariff structure adopted by SEBs acted as disincentive for power capacity addition in the country. In FY11, eight states in India have revised the power tariffs in the range of 8-14%. We expect other states to follow suit, as the major SEBs in India are facing losses because of a huge gap between the average cost of supply and average revenue realised per unit. The only way out of this situation will be rationalisation of power tariffs in the near-term.

Power demand and supply

1200 900 40 30 20 10 300 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Total Consumption in BU - (LHS) % of T&D Loss % Growth in consumption
Source: SBICAP Securities Research

1,200

900
% BU's

BU's

600 300

600

0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Domestic Commercial Industry Traction Agriculture Others

Other major factor that would provide impetus for increasing power capacity would be the lowering of T&D losses. Currently, T&D losses in the country are ~28% and we expect it to decrease by 20-22% in FY17E. The combined effect of both these steps would act as a strong trigger for generation business in the country.

SUMMARY
We believe the current lull in the power sector is a temporary pause in the long run. The major structural changes like reduction in T&D losses, T&D sector reforms and tariff rationalisation to support the long-term growth of the sector have become imperative. The first step towards energising the sector has already been taken by rationalising power tariffs across eight states in India; however, more effort needs to be done. The rationalisation of competitive intensity of players from LCCs would also support the growth prospects of established power players in India. Feeble competition from new domestic players would have marginal impact on BHELs growth potential. Only established players in power industry having their own manufacturing base, technology support and strong project management capabilities will be able to stand the volatilities of Indian power sector.

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BHEL

INDUSTRY CONCERNS
Rise in coal prices and delay in fuel linkages We believe one of the reasons for delay in capacity addition would be increase in coal prices. The impact of the same will be felt by most IPPs, who are setting up their power plants on case 1 bidding and have applied for revision of PPA. Delay in pace of project execution Lack of fuel linkages is one of the main issues, which has delayed the financial closure for multiple projects. Consistent delays in fuel linkages from domestic mines and increased logistical cost of importing coal have also acted as major concerns for the entire industry.

COMPANY PROFILE
BHEL is a prominent PSU of India with core specialisation in power domain. The companys base of operations is spread across 15 manufacturing units, 2 subsidiaries, 7 JVs and an infrastructure to deal with more than 150 project locations simultaneous. Until date, the company has set up 115GW of power and accounts for 62% of Indias power generation capacity. It has installed 330 coal-based sets and 374 hydro utilities. In power sector, its product portfolio comprises manufacturing and supplying steam turbines, generators, boilers and related auxiliaries up to 800MW. Other business verticals of BHEL include nuclear power with an installed capacity of 700MWe and above. In railway business, it is capable of manufacturing electric locomotives, which are manufactured in its West Bengal based plant. In solar business, it is capable of setting up and manufacturing silicon wafers, solar cells and modules. In defence business, it is capable of manufacturing Naval guns, which are mounted on warships. BHELs manufacturing plants are located in Bhopal, Jhansi, Haridwar, Trichy, Panipat and Hyderabad. Plant-wise revenues (%)
Year BHOPAL HARDWAR TRICHY HYDERABAD POWER GROUP (EPC) OTHERS
Source: SBICAP Securities Research

FY02 16 9 23 17 12 23

FY03 18 11 24 17 15 16

FY04 18 11 22 16 16 16

FY05 15 9 20 17 19 19

FY06 14 10 24 17 20 16

FY07 13 11 24 12 20 19

FY08 14 11 25 15 18 17

FY09 13 10 26 14 19 17

FY10 12 9 29 15 18 17

FY11E 11 9 28 13 18 21

FY12E 12 9 31 14 21 12

For the super-critical boilers, the company has received orders for 14 turbine sets and 14 steam generators. Super-critical orders basket: o o o o 2X660MW Barh (SG & TG) 3X660MW Bara (SG & TG) 2X800MW Krishnapatnam (SG) 2X800MW Yermarus (SG & TG) o o o o 1X800MW Edlapur (SG & TG) 1X700MW Bellary #3 KPCL (EPC) 2x660MW NTPC Bulk Tender (TG) 3x660MW Bajaj Hindustan (SG & TG)

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17

BHEL

SBICAP Securities Ltd

Strategic alliance with BEL to form JV for setting up manufacturing facility (250MW) for silicon wafers, solar cells and modules Joint Working Arrangement with AbengoaSpain for Concentrated Solar Power Plant (CSP) Steam generators for new rating 700MWe nuclear sets

Solar

Nuclear

Tripartite JV with NPCIL and Alstom in process for conventional island of Nuclear Projects for 700 MWe and above MoU with GE-Hitachi for cooperation in nuclear island equipment for power plants to be set up by NPCIL MoUs with Alstom and GE for participating in the tender for setting up a factory for Electric Loco components at Dankuni, West Bengal and Diesel Loco factory at Marhowra, Bihar respectively.

Transportation

Breakthrough orders for the state-of-the-art propulsion equipment for 6,000hp Electric Locomotives and 1,400hp AC EMUs (IGBT based) Executing an order for 200 numbers of 5,000hp 25kV AC Mainline Electric Locomotives (Type WAG -7) for Indian Railways.

T&D

Strategic alliance with Toshiba, Japan to establish a JVC to address T&D business in India and other mutually agreed countries. The JVC will cover equipments and projects in EHVAC and UHVAC range including 765kV transformers and reactors and GIS, in addition to other products and systems. Manufacturing Associate Agreement with GE India Industrial Private Limited (GEIIPL) for Water Treatment Equipment. BHEL will be able to provide more cost-effective membrane-based water treatment systems for power plants and industrial sector for all type of input water like sea water, brackish water and waste water. Total solution provider in power generation

Water

NBFC

To finance power projects by providing funding support to attract potential customers and optimise returns on our huge cash reserves. May also expand to other segments like erenewables where funding support is critical

Source: SBICAP Securities Research

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BHEL

FINANCIAL STATEMENTS
Income Statement
Year to Mar Net Sales % Growth EBIDTA % Growth Other Income Interest Depreciation PBT % Growth Tax Adj PAT % Growth Extra-ordinary Reported PAT % Growth Dividend (%) EPS (Rs) BVPS (Rs)
Source: Company, SBICAP Securities Research

(` mn)
FY09A 267,268 35.5 42,190 12.8 9,829 307 3,343 48,370 9.4 17,106 31,263 9.8 0.0 31,263 9.8 170 64.1 264 FY10A 333,549 24.8 59,200 40.3 11,549 335 4,580 65,834 35.9 22,800 43,034 37.4 0.0 43,034 37.4 233 88.1 325 FY11A 422,282 26.6 86,954 46.9 9,091 547 5,441 90,057 36.6 29,945 60,112 39.5 0.0 60,112 39.5 250 122.8 412 FY12E 462,078 9.4 97,735 12.4 8,317 662 6,874 98,516 9.4 30,912 67,605 12.5 0.0 67,605 12.5 265 138.1 518 FY13E 512,079 10.8 107,009 9.5 9,217 734 7,556 107,938 9.6 33,832 74,106 9.6 0.0 74,106 9.6 280 151.4 636 FY14E 540,532 5.6 115,195 7.6 9,730 774 7,965 116,185 7.6 36,483 79,702 7.6 0.0 79,702 7.6 290 162.8 765

Segment breakup
Period/Segment Power Growth % Industry Growth % Total Gross Revenue Growth % Power EBIT Growth % Industry EBIT Growth % Common Expenses Growth % Total EBIT Growth % Interest Growth % PBT Growth % Tax Growth % PAT Growth % Capital Employed (Power) Capital Employed (Industry) Common Capital Employed
Source: Company, SBICAP Securities Research

(` mn)
FY09A 213,444 34.1 67,451 20.9 280,895 30.7 38,618 (1.8) 12,146 11.8 1,968 (64.3) 48,796 9.2 307 (13.3) 48,489 9.4 17,106 8.9 31,382 9.7 (5,712) 13,870 121,230 FY10A 268,607 25.8 73,378 8.8 341,985 21.7 63,170 63.6 16,425 35.2 13,353 578.4 66,242 35.8 335 9.1 65,907 35.9 22,800 33.3 43,106 37.4 25,057 22,489 111,628 FY11A 347,914 29.5 85,885 17.0 433,799 26.8 83,116 31.6 19,151 16.6 11,663 (12.7) 90,604 36.8 547 63.3 90,057 36.6 29,945 31.3 60,112 39.5 10,437 18,895 172,206 FY12E 385,761 10.9 87,678 2.1 473,439 9.1 88,725 6.7 19,922 4.0 9,469 (18.8) 99,178 9.5 662 21.0 98,516 9.4 30,912 3.2 67,605 12.5 11,573 20,166 221,967 FY13E 428,121 11.0 96,548 10.1 524,669 10.8 98,468 11.0 20,697 3.9 10,493 10.8 108,671 9.6 734 10.8 107,938 9.6 33,832 9.4 74,106 9.6 12,844 22,206 276,451 FY14E 449,549 5.0 104,272 8.0 553,822 5.6 101,149 2.7 26,887 29.9 11,076 5.6 116,960 7.6 774 5.6 116,185 7.6 36,483 7.8 79,702 7.6 13,486 23,983 336,840

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19

BHEL Balance Sheet

Year to Mar Eqty Cap Reserves Networth Secured loans Unsecured loans Total loans Total Liability Net Block Investments Deffered Tax Assets Inventory Debtors Cash balance Other CA Current Liabilities Provisions NCA Misc Exp Total Assets
Source: Company, SBICAP Securities Research

SBICAP Securities Ltd (` mn)

FY09A 4,895 124,493 129,388 1,494 1,494 130,882 26,274 523 18,403 78,370 159,755 103,147 27,739 233,573 49,756 85,682 130,882 FY10A 4,895 154,278 159,174 1,278 1,278 160,451 39,450 798 15,272 92,355 206,888 97,901 32,205 280,237 44,180 104,931 160,451 FY11A 4,895 196,643 201,538 1,634 1,634 203,172 51,631 4,392 21,635 109,630 273,546 96,302 35,470 313,466 75,968 125,514 203,172 FY12E 4,895 248,811 253,706 1,634 1,634 255,340 61,239 4,392 21,635 116,476 297,926 135,261 39,093 338,861 81,822 168,073 255,340 FY13E 4,895 306,606 311,501 1,634 1,634 313,135 57,284 4,392 21,635 135,821 330,164 177,563 43,023 361,151 95,597 229,823 313,135 FY14E 4,895 369,414 374,310 1,634 1,634 375,944 52,119 4,392 21,635 155,245 348,509 232,019 45,274 376,940 106,310 297,797 375,944

Cash Flow
Year to Mar PBT Depreciation/Amortisation Lease Equalisation Profit on sale of Fixed assets Provision for Loss on investment Interest paid Interest/Dividend Income Operating Profit before Working Capital changes Adjustment for: WC Changes Cash generated from operations Direct Taxes Paid NET CASH INFLOW FROM OPERATING ACTIVITIES Purchase of Fixed Assets Sale and Disposal of Fixed Assets Purchase on Investment Sale on Investments Interest & Dividend Receipts NET CASH USED IN INVESTING ACTIVITIES Long Term Borrowings Dividend Paid (including tax on dividend) Interest paid Other Adjustment NET CASH USED IN FINANCING ACTIVITIES NET INCREASE IN CASH AND CASH EQUIVALENTS Opening Balance of Cash and Cash Equivalents Closing Balance of Cash and Cash Equivalents
Source: Company, SBICAP Securities Research

(` mn)
FY09A 48,488 3,343 (179) (84) 0 307 (7,881) 43,995 11,986 55,981 (23,069) 32,912 (13,556) 319 (441) 0 8,549 (5,128) 526 (8,730) (293) (8,498) 19,286 83,860 103,147 FY10A 65,907 4,582 (270) (3) 0 336 (8,239) 62,313 (27,428) 34,885 (19,035) 15,851 (17,223) 85 (275) 0 7,746 (9,666) (215) (10,879) (337) (11,430) (5,246) 103,147 97,901 FY11E 90,057 5,441 0 0 0 547 (9,091) 86,954 (22,182) 64,772 (36,308) 28,464 (17,623) 0 0 (3,594) 9,091 (12,126) 357 (14,563) (547) (3,184) (17,938) (1,599) 97,901 96,302 (16,099) 38,960 96,302 135,261 (17,044) 42,302 135,261 177,563 (17,668) 54,456 177,563 232,019 FY12E 98,516 6,874 0 0 0 662 (8,317) 97,735 (3,600) 94,135 (30,912) 63,223 (16,482) 0 0 0 8,317 (8,165) 0 (15,437) (662) FY13E 107,938 7,556 0 0 0 734 (9,217) 107,009 (19,449) 87,560 (33,832) 53,728 (3,600) 0 0 0 9,217 5,617 0 (16,311) (734) FY14E 116,185 7,965 0 0 0 774 (9,730) 115,195 (13,517) 101,678 (36,483) 65,195 (2,800) 0 0 0 9,730 6,930 0 (16,893) (774)

20

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SBICAP Securities Ltd Ratios

Year to Mar OPM % NPM % ROE % ROCE % (After Tax) Int. Cover (x) D/E (x) Asset Turnover (x) Debtors Days Inventory Days (Without FG and WIP) Creditors Days (With Out Advances from Customers) Net Working Capital Days Valuation ratios P/E (x) P/CF per share (x) EV/EBIDTA (x) EV/Sales (x) Mkt Cap/Sales(x) CEPS (Rs) P/ BV (x)
Source: Company, SBICAP Securities Research

BHEL
FY09A 15.8 11.7 24.2 24.0 158.9 0.0 2.0 208.0 83.5 129.7 161.8 30.1 27.3 16.2 3.1 3.5 70.7 7.3 FY10A 17.7 12.9 27.0 27.0 197.7 0.0 2.1 221.1 85.9 140.0 167.0 21.9 19.8 12.0 2.5 2.8 97.3 5.9 FY11E 20.6 14.2 29.8 29.8 165.6 0.0 2.1 230.2 87.6 140.0 177.8 15.7 14.4 8.8 2.0 2.2 133.9 4.7 FY12E 21.2 14.6 26.6 26.7 149.8 0.0 1.8 230.0 87.6 140.0 177.6 14.0 12.7 7.6 1.7 2.0 152.1 3.7 FY13E 20.9 14.5 23.8 23.8 148.1 0.0 1.6 230.0 87.6 141.0 176.6 12.7 11.6 6.6 1.5 1.8 166.8 3.0 FY14E 21.3 14.7 21.3 21.3 151.1 0.0 1.4 230.0 87.6 142.0 175.6 11.8 10.8 5.7 1.3 1.7 179.1 2.5

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Key to investment Ratings Guide to the expected return over the next 12 months. 1=BUY (expected to give absolute returns of 20 or more percentage points); 2= ACCUMULATE/ADD (expected to give absolute returns between 10 to 20 percentage points); 3=REDUCE (expected to give absolute returns between 0 to 10 percentage points); 4=SELL (expected to give absolute negative returns)

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