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Bharat Heavy Electricals (BHEL) Too much premium for predictability, downgrade to Neutral • BHEL’s provisional

Bharat Heavy Electricals (BHEL)

Too much premium for predictability, downgrade to Neutral

BHEL’s provisional results for FY2009 showed strong execution and signs of easing material cost pressures. 4Q PAT was however 16.5% lower than estimates (FY2009: Rs30.4B, 4Q: Rs12.5B) due to a sudden gratuity provision of Rs6B. We are disappointed that management had not anticipated or guided for this liability earlier.

We lower our estimates for FY2010 by 7%. We now have sales and PAT growth of 21.4% and 29.6% and EBITDA margin improvement of 290bps. Non-recurrence of gratuity provisions and end of wage hike provisions account for the margin expansion.

During the meltdown, BHEL’s outperformance and premium multiples arose from predictability of growth (at least the topline) in a difficult environment. An OB of ~Rs1180B guarantees visibility through 2012. This OB remains relatively immune to cancellations due to the predominance of gov’t utility power projects with guaranteed returns. The company’s ability to allay market fears of execution bottlenecks was also an important contributor to outperformance.

However, the return of risk appetite will likely see markets placing a lower premium to this predictability. In our view, L&T (OW) might outperform BHEL in a rising market, as it has done in past rising markets. We revisit our 'everything goes right' DCF model originally published 15 months back and believe our new Mar-2010 PT of Rs1,300 (down from Rs1400 earlier, terminal growth rate (g):6%, WACC: 11.5%, terminal year: FY17), implying 16.2-x FY2010 earnings, is fair for the stock. We downgrade the stock to Neutral. Key upside risk to our PT is stronger than expected margin improvement and a rise in investor preference for safe growth stocks.

BHEL (Bloomberg: BHEL IN; Reuters: BHEL.BO)

Rs. in millions, year-end March

Asia Pacific Equity Research

05 April 2009

Neutral

Previous: Overweight

BHEL.BO, BHEL IN Price: Rs1,531.85

Price Target: Rs1,300.00 Previous: Rs1,400.00

India

Engineering

Shilpa Krishnan AC

(91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Sumit Kishore

(91-22) 6639-3007 sumit.x.kishore@jpmorgan.com

J.P. Morgan India Private Limited

Price Performance 2,000 Rs 1,400 800 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 BHEL.BO share price (Rs
Price Performance
2,000
Rs
1,400
800
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
BHEL.BO share price (Rs
NIFTY (rebased)
YTD
1m
3m
12m
Abs
9.3%
10.9%
8.8%
-17.3%
Rel
3.4%
-9.2%
3.4%
15.2%
 

FY08

FY09E

FY10E

FY11E

 

Sales Net profit (adjusted) EPS (Rs) DPS (Rs) Net sales growth (%) Net profit growth (%) EPS growth (%) ROE (%) ROCE (%) BVPS (Rs) P/E (x) P/BV (x) EV/EBITDA (x)

193,046

254,879

309,409

386,403

52-week range (Rs) Market cap (Rs B) Market cap (US$ B) Shares o/s (MM) Free float (%) Avg. daily value (Rs MM) Avg. daily value (US$ MM) Avg. daily volume (MM ) Exchange rate (Rs/US$)

984.1-1934

25,892

30,390

39,400

49,242

749.9

52.9

62.1

80.5

100.6

14.9

15.3

17.9

23.2

29.0

489.5

12.0

32.0

21.4

24.9

32.3

8.1

17.4

29.6

25.0

2396.0

NM

17.4

29.6

25.0

47.5

26.5

23.8

28.5

29.3

1.70

45.2

34.9

43.1

44.4

50.4

220.1

255.9

309.4

376.4

 

29.0

24.7

19.0

15.2

7.0

6.0

5.0

4.1

16.3

12.2

12.1

9.0

Source: J.P. Morgan estimates, Company data.

See page 19 for analyst certification and important disclosures, including non-US analyst disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

of this report. Investors should consider this report as only a single factor in making their

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 Valuation and stock view The strong outperformance of BHEL

Valuation and stock view

The strong outperformance of BHEL over the last 12 months has prompted us to revisit the ‘Everything goes right’ scenario in our DCF model, originally published 15 months back. This model is a simplified top-down version, where we begin by modeling India’s power capacity addition, and then BHEL’s market share, margins and so on. Clearly, assumptions on power capacity addition, industry sector growth, margins, WACC, near-term cash-flow accretion and value-addition from power project JVs are significantly lower than what we had 15 months ago. Based on this analysis, we conclude that it is difficult to model a scenario justifying the current stock price. An ideal blue sky scenario would result in a fair value of Rs1,435, while a more realistic scenario results in a fair value of Rs1,300 (down from Rs1,400 earlier, terminal growth rate (g):6%, WACC: 11.5%, terminal year: FY17) which is our current DCF-based PT.

Table 1: Everything goes right DCF scenario (not our base-case)

Rs. in billions, year-end March

 

2008

2009

2010

2011

2012

2013

2014

2015

2016

2022

India's capacity addition (GW)

10

12

15

17

19

21

23

25

27

39

Total installed capactity (GW)

140

152

167

184

203

224

247

272

299

503

BHEL's mkt share (%) BHEL's domestic delivery (GW)) BHEL's overseas delivery (GW)

60

65

65

65

65

65

65

65

65

65

6.0

7.8

9.8

11.1

12.4

13.7

15.0

16.3

17.6

25.4

0.9

1.5

1.5

1.5

1.5

3.0

3.5

4.0

4.0

4.0

BHEL's total delivery (MW)

6.9

9.3

11.3

12.6

13.9

16.7

18.5

20.3

21.6

29.4

Per MW prices (Rs mn) % escalation

25.0

25.8

26.5

27.3

28.1

29.0

29.9

30.7

31.7

37.8

3.0

3.0

3.0

3.0

3.0

3.0

3.0

3.0

3.0

Power revenues (Rs bn) Industry revenues (Rs bn) % growth

172.5

239.5

298.4

342.8

389.7

482.5

550.8

622.6

682.5

1,109.9

55.8

75.3

86.6

86.6

90.9

101.9

114.1

127.8

143.1

282.5

35.0

15.0

-

5.0

12.0

12.0

12.0

12.0

12.0

Total revenues (Rs bn)

228.3

314.8

385.0

429.5

480.7

584.4

664.8

750.4

825.6

1,392.3

EBIT margin Tax rate EBIT (1-t) % Depreciation NOPAT/Rev (%)

13.2

10.2

12.5

14.6

15.0

15.0

15.0

15.0

15.0

15.0

34.0

34.0

34.0

34.0

34.0

34.0

34.0

34.0

34.0

34.0

8.7

6.7

8.3

9.7

9.9

9.9

9.9

9.9

9.9

9.9

3.0

3.2

4.1

4.8

5.5

5.8

6.0

6.2

6.5

7.7

10.0

7.8

9.3

10.8

11.1

10.9

10.8

10.8

10.7

10.5

NOPAT (Rs bn)

22.9

24.4

35.9

46.3

53.2

63.8

72.0

80.7

88.4

145.9

Capex (Rs bn) Incremental working cap to sales (%) Additional working capital (Rs bn)

(8.0)

(11.6)

(12.0)

(12.0)

(12.0)

(4.0)

(4.0)

(4.0)

(4.0)

(3.0)

(5.9)

11.7

2.0

1.1

0.0

3.0

3.0

3.0

3.0

3.0

13.4

(36.8)

(7.6)

(4.5)

(0.1)

(14.5)

(16.5)

(18.7)

(20.5)

(33.3)

FCF (Rs bn)

28.3

(23.9)

16.3

29.8

41.1

45.3

51.5

58.0

63.9

109.6

WACC (%) Disc factor DCF (Rs bn)

 

11.0

11.0

11.0

11.0

13.0

13.0

13.0

13.0

13.0

1.0

1.0

0.9

0.8

0.7

0.6

0.5

0.5

0.4

0.2

28.3

(23.9)

14.7

24.2

30.1

27.8

27.9

27.9

27.2

22.4

Sum of DCF (Rs bn)

304

 

Disc. terminal value (Rs bn)

 

Terminal

339

g (%)

6.0

Add: cash in hand (Rs bn) Value for power projects (Rs bn) Market cap (Rs bn)

60

 

0

703

Per share (Rs)

1,434

Source: J.P. Morgan estimates, Company data.

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Table 2: Indian Capital Goods: Valuation comps & estimates

Rs. in millions, year-end March

comps & estimates Rs. in millions, year-end March Company Rating CMP Target price Mkt cap

Company

Rating

CMP

Target price

Mkt cap

P/E(x)

EV/EBITDA

 

(Rs)

(Rs)

(US$ bn)

FY09E

FY10E

FY11E

FY09E

FY10E

FY11E

BHEL ABB Siemens Crompton Greaves Larsen & Toubro Punj Lloyd

N

1,532

1,300

14.9

24.7

19.0

15.2

12.2

12.1

9.0

N

440

500

1.8

16.5

14.4

12.1

10.4

8.8

7.1

UW

272

188

1.8

17.9

15.2

12.5

8.2

7.0

5.4

N

131

120

0.8

9.6

8.8

8.2

4.7

4.3

3.7

OW

717

880

8.4

14.3

12.1

11.0

11.3

10.1

9.4

N

107

130

0.6

15.3

6.1

6.4

6.1

5.7

5.2

Source: J.P. Morgan estimates, Company data. Note: P/E and EV/EBITDA estimates for Siemens and ABB have been fiscalized.

Tracking multiples and stock performance over time

Historically, BHEL’s P/E multiple has shown a high correlation to the revenue visibility provided by its order book. However, over the last 5 quarters, the focus has shifted from order book to execution. Concerns on execution, coupled with weak market sentiment have led to a decline in multiples despite the continued OB expansion (Figure 1 & 2).

Another commonly used multiple for BHEL is the EV/OB (Figure 3). Barring the FY06-08 phase when markets were exceptionally bullish, BHEL has traded at an EV/OB ranging from 0.3x (FY00) to 0.6x (current).

From the movement of these multiples over cycles, we conclude that BHEL’s multiples, which appear cheap vis-à-vis recent history, are currently at normalized mid-cycle levels. With limited potential for OB expansion from present high levels, we believe multiples too might remain at current levels or drift lower.

Figure 1: BHEL: Analyzing correlation between P/E and OB visibility (trailing 12-months)

Year-end March 50.0 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 P/E (LHS)
Year-end March
50.0
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
P/E (LHS)
Visibility (RHS)
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09

Source: J.P. Morgan estimates, Company data.

6.00

5.00

4.00

3.00

2.00

1.00

0.00

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 Figure 2: BHEL: Analyzing correlation between P/E and OB

Figure 2: BHEL: Analyzing correlation between P/E and OB visibility (1-year forward)

Year-end March 40 30 20 10 0 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01
Year-end March
40
30
20
10
0
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
P/E (x )
OB v isibility
(fw d 12-mth rev )

Source: J.P. Morgan estimates, Company data.

Figure 3: BHEL: EV/OB trend

Year-end March OB (Rs B, LHS) EV (Rs B, LHS) EV/OB (x, RHS) 1,200 1,000
Year-end March
OB (Rs B, LHS)
EV (Rs B, LHS)
EV/OB (x, RHS)
1,200
1,000
800
600
400
200
0
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09

Source: J.P. Morgan estimates, Company data.

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

4

3

2

1

0

Tracking BHEL’s performance vs. L&T over time

BHEL’s P/E multiple vs. L&T has been at an average premium of ~60% over the last 2 decades (Figure 4, 5). However, in our experience, L&T has tended to outperform analysts’ EPS estimates much more sharply, as compared to BHEL, during periods of economic boom. Thus, what appears to be a premium multiple in hindsight, is misleading. From our experience, BHEL tends to trade at 10-15% premium to L&T over the cycle with two exceptions: 1) During the peak of the markets (Eg: 2008), we found L&T’s multiples outstripping those of BHEL, as L&T is perceived to be a bigger growth play during such times and 2) When markets are weak, BHEL’s premiums to L&T tend to expand, as BHEL is always considered a safer growth stock than L&T

Nov-92 Nov-93 Nov-94 Nov-95 Nov-96 Nov-97 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08

Nov-00

Nov-06

Nov-96

Nov-99

Nov-98

Nov-08

Nov-94

Nov-04

Nov-95

Nov-05

Nov-92

Nov-02

Nov-93

Nov-03

Nov-97

Nov-07

Nov-01

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 Figure 4: 1-yr forward P/E: BHEL & L&T 50.0
Figure 4: 1-yr forward P/E: BHEL & L&T 50.0 40.0 30.0 20.0 10.0 0.0
Figure 4: 1-yr forward P/E: BHEL & L&T
50.0
40.0
30.0
20.0
10.0
0.0

Source: J.P. Morgan estimates.

BHEL

L&T

Figure 5: 1-yr forward P/E(x): BHEL's historical premium/ (discount) to L&T

200

150

100

50

0

-50

storical premium/ (discount) to L&T 200 150 100 50 0 -50 Source: J.P. Morgan estimates. BHEL

Source: J.P. Morgan estimates.

BHEL Premium/ (Discount) to L&T (%)

BHEL’s absolute performance vs L&T and relative performance vs Sensex offers interesting conclusions, in our view. Since 1996, BHEL has outperformed the Sensex and L&T in bear market. L&T has underperformed the Sensex in bear markets (see charts for FY96-98, FY00-03, and FY08-now).

In the bull markets of 03-07, both L&T and BHEL massively outperformed the Sensex. L&T marginally outperformed BHEL. In the bull rally in 98-99 too L&T had outperformed BHEL.

Thus, historically, performance of L&T>BHEL>Sensex in bull markets and performance of BHEL>Sensex>L&T in bear markets. BHEL has had a positive impact on a portfolio irrespective of market movement, but L&T has had an even more positive impact during bull markets. During bear markets, L&T is the stock to avoid, in our view.

Jun-96 Aug-96 Oct-96 Dec-96 Feb-97 Apr-97 Jun-97 Aug-97 Oct-97 Dec-97 Feb-98 Apr-98 Jun-98 Aug-98 Oct-98

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 Figure 6: Price Performance: L&T, BHEL & Sensex
Figure 6: Price Performance: L&T, BHEL & Sensex (96-98) 300 250 200 150 100 50
Figure 6: Price Performance: L&T, BHEL & Sensex (96-98)
300
250
200
150
100
50
0

Source: Bloomberg, J.P. Morgan.

BHEL

L&T

Sensex

Figure 7: Price Performance: L&T, BHEL & Sensex (98-99) 300 250 200 150 100 50
Figure 7: Price Performance: L&T, BHEL & Sensex (98-99)
300
250
200
150
100
50
0
Dec-98
Jan-99
Feb-99
Mar-99
Apr-99
May -99
Jun-99
Jul-99
Aug-99
Sep-99
Oct-99
Nov -99
Dec-99
BHEL
L&T
Sensex

Source: Bloomberg, J.P. Morgan.

Figure 8: Price Performance: L&T, BHEL & Sensex (00-03) 125 105 85 65 45 25
Figure 8: Price Performance: L&T, BHEL & Sensex (00-03)
125
105
85
65
45
25
5
-15
BHEL
L&T
Sensex
Jan-00
Mar-00
May-00 Jul-00
Sep-00
Nov-00 Jan-01
Mar-01
May-01 Jul-01
Sep-01
Nov-01 Jan-02
Mar-02
May-02 Jul-02
Sep-02
Nov-02 Jan-03
Mar-03
May-03

Source: Bloomberg, J.P. Morgan.

Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 Figure 9: Price Performance: L&T, BHEL & Sensex
Figure 9: Price Performance: L&T, BHEL & Sensex (03-07) 2500 2000 1500 1000 500 0
Figure 9: Price Performance: L&T, BHEL & Sensex (03-07)
2500
2000
1500
1000
500
0

Source: Bloomberg, J.P. Morgan.

L&T

Sensex

BHEL

Figure 10: Price performance: L&T, BHEL & Sensex (08-now) 100 80 60 40 20 0
Figure 10: Price performance: L&T, BHEL & Sensex (08-now)
100
80
60
40
20
0
Jan-08
Feb-08
Mar-08
Apr-08
May -08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov -08
Dec-08
Jan-09
Feb-09
Mar-09
L&T
Sensex
BHEL

Source: Bloomberg, J.P. Morgan.

Financials: growth drivers in place

Revenues: demand in place, capability to supply is the constraint

BHEL has an order backlog of ~Rs1180B as on 31Mar 2009, providing earnings visibility through FY12. ~84% of OB is accounted by power sector, ~9% by industry and balance 7% by exports. State & Central government orders constitute ~85-90% of the order book; balance is from private sector players. This OB remains relatively immune to cancellations due to the predominance of gov’t utility power projects with guaranteed returns.

In FY09 BHEL has reported Rs597B of new orders (+18.7% YoY). In our view FY10, would be the peak year of 12th Plan (FY13-FY17) ordering; the country is targeting capacity addition of ~95GW in the next plan period.

The average execution period of projects is ~36months. The margins are higher in BTG/ product orders and are lower in EPC orders. The EPC orders include BOP and civil work where value addition and profit margins are lower. The composition of

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 order book in the 10th plan period (FY03-07) had

order book in the 10th plan period (FY03-07) had a higher chunk (70:30) of EPC orders. Over the past many quarters BHEL has been booking more product orders, bringing the composition of EPC to BTG orders down to around 50:50.

BHEL follows percentage completion method of booking revenues on orders. Given that demand is in place, execution capacity is the only constraint. Current capacity is 10GW, increasing to 15GW by Dec-2009 and 20GW by Dec-2011. We are not unduly concerned that capacity constraints would pose a serious risk to growth, barring one-off quarterly fluctuations in execution and revenue recognition.

Figure 11: BHEL: Order booking, Order backlog and visibility trend for BHEL

Year-end March Order booking (Rs bn, LHS) Order backlog (Rs bn, LHS) Years of visibility
Year-end March
Order booking (Rs bn, LHS)
Order backlog (Rs bn, LHS)
Years of visibility (RHS)
1,200
1,000
800
600
400
200
0
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09

Source: J.P. Morgan estimates, Company data.

6.00

5.00

4.00

3.00

2.00

1.00

-

Operating margins: the contribution of operating leverage likely to be lower going ahead

There are 3 important determinants of margins: pricing, material cost and operating leverage.

Competitive pressures on pricing unlikely to be felt near term: In our view, power plant equipment prices have been firm over the past few years, mainly owing to reduced Chinese competitive pressures as a result of the RMB appreciation vs INR. However, competition from L&T is likely to be stronger going ahead. This might impact margins beyond FY12, as revenues through FY12 are already secured.

Easing material cost likely to be a positive margin contributor: As of now, 60% of the orders are on cost-plus basis and balance 40% are fixed price contracts. In FY09, raw material, erection and engineering expenses were 60.3% of net sales, ~100bps higher than FY08. Typically BHEL maintains an inventory of 3-4 months for indigenous materials and 6 months for imported materials. Commodity prices were at their peak in Sep-q, thus the maximum impact on margins was felt during the Sep & Dec quarters where OPM declined 420bps and 300bps respectively. The raw material cost pressures have eased out considerably in 4Q09 in our view.

Operating leverage-led margin gains unlikely through FY12, barring the near- term impact of cessation of wage-arrear provisioning: Operating leverage was the

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 most important contributor to margin expansion between

most important contributor to margin expansion between FY02-07 (Figure 12). While BHEL’s capacities were underutilized, the company was overstaffed. Increase in capacity utilization via more shifts and minor de-bottlenecking, coupled with the reduction of staff strength from 68K to 43K contributed greatly to the reduction of fixed overheads, even as revenue continued to grow.

Figure 12: BHEL: Operating leverage in employee and other expenses 25.0 20.0 15.0 10.0 5.0
Figure 12: BHEL: Operating leverage in employee and other expenses
25.0
20.0
15.0
10.0
5.0
0.0
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09E
FY10E
FY11E
FY12E
Manpow er cost (ex -w age prov ision)
Other ex penses [a]

Source: J.P. Morgan estimates, Company data. Note: [a] Other expenses include sales & admin expense, power & fuel, stores & spares and stock variation.

Going forward, employee numbers are slated to rise to 53K (currently 46K), while manufacturing capacity is slated to double to 20GW (currently 10GW). In our view, these factors would result in an absolute increase in fixed overheads, and fixed expenses as % of sales are likely to remain flat at best.

In FY10, we expect a 290bps margin improvement as provisions for wage arrears are done with. We believe overall employee cost would decline in absolute terms (Table 2). The implementation of 6 th Pay Commission recommendations would result in 40% increase in per employee wages. We have not factored in margin improvement on account of commodity price decline for FY10, and we shall wait for June-q results to review our assumptions.

Table 3: BHEL: Employee cost estimates

Rs. in millions, year-end March

FY2007

FY2008

FY2009E

FY2010E

FY2011E

No of employees (yr-end) Per employee wages (Rs, based on average employees) % increase

42,124

43,636

46,000

50,000

53,000

559,216

608,137

699,357

979,100

1,077,010

9

15

40

10

Employee cost (Rs mn)

23,690

26,077

31,344

46,997

55,466

Wage arrears provision (Rs mn) Other provisions (Rs mn)

800

5,140

19,000
19,000

0

0

0

2,000

0

0

0

Total employee cost (Rs mn)

24,490

31,217

50,344

46,997

55,466

Source: J.P. Morgan estimates, Company data.

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Table 4: BHEL: P&L statement

Rs. in millions, year-end March

Asia Pacific Equity Research 05 April 2009

year-end March Asia Pacific Equity Research 05 April 2009   FY08 FY09E FY10E FY11E FY12E Gross
 

FY08

FY09E

FY10E

FY11E

FY12E

Gross Sales Less: Excise duty

214,977

275,050

334,496

417,733

426,598

(21,322)

(20,171)

(25,087)

(31,330)

(31,995)

Net Sales

193,655

254,879

309,409

386,403

394,603

Other op income (Inc)/Dec in WIP Raw material consumption Staff cost Other expenses Total Expenditure

4,927

6,200

6,200

6,200

6,200

8,273

10,754

10,754

10,754

10,754

(114,895)

(153,701)

(186,484)

(232,889)

(239,964)

(31,459)

(50,344)

(46,997)

(55,466)

(56,513)

(21,906)

(26,245)

(33,359)

(38,959)

(42,562)

(159,987)

(219,536)

(256,085)

(316,559)

(328,284)

EBIDTA

38,595

41,544

59,524

76,044

72,519

Other income

9,035

7,295

5,554

5,849

7,387

EBIDT

47,630

48,839

65,077

81,893

79,907

Interest

(354)

(300)

(300)

(300)

(300)

Depreciation

(2,972)

(3,239)

(5,081)

(6,984)

(8,653)

PBT

44,304

45,300

59,697

74,609

70,953

Tax

(15,711)

(14,910)

(20,297)

(25,367)

(24,124)

Reported PAT

28,593

30,390

39,400

49,242

46,829

EPS

58.4

62.1

80.5

100.6

95.7

 

13,962

13,495

11,754

12,049

13,587

Growth (%)

Net Sales

31.6

21.4

24.9

2.1

PAT

Key ratios (%) Raw Material to Sales Excise duty to sales Staff Cost to sales Other exp to sales

 

6.3

29.6

25.0

(4.9)

59.3

60.3

60.3

60.3

60.8

9.9

7.3

7.5

7.5

7.5

16.2

19.8

15.2

14.4

14.3

11.3

10.3

10.8

10.1

10.8

EBIDTA margin

19.9

16.3

19.2

19.7

18.4

Effective tax rate

35.5

32.9

34.0

34.0

34.0

Source: J.P. Morgan estimates, Company data.

First-cut analysis of FY2009 provisional results

BHEL’s provisional results for FY2009 showed strong execution and signs of easing material cost pressures. 4Q PAT was however 16.5% lower than estimates (FY2009:

Rs30.4B, 4Q: Rs12.5B) due to a sudden gratuity provision of Rs6B. In a television interview, management said that that at the last minute they had to provide for gratuity increase as well as the recent hike announced by the finance ministry – as a result they had to provide for about Rs 19B instead of Rs 13B anticipated earlier. We are disappointed that management had not anticipated or guided for the Rs6B gratuity provision earlier. Management continues to guide towards a 20-25% revenue growth and 25-30% PAT growth in FY2010.

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Table 5: BHEL: Mar-q & FY09 detailed estimates post provisional results

Rs. in millions, year-end March

post provisional results Rs. in millions, year-end March   9M09 9M08 %YoY FY09E FY08 %YoY
 

9M09

9M08

%YoY

FY09E

FY08

%YoY

4Q09E

4Q08

%YoY

Gross Sales Less: Excise duty Net Sales Other op income (Inc)/Dec in WIP Raw material consumption Staff cost Other expenses Total Expenditure EBIDTA Other income EBIDT Interest Depreciation PBT Tax PAT EPS

169,551

135,378

25.2

275,050

214,977

27.9

105,499

79,599

32.5

(12,610)

(13,744)

(8.3)

(20,171)

(21,322)

(5.4)

(7,561)

(7,578)

(0.2)

156,941

121,634

29.0

254,879

193,655

31.6

97,938

72,021

36.0

3,144

2,463

27.6

6,200

4,927

25.8

3,056

2,464

24.0

9,793

4,342

125.5

10,754

8,273

30.0

961

3,931

(75.5)

(101,977)

(72,952)

39.8

(153,701)

(114,895)

33.8

(51,724)

(41,943)

23.3

(27,053)

(19,799)

36.6

(50,344)

(31,459)

60.0

(23,291)

(11,660)

99.7

(16,653)

(13,191)

26.2

(26,245)

(21,906)

19.8

(9,592)

(8,715)

10.1

(135,890)

(101,600)

33.8

(219,536)

(159,987)

37.2

(83,646)

(58,387)

43.3

24,195

22,497

7.5

41,544

38,595

7.6

17,349

16,098

7.8

5,908

7,258

(18.6)

7,295

9,035

(19.3)

1,387

1,777

(21.9)

30,103

29,755

1.2

48,839

47,630

2.5

18,736

17,875

4.8

(226)

(312)

(27.6)

(300)

(354)

(15.3)

(74)

(42)

76.2

(2,334)

(2,145)

8.8

(3,239)

(2,972)

9.0

(905)

(827)

9.4

27,543

27,298

0.9

45,300

44,304

2.2

17,757

17,006

4.4

(9,636)

(9,813)

(1.8)

(14,910)

(15,711)

(5.1)

(5,274)

(5,898)

(10.6)

17,907

17,485

2.4

30,390

28,593

6.3

12,483

11,108

12.4

 

36.6

35.7

2.4

62.1

58.4

6.3

25.5

22.7

12.4

Key ratios (%) Raw Material to Sales Excise duty to sales Staff Cost to sales Other exp to sales EBIDTA margin Effective tax rate

65.0

60.0

60.3

59.3

52.8

58.2

7.4

10.2

7.3

9.9

7.2

9.5

17.2

16.3

19.8

16.2

23.8

16.2

10.6

10.8

10.3

11.3

9.8

12.1

15.4

18.5

16.3

19.9

17.7

22.4

35.0

35.9

32.9

35.5

29.7

34.7

Source: J.P. Morgan estimates, Company data.

Table 6: BHEL: Key model revisions

 

Rs. in millions, year-end March

 
 

2009E

2010E

2011E

Revenues old

250,115

314,444

388,492

Revenues new

254,879

309,409

386,403

Revision (%)

1.9

(1.6)

(0.5)

YOY growth (%)

32.0

21.4

24.9

EBITDA old

41,170

58,400

78,231

EBITDA new [a]

38,148

56,616

73,714

Revision (%)

(7.3)

(3.1)

(5.8)

YOY growth (%)

(7.0)

48.4

30.2

EBITDA margin(%) old

16.5

18.6

20.1

EBITDA margin(%) new

15.0

18.3

19.1

Revision (bps)

(149.3)

(27.4)

(106.0)

Adjusted PAT old

32,859

42,216

54,727

Adjusted PAT new

30,390

39,400

49,242

Revision (%)

(7.5)

(6.7)

(10.0)

YOY growth (%)

17.4

29.6

25.0

Diluted EPS old (Rs)

67.1

86.2

111.8

Diluted EPS (Rs) new

62.1

80.5

100.6

Revision (%)

(7.5)

(6.7)

(10.0)

Source: J.P. Morgan estimates.

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Table 7: BHEL: Reported orders in Mar-q

05 April 2009 Table 7: BHEL: Reported orders in Mar-q Date Description Size (Rs. Mn.) 27-Feb-09

Date

Description

Size (Rs. Mn.)

27-Feb-09

BHEL received the first-ever order for Steam Generators for New Rating 700 MWe Nuclear Sets. The order has been placed on BHEL by Nuclear Power Corporation of India limited (NPCIL) for Kakrapara Atomic Power Project (KAPP) in Gujarat. For the first time in India, NPCIL is installing two units of 700 MWe rating at KAPP, the highest rating developed indigenously, based on Pressurised Heavy Water Reactors, the other order has been placed on L&T. Valued at Rs.3,450 Million, the order envisages manufacture and supply of 4 Steam Generators, for use in the Primary cycle of the

3,450

23-Feb-09

Nuclear Power Plant for one Reactor of 700 MWe unit rating. Outbidding Chinese equipment suppliers under international competitive bidding, Bharat Heavy Electricals Limited (BHEL) has won an order for the main plant package at the upcoming Malwa Thermal Power Project (TPP) in Madhya Pradesh, involving two new- rating units of 600 MW each. Valued at Rs.31,500 Million, the order for the greenfield power project has been placed on BHEL by Madhya Pradesh Power Generating Company Limited (MPPGCL). BHEL has bagged four major contracts from various customers for the supply and installation of main plant equipment for thermal power projects. The projects, with a cumulative capacity of 3,250 MW, are located in Madhya Pradesh, Uttar Pradesh, Tamil Nadu and Maharashtra. Cumulatively valued at around Rs.70,000 Million, the contracts have been placed on BHEL by NTPC Ltd. (2000MW), NLC Tamil Nadu Power Limited (1000MW) and Mahagenco (250MW).

31,500

9-Feb-09

70,000

Source: Company reports.

Working capital: a near term concern

Net working capital may have gone up from negative Rs5B as on March-08 to Rs31.7B as of Mar-09, in our estimate. The following factors have been responsible for the increase in our view-

Higher inventory due to execution pressures. Inventory days have gone up sharply from their FY07 levels (100 days) to around ~156 days in FY09.

Although we expect marginal decrease in the collection period, liberal credit terms to vendors led to higher working capital pressure, in our view

Sharp rise in loans & advances

Customer advance as a percentage of turnover may have gone up significantly as well - this offsets higher working capital need to some extent

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Table 8: BHEL: Working capital details and key efficiency metrics

Rs. in millions, year-end March

and key efficiency metrics Rs. in millions, year-end March   FY04 FY05 FY06 FY07 FY08 FY09E
 

FY04

FY05

FY06

FY07

FY08

FY09E

FY10E

FY11E

 

Current assets :

Inventories Sundry debtors Cash & Bank Balances Loans & advances Others Total current assets

21,039

29,161

37,444

42,177

57,364

92,242

113,336

141,539

46,085

59,721

71,681

96,958

119,749

148,838

185,118

231,184

26,596

10,392

31,779

12,297

41,340

11,999

58,089

11,409

83,860

55,513

66,988

89,783

11,863

35,000 30,000 10,000
35,000
30,000
10,000

135

472

845

1,997

4,211

10

10

10

104,247

133,430

163,308

210,630

277,047

331,604

395,453

472,516

Current liabilities :

Sundry Creditors

17,380

20,997

28,041

35,390

43,851

44,464

57,099

70,689

Advances (customers)

31,330

45,849

54,792

77,755

113,946

151,951

180,628

213,044

Others

3,259

4,359

5,245

5,834

7,967

8,365

8,784

9,223

Provisions :

Taxation

1,282

1,228

1,477

980

(2,015)

(2,015)

(2,015)

(2,015)

Dividends

830

1,256

490

2,937

3,060

10,164

13,177

16,469

Others

9,287

10,770

13,156

21,305

31,399

31,399

31,399

31,399

Total current liabilities

63,369

84,459

103,200

144,201

198,208

244,329

289,072

338,809

Net current assets

40,878

48,971

60,108

66,429

78,839

87,275

106,381

133,707

Net current assets (ex-cash)

14,282

17,192

18,768

8,340

(5,021)

31,761

39,393

43,924

 

Inventory turnover (x)

3.6

3.1

3.2

3.6

3.0

2.3

2.5

2.4

Inventory (days)

101

119

114

100

121

156

149

150

 

Receivables/Sales (%) Collection period (days)

53

58

49

52

56

55

55

55

194

211

180

189

204

202

202

202

Payables/purchase (%)

23

23

23

23

25

21

21

21

Average credit received (days)

83

86

86

84

93

75

75

75

 

Customer advances as % of turnover

36

44

38

41

53

57

54

51

Source: J.P. Morgan estimates, Company data.

Working capital pressures may be responsible for BHEL’s negative FCF in FY09, in our view. BHEL has generated negative FCF only twice since FY95. See Table 8 for contribution of net-working capital components to FCF

Table 9: BHEL: Contribution of change in working capital components to FCF

Rs. in millions, year-end March

 

FY05

FY06

FY07

FY08

FY09E

FY10E

FY11E

Decrease/ (Increase) in current assets -Inventory -Sundry Debtors -Loans & advances -Others

(24,001)

(20,317)

(30,573)

(40,646)

(82,904)

(52,374)

(54,268)

(8,122)

(8,283)

(4,733)

(15,187)

(34,878)

(21,094)

(28,203)

(13,637)

(11,959)

(25,278)

(22,791)

(29,090)

(36,280)

(46,065)

(1,905)

298

590

(455)

(23,137)

5,000

20,000

(337)

(373)

(1,152)

(2,214)

4,201

0

0

Increase/ (Decrease) in current liabilities -Sundry Creditors

21,090

18,741

41,001

54,007

46,121

44,743

49,737

3,617

7,044

7,349

8,462

613

12,635

13,590

-Advances (customers)

14,519

8,943

22,964

36,191

38,005

28,677

32,416

-Others

1,100

886

589

2,133

398

418

439

-Provisions

1,855

1,868

10,100

7,222

7,105

3,013

3,292

Decrease in net current assets (ex-cash) FCF

(2,910)

(1,576)

10,428

13,361

(36,783)

(7,631)

(4,531)

4,160

12,253

28,057

27,497

(28,210)

15,376

31,829

Source: J.P. Morgan estimates, Company data.

Shilpa Krishnan (91-22) 6639-3010 shilpa.x.krishnan@jpmorgan.com

Asia Pacific Equity Research 05 April 2009

Asia Pacific Equity Research 05 April 2009 The working capital pressures are on expected lines cons

The working capital pressures are on expected lines considering the impact of the ongoing credit crunch; however we believe that in FY10 and FY11 the incremental impact of increase in WC on FCF would be muted.

BHEL continues to have a strong balance sheet with FY09 estimated net-cash of

Rs55B.

Table 10: BHEL: Balance Sheet

Rs. in millions, year-end March

 

FY 2005

FY 2006

FY 2007

FY 2008

FY 2009E

FY 2010E

FY 2011E

Share capital Reserves and surplus Share holders equity Secured loans Unsecured loans Total Borrowings

2,448

2,448

2,448

4,895

4,895

4,895

4,895

57,821

70,566

85,435

102,847

120,360

146,583

179,356

60,269

73,014

87,883

107,742

125,255

151,478

184,251

5,000

5,000

-

-

-

-

-

370

582

893

952

893

893

893

5,370

5,582

893

952

893

893

893

Total Capital

65,639

78,596

88,776

108,694

126,149

152,371

185,144

Gross Fixed Assets (Less) Acc. Depreciation Capital work in progress Net Fixed Assets Investments Cash and Bank Balances Net Current Assets ex-cash

36,289

38,221

41,351

44,435

56,015

73,015

89,015

26,193

28,528

31,171

34,031

39,111

46,095

54,749

953

1,846

3,025

6,580

10,000

8,000

7,000

11,396

11,668

12,913

16,393

26,412

34,528

40,975

90

83

83

83

83

83

83

31,779

41,340

58,089

83,860

55,513

66,988

89,783

17,192

18,768

8,340

(5,021)

31,761

39,393

43,924

Total Assets

65,639

78,596

88,776

108,694

126,149

152,371

185,144

Net Debt

(26,409)

(35,757)

(57,196)

(82,908)

(54,620)

(66,095)

(88,890)

Source: J.P. Morgan estimates, Company data.

We estimate capex of Rs45B over the next three years for ongoing capacity expansion from 10GW to 15GW, followed by further expansion to 20GW. This can easily be met through internal accruals (estimated 90B of retained earnings from FY10-12), in our view. We have forecasted strong operating cash flows for BHEL over FY10-12 as impact of incremental working capital pressures is muted.

Table 11: BHEL will deliver strong positive FCF from FY10-12

Rs. in millions, year-end March

FY2007

FY2008

FY2009E

FY2010E

FY2011E

FY2012E

EBIT D&A Tax Decrease in WC Operating CF

31,999

33,215

35,344

53,324

69,844

66,319

2,730

2,972

3,239

5,081

6,984

8,653

13,214

15,711

14,910

20,297

25,367

24,124

10,428

13,361

(36,783)

(7,631)

(4,531)

(84)

31,944

33,838

(13,110)

30,476