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                                COMPANY RESEARCH REPORT
                                      INITIATING COVERAGE

                                      BHEL LIMITED
                                      RECOMMENDATION: BUY

                                      CMP: Rs. 260

                                      TARGET: Rs. 400

                                      HOLDING PERIOD: 2 YEARS

                                      RISK PROFILE: MODERATE - AGGRESSIVE
                                                                       INITIATING COVERAGE- ‘BUY’ : BHEL

 In a sweet spot due to structural deficit
                                                                        NSE Code:                  BHEL
  Power sector plays a crucial role in the economic progress of the
                                                                        BSE Code:                  500103
  country given the importance of electricity in the economic
                                                                        ISIN Code:                 INE257A01026
  activity. Currently, at the end of August 2011, the power             Reuters Code:              BHEL.BO
  generation capacity stood at 176,990.40 MW including the              Bloomberg Code:            BHEL IN
  renewable energy sources such as wind, solar etc. However the                       Website:
  country faces a peak power shortage of 13 percent as rising
  demand from industry, homes and shopping malls outstrips
  capacity growth. The energy-hungry nation needs to add over           Sector:                        Electric Equipment
  75,000 megawatts in the five years to March 2017 to support its       EPS (TTM):                     Rs.24.73
  target of 9 percent GDP growth                                        PE (TTM):                      11.06
                                                                        Industry PE:                   13.62
 Mammoth orders in book                                                Mkt. Cap (In crores):          66956.1
  Though the order inflow is muted during the year under review,
                                                                        52 Wk high:                    Rs.475.8
  BHEL has an outstanding order book of Rs. 1, 61,000 Crore as
                                                                        52 Wk low:                     Rs.246.2
  on September 2011, which comes at 3.30 times FY12E revenue,
  gives a clear revenue visibility for the next three years, coupled    P/BV:                          3.32
  with strong execution capabilities. The company is also looking       Beta:                          0.86
  to get into agreements with many State Governments and other          Dividend Yield (%):            2.28
  organizations which clearly signify the company‟s prospect for        Face Value:                    2
  the next 3-4 years.                                                   Debt/Equity:                   0.01
                                                                        Foreign Institutional          12.87%
 Minimal debt and cash rich company                                    Holding:
  Bhel is a low leveraged company having only 1% debt in the
  total financing coupled with a huge cash reserve of Rs.9000
                                                                        PRICE Vs SENSEX CHART    Period: 10/12/2010 - 09/12/2011
  crore, with which the company could withstand the effects of
  higher interest rate prevailing in the economy and finance the
  projects with much ease

 Outlook and Valuations: Attractive; Initiate Coverage with
  Our DCF model with 15.3% discount rate values the company at
  Rs.400 per share giving an upside of 53.8% from the current
  level of Rs.260.       We initiate coverage with a „BUY‟
  recommendation for a target price of Rs.400. Those with a
  moderate to aggressive risk appetite can consider investing in        Shareholding Pattern (%)
  BHEL at current level.
                                                                        President of India                                  67.72
 Risks                                                                  Public Shareholding:

 At the macro level, the current global economic scenario               Foreign Institutional Investors                     12.87
 presents the most highly risk factor as any fall of the global         MF’s ,Financial Institutions                        6.78
 economy into a double-dip recession can lead to a slower growth        Insurance Companies                                 6.49
 in our economy. Apart from that, the other concerns include the        Bodies Corporations                                 3.55
 possibility for unusual further surge in the prices of commodities
 such as copper and steel, competition from the overseas players,        Retail Holding                                     2.5
 persistence of the higher interest rate and higher coal prices
 causing delaying of projects etc. We expect all these concerns to
 ease in the medium term, which would otherwise impact the
 prospects of the company.
                                                                                                                       INITIATING COVERAGE- ‘BUY’ : BHEL


Business Summary ............................................................................................................................................................... 1

   Business Verticals ............................................................................................................................................................. 1

Industry..................................................................................................................................................................................... 4

Financials .................................................................................................................................................................................. 5

Valuations ................................................................................................................................................................................. 7

Investment Rationale........................................................................................................................................................... 8

Sensitivity Analysis ............................................................................................................................................................. 10

Risks ......................................................................................................................................................................................... 11

Financial Highlights ............................................................................................................................................................. 13

Financial Ratios .................................................................................................................................................................... 14

Financials Graph and Peer Group Comparison ........................................................................................................ 15

Analyst Notes And Company News .............................................................................................................................. 16
                                                                           INITIATING COVERAGE- ‘BUY’ : BHEL

                              Business Summary
                              BHEL is the largest engineering and manufacturing enterprise in India in the energy-
                              related/infrastructure sector today. BHEL was established in 1964, ushering in the
                              indigenous Heavy Electrical Equipment industry in India. BHEL is amongst world‟s rarest
                              few who have the capability to manufacture entire range of power plant equipment.
                              BHEL is maintaining a consistent track record of growth, performance and profitability
                              since 1976-77.

                              BHEL has grown in stature over the years with continued inflow of orders, manufacturing
                              prowess, continued thrust on technology leading to a strong presence in domestic and
                              international markets as a major supplier of power plant equipments besides
                              establishing substantial inroads in select segment of products in Industrial sector and
                              Railways. BHEL has been augmenting its capacity and capability and has already
                              enhanced its power generating equipment manufacturing capacity from 6000 MW per
In addition to the power      annum in 1999-2000 to 15,000MW of now. It is further planned to increase the capacity
 generation equipment ,       to 20,000 MW per by March, 2012. Besides capacity augmentation in the areas of
BHEL products cater to a      Thermal, Gas, Hydro and Nuclear, other major areas of investment include the facilities
     wide spectrum of         for Nuclear Turbines upto 700/ 1000 MW, Advanced Class Gas Turbines, 765 KV
customers encompassing        Transformers and augmentation of transformer capacity from 20500 MVA to 45000 MVA.
      various fields of
operation, like Fertilizers   BHEL has diversified its product base over the years and today caters to the needs of
                              almost all the key sectors of the economy. In addition to the power generation
     & Petrochemicals,
                              equipment , BHEL products cater to a wide spectrum of customers encompassing
       Refineries, Oil
                              various fields of operation, like Fertilizers & Petrochemicals, Refineries, Oil Exploration
      Exploration and         and production, Steel and metals, cement ,sugar and paper plants, transportation and
   production, Steel and      non-conventional energy sources etc.
  metals, cement ,sugar
     and paper plants,        BHEL has
 transportation and non-
                                  Installed equipment for over 1,17,000 MW of power generation- for Utilities,
    conventional energy
                                   Captive and Industrial users
          sources                 Supplied over 2,25,000 MVA transformer capacity and other equipment operating
                                   in Transmission & Distribution network up to 400 kV (AC & DC).
                                  Supplied over 25,000 Motors with Drive Control System to Power projects,
                                   Petrochemicals, Refineries, Steel, Aluminum, Fertilizer, Cement plants, etc.
                                  Supplied Traction electrics and AC/DC locos to power over 12,000 KMs Railway
                                  Supplied over one million Valves to Power Plants and other Industries

                              Business Verticals
                              BHEL‟s business is around 3 main core areas: Power, Industry and Overseas business.
                              This enables the company to have engagement with clients from different sectors and
                              respond quickly to the needs and requirements of the clients thereby utilizing
                              opportunities as per the pulse of the market.

                                                                      INITIATING COVERAGE- ‘BUY’ : BHEL





                                                                             Oil & Gas

       Utility power                                                       Transmission
     generating sets
supplied by BHEL have                                                      International
 crossed the landmark                                                        Business
  of 1, 00,000 MW and
  continue to maintain     BHEL‟s products are mainly concentrated in the Power, Industry, Transmission,
   the record of nearly    Transportation, Non- Conventional Energy, Oil & gas, Transmission and International
two-third of the overall   business.
 installed capacity and
 around three-fourth of    Power
                           In Power generation segment, BHEL is the largest manufacturer in India supplying wide
the power generated in
                           range of products & systems for thermal, nuclear, gas and hydro-based utility and
                           captive power plants. BHEL has proven turnkey capabilities for executing power projects
                           from concept-to-commissioning. BHEL supplied utility power generating sets have
                           crossed the landmark of 1, 00,000 MW and continue to maintain the record of nearly
                           two-third of the overall installed capacity and around three-fourth of the power
                           generated in India. BHEL supplies steam turbines, generators, boilers and matching
                           auxiliaries up to 800 MW ratings, including sets of 660/700/800 MW based on
                           supercritical technology. BHEL has facilities to go up to 1000 MW unit size. BHEL is the
                           only Indian company capable of manufacturing large-size gas-based power plant
                           equipment, comprising of advanced-class gas turbines up to 289 MW (ISO) rating for
                           open and combined-cycle operations.

                           Under industrial segment, BHEL is a leading manufacturer of a variety of Industrial
                           Systems & Products to meet the demand of a number of industries, like metallurgical,
                           mining, cement, paper, fertilizers, refineries & petro-chemicals etc. besides
                           captive/industrial power utilities. BHEL has supplied systems and individual products
                           including a large number of co-generation Captive power plants, Centrifugal
                           compressors, Drive Turbines, Industrial boilers and auxiliaries, Waste heat recovery
                           boilers, Gas turbines, Pumps, Heat exchangers, Electrical machines, Valves, Heavy
                           castings and forgings, Electrostatic precipitators, ID/FD fans, Seamless steel tubes etc.
                           to a number of industries other than power utilities.

                                                  INITIATING COVERAGE- ‘BUY’ : BHEL

    BHEL supplies traction and propulsion systems for the trains of Indian railways whether
    electric or diesel powered. The systems supplied are both with the conventional DC and
    state -of –the art AC drives. India‟s first underground metro at Kolkata runs on drives
    and controls supplied by BHEL. Almost all the EMUs in service are equipped with electrics
    manufactured and supplied by BHEL. The company BHEL has also diversified into the
    area of track maintenance machines and coach building for Indian Railways and
    undertakes retrofitting and overhauling of rolling stock.

    Renewable Energy
    In conformity with its concern for the environment, BHEL has been contributing to the
    national effort for developing and promoting renewable energy based products on a
    sustained basis. Starting from small applications like Solar Powered Street Lighting,
    Rural Water Pumping Systems, Railway signaling, Offshore Drilling Platforms, etc., BHEL
    has supplied and commissioned large size stand-alone as well as Grid interactive Solar
    Power Plants in a number of major cities and remote areas of the country. With an aim
    to perform a significant role in National Solar Mission‟s proposed target of 20,000 MW of
    grid connected solar power, BHEL signed an agreement with Abengoa, Spain, a leader in
    solar projects to provide EPC solutions in Concentrated Solar Thermal Power (CSP)

    Oil & Gas
    BHEL possesses expertise to design, manufacture and service various types of onshore
    rigs to suit the Indian service conditions. The range of equipment covers onshore deep
    drilling rigs, super-deep drilling rigs, helirigs, work-over rigs, mobile rigs and desert rigs
    with matching draw works and hoisting equipment. BHEL now has the capability to
    manufacture conventional on shore deep drilling rigs up to a depth of 9,000 meters,
    mobile rigs to a depth of 3,000 meters and well servicing rigs to a well depth of 6,100
    meters. The company is in the process of manufacturing environment friendly AC-
    technology based oil rings for on shore application.

    BHEL has significant presence in the field of power transmission in India with a wide
    range of transmission systems and products. The products manufactured by BHEL
    include Power transformers, Instrument transformers, Dry type transformers, Shunt
    reactors, Vacuum and SF6 switchgear, Gas insulated switchgears, Ceramic insulators,
    etc. Major critical hardware such as capacitor banks, circuit breakers, control and
    protection equipment and thyristor valves are in its manufacturing range.

    International Business
    The company is poised to maintain its references in the overseas market encompassing
    almost the entire range of products and services, covering Thermal, Hydro and Gas-
    based turnkey power projects, Substation projects, and Rehabilitation projects, besides
    a wide variety of products like Transformers, Motors, Compressors, Valves, Electrostatic
    Precipitators, Photovoltaic equipments, Insulators, Heat Exchangers, and Switchgears
    etc. The company has been successful in meeting the requirements of international
    markets in terms of complexity of work as well as technology, quality and other
    requirements. Continued focus on After-Sales-Services led to orders for Spares &
    Services from UAE, Bangladesh, Nepal, France, Sri Lanka, Kazakhstan, Iraq, New
    Zealand, Malta, Thailand, Yemen and Libya. Besides undertaking turnkey projects on its
    own, BHEL also possesses the requisite flexibility to interface and complement other
    international companies for large projects.

                                                                      INITIATING COVERAGE- ‘BUY’ : BHEL

                         Power equipment manufacturing is the back bone of any economy. An economy which
                        has an objective to be developed has to cater the needs of the different sections of the
                        society, power and various engineering products play a vital role in improving the quality
                        of life of the common public. The industry is very closely linked to the development of
                        key elements in the nation. The pace at which our population grows makes the
                        requirement for basic infrastructure and power a key concern area and it has to progress
                        at a very high rate so that deficit can be met and is a priority sector. Government is also
                        focused on the development of the core sector by setting targets through 5 year plans
                        and other related plans so that deficiencies can be reduced in the system. Government is
                        also encouraging private players from both domestic and from international segment so
                        that improvements can be made. The technological improvements which can be brought
                        in by foreign players is really necessary for reducing the cost involved in the project and
                        will act as a major development when compared to traditional methods. The participation
                        of private players is going to bring a huge development in the coming years and a
                        company like BHEL is going to derive the benefit of such developmental efforts. Reforms
                        in this sector, for making the power sector efficient and more competitive, have been
                        under way for several years and while there has been some progress, shortage of power
                        and lack of access continues to be a major constraint on the economic growth. Currently,
                        at the end of March 2011, the power generation capacity stood at 173.626 GW including
                        the renewable energy sources such as wind, solar etc. of about 16.787GW.So far in the
 With approximately     11th five year plan period (2007-08 to 20011-12) the country has added about 37.900
110 GW of generation    GW of which about 9.026 GW was renewable energy. Though new generation capacity
capacity is estimated   addition so far in the current five year plan period is greater than what it was achieved in
  to be added over      each of earlier plans, the country is all expected to fall short of its revised 11th five year
FY10-15E, the power     plan target to about 63GW. The double digit peak power deficit is largely on the cyclical
  deficit will reduce   slowdown in the industrial sector which began in fiscal 2008 got compounded by the
                        global slowdown and was arrested only at the beginning of fiscal 2010.With
from 13% in FY11 to
                        approximately 110 GW of generation capacity estimated to be added over FY10-15E, the
   3.3% in FY15E
                        power deficit will reduce from 10.1% in FY10 to 3.3% in FY15E. While power supply is
                        likely to rise at a CAGR of 10.2%, the demand is expected to rise at 8% CAGR. So, the
                        companies in the industry have huge prospects to grow and the most competitive ones
                        will be benefitted most.

                         There is a huge disparity in the demand and supply of power in the country. The
                        mismatch between the two is unlikely to narrow immensely in the future as the growth
                        in the demand is expected to shoot up in a gigantic way and the capacity acceleration
                        will not be sufficient to meet it. The pace at which the manufacturing sector grows is
                        tremendous and our nation‟s dream of attaining a double-digit growth has to be
                        supplemented by demand from the production category, the manufacturing sector has
                        been facing a slow growth due to the macro elements like high inflation, high interest
                        rate, so in the coming quarters demand will grow once these elements get stabilized.

                                                                          INITIATING COVERAGE- ‘BUY’ : BHEL

                         BHEL has registered a robust growth in revenue, at a CAGR of 23% between FY 2007
                         and FY2011. During 2011, it has seen a surge of 27% over the previous year to reach Rs
                         42,329 Crore from Rs 34,613.43 crore a year ago. Meanwhile, the profit after tax,
                         during the five year period, grew at a CAGR of 25.6% to settle at Rs.6011.2 crores. For
                         FY11, the latter had witnessed a robust growth of 37.3%. The strong performance in the
                         FY11 was mainly aided by changes in the company's accounting policies that the
                         company introduced in 3QFY11. The core operating profit of the company, for the year,
                         has increased by 45.36% YoY at Rs 8,466.97 crore as compared to Rs 5,824.96 crore a
                         year ago. Among the other significant expenditures, the employee cost decreased by
                         0.5% YoY at Rs 5,466.30 crore and the other expenditure increased by 101.31% YoY at
                         Rs 5,609.49 crore.      Consequently, operating margins were stood at 20.22% as
                         compared to 17.56% yoy.

                                        Bharat Heavy Electricals Ltd. Profit And Loss - Consolidated [INR-Crore]
                         DESCRIPTION                      FY10              FY11             FY12E            FY13E
                         Net Sales                        33557.67          42328.93         48678.27         55980.01
                         Total Expenditure                30659.88          35117.01         39090.64         45029.24
                         Operating Profit                 3358.05           7758.29          9587.63          10950.77
                         Interest                         36.69             56.38            48.68            55.98
    While BHEL has
                         Depreciation                     460.26            546.37           546.37           648.03
  registered a robust
                         Profit Before Tax                6620.89           9065.68          9699.51          10982.33
growth in revenue, at
                         Profit After Tax                 4326.92           6053.36          6498.67          7358.16
    a CAGR of 23%
between FY 2007 and      PAT Margin                       0.13              0.14             0.13             0.13
   FY2011, the profit    EPS                              17.68             24.73            26.55            30.06
 after tax, during the   PER(x)                           16.46             11.77           10.96           9.68
five year period, grew                                                                   Source: Company, Hedge Research
 at a CAGR of 25.6%
                          Coming to FY12, the company has put out the figures for H1FY12, which have appeared
to settle at Rs.6011.2
                         being reasonable, though the policy changes had some impact on the figures. The first
                         half is usually the period which contributes lower to the annual numbers with less than
                         30% of the annual. During H1FY12, the company has registered a 17.67% and 23.06%
                         increase in the top line and bottom line respectively.

                         Numbers Impacted By Accounting Policy Changes

                          The annual turnover of BHEL for FY11 as a whole, increased by Rs 2,772 crore (6 per
                         cent of sales) as a result of a change in accounting for provision made for warranties in
                         respect of construction contracts. The company earlier followed a policy of creating a
                         provision of 2.5 per cent of the contract value and deferred the warranty provision as
                         well as the corresponding revenue until completion of trial operation. This has now been
                         changed to providing warranty costs at 2.5 per cent of revenue progressively as and
                         when the revenue is recognized. Accounting for this change, revenue as well as fresh
                         provisions were higher. The sales growth eliminating this change was at a more sedate
                         19 per cent. However, given that this policy is going to be followed in future as well, the
                         same has to be understood by as a recurring event. Similarly, the company has changed
                         its policy on accounting for leave liability for employees to actuarial basis from accrual

                                                                    INITIATING COVERAGE- ‘BUY’ : BHEL

                         basis, and also changed its method of depreciation on cranes, based on their useful life.
                         This has reduced the depreciation charged.

                         The above three changes together resulted in increasing the company's profit before tax
                         for FY-11 by a good Rs 983 crore. Eliminating these, profits before tax grew by a still
                         healthy 22 per cent. However, given that these are policy changes and not one-off
                         adjustments, their impact would be recurring and hence have to be considered for future
                         financial performance. Net of the above impacts, raw materials consumed to sales had
                         declined by about 1.3 percentage points for FY-11 compared with a year ago.

                         Top line and bottom line to maintain momentum
                         BHEL is expected to keep up the momentum that it holds for the last couple of quarters
                         on the back of impressive order book and execution capabilities. We expect the company
                         to post a top line growth at a CAGR of 15% which would take it at Rs.74034 crore for
                         FY15. Meanwhile, the bottom line is also estimated to register a growth to the same
                         tune at 15% as the expenditure book, primarily constituted by raw material cost and
     We expect the
                         employee cost, has already peaked and the management has implemented number of
  company to post a      measures to arrest the spiky cost.
 top line growth at a
 CAGR of 15% which
                         Margins improved aided by cost-cutting measures
    would take it at
                         The company has managed to cut the significant cost items like raw material cost (as
  Rs.74034 crore for
                         percentage of sales) significantly during FY11 from that of the previous years. In FY11,
  FY15. Meanwhile,
                         raw material cost came in at 46% of total revenue compared to 52%, 57% and 51% in
   the bottom line is    FY10, FY09 and FY08 respectively. This was at a time when the global commodity prices
   also estimated to     went up drastically. The company had introduced different cost control measures like
 register a growth to    indigenous technologies and localization of material costs. The company's long-term
the same tune as the     arrangements with key material suppliers and its attempt to secure material from
   expenditure book,     cheaper resources, including China, have paid well in terms of curbing the impact of
 primarily constituted   rising material costs. This has helped the company boost its margins, despite pricing
 by raw material cost    pressures in a competitive environment. With these, the company could achieve a 21%
                         operating margin in FY11, a better number compared to that of the previous years.
 and employee cost,
                         Going forward, we expect, in long run, the margins to sustain at the levels though some
  has already peaked
                         short term pressure is likely in short to medium term.
        and the
   management has
                         Strong Order book gives clear revenue visibility despite muted intake
implemented number
    of measures to       BHEL, India‟s largest power equipment manufacturing company, has a healthy order
                         book of At the end of Q2 FY12, of INR 1,61000 crores i.e. 3.30x FY12E revenue. Based
 arrest the spiky cost
                         on sector division, order book for BHEL stood at INR 128000 crore (80%) from power
                         sector, INR 22700 (14%) from Industry and remaining INR 380 crores (6%) from
                         exports. Meanwhile, the order inflow during the year has been muted with the same for
                         H1FY12 limited to Rs.16800 against an annual guidance of Rs.66700 crore. Though this
                         is seen as a negative for the company, the strong book would help meet the annual
                         revenue guidance with ease.

                                                                                                        INITIATING COVERAGE- ‘BUY’ : BHEL

                         1700                                                                                                                      250


                         1550                                                                                                                      150
                                                                                                                                                         Order Book
                         1500                                                                                                                      100
                                                                                                                                                         Order Inflow

                         1350                                                                                                                      0

                                         Q1FY11         Q2FY11            Q3FY11               Q4FY11            Q1FY12            Q2FY12

                                                                                                                                Source: Company, Hedge Research

                                70,000                                                                                                       100
                                             60,476          59,037           59,678
We initiate coverage            60,000
 on the stock with a                                                                           50,270
        “Buy‟                                                                                                                                60          Order Inflow
recommendation for              40,000
                                                                                                        41.03                                40
  those who have a              30,000

     moderate to                20,000
                                                                                                                                18,938       20
                                                                                                                                                         % growth of
    aggressive risk                                   2.43                                                                               0   0
                                                                                                                                                         Order Inflow
                                10,000                                -1.07
  appetite since the
valuation as well as                0                                                                                                        -20

 the future outlook                          FY 10-11        FY 09-10         FY 08-09         FY 07-08         FY 06-07        FY 05-06

   looks impressive
                                                                                                                                  Source: Company, Hedge Research

                       DCF values the stock at Rs.400

                       Our DCF model with a discount rate of 15.3% values the company at Rs 400 for FY13
                       taking into account the main component of the expenditure book i.e. raw material cost
                       as 52% of sales which seems to be more conservative compared to the previous years‟
                       figure and net sales growth at 15% which is the lowest of the last 5 years. We initiate
                       coverage on the stock with a “Buy‟ recommendation for those who have a moderate to
                       aggressive risk appetite since the valuation as well as the future looks impressive.

                       PE Valuation looks attractive

                       BHEL is currently trading at 9.68x its FY13E EPS of Rs.30.08, which looks impressive.
                       The Company had an EPS of Rs.24.73 for FY11 and expects the same to be Rs. 26.55
                       and 30.08 for FY12E and FY13E respectively. Recently, the stock price has come down
                       drastically making the valuations attractive mainly on the back of some global macro
                       developments as well as some weakness seen in the industry. With the concerns
                       started slackening, investors with a long term point of view can make use of the
                       opportunity and should invest proportionately on every dips so that the cost can be
                       brought down.

                                                                     INITIATING COVERAGE- ‘BUY’ : BHEL

                         Investment Rationale
                         Part of a fast growing Economy

                         India as a nation has a long way to go to achieve a developed status. The way in which
                         the infrastructure facilities, rails, highways, ports should improve to be among the
                         developed nation is huge and country where enough human resources and natural
                         resources are available in plenty and the highly skilled people from various profession
                         are available to make use of developing technology makes our country in a must growing
                         stage and it is a platform for a company like BHEL to attain growth at the same rate. The
 From the present        growth of the power sector in the company has to be around 6.5%-7% as the economy
level of 15000 mw        will grow at a rate of 7.25%-7.75% considering into account the elasticity factor as
capacity, BHEL is        0.9%.
poised to mark the
                         Diversified Strategy
capacity at 20000
mw by FY12 as a          BHEL is a company which is not only involved in manufacturing of traditional power
part       of      its   generation and transmission equipment, but also undertake turnkey contracts in setting
continuous capacity      up eco-friendly Solar power cells which are manufactured and used for domestic as well
addition     program.    as in foreign countries like Germany, Italy, Australia. BHEL is also engaged in other
                         sectors like power transmission, oil and gas, transportation etc which would enable the
The higher capacity
                         company to set off the risk in one segments by another.
will help execute the
strong order book        Technological Competence
which is currently        The capability of the company to develop world class technology makes it a competitive
stands      at    INR    among the major players in the world. BHEL‟s focus towards developing new
1,61,000 crores i.e.     technologies & products is going to bring huge revenues to the firm. BHEL recently
3.30x           FY12E    developed Ultra High Voltage AC 1200 kV Transformer and is going to act as a major
revenue.                 milestone towards India‟s self-reliance in UHVAC transmission system where the country
                         is aspiring to shift to 1200KV during the 12 th plan (2012-17). So, every chance remains
                         for the company to utilize India‟s growing requirements and to be a part of India growth

                         Gigantic execution capabilities coupled with strong order book

                         From the present level of 15000 mw capacity, BHEL is poised to mark the capacity at
                         20000 mw by FY12 as a part of its continuous capacity addition program. The higher
                         capacity will help execute the strong order book which is currently stands at INR
                         1,61,000 crores i.e. 3.30x FY12E revenue.

                         International Presence

                         BHEL has got international presence which enables it to make use of growing
                         opportunities in other emerging markets as well as the diversification of risk. Recent
                         developments in the Middle East & North Africa have also adversely affected the
                         business prospects in our traditional markets with many projects on hold. In spite of
                         such challenging trends, BHEL has been able to sustain its exports momentum with a
                         physical export order inflow of Rs. 3738 Crores from 24 countries spread over five
                         continents during the year registering a 5% growth over last year.

                                                                            INITIATING COVERAGE- ‘BUY’ : BHEL

                       Consistently Profit making and Dividend Paying Company

                       BHEL is a “Navratna” status company and a major integrated power plant equipment
                       manufacturer in the world. It is a profit making company for the last 30 years and is
                       consistently paying the dividends to its share holders. So far, out of the profits
                       generated, the company has been maintaining a payout of about 20-30%. BHEL has
                       been managed to post a bottom line growth at a CAGR of 26% during FY07-FY11. Going
                       forward, we expect the company to post an average growth of 15%.

  It would also be a
   better choice to                                                EPS & Dividend
invest in a company      140.00                                                                                           30.00%
    where the debt
                         120.00                                                                                           25.00%
 content is very low
 especially during a                                                                                                      20.00%
  time when higher                                                                                                        15.00%
     interest rate                                                                                                        10.00%
    pressures exist       40.00
      everywhere          20.00

                           0.00                                                                                           0.00%

                                     1                  2          3                 4         5               6

                                         Earnings Per Share (Rs)       Dividend Per Share     Dividend Pay Out Ratio(%)

                                                                                            Source: Company, Hedge Research

                       Plans to float a NBFC to utilize high cash reserve

                       BHEL is planning to float a NBFC in order to make use of the huge cash surplus of Rs
                       9,000 crore which can be used to finance power projects. Revenues from the financing
                       projects would enable the company to add its earnings which otherwise would have been
                       kept idle.

                       Low leverage level to help in higher interest rate regime

                       Apart from the status of a cash rich company, BHEL‟s capital mix is of only 1% debt. It
                       would also be a better choice to invest in a company where the debt content is very low
                       during a time when higher interest rate pressures exist everywhere. Such companies
                       would be free of interest burden which can act as a negative element in times of slow

                                                                       INITIATING COVERAGE- ‘BUY’ : BHEL

                         Sensitivity Analysis

                                            Raw material                 Net Sales Growth Rate
                                            cost @52% of   13%   14%        15%       16%        17%      18%

                                               14.90       358   383        415        443       473      505
                                               15.10       352   377        407        435       464      496
                                               15.30       346   370        400        427       455      486
   BHEL fair value is
    found to be very                            15.5       341   364        393        419       447      477
   sensitive to sales                           15.7       335   358        386        411       438      468
     growth and raw
      material cost      The valuation has been found very sensitive to cost of equity as well as sales growth.
variations. If the raw   When the sales growth is 15% which is the least of the last 5 years and the cost of
   material surges to
                         equity at 15.3% assuming the raw material cost constant at 52% of sales, the fair
   54% of sales and
                         value of the scrip is found to be varying in a range of Rs.335 and Rs.505.
 sales growth slip to
 12%, the fair value
might reach Rs.284.
  On the other hand,                         Net Sales             Raw Material Cost As % Of Sales
     the value could                        Growth Rate
  touch Rs.531 if the                          @15%
                                                           49%   50%       51%        52%        53%     54%
 former comes down                             14.90       485   460       435        415        387     358
   favorably to 49%
      and the latter                           15.10       476   451       427        407        379     351
manages to grow at                             15.30       467   443       419        400        373     345

          17%.                                  15.5       459   435       412        393        366     339
                                                15.7       451   428       405        386        360     333

                         When the sales growth is assumed to be constant at 15%, the fair value of the share
                         found to be at Rs 400 when cost of equity and raw material cost as % of sales are 15.3
                         and 54 respectively. The fair value is bound to go higher if the raw material cost comes
                         down or cost of equity reduces and vice versa. As per this, the stock price has a
                         potential to move between Rs.333 and Rs.358

                                               Ke                  Raw Material Cost As % Of Sales
                                             @15.30%       49%   50%       51%        52%        53%     54%

                                                12%        384   364        351       324        306      284
                         Net Sales Growth

                                                13%        410   389        375       346        327      302
                                                14%        438   415        401       370        349      323

                                                15%        467   443        428       400        373      345
                                                16%        498   473        456       427        398      368
                                                17%        531   504        486       455        424      393

                                                   INITIATING COVERAGE- ‘BUY’ : BHEL

     The valuation may move heavily in the range of Rs. 284 and 531 in response to
     changes in the raw material cost as well as sales growth which are the key criteria to
     be considered to find out the fair value. Since our valuation is based on the moderate
     levels of the above mentioned criteria, the valuation of Rs.400 looks sensible. A higher
     growth rate in sales and a reduction in raw materials can improve the situation further
     whereas the recent developments in India including Mining Bill, Land Acquisition Bill
     can have an impact on sectoral performance.

     Global situation stands as a foremost concern

     At the macro level, the current global economic scenario presents the most highly risk
     factor as any fall of the global economy into a double-dip recession can lead to a slower
     growth in our economy which would translate into a contraction in the manufacturing
     sector as a whole as our economy is directly and indirectly related to global economy.

     Further spike in commodity prices to hit bottom line

     Global commodity prices have shot up into buoyant levels, which had affected the
     company‟s margins. In spite of that, the company managed to bring down the cost by
     adopting different measures like sourcing products from china, lean manufacturing etc.
     Though our valuation model factored in high commodity prices, unusual further surge in
     the prices of commodities such as copper would change the scenario whereby the
     earnings of the company would directly be affected.

     Competition from overseas players

     One of the significant concerns the company has been facing for the last couple of years
     was that the rising competition from private players along with international
     counterparts especially from Korea and China translating into aggressive bidding that
     resulted in a fall in the order intake and deterioration in the margin. They were able to
     offer the equipments at cheaper prices compared to prices offered by the domestic
     players due to the cost advantage enjoyed by them. To the consolation for the company,
     the government considers imposing excise duty on the imports of heavy industrial
     equipments including the ones above the 1,000 MW capacities. Presently, projects with
     less than 1,000 MW generation capacities attract 5% import duty while there is no duty
     on the rest.

     Macro headwinds like higher interest rate, if don’t ease, might affect the
     company in the long run

     The Company faces some problems with regard to order inflow because of some macro
     concerns like higher interest rate, delay in environmental clearances, lack of fuel
     security caused by some pricing issues in the main coal supplying countries like
     Indonesia and Australia and the resultant higher domestic prices. We expect these
     concerns to get solved in the medium term. Otherwise, the company‟s prospects would
     get affected by a dry down in the level of activity. However, these concerns are unlikely
     to affect the company in the medium term as it has a strong order book that gives
     revenue visibility for at least three years. There were concerns because of the bad
     financial condition of the state electricity boards due to lack of tariff hike and distribution

                                                INITIATING COVERAGE- ‘BUY’ : BHEL

     Higher dependence on CapEx in diversified sectors remains as a concern

     The future prospect of BHEL is highly dependent upon the CapEx plans of refining, Oil &
     Gas and petrochemicals sector, that is, any shortfall in the CapEx will have an effect on
     the company‟s business. Unlike other businesses, the petrochemical sector is highly
     bound to the changes in Government policy and regulations. Since the company is
     predominantly in the sector, government‟s stance is much significant to the company‟s
     performance going forward.

                                                                   INITIATING COVERAGE- ‘BUY’ : BHEL

                                      Financial Highlights
Description                                Mar-11         Mar-10     Mar-09       Oct-08     Oct-07
                                       Inc / Exp Performance
Total Income                             43929.20     37000.81      27654.08    20612.76   17868.14
Total Expenditure                        34324.68     29918.65      22440.25    15849.74   13815.77
PBIDT                                     9604.52      7082.16       5213.83     4763.02    4052.37
PBIT                                      9060.40      6624.15       4879.56     4465.81    3779.40
PBT                                       9005.67      6590.65       4848.85     4430.39    3736.07
PAT                                       6011.20      4310.64       3138.21     2859.34    2414.70
                                         Sources of Funds
Equity Paid Up                             489.52      489.52         489.52      489.52     244.76
Reserves and Surplus                     19664.32    15427.85       12449.29    10284.69    8543.51
Net Worth                                20153.84    15917.37       12938.81    10774.21    8788.27
Total Debt                                 163.35      127.75         149.37       95.18      89.33
Capital Employed                         20317.19    16045.12       13088.18    10869.39    8877.60
                                        Application of Funds
Gross Block                               8049.74      6580.14       5224.87     4443.47    4135.05
Investments                                439.17        79.84         52.34        8.29       8.29
Cash and Bank balance                     9630.15      9790.08      10314.67     8386.02    5808.91
Net Current Assets                       12551.37     10472.60       8568.17     7883.88    6642.87
Total Current Liabilities                46376.94     36694.35      33927.16    24455.13   17523.10
Total Assets                             20317.19     16045.12      13088.18    10869.39    8877.60
                                             Cash Flow
Cash Flow from Operations                 2658.61     1585.06        3291.22     3477.90    2821.37
Cash Flow from Investing activities      -1342.82      -966.64       -512.82      -12.54    -212.66
Cash Flow from Finance activities        -1475.72    -1143.01        -849.75     -888.25    -933.77
Free Cash flow                            7918.51     6733.28         918.42      589.82    1647.92
                                             Key Ratios
Debt to Equity(x)                            0.01           0.01        0.01        0.01       0.01
Current Ratio(x)                             1.27           1.29        1.25        1.32       1.38
ROCE(%)                                     49.83          45.47       40.74       45.23      45.16
RONW(%)                                     33.33          29.88       26.47       29.23      30.02
PBIDTM(%)                                   21.82          20.44       18.26       21.83      21.20
PATM(%)                                     13.66          12.44       10.99       13.10      12.63
CPM(%)                                      14.89          13.76       12.16       14.46      14.06
                                            Market Cues
Close Price (Unit Curr.)                   412.17      477.09         300.87      411.31     226.08
High Price (Unit Curr.)                    539.00      510.00         417.60      585.00     266.80
Low Price (Unit Curr.)                     381.00      290.04         196.82      214.50     153.12
Market Capitalization                   100882.73   116772.55       73640.94   100672.24   55334.12
Adjusted EPS                                24.56       17.61          12.82       11.68       9.87
Price / Book Value(x)                        5.01        7.34           5.69        9.34       6.30
Equity Dividend %                          311.50      233.00         170.00      152.50     185.00
Enterprise Value                         91415.93   107110.22       63475.64    92381.40   49614.54
Dividend Yield %                             1.51        0.98           1.13        0.74       0.82
PE (x)                                      16.78       27.09          23.47       35.21      22.92

                                                            INITIATING COVERAGE- ‘BUY’ : BHEL

                                 Financial Ratios
 Description                          Mar-11      Mar-10       Mar-09   Oct-08   Oct-07
                             Operational & Financial Ratios
 Earnings Per Share (Rs)               122.8       88.06        64.11    58.41    98.66
 Adjusted EPS (Rs.)                    24.56       17.61        12.82    11.68     9.87
 CEPS(Rs)                              26.78       19.48        14.19     12.9    10.98
 DPS(Rs)                               31.15        23.3           17    15.25     18.5
 Adj DPS(Rs)                           31.15        23.3           17    15.25     18.5
 Book Value (Rs)                      411.71      325.16       264.32    220.1   359.06
 Adjusted Book Value (Rs)              82.34       65.03        52.86    44.02    35.91
 Tax Rate(%)                           33.25       34.59        35.28    35.46    35.37
 Dividend Pay Out Ratio(%)             25.37       26.46        26.52    26.11    18.75
                                     Margin Ratios
 PBIDTM (%)                            21.82       20.44        18.26    21.83     21.2
 EBITM (%)                             20.58       19.12        17.09    20.46    19.77
 Pre Tax Margin(%)                     20.46       19.02        16.99     20.3    19.54
 PATM (%)                              13.66       12.44        10.99     13.1    12.63
 CPM(%)                                14.89       13.76        12.16    14.46    14.06
                                  Performance Ratios
 ROA (%)                                33.06     29.59          26.2    28.96    28.85
 ROE (%)                                33.33     29.88         26.47    29.23    30.02
 ROCE (%)                               49.83     45.47         40.74    45.23    45.16
 Asset Turnover(x)                       2.42      2.38          2.38     2.21     2.28
 Inventory Turnover(x)                   4.36      4.06          4.21     4.38      4.8
 Debtors Turnover(x)                     1.83      1.89          2.04     2.02     2.28
 Fixed Asset Turnover (x)                6.02      5.87          5.91     5.09      4.8
 Sales(x)/Working Capital                3.51      3.31          3.33     2.77     2.88
                                   Efficiency Ratios
 Fixed Capital/Sales(x)                  0.17        0.17        0.17      0.2     0.21
 Receivable days                       199.19     193.13       178.68   180.53   160.21
 Inventory Days                         83.74      89.93        86.77    83.24    76.01
 Payable days                          102.76      88.21        89.24    97.57     85.7
                                     Growth Ratio
 Net Sales Growth(%)                   26.39      24.76         36.09    12.45       29
 Core EBITDA Growth(%)                 35.62      35.83          9.46    17.54    41.25
 EBIT Growth(%)                        36.78      35.75          9.26    18.16    44.08
 PAT Growth(%)                         39.45      37.36          9.75    18.41     43.8
 EPS Growth(%)                         39.45      37.36          9.75   -40.79     43.8
                               Financial Stability Ratios
 Total Debt/Equity(x)                    0.01        0.01        0.01     0.01     0.01
 Current Ratio(x)                        1.27        1.29        1.25     1.32     1.38
 Quick Ratio(x)                          1.03        1.03        1.02     1.09     1.14
 Interest Cover(x)                    165.55       197.74      158.89   126.08    87.22

                                                                                               INITIATING COVERAGE- ‘BUY’ : BHEL

                          Financials Graph and Peer Group Comparison



                                                                                                                       Net Sales
                                          82.34    351.07
                                                             41.9                                                      Adj. EPS(Rs)
      15000                                                             35.7       102.18
                                                                                                                       Book Value


                          Larsen &
                                     Areva T & D
                           Tourbo                  Siemens
                                                                          Projects (I)

                                           Peer Group Comparison FY2011
Company                                                                                                  Crompton   Alstom
                   BHEL                 L&T                  Areva T&D                  Siemens
Name                                                                                                     Greaves    Projects

Net Sales          42328.93             44055.55             4020.04                    9698.14          10005.11   1803.64

PBIDT              9660.68              7659.85              490.24                     1395.39          1457.97    303.46

PAT                6053.36              3957.89              186.74                     756.56           919.14     169.22

                   24.73                65                   7.81                       22.48            14.45      25.25

PBIDTM%            21.8                 11.82                11.49                      14.04            14.11      16.41

Book Value         82.34                351.07               41.9                       35.7             102.18     86.57

                            INITIATING COVERAGE- ‘BUY’ : BHEL

     Analyst Notes And Company News

                                                                                                           INITIATING COVERAGE- ‘BUY’ : BHEL

Researched and prepared by:

               Muhammed Aslam E
               Fundamental Analyst
               Ph: (0484) 3040400, 3040419

               In co-operation with:

               Krishnan Thampi K
               Head of Research and Strategies

HEDGE RESEARCH & STRATEGIES GROUP                                                     DIRECT ALL RESEARCH QUERIES TO:

Head of Research: Krishnan Thampi K
Sr. Fundamental Analyst: Amar Chandramohan                                            Research & Strategies Group
Fundamental Analyst: Muhammed Aslam E                                                 Hedge Equities Ltd
Analyst: Vignesh SBK                                                                  12 Floor, -Mini Muthoot Tech Towers
Sr. Equity Technical Analyst: Kesavamoorthy B                                         Kaloor, Kochi– 682017, Kerala, India
Equity Technical Analyst: Ranjith                                                     Phone: (0484) 3040400
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