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BHEL Result Update Q4FY10

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BHEL Result Update Q4FY10 Powered By Docstoc
					Bharat Heavy Electricals Ltd (BHEL)                       CMP: Rs. 2,277.55

    Q4FY10 & FY10 Result Update                                                                                           June 9, 2010
BHEL, the largest engineering and manufacturing enterprise in India, reported its Q4FY10 result that were ahead of street expectations,
particularly on the operating margins front. BHEL’s topline (net sales) grew by 28.6% y-o-y to Rs. 13,599 cr (up 91% q-o-q partly due to
seasonal factors), operating margins expanded by 210 bps y-o-y to 20.6% (down 100 bps q-o-q) while net profit registered growth of
41.7% y-o-y and 78% q-o-q to Rs. 1,909.6 cr.

Key Highlights of the Results

(Rs. in cr)                        Q4FY10      Q4FY09       % Chg y-o-y     Q3FY10       % Chg q-o-q       FY10        FY09      % Chg y-o-y
Net Sales                          13559.1     10540.1           28.6%       7100.3           91.0%      32880.3     26234.2          25.3%
Other Operating Income               385.6       310.0           24.4%        128.9          199.1%        692.5       624.4          10.9%
Other Income                         208.0       197.2            5.5%        193.3            7.6%        823.9       788.0           4.6%
Total Income                       14152.6     11047.2           28.1%       7422.5           90.7%      34396.7     27646.6          24.4%
Total Expenditure                  11071.8      8843.8           25.2%       5667.5           95.4%      27314.5     22432.8          21.8%
EBIDTA incl other income            3080.8      2203.5           39.8%       1755.0           75.5%       7082.2      5213.8          35.8%
Depreciation                         164.7       100.8           63.3%        103.8           58.7%        458.0       334.3          37.0%
EBIT                                2916.1      2102.6           38.7%       1651.2           76.6%       6624.2      4879.6          35.8%
Interest                              17.8         8.1          120.0%          6.9          158.0%         33.5        30.7           9.1%
PBT                                 2898.3      2094.5           38.4%       1644.3           76.3%       6590.7      4848.9          35.9%
Tax (incl DT)                        988.7       747.1           32.3%        571.7           72.9%       2319.2      1787.8          29.7%
Adjusted PAT                        1909.6      1347.5           41.7%       1072.6           78.0%       4271.4      3061.1          39.5%
Prior period tax                       0.0         0.0              NA          0.0              NA        -39.2       -77.2         -49.2%
Reported PAT                        1909.6      1347.5           41.7%       1072.6           78.0%       4310.6      3138.3          37.4%
EPS on Reported PAT                   39.0        27.5           41.7%         21.9           78.0%         88.1        64.1          37.4%
Equity                               489.5       489.5                        489.5                        489.5       489.5
Face Value                            10.0        10.0                         10.0                         10.0        10.0
OPM (%)                             20.6%       18.5%                        21.6%                        18.6%       16.5%
NPM (%)                             13.5%       12.2%                        14.5%                        12.5%       11.4%
Cost as a % of sales
Input Cost                          59.2%       64.0%                         55.5%                        58.7%      60.9%
Staff Cost                          12.9%       13.4%                         17.3%                        15.7%      15.7%
Other expenses                       9.6%        6.5%                          7.0%                         8.7%       9.0%
                                                                                                                   (Source: Company, HDFC Sec)


•   BHEL reported sales of Rs. 13,599 cr, up 28.6% y-o-y and 91% q-o-q. While BHEL had disappointed on the execution front over
    the past couple of quarters, it made up for it in Q4FY10. The topline growth is mainly driven by growth in the power division (29.6%
    y-o-y increase) as shown in the segmental performance given later. However, the industry segment also reported decent growth of
    15% y-o-y, higher than that witnessed over 9MFY10 (4.3% y-o-y growth in 9MFY10).

•   BHEL surprised positively on the margin front. Operating margins expanded by 210 bps y-o-y to 20.6%. However, q-o-q the
    margins were lower by 100 bps due to higher raw material costs and higher other expenses (partly offset by lower staff cost - in
    terms of % to sales). Raw material costs as % of sales stood at 59.2% against 64% in Q4FY09 and 55.5% in Q3FY10. Further, the
    company finalized wage agreement with its workers and provided a net amount of Rs. 338.2 cr in the profit and loss account. No
    incremental provisions in this regard are likely in FY11 and hence, employee costs are expected to increase at normalized rates
    henceforth. 

•   Other expenses (which comprises provisioning on account of contractual obligations, liquidation damages and doubtful debts) were
    also higher by Rs. 125 cr in Q4FY10 due to a change in the company’s accounting policy with respect to doubtful debtors, which
    led to higher provisioning. As against earlier practice of creating provision on a case-to-case basis, the company has revised it that
    wherever trial operation has been conducted and the debtors are outstanding for more than 3 years from the date of trial operation,
    provisions (including contractual obligations) shall be equal to the debtors as prevalent on that date. In line with this any shortfall in
    provision with regard to total outstanding has been provided and excess if any, has been withdrawn during the quarter.

•   In Q4FY10, interest costs were up 120% y-o-y and 158% q-o-q at Rs. 17.8 cr due to higher execution carried out by the company.
    However, interest costs are a negligible cost for the company. Depreciation was up 63.3% y-o-y and up 58.7% q-o-q at Rs. 164.7
    cr in line with the capex carried out by the company (expansion in capacity from 10,000 GW to 15,000 GW has been completed).

•   Expansion in EBIDTA margins along with strong execution led to bottomline growth of 41.7% y-o-y and 78% q-o-q to Rs. 1,909.6
    cr. EPS for the quarter stood at Rs. 39.

•   On a full year basis, BHEL reported a topline of Rs. 32,880.3 cr, up 25.3% y-o-y, which was at the higher end of its guidance. This
    was about 4.4% higher than our estimate of Rs. 31,481 cr. The company reported operating margins of 18.6%, up from 16.5% in


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     FY09, mainly driven by lower raw material costs. PAT grew by 37.4% to Rs. 4310.6 cr, translating into an EPS of Rs. 88.1, about
     0.5% higher than our estimate of Rs. 87.6.

•    A final dividend of Rs. 12.3 per share has been declared by the company in addition the interim dividend of Rs. 11 per share paid
     during the year.

•    Order inflows during Q4FY10 stood at about Rs. 22,606 cr, up about 43% y-o-y and 41.3% q-o-q. The management had indicated
     that there was a delay in closing certain orders in the 9MFY10 due to the completion of some formalities. As a result order inflow
     was much higher in Q4FY10. For the full year, order inflow stood at Rs. 59,031 cr, down 1.1% y-o-y. Of this, power accounted for
     71% (16,489 MW) with almost 90% orders from the private sector (14,689 MW). Industry made up for 24.3% of the order intakes.
     Order backlog stood at Rs. 1,43,800 cr, up 22.9% y-o-y, with the power sector orders making up 81%, industrial 13% and
     international orders comprising the balance. Private power developers like Jaiprakash Power Ventures, Indiabulls Power, Adhunik
     Power, Jindal Power and others awarded orders to BHEL in FY10. The current order backlog is at 4.3x FY10 sales.

•    Some of the orders won by BHEL during the quarter have been listed below.

Project                                Agency                  Project details                                                Order size (Rs cr)
Raichur, Karnataka                     KPCL                    Solar Power plant of 3 MW                                                     42
Nasik & Amravati                       India Bulls Group       Thermal power project of 1,350 MW                                          5,778
Jammu and Kashmir                      NHPC                    Setting up 330 MW (hydro project)                                            495
Bhutan                                 PHPA                    Equipment package for 1,200 MW Hydro project                               1,000
                                                                                                                        (Source: Company website)

Segmental Analysis

(Rs. Cr)                                      Q4FY10       Q4FY09       % Chg y-o-y Q3FY10 % Chg q-o-q          FY10          FY09 % Chg y-o-y
Revenue
Power                                         11154.9       8607.9            29.6%    5708.7       95.4%     26860.7      21344.4        25.8%
Industry                                       3149.1       2716.1            15.9%    1802.0       74.8%      7879.0       7249.5         8.7%
Total Revenue                                 14304.0      11324.0            26.3%    7510.7       90.4%     34739.7      28593.9        21.5%
EBIT
Power                                          3058.4       1730.8            76.7%    1308.6      133.7%      6317.0       3861.8        63.6%
Industry                                        804.9        584.4            37.7%     405.1       98.7%      1642.5       1214.6        35.2%
Total EBIT                                     3863.2       2315.2            66.9%    1713.7      125.4%      7959.5       5076.4        56.8%
Revenue Mix
Power                                             78.0        76.0                       76.0                    77.3          74.6
Industry                                          22.0        24.0                       24.0                    22.7          25.4
EBIT Margin (%)
Power                                             27.4        20.1                       22.9                    23.5          18.1
Industry                                          25.6        21.5                       22.5                    20.8          16.8
Capital Employed
Power                                          2505.7       -571.2          538.7%     -852.4     -394.0%      2505.7       -571.2       538.7%
Industry                                       2248.9       1387.0           62.1%     1859.4       20.9%      2248.9       1387.0        62.1%
Unallocated net assets / liabilities           8233.7       9275.1          -11.2%    10911.5      -24.5%      8233.7       9275.1       -11.2%
Total                                         12988.3      10090.9           28.7%    11918.5        9.0%     12988.3      10090.9        28.7%
                                                                                                              (Source: Company, HDFC Securities)

•    In Q4FY10, there was strong execution in both segments. The Power segment contributed 78% of the company’s revenues in
     Q4FY10. Revenues were up 29.6% y-o-y and 95.4% q-o-q. PBIT margins expanded to 27.4% from 22.9% in Q3FY10 and 20.1% in
     Q4FY09. Lower commodity prices and better inventory management kept material costs under control.

•    The industry segment, which had been seeing muted growth until Q3FY10, reported decent growth in Q4FY10, Topline grew by
     15.9% y-o-y and 74.8% q-o-q while PBIT margins stood at 25.6% (vs 21.5% in Q4FY09 and 22.5% in Q3FY10). The industrial
     equipment division primarily caters to process industries, transportation (including leasing of locomotives to Indian Railways),
     transmission, defense and diesel generating sets (DG).

Other Developments / Takeaways
Additional capacity to come on stream by March 2012 - BHEL intends to expand its capacities to 20 GW by March 2012, after
having increased it to 15 GW in Q4FY10, becoming significantly larger than the relatively new domestic competition. Incrementally, the
company has indicated it will maintain order inflows of Rs. 60,000 cr in FY11 and capacity utilization will top 100% (~16-17GW). For
FY11, the capex target is about Rs. 1,900 cr.




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Private sector surprises in FY10 - Of the nearly 16.5 GW new orders secured by BHEL in FY10, the private sector accounted for
~14.7 GW. In our view, this is a positive development given that nearly 50% of the power capacity addition for the XII Plan will come
from the private sector (vs. 14% in the XI Plan). Historically, BHEL’s market share in the private sector has been low due to the long
execution period associated with the company and intense competition from Chinese players (quicker delivery period and more price
competitive). We expect BHEL’s share in the private sector to increase in the XII Plan due to the high share of private sector orders in
the XII Plan and limited competition from foreign equipment suppliers in ultra mega power projects (UMPPs).

BHEL is to a certain extent protected from competition in NTPC-DVC bid - In the recently floated bulk equipment tender by NTPC
and Damodar Valley Corporation (DVC), there were only two bidders in the boiler segment (BHEL and L&T) and five bidders in the
turbine segment (BHEL, L&T-MHI, Bharat Forge-Alstom, JSW-Toshiba and Power Machines). Chinese and Korean players were left
out due to the requirements of an indigenous domestic manufacturing facility and partnership with a local player. The tender is for the
supply of 11 turbines and 11 boilers of 660 MW each (worth Rs 40,000-45,000 cr) to be awarded by July 2010, with BHEL assured of
winning orders for at least five boilers and four turbines (6+5 in case it is the L1 bidder). Nevertheless, there could be strong price
competition in the bidding process, especially from new players, as they will look to establish themselves in the market through this bid.
With BHEL enjoying a strong position in the NTPC-DVC bid and expected orders from SEBs, we expect the government sector to
contribute a majority of the new orders in FY11 (E). A majority of these are expected to come in H1FY11. We expect private sector
ordering to remain subdued this year as majority of private sector clients have already placed orders.

Limited scope to expand margins in FY11E - In FY10, BHEL has reported operating margins of 18.6%. In Q4FY10, margins stood at
20.6%, down 100 bps q-o-q. FY10 margins were mainly aided by lower commodity prices and cost saving initiatives by the company.
However, for FY11 (E) it could be difficult for the company to sustain these margin levels. BHEL will find it tough to expand margins
considering the increased competition (L&T bidding aggressively for power projects in recent months) and rising commodity prices.
Further, the higher share of supercritical orders executed by the company (10-20% of operations in the initial years) is likely to
contribute to margin pressures (due to higher input content). Consequently, we expect BHEL’s EBITDA margins to decline to 17.9% in
FY11 (E).

However, on the upside, despite the margin pressure, BHEL will continue to enjoy higher EBITDA margins vis-à-vis domestic and
international peers due to the continuance of its leadership position in the power sector. The management recognizes that being cost
competitive is integral for BHEL to maintain its leadership status, thus focusing on initiatives as design to cost, lean manufacturing, and
purchase and supply management. Supply chain initiatives include leveraging IT (negotiations through reverse auctions, e-
procurement), long-term rate contracts (steel, copper, transformer oil, etc), vendor base expansion for BOPs, outsourcing (low
technology/low core manufacturing), etc.

Guidance - For FY11 (E), the management has announced a normal turnover target of Rs 38,000 cr (and excellent target of Rs. 39,500
cr). We believe the targets are conservative given BHEL’s large order book and enhanced execution capabilities. The current order
book is at 4.3x FY10 revenue. Consequently, we expect BHEL to report a topline of about Rs. 39,230 cr in FY11 (E).

MoUs and Joint Ventures - BHEL has signed MoUs with state gencos of Maharashtra, Tamilnadu, Madhya Pradesh and Karnataka
for forming JVs to setup power plants in these states. BHEL expects to receive orders for equipments, by leveraging its share of equity.
In April-10, it received a 1,600 MW BTG order worth Rs. 63 bn from its JV with KPCL (Karnataka). It had also setup a JV with NTPC for
undertaking balance of plant activities, and had received an order for gas-based power plant in previous quarters.

BHEL is exploring growth opportunities in renewable energy and has recently won a turnkey order for setting up a 3MW solar power
plant in Karnataka. The company plans to focus on getting more orders in the renewable energy segment going forward in order to
pursue growth opportunities and also to diversify its revenue stream.

Concerns
•   Delays in power-sector reforms could affect order flows and earnings.
•   Regulatory uncertainties.
•   Decline in order inflows is a cause of concern for BHEL.
•   Execution delays in orders.
•   Super-critical equipment has lower margins due to the high import component requirement, which could put pressure on BHEL’s
    margins going ahead. However, BHEL is an integrated manufacturer and the management expects the import component
    requirement to reduce going ahead as BHEL gains scale of operations and hence the impact on margins to be mitigated.
•   Competition pressures from global majors: In the domestic market, BHEL is facing stiff competition from international players,
    particularly from Chinese power plant equipment (PPE) manufacturers, who have twin advantages of economies of scale and
    global reach. However, expectation of licensing restrictions on Chinese players in supercritical boilers could bring some relief to
    BHEL.
•   Margin contraction due to higher commodity prices.
•   Currency appreciation may lead to preference for imported equipment.

Conclusion
BHEL is India’s largest electrical equipment supplier–accounting for around 65% of India’s installed power capacity. While BHEL’s order
book provides comfort for the next 4 years, order execution is a key challenge area for the company. However, this risk is partly
mitigated as BHEL has managed execution reasonably well in FY10. The company also faces diverse set of challenges emanating from


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the increasing competition in the sector and capacity constraints. Part of these concerns are allayed with the 5,000 GW expansion
coming on stream. Bulk tendering for supercritical power equipment catalyzes competition for BHEL. The government appears keen on
more players in power equipment manufacturing. A substantial ramp up in exports may also be limited by technology alliances, which
may limit export opportunity to relatively smaller countries. However, BHEL is actively looking to enter into a JV / acquire a foreign
company focused on technology.

The company has been successful in gaining private sector’s confidence, with the latter forming about 85-90% of the total order inflows.
The management indicated that order inflow in FY11 could be about Rs. 60,000 cr. While the sector and the company hold a lot of
promise, all eyes will be on whether the company is able to maintain margins. Rising costs and pricing pressures did not quite impact
BHEL’s operating profitability in the March quarter. The firm contained costs and reported an operating profit margin of 20.6%,
compared with 18.5% a year earlier and around 21.6% in the preceding quarter. Earlier pangs of high-wage costs and lowering of
execution rates normalized during the quarter as well.

Momentum of order inflow in the near term is expected to be maintained on the back of ordering for the XII plan (including bulk ordering
by NTPC/DVC) and orders from JVs with state gencos. The expanded manufacturing capacity of 15,000 GW has stabilized during
Q4FY10, and should aid in revenue growth going forward.

At the current market price, BHEL trades at 22.8x our FY11 (E) EPS of Rs. 100.10. Historically, BHEL has traded between 10-30x one
year forward earnings, with an average of 23x. Though we continue to like BHEL, at the current valuations the stock appears to be fairly
valued. BHEL works in the public-sector-dominated power sector and was a strong defensive against crisis of confidence in private
enterprise and tough financing environment. Also, according to reports, the government is considering selling 10% stake in BHEL and a
final decision is yet to be taken. The positives of intermediate term visibility of revenues could be partly offset by concerns on long term
visibility of revenues due to emerging competition, pressure on margins due to commodity price rise expectation and overhang of
supply of stock due to equity dilution.

In our Q3FY10 Result Update dated Jan 29, 2010, we had stated, “Fresh investors can enter the stock in the Rs. 1,970 – 2,100 band
for a price target of Rs. 2,458 (23 x FY11 (E) EPS)”. The stock touched a low of Rs. 2,231.5 on 26 May 2010 and a high of Rs. 2,585 on
12 April 2010.

We are revising our estimates for FY11 (E) raising our sales estimates but reducing our margin expectations. We expect an EPS of Rs.
100.1, a growth 13.6% y-o-y. BHEL is leveraged to the economy and corporate capex spending. Execution risks have increased due to
higher exposure to private capex compared to earlier days where it was exposed to the public sector only. Further, equity dilution is
another risk. Also, FIIs stake has been falling, though gradually over last 3-4 quarters (from 17.07% in June 30, 2009 qtr to 15.21% in
Mar 2010 qtr). These shares have been largely picked up by domestic mutual funds.

We expect the stock to trade in the Rs. 2,051 (20.5x FY11 (E) EPS) – Rs. 2,451 (24.5x FY11 (E) EPS) band for the next 1-2 quarters.

Quick Estimates

 (Rs cr)                                                   FY09              FY10 (E)                  FY10A              FY11 (OE)               FY11 (RE)
 Net Sales                                                26234                31481                   32880                 38092                    39230
 EBIDTA (excluding other income)                           4426                 5824                    6258                   7276                     7030
 EBIDTA (%)                                               16.5%                18.5%                   18.6%                 19.1%                   17.9%
 Reported PAT                                              3138                 4288                    4311                   5233                  4897.7
 EPS                                                        64.1                 87.6                    88.1                 106.9                    100.1
 P/E                                                        35.5                 26.0                    25.9                   21.3                     22.8
                                                                             (Source: Company, HDFC Securities, OE – Original estimate, RE – Revised estimate)




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