Macquarie — Bharat Heavy Electricals BHEL
Bharat Heavy Electricals - April 7, 2008.pdf
Bharat Heavy Electricals
Execution worries look overdone
Event
Bharat Heavy Electricals' (BHEL) provisional numbers for FY3/08 disappointed on account of a delay in the execution of projects and one-time charges. We are cutting our target price to Rs2, 227 from Rs2, 751. We believe the price correction of 22% over the last week has overcompensated for the earnings cut. We reaffirm our Outperform recommendation on the stock.
Impact
Extreme pessimism on execution unwarranted: In a complete turnaround, concerns on BHEL's order inflow/backlog have taken a back seat, and we believe execution ramp-up is the key concern for the stock. We expect execution to improve in FY3/10 for the following reasons.
=> Capacity expansion to boost growth: We believe the company will begin to benefit from the capacity expansion to 10GW that was achieved in Dec-07 and the further expansion to 15GW expected by Dec-09.
=> Order book matures to deliver growth: A bulk of the order book comprises orders received in FY3/08, which typically do not contribute to revenues for three quarters, as they are in initial stages of design and engineering.
Order backlog/inflow remains robust: The Company has reported FY3/08 order inflow and order backlog growth of 41% and 56%, respectively. Management has guided to Rs400-500bn of further order inflow for FY3/09. A further boost to the order book could come from negotiated orders for supercritical equipment that we believe could be placed by the government.
Stock building in the worst-case scenario for execution and growth: We expect the execution rate will decline in FY3/09 to its lowest level in many years and then see a rebound in FY3/10. Even at a lower execution rate, we believe the company is set to deliver 47% earnings growth over FY3/08-10, and with visibility for growth
up to FY3/12 based on the projected order backlog to end-FY3/10. The current price builds in 0% growth in order inflow beyond FY3/09.
Earnings revision
We are lowering our FY3/09-10 earnings estimates by 8-10%, based on lower top-line expectations.
Price catalyst
12-month price target: Rs2,227.00 based on a PER methodology.
Catalyst: Clarity emerging on execution would be the most critical trigger
Action and recommendation
We have lowered our target price to Rs2,227, based on 18x FY3/10E earnings, to factor in the earnings revision and a lower PER. The multiple is supported by our DCF analysis and strong earnings growth beyond FY3/10. We reaffirm our Outperform rating on the stock.
