Just because BHEL is suffering from a severe drop in capex in the investment cycle, it is not the end of business or end of the road for this company, says Amol Rao of Anand Rathi. The company will not be able to perform up to its historical highs, but it may garner orders of around 6000 megawatts for FY14, he says. "The pessimism is overdone and at some point in time your valuations deserve a look," he adds.
He believes it'll take another 5-6 months for order bookings to resume, which would then lead to an improvement in the rating of the stock. Today, the requirement of state and central electricity boards is 7,000-8,000 MW, which can be serviced only by two or three players with such large operating capacity, Rao says. Going forward, these are going to have environmental clearances and coal availability in place, with financial closure, he says. These projects are primarily central and state backed, he adds.
Abhineet Anand of Quant Capital says there is a high probability that the BHEL stock might actually hit Rs 110-120. Though, he has a target of Rs 140 on the stock.
Below is the verbatim transcript of Amol Rao and Abhineet Anand's interview on CNBC-TV18
Q: We continue to get bad news in terms of capex, people pulling out orders, what makes you bullish on the stock – anything other than valuations at all?
Rao: I think the stock suffers from a perception problem for the simple reason that it is a long trailing industry.
Let us not forget that National Thermal Power Corporation (NTPC) bulk tenders were significantly delayed and we did have a problem because of coal block allocations for almost 12 to 18 months.
A lot of people believe that capex would just grind to a halt and nothing would happen in this country. Despite that, Bharat Heavy Electricals Limited (BHEL) garnered 8000-8500 megawatts of orders last year. This year too, BHEL should be able to garner around 6000 megawatts largely lead by central and state government utilities.
So, yes the company is not going to able to perform up to its historical highs, but going forward we do not believe it is the end of business or end of the road for this company. The pessimism is overdone and at some point in time valuations deserve a look.
Q: What would your argument be? There is a lot of talk about a lot of hope perhaps an improvement in margins etc, but we have seen so many quarters of pain for this company – do you see more?
Anand: This industry has a long gestation period. A typical power plant would take 3-4 years and if your orders have actually dried at this point in time, your FY14 and FY15 are going to be bad that is for sure.
If you look at our numbers for FY15 - around 11-11.5, the stock at Rs 140 is not cheap. I disagree that it is a cheap stock because at 11-11.5, the stock is trading at 13 times and if one compares it with others in the industry, say Larsen and Turbo is currently trading at 14 times, 15 times with 5-6 percent growth in earnings.
We have a stock of BHEL with 30-35 percent degrowth in earnings. Thereof from FY15-16 maybe we will stabilize on Rs 10-12 earnings per share (EPS). So, a stock which is having an EPS of Rs 10-12 with a question mark on growth, I would say 10-11 times is maximum that one can actually ascribe. So there is high probability that the stock can actually hit again somewhere around Rs 110-120 to my mind.
Q: What are your price targets for the stock?
Rao: We believe that the company could on the back of significant advances – generate quite a bit of other income on cash that it is sitting on. Due to that we feel that the company could earn somewhere in the range of around Rs 15-16. This is a point where Abhineet and I agree that okay fine 10 times is justifiable earnings multiple, but I do believe that 10 times is rock bottom for the simple reason that BHEL is not the same company that it was 10 years back when it hit that turf in 2000-2001. This company’s order book is significantly diversified since then. The companies operating scale and the depth of its product profile is significantly better than what it was then.
Let us not forget that this is a company which is not only a market leader but also very-very good at tailoring products for its clients which happen to be in India. This is not an easy task especially for foreign companies that have entered through the joint venture route with local players. Given the preference for BHEL, we believe that order bookings, once the muddy waters clear, which may take another 5-6 months, would resume and that would lead to an improvement in the rating of the stock.
Q: But how are you factoring in this 5-6 months because that is something that people are expecting for almost 2-3 years now and given the Indian coal availability scenario recovery in order booking does not look like it is anywhere on the cards?
Rao: The same question was post to me last year. That point in time it did not seem very likely that even 10,000 megawatts would be tendered around the country. But today one sees 7,000 to 8,000 megawatt requirement coming from just state and central electricity boards and only two or three players can service this need with such high operating capacity. I do believe that the scales would be significantly tilted in favour of BHEL.
Going forward, I do not think there are projects that are not going to be clean. That means there are projects which are going to have environmental clearances and coal availability in place with financial closure also. These are primarily Centre and state backed. With 6,000-8,000 megawatt of steady state, tendering out I do think BHEL would be able to maintain its market share of 60-70 percent, not withstanding all the noise made about capacity by other players.
Q: Your target is still Rs 150 for the stock?
Anand: Rs 140. We have put in a model where we believe that 6,000-7,000 gigawatt of inflows will happen and BHEL has 50-55 percent market share. Even on those numbers without much growth on the terminal value we have around Rs 140 as target. But the near-term concerns stays even though some of them are getting addressed by the power ministry. In Q1 we saw a drop in profit of more than 60-70 percent.
If revenue is going to drop by 20 percent, your EBITDA margin is going to contract because the whole of operating leverage goes for a toss. At the PAT level, there could be a 30 percent plus decline in earnings so that will actually see the stock bottoming out and then people will realize that around Rs 100-110, once the momentum comes into the sector then we will see an uptick from those levels.