Moneycontrol
Apr 20, 2012 08:38 PM IST | Source: CNBC-TV18

Here's why Kotak prefers L&T over BHEL right now

Kotak expects a drop in BHEL profits in the current fiscal year, leading to a earnings per share of Rs 28-25.


Kotak Securities expects a drop in Bharat Heavy Electricals (BHEL) profits in the current fiscal year, leading to an earnings per share of Rs 28-25.


In the last two years, BHEL has been plagued with order backlog issues. However, the capital goods major was able to execute well and the revenues kept growing.


Sanjeev Zarbade, analyst at Kotak Securities believes the revenue outlook remains grim unless the order intake accelerates more than the revenue growth. 


BHEL reported Q3FY12 net negative order inflow of Rs 1500 crore. Many say that the order book is expected to decline this year and result in revenue and earnings decline for FY13E and FY14E.


"I concur with what the reports are indicating that over the next two-three years, the profit growth for the company will be more or less on the lower side," he told CNBC-TV18 in an interview.


The company reported a lower-than-expected 2.1% rise in quarterly profit in Q3FY12. In the December quarter, the company's net profit rose to Rs 1,432.6 crore. The same stood at Rs 1,412 crore in the year-ago period.


Sales in the December quarter stood at Rs 11,078.3 crore as against Rs 10,757.6 crore in the comparable period.


Zarbade says greater competition is leading to poor pricing for the PSU. Also, it had lost a few bulk orders to Chinese and private Indian competitors.


According to brokerages, rising competition in the boiler, turbine, and generator (BTG) segments is also expected to put pressure on the company's margins. Its peers L&T and Thermax operate at 17% and 11% margins, respectively. At 22%, BHEL's margins are superior.


Increasing competition may reduce BHEL's margin.


Kotak has a 'Reduce' rating on BHEL. "We have reduced rating with a price target of Rs 269," he told the channel adding, "we prefer L&T over BHEL at this point of time and on that we have a price target of Rs 1469."


Next page: Transcript of Sanjeev Zarbade's exclusive interview on CNBC-TV18 


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Below is an edited transcript of Zarbade's interview on CNBC-TV18. Also watch the attached video.


Q: It is estimated to be a structural problem as per your peers and they do estimate around 30% drop in profits from FY12 to FY15. Would you concur and what would your analysis be?


A: The analysis is more or less on the right lines. In fact we are expecting a drop in profit in FY13 itself from around Rs 28 to Rs 25. That is our estimate and the street estimates are probably even lower. By FY14 estimates of some of the reports are indicating around Rs 21-22 earnings per share. So for BHEL, the order backlog is down and the order intake is also quite weak. So in the last two years, the company has been on the back of the order backlog. The company was able to execute well and the revenue kept growing.


But now from this point of time, unless the order intake accelerates, more than the revenue growth, the outlook for the revenue growth is definitely not very positive. So, I concur with what the reports are indicating that over the next two-three years, the profit growth for the company will be more on the lower side, the negative side.


Q: Basically power as the report say has become from an undersupplied market to oversupplied market so it has obviously hit margins. What may the margins fall to?


A: Yes, definitely. Three-four years back, BHEL was the only player. There were the Alstom projects but that company hardly got any orders from the government. But in the last three-four years, BHEL had a capacity of 6,000 megawatt (MW) and now it plans to increase the capacity to around 20,000 MW and there are other players also who have jumped into the fray.


So the overall market capacity in the next one year to one and a half year will grow to around 35,000-39,000 MW, so that is a quantum jump in the capacity. At the same time, the market for power projects has shrunk. So it is a very adverse situation wherein you have a huge capacity, but the market has not turned up as per the expectations. So definitely it will have a pressure on the margins. There will be aggressive pricing as most of the players would prefer to have their capacity booked. So we have already seen that happening in the bulk tenders.


Another reason for BHEL margins to decline is its fixed cost structure. It has around 16% of its April employee cost to revenue. So that will continue to grow and definitely the fixed cost structure will come to bite the margins of the company in the coming years.


Q: What is your recommendation to investors on BHEL? What is your call on Adani Ports and L&T as well which this report in particular has recommended switching to?


A: Actually I can tell about my call. We have reduced rating on BHEL. We have been negative on the company. We have reduced rating with a price target of Rs 269.


We prefer L&T over BHEL at this point of time and on that we have a price target of Rs 1469.


Q: Have you looked at Adani Port?


A: We are covering the stock but I myself do not have a view on the company.


Q: What do you expect in terms of earnings growth for BHEL? Do you see also a valuation fall?


A: The valuation fall has already happened. In fact as earnings per share goes down the valuation will start looking higher. In FY14 if earnings per share comes to around Rs 21-22 so on FY13 basis it is trading at around 10 times and on FY14 probably with the earnings de-growth it will trade at 12-13 times.


Q: But if it is a lack of capacity utilization that the company is staring at when do you see that less than 100% utilization kicking in? In FY13 itself or will it take a while and won’t that affect even L&T?


A: It will be a problem for the entire sector but BHEL being the incumbent player will be the most affected. The other players will try to get orders from other verticals and other geographies. But the problem with BHEL is that is focused on mainly on one sector and one market so that is where the issue is.


Q: What kind of capacity utilization falls in FY13 itself?


A: It is difficult to say capacity utilization because it is a misnomer in our sector. There are so many different ways wherein you can do the capacity addition. On an average the company’s capacity will increase to 20,000 megawatt and yearly inflow would be around 10,000 to 11,000 megawatt.


Q: What about market share because we have seen that decline progressively over the years for BHEL? What would you think it would finally stabilize at for the boiler, turbine, and generator (BTG) segment?

A: Difficult to say at this point of time but market share has already started. The indications are that the market share has started to come down. BHEL enjoyed a very high market share in NTPC orders. Virtually most of the NTPC orders use to go to BHEL and now with the bulk tender the market share has come to around 45-50%. So that is the first signal that the market share has began to come down.

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