Have cut BHEL's FY14 EPS estimate by 20%: Anand Rathi

Anand Rathi Institutional Equities has cut Bharat Heavy Electricals' (BHEL) earnings per share estimate for FY14 by around 20 percent said Amol Rao of the broking firm. He believes lack of order inflows can be a problem for the capital goods companies and the industry is likely to witness weak order inflow for the next two-thre years.

In an interview to CNBC-TV18, he cautioned that BHEL’s margin pressures could persist in the next quarter after they came down to 6 percent in Q1. “The liquidity issue still plagues the country, the economy and the clients that BHEL had problems with in this quarter could not garner their finances and this problem could persist in the next quarter,” he adds.

BHEL's order book stands currently at Rs 1.08 lakh crore.

Below is the verbatim transcript of Amol Rao's interview on CNBC-TV18

Q: You have a buy rating on BHEL. While you have lowered your target price to Rs 228, it still implies an 82 percent upside from current levels. What makes you little positive on BHEL?

A: The target price is Rs 199. We have lowered that after the quarter's earnings. A company similar in size to BHEL has significant scale to its advantage. A lot was being made about the overcapacity in the economy right now, but a lot of that overcapacity is elusory.

A lot of people who have set of capacity are searching for orders that we do not think will get in the near-term. In the near-term if there are any winners, BHEL is going to be one of the largest and this current problem that is lack of orders is a problem that is going to stay for 2-3 quarters.

As we enter FY15, this problem is going to be solved primarily because capacity creation in the power generation space has lagged the planned targets.

The ordering would reach a crescendo somewhere towards the end of FY15 and beginning of FY16. This is all a function not only of interest rates but also of investments in the other areas of the economy and that would happen post the general elections in FY15. So, the company on this kind of a gross block, this kind of an asset base and an execution track record should not have any problems. These problems could persist for 3-4 quarters, but nothing more.

Q: What is your earnings per share (EPS) forecast? They did Rs 25.5 last year. How much will they do this year?

A: We had an EPS target of around Rs 20-21 before the call, but after talking to the company and doing some channel checks, we believe this could come down to as low as Rs 17.5 this year. So we have cut down our EPS estimate this year by around 20 percent and this problem of execution could manifest itself a little bit into next year as well.

The stock could get cheaper, but I am taking one-one and half year view and we are not in the business of giving short-term calls.

Q: At Rs 17.5 are you actually giving them something like 11 times at Rs 200?

A: Absolutely, because we are not only valuing this company on an EPS basis for FY14 or FY15, we are also valuing this company on a discounted cash flow (DCF).

The company has Rs 1.08 lakh crore of order book, 2.3 times order book coverage and in addition it has around 8,500-9,000 MW of order visibility for this year. Going forward this number would translate into better revenues in FY15, FY16 and FY17 because this is a long-tailed business.

Q: Margins have already come down to 6 percent. If the next 3-4 quarters are fairly challenging, what is your expectation on the margin front? How low can it get?

A: This is the lowest in the last 30 quarters and could persist into the next quarter as well. The liquidity issue still plagues the country and the economy and the clients that BHEL had problems with in this quarter could not garner their finances and this problem could persist in the next quarter. So, margins in next quarter could be as low or even slightly lower. BHEL's historical low in margins has touched around 3-3.5 percent, so I would not be surprised if this is touched in next one or two quarters.