L&T remains top bet among industrials: Anand Rathi

Below is verbatim transcript of the interview:

Q: You were one of the first persons to call a buy on Bharat Heavy Electricals Ltd (BHEL) when it was trading closer to Rs 100. It has done its run, do you think it is overpriced now, would you be in the sell camp?

A: We think valuations are definitely above fair levels. So in the near-term the company would see some amount of stagnation. The reason we have turned our opinion from positive to negative is because we believe that this price, all the positives are factored in. However, this company is indicator of a very long tail sector and so, any instrument that has to come would reflect in its financials only two-three years down the line. You could have an alternative opinion that stock is trading close to bottom valuations from five-six year perspective. That is too long a call to take at this moment and hence we have turned slightly bearish in our opinion.

Q: The EBITDA margins of BHEL in FY14 were at 20-year lows and going forward up till FY17 onwards, we will also see a possible wage revision which could impact the margins and besides that the earning depression that is expected at least for the next two years. What is your sense in terms of at least the margins for BHEL going forward and the impact that it could have on profits, EPS as well as valuations?

A: The EBITDA margins of BHEL are at a decade low but one has to look at things in perspective. In the last decade, BHEL had 90 percent of its order book made up purely of NTPC. Today, it is not more than 60-65 percent.

Secondly, BHEL has a much larger scale than what it had in the decades, 1990 and 2000. So the company has increased its production scale. The wage revision is the phenomenon that occurs every five-seven years and there is nothing one can do about it and till FY17 you could see depressed earnings but all this has been captured in the price.

Sub-15 percent margins, low ROEs and low ROCs till FY17 are fairly in the price right now at around Rs 210-220. The stock is trading just above fair valuations but I don’t think there is any cause of concern in this counter because investors are very well aware of what the problems are and don’t expect any great improvements anytime soon.

Q: We are beginning to see a bit of power sector orders coming in. Power Grid got one in another space and today we saw Larsen and Toubro (L&T) get one, is the curve turning at all or are these going to be flash in the pan?

A: I think for now these are all flash in the pan. These are all pent up orders, orders that have been stuck over the last two-three years, which due to some issue or the other - either red tape or environment clearances or coal linkages have not been coming into the order books of various companies. It is this demand that will be materialising over the next 12 months and it is this demand that will be driving the order book forward.

However, to have a long-term and sustainable recovery is going to be sometime away. We could see another 12-14 months of a dry order book spell in terms of the large orders, which are in the region of Rs 5,000-6,000 crore. So once that starts, you could probably say that the curve has turned for good but right now this all the pent up demand that is basically materialising in the orders.