Buy BHEL at Rs 140-150/sh, more downside seen: Religare Cap

As concerns over availability of coal looms large, BHEL has been shunned off by investors. Most brokerages feel that its order book is at risk of cancellation or deferment due to coal shortage. Misal Singh, Director- Institutional Research, Religare Capital Markets advises to enter BHEL at Rs 140-150 per share.

In an interview to CNBC-TV18, "A steady state earnings for BHEL should be between Rs 18-20 and about Rs 160-200 should be the trading band for BHEL, so basically if you need to make money on BHEL you would come in at about Rs 130-140 that's the price you will look at entering in BHEL."

However, he also warns that it could see some more downside from current levels as it's declining order book could adversely impact revenue.

Below is the verbatim transcript of the interview...

Q: What is your sense? The fact that power sector will go slow has been kind of in the news for the past year or so? Is the bad news priced in you think?

A: If you look at the earnings of BHEL in 2012, it was at about Rs 26. Steady state earnings for BHEL should be between Rs 18-20. About Rs 160-200 should be the trading band for BHEL. So, basically if you need to make money on BHEL, you should enter around Rs 130-140 levels.

If you look at the consensus earnings estimates, they are still trending down. At the end of the last quarter, it was at about Rs 24-25 for 2014. It is still trending down so not all the bad news is factored in. So, I think the stock still has some way to go down.

Q: BHEL always worked with a reasonable amount of visibility in terms of its order book. It had worked for at least 24-36 months down the line. Do you think their FY13 revenues would be under threat? Are you seeing its order book getting contracted because of some people withdrawing orders?

A: That was the case in quarter one and so was the case in quarter four. They did have some order cancellations. I think it’s just that that is a process which is accelerating. So, maybe in quarter two also you will see some order cancellations. To add to that, you have some delays in the booking of orders.

For example, the super critical orders from NTPC, they were to be booked in quarter four; they will be booked mostly in quarter two. So, to that extent, the order book is declining and that has an impact on revenues.

So, we are estimating a decline in revenues in 2014 and we are estimating a decline in EPS in 2013 as well as 2014. That is something which will play out for BHEL that even though they have a visibility, it’s just that the order book is declining which will show up in revenues by 2014.

Q: We have heard a analysts saying that there is a structural shift in the kind of order book run rate that BHEL is likely to see. The 11th Plan being a new high, I think we added more than 50,000 in terms of megawatts and we are unlikely to see anything like that in the 12th Plan. Would you give it a long lean span maybe of three-four years?

A: That’s what I meant, initially, when I said that the steady state earnings for BHEL should be at about Rs 20 per share. It peaked at about Rs 26 per share in 2012. So, that earnings estimate which is steady state earnings does take into account that the order inflows in the 11th Plan period did peak. Going ahead, the steady state order inflows for BHEL will be coming down.

Q: Can you give us some as to which orders are under threat or what percentage are they in threat? When you say revenues going down, if you can quantify, what are you expecting in terms of revenue and EPS downgrades?

A: In the last three months, the events that have unfolded have put order backlog of close to about Rs 22,000-25,000 crore under threat. This would generally be the private sector order backlog that they have. That’s roughly about 15-20% of the total order backlog.

So, that is something which could be a threat. In the past, we have seen a few projects being cancelled or deferred in quarter four and quarter one. If you look at the last three months – this is the new piece of information that at least about 20% of the order flows or order backlog could be under threat.

However, the structural decline in order flows has been around for a year now. So, that is a hypothesis which has been around for a year. The new thing is that - private sector order backlog will get deferred or will be under threat because of the events that have unfolded in the recent past.

Q: What about margins? When there are few orders to go around, would you expect that bidding to be aggressive? Are you marking down margins as well?

A: If you look, margins are impacted by a weaker addressable market. Secondly, you have much higher competition because lots of domestic players setting up capacities. So, margins will come down. If you look at the return on capital employed for BHEL, that’s around 32-35% which is unsustainable.

We believe that is a return which should trend downwards, more towards the cost of capital as things evolve. So, margins will trend downwards on a structural basis for BHEL.