Hold BHEL; target of Rs 220: Emkay

Emkay Global Financial Services has recommended hold rating on Bharat Heavy Electricals (BHEL) with a target of Rs 220 in its September 20, 2012 research report. According to the research firm, BHEL’s Industrial business can grow at 6-8% CAGR in the long run.

“BHEL is expected to commission additional 100 GW of generation capacity in next 15 years. We expect the spares business to multiply 4X over FY12-27E from Rs27 bn to Rs120 bn and jump from 5% of revenues in FY12 to 20% in FY27E. Industrial business can grow at 6-8% CAGR in the long run. Our assessment is based on (1) emerging growth drivers in Industrial business (2) exports business of Rs12.0 bn factored in industrial segment and (3) growth in the base business of T&D products, Industrial equipments, Photovoltaic, Railways supply, etc. We expect Industrial business to grow from Rs116.6 bn in FY12P to Rs345.4 bn in FY27E. Almost 100 GW of orders were finalized in FY10-12 period. Annual ordering peaked at 56 GW in FY11. Estimated industry wide cumulative inflows of 183 GW for the next 15 years. BHEL’s market share has reduced from 95% in 10th FYP to 51% in 11th FYP to 40% in 12th FYP. Expect the market share to decline further to 28%. BTG equipment prices have declined by 22% on separate packages of boiler and turbines (NTPC Bulk Tender) from Rs29.5 mn/MW to Rs23.0 mn/MW. This will eventually trigger gross margin decline of 1200 bps. But considering revenue mix change, gross margin decline curtailed at 410 bps to 40.6%.”

“Current BTG prices are Rs23.0 mn/MW. This is the ultimate panic price! Because at Rs23.0 mn/MW, a player like BHEL would generate contribution margin of 17.8% and EBIDTA of barely 4%-6% at full-capacity utilization. This indicates far higher trouble for rest of the players. Upside in market shares for BHEL is a possibility, driven by (1) Sharp depreciation of Indian currency (+27% to Chinese Yuan, +22% to Korean Won) and (2) instances of failures or lower PLF or higher auxiliary consumption in power plants with imported equipment.  With peak capex in FY13E and capex spends of Rs49 bn in FY14-27E (13 years) against Rs75 bn in FY09-13E period (5 years), BHEL is expected to generate strong free cashflows. Rise in yields (either financial or business investments) could drive earnings, cash generation and return ratios in long run”

“We belong to the club of analysts who believe that structural catalysts in BTG market are missing.  But, we choose to differ on the extent of incremental de-rating. We are taking a contrarian stand.  While things are bad for BHEL in the core business (BTG), there are other growth drivers and emerging catalysts, which remain ignored.  BHEL’s fair value (from different valuation methodologies) is in the range of Rs200-240/Share. We expect BHEL to oscillate in this range. Retain hold, but with a positive bias,” says Emkay Global Financial Services research report.

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