Is BHEL overpriced or still a good buy?

Anuj: Would you be as bullish on BHEL or would you be tempted to book profits now?

Joshi: Clearly if you look at the performance of BHEL it has indeed been volatile and if you look at the book to bill ratios from a peak of 5.2 times in FY09 it had actually fallen to 2.3 times in the second quarter FY14 that has actually bounced back to around 2.6 times.

So most of the negatives at least in terms of revenue visibility are more or less getting played out of the stocks. The other important aspect also to be seen is in terms of the ordering because at the time when BHEL was expanding capacities there was an economic slowdown and the National Thermal Power Corporation (NTPC) bulk tendering order was coming through which actually bought down the prices of both boilers and turbines. To add to that there was a huge amount of competition intensity both from Indian players and Chinese players and the foreign players already account for around 43 percent of the 90 gigawatt under construction.

Clearly in terms of margins BHEL has seen the worse. So our take is that most of the price factors in the worst for BHEL to possibly have taken place both in terms of the EBITDA margins, in terms of the order book and in terms of the cash flows to improve. So from here onwards the street is expecting new orders to come through. We have already seen that in second quarter orders were Rs 3,500 crore from the EBC side. On Telangana 100-118 megawatts worth of orders came through. So there would be increased revenue visibility with consolidation of fewer players probably in the power sector itself and as Ambareesh was mentioning the power sector itself throws up a huge amount of opportunities for players like BHEL.

But do I take a call on BHEL right now. The operating leverage environment under which BHEL functions is still very poor, the cash flows are still very poor. It works under a negative operating leverage and the EBITDA margins will still get impacted. The capital goods sector overall is still bereft of new and substantial orders probably coming through. So our probable take is that the margin compression might be seen in BHEL over the next couple of quarters. So the suggestion would be yes, it is a lovely play on the power story going forward. But I would ideally wait for a decline on the stock to buy in and again from a valuation perspective as Ambareesh was mentioning apart from the EPS estimates on a price to book parameter the peak valuation would be around 4-4.2 times. The low that it touched was around 0.8-0.9. It is currently between 1.4-1.5 times. So still there is a long way to go in terms of potential upside. But do I buy it right now, I will actually wait for cash flows to improve probably on the stock over the next couple of quarters before taking in it.

Anuj: 2011 was when it hit peak earnings. After that it has been very volatile. So you can’t be sure about that earnings numbers that you mentioned and in that case it can differ?

Menaka: Also on the receivables issue which was a big controversy a few months ago when you talk about negative operating leverage this company has had a bad, not debts, but orders problem for a long time with a large amount of pending receivables?

Baliga: Yes, but you should look at the environment which was there between 2010-2013, it was quite uncertain. Lot of projects were cancelled in between.

Menaka: But nobody is blaming the company for it. I am just adding to Anuj’s point that there are some negatives that you cannot ignore?

Baliga: Absolutely, but then going ahead 2014-2015 to 2018-2020 are we expecting the total environment to be stable and possibly declining, no. We are looking at growth. We are talking of India growing at 7.5-8 percent. So there is no way you can see that stuff of growth without overall infra growing, overall power sector growing and if that happens there is no way BHEL may not be a performer, that probability is very low.

Menaka: L&T is a smaller power business than BHEL, much smaller in that sense, but wouldn’t you say that if you are playing on the pickup in power a year or two years down the line then L&T is a better way to play than BHEL given its fundamental strengths, quality of management etc?

Baliga: Absolutely, L&T is clearly a much better player but since we are discussing BHEL I talked about it. But then if you are talking of which is the best pick in that sector clearly number one is L&T. There is no doubt about that. BHEL was not even on my buy list say about 8-9 months back. Yes, I missed that moved from 120 onwards to about 300 but then I did not miss it this time when it came to Rs 210.

Menaka: Hands down L&T is a better pick than BHEL, wouldn't you rather allocate money to L&T than BHEL?

Joshi: Probably yes because I think it is much more diversified and again I think in terms of the capex cycle turning around L&T looks better poised both in terms of playing the cycle in the entirety and again I think the kind of management commentary that we have been hearing both in terms of topline growth, in terms of the order wins and clearly I think the non-core business which L&T probably intends to sell off is an additional benefit for L&T. So, yes L&T would more or less be a preferred pick. However the cons for BHEL would probably be pay commission and if that comes through I think that will be a substantial hit on their staff costs. The coal de-allocation would also have negative impact if it doesn't turn out the way the government is expecting over the next 3-4 months. Clearly I think the order book composition also consists a lot of slow moving orders and a lot of unexecuted orders. So, execution issues are also pertinent threat for BHEL going forward.