BHEL hit by core issues; buy Cummins in cap goods: Religare

Calling it a ‘dead cat bounce’, Misal Singh of Religare Capital Markets believes that current valuations of Bharat Heavy Electricals Limited (BHEL) are expensive. There are structural problems related to reduced order inflows and lower capacity utilisation in the company, he says. This will also reflect in its second quarter results (Q2) and its return on equity (RoE), he told CNBC-TV18.

The company’s scrip rose more than 20-22 percent in the September series. It probably would have been on the back of positive reforms in the power sector, Singh says. Meanwhile, he is positive on Larsen and Toubro’s (L&T) attempt of a stake sale in the Dhamra Port. The company is looking for freeing some capital, Singh adds. Cummins India in capital goods space remains his top pick. Also read: FIIs being overweight is a risk for market: Barclays Cap Below is the edited transcript of his interview to CNBC-TV18. Q: 28 percent rise in the September series for BHEL. The bull case analyst was quite convinced that the worst is perhaps over for BHEL. Do you believe the same? Or is this just one of those trading bounces that will get sold into? A: This is more like a dead cat bounce. There are structural problems at BHEL, which is related to plateauing out of order inflows and lower capacity utilisation. It should kick in from 2015 onwards, which will have an impact on margins. The recent run up probably on account of some of the reforms, which have been initiated in the power sector, which is fair. Even then, at current valuations, the stock is expensive. Q: What do you see as the right price for the stock? A: Our target price is Rs 110 for March 2014 which is below book value. We believe that the return on equity (RoE) and the growth dynamics are such that the stock should trade below book value. Q: What then are you expecting by way of earnings, I thought people were looking at Rs 18, right? A: Yes, we are at about Rs 17 for 2014 and for 2015 we are further lower at around Rs 10. They did about Rs 27 for 2013. So, earnings are declining significantly over the next two years. Q: In contrast, what about Larsen and Toubro (L&T)? You have the buy on that stock with a target price of Rs 1,000, what kind of earnings performance are you expecting and how do you justify this target price? A: For L&T in 2014, we expect a decline in the standalone earnings. I think 2015 should see a decent growth from the levels of 2014. So in L&T, we expect some kind of recovery as L&T is a more diversified business model. So, valuing the standalone business at about 14 times one-year forward, you get roughly about Rs 800. Valuing the subsidiaries at Rs 200, we get to Rs 1,000 of a target price, which still has a meaningful upside from these levels. However, the key risk on L&T is that the macro environment is pretty weak. It probably has a bearing on the business confidence and in turn on the order inflows at some point. Q: What is your price target then? A: Rs 1,000, which is about Rs 800 for the standalone entity and Rs 200 for the subsidiaries. Q: What do you make of L&T-IDPL analyst meet? There is a possibility of that Dhamra port stake sale too. How do you think that is? A: The company is intending to sell stake in some of these infrastructure assets. That has been in the work for the last one-year. There are a lot of infrastructure projects across the sector which is up for sale. So, yes, they are intending to sell it and as and when that happens, that is a positive because that will free-up some capital from a very capital intensive and low RoE business. So whenever that happens, that is a positive. Q: Anything else in the capital goods space where you have a view? A: Cummins is our other top pick in capital goods.