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Bhel: Are valuations justified?

Feb 15, 2001

India's No.1 engineering company, Bharat Heavy Electricals Limited (Bhel), has been on an upswing in the last couple of months. In the last six months the stock has appreciated by nearly 40%. This despite the fact that the company is mired in losses for most part of FY01. Why so?

In the first nine months of FY01, Bhel has reported a huge net loss of Rs 1.8 bn. During the corresponding period in FY00, the company had made a net profit of Rs 2.5 bn. So why this bouyancy in Bhel's stock price? What has changed?

(Rs m) 3QFY00 3QFY01 Change 9m FY00 9m FY01 Change
Net Sales 15,198 13,888 -8.6% 40,938 35,865 -12.4%
Other Income 548 348 -36.5% 1,393 1,040 -25.3%
Total expenditure 13,437 14,986 11.5% 37,061 36,162 -2.4%
Operating Profit (EBDIT) 1,761 -1,098 -162.4% 3,877 -297 -107.7%
Operating Profit Margin (%) 11.6% -7.9%   9.5% -0.8%  
Interest 67 91 36.0% 131 144 10.3%
Depreciation 376 420 11.7% 1,160 1,196 3.0%
Profit before Tax 1,866 -1,262 - 3,978 -596 -115.0%
Extraordinary items
(deferred expenditure)
270 749 177.6% 270 1,245 361.0%
Tax 579 -32 -105.4% 1,249 0 -
Profit after Tax/(Loss) 1,017 -1,980 -294.7% 2,459 -1,840 -174.8%
Net profit margin (%) 6.7% -14.3%   6.0% -5.1%  
No. of Shares (eoy) (m) 244.8 244.8   244.8 244.8  
Earnings per share*       13.4 -10.0  

The management maintains that the net loss is mainly due to a shortfall in turnover, higher power and fuel costs and additional impact of wage arrears over and above the provisions made. The management maintains that Bhel will be able to wipe out the entire loss in the fourth quarter and generate a reasonable profit for FY01. The company will also get an income tax benefit in 4QFY01 due to the wage revision.

Even if what the company says turns out to be true, still the valuations the it is getting at present seem unrealistic. Let us assume that Bhel declares a huge net profit of Rs 3 bn in 4QFY01 (and this is the best case scenario). This means Bhel's annual FY01 profits stand at Rs 1.2 bn. At the current price of Rs 188, the stock trades at a P/e multiple of 38 times its assumed (best case scenario) FY01 earnings. Even these valuations look too high for this engineering behemoth.

The other reasoning that market movers seem to be giving for these valuations is that Bhel is a PSU and is among the probables to be divested. However, we reiterate that the disinvestment of BHEL anytime soon is highly unlikely. Given the company’s sheer size and area of operations, a desirable strategic partner will be difficult to find. The company also manufactures some defence related equipment for the government. So, the disinvestment of BHEL is a sensitive issue.

Please note that we are not saying that the government will not divest stake in BHEL, but we are merely suggesting that its disinvestment is one of the trickier issues and will take some time. If in a hurry, the government decides to divest its stake in favour of the public, it will not improve the company’s sagging valuations.

We do agree that Bhel has a huge potential and its FY01 performance till date, is only a temprorary phase, but in the current scenario we believe the valuations are not justified.

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