BHEL: How far is too far? - Views on News from Equitymaster

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BHEL: How far is too far?

Mar 9, 2004

If one were to look at the performance of the stock markets over the last month, Rs 100 invested would have appreciated marginally to Rs 104 (4% gain). However, there are stocks have outperformed the benchmark index significantly during this period. We take a look at the engineering sector in general with specific mention to BHEL (Bharat Heavy Electricals Limited) and ABB, the market leaders. We also analyse the reason for this optimism and the future growth prospects

Before going any further, Rs 100 invested in ABB and BHEL would have appreciated by 5% and around 21% respectively in the last one month. Though there has not been any fundamental change in the company, it seems that lot of the rally has due to over optimism.

BHEL gained momentum on the bourses after the company declared its 9mFY04 results. The company witnessed a 15% growth in topline and a 64% increase in bottomline, beating market expectations. BHEL has shown significant improvement in its operating margins over last three-quarters of FY04. Due to substantial improvements in the EBIT margins from its industrial segment (up 670 basis points), operating margins for the nine-month period was higher by 260 basis points.

Since BHEL has exhibited the capability to install large-scale power projects, EBIT margins from the company's power business has been on higher side as compared to industry average of 8%-10% (which is the case for the companies like ABB and Siemens). The company's industrial segment that includes water treatment has better EBIT margins as compared manufacturing motors and switchgears, as these projects are highly customised.

The company has received orders worth Rs 12 bn in its last quarter as of now, out of which more than Rs 4 bn have flown in the one month. The company's orderbook stood at Rs 235 bn as on 31st December 2003, which is around 3.2x FY03 revenues. With every new order, investors seem gain confidence in the company, which sometimes is over stretched.

Comparative valuations…
(FY05E figures)ABBBHEL
Net sales (Rs bn)18.2 96.1
Operating profit margin (%)10.9%16.0%
PAT (Rs m)1,421 8,270
Net profit margin (%)7.8%8.9%
Market Cap to sales (x)1.64 1.60
P/E ratio (x)21.018.6
Orderbook (Rs bn)*11.0235.0
*as on 31st December 2003

At the current price levels of Rs 630, the stock trades at the P/E ratio of 18.6x expected FY05 earnings, which is on higher side for an engineering company. The stock is trading at the upper limit of market capitalisation to sales ratio as well. As the power sector in India grows, the order inflows for major engineering companies like BHEL are likely to keep growing going forward. But as we have been saying earlier, there is price for every business. It seems that the stock price has factored in the future growth. Going by the valuation discipline, the stock looks fully valued at current juncture.

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