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BHEL: The Goliath stumbles - Views on News from Equitymaster

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BHEL: The Goliath stumbles

May 24, 2008

Performance summary
  • Sales grow 12% YoY in FY08, led by a 15% YoY growth of the ‘power’ segment. Growth during 4QFY08 at just around 4%. Actual sales figure 9% lower than our estimates.

  • Operating margins contract by 1.7% YoY during the fiscal owing to higher raw material and staff costs (both as percentage of sales). Margins drop a substantial 4% YoY during the fourth quarter – material and staff costs the culprit again.

  • Net profits grow by 18% YoY during FY08, decline 3% YoY in 4QFY08. Actual profit figure for the fiscal 18% lower than our estimates.

  • Recommends final dividend of Rs 6.25 per share. Total dividend paid for the fiscal thus stands at Rs 15.25 per share (dividend yield of 0.9%).

Financial performance: A snapshot
(Rs m) 4QFY07 4QFY08 Change FY07 FY08 Change
Sales 69,197 72,020 4.1% 172,375 193,655 12.3%
Expenditure 53,325 58,387 9.5% 139,466 159,987 14.7%
Operating profit (EBDITA) 15,872 13,633 -14.1% 32,909 33,668 2.3%
Operating profit margin (%) 22.9% 18.9%   19.1% 17.4%  
Other income 2,860 4,242 48.3% 7,615 13,962 83.3%
Interest 47 42 -10.6% 433 354 -18.2%
Depreciation 762 827 8.5% 2,730 2,972 8.9%
Profit before tax 17,923 17,006 -5.1% 37,361 44,304 18.6%
Tax 6,419 5,897 -8.1% 13,214 15,711 18.9%
Profit after tax/(loss) 11,504 11,109 -3.4% 24,147 28,593 18.4%
Net profit margin (%) 16.6% 15.4%   14.0% 14.8%  
No. of shares       240.3 489.5  
Diluted earnings per share (Rs)       49.3 58.4  
P/E ratio (x)         29.9  

What has driven performance in FY08?
  • As was reported by BHEL’s management during the announcement of provisional results for FY08 in April, the company’s performance has taken a real hit during the fourth quarter owing to reasons like acute shortage of workers and delays in order execution owing to capacity constraints. As a consequence, the company’s power segment recorded a topline growth of just around 15% YoY during FY08 as compared to 27% YoY growth recorded during FY07 and a CAGR of 32% during the period FY04 to FY07.

    The company commissioned 7,150 MW of power plant equipment during FY08, including 6,772 MW of utility and captive/industrial sets and 378 MW in the industrial markets. The installed capacity of BHEL supplied utility sets went up to 85,786 MW. The company maintained its share of 64% in India’s total power generation installed capacity of 134, 697 MW. Power segment

    Segment-wise performance
    (Rs m) 4QFY07 4QFY08 Change FY07 FY08 Change
    Revenue 54,220 56,740 4.6% 138,575 159,188 14.9%
    % share 70.3% 70.2%   72.0% 72.6%  
    PBIT margin 32.2% 31.3%   25.8% 24.7%  
    Revenue 22,917 24,133 5.3% 53,763 60,106 11.8%
    % share 29.7% 29.8%   28.0% 27.4%  
    PBIT margin 24.3% 26.1%   16.3% 18.1%  
    Gross Total*            
    Revenue 77,137 80,873 4.8% 192,338 219,294 14.0%
    PBIT margin 29.9% 29.7%   23.2% 22.9%  
    * Excluding inter-segment adjustments

  • Order inflows: BHEL secured all-time high orders worth Rs 503 bn during FY08 from domestic and international markets. At the end of the year, outstanding orders in hand for execution in FY09 and beyond, stood at Rs 855 bn (4.4 times FY08 total sales). Around 82% of the new order inflows were in the company’s ‘Power’ segment. These orders amounted to 14,556 MW of new capacity, indicating an average realisation of Rs 28 m per MW for the company. The company also booked orders of Rs 24 bn for the supply of spares and services in this segment.

  • Industry segment: As for the ‘industry’ segment, sales grew by 12% YoY during FY08 as compared to 32% YoY growth recorded during FY07 and a CAGR of 22% during the period FY04 to FY07. The company recorded an order inflow of Rs 79 bn (higher by 20% YoY) for this segment during the fiscal. These orders were for a variety of products and systems for applications in captive power, transmission and transportation sectors. Apart from this, the company received Rs 23 bn worth of international orders.

  • Capacity expansion: BHEL incurred a capex of Rs 7.3 bn during FY08 towards augmentation of manufacturing capacity and modernisation of facilities in manufacturing units and at power project sites. This capex is almost double of what the company had expended during FY07. The company has achieved manufacturing capacity of 10,000 MW per annum for power plant equipment in December 2007 (from 6,000 MW earlier).

    The management has indicated of a capex of Rs 42 bn during the eleventh five-year plan (FY08 to FY12). The company is further enhancing its manufacturing capacity to 15,000 MW per annum to be completed by December 2009. Besides capacity augmentation of existing products in the areas of thermal, gas, hydro and nuclear, other major areas of investment shall include facilities for higher rating nuclear sets, 765kV transformers and other associated distribution and transmission equipment and capacity augmentation of transformers from 20,500 MVA to 45,000 MVA.

  • Operating margins: BHEL recorded a 1.7% YoY contraction in operating margins during FY08. This was largely due to increase in its raw materials and staff costs. While the former increased from 57.3% of sales in FY07 to 59.3% in FY08, the latter increased from 14.2% to 16.2%. What impacted the full year’s profitability performance was the raw material pressure that BHEL faced during 4QFY08. Raw material costs moved sharply up from 51.9% of 4QFY07 sales to 58.2% in 4QFY08. Sharp rise in cost of key commodities like steel, aluminium and copper seems to have hurt BHEL’s margins during the quarter and the fiscal.

  • Bottomline picture: Despite contraction in operating margins, BHEL managed to grow its bottomline at a rate faster than topline growth. Other income increased by 83% YoY during FY08 (largely aided by a large income tax refund of Rs 2.7 bn received during 2QFY08). The 18% YoY decline in interest costs also helped the net profits, which grew by 18% YoY during the fiscal.

What to expect?
At the current price of Rs 1,747, the stock is trading at a multiple of 12.5 times our estimated FY10 earnings for the company. Considering the FY08 performance, however, wherein the company’s actual bottomline has been 18% lower than our estimates, we will have to downgrade our numbers for the company.

Our concerns with respect to execution and volatile raw material prices have come to the fore and have impacted the company’s latest quarter performance. While quarterly volatility is a norm for engineering companies like BHEL as project delays and execution issues impact performance, we believe that investors need to look at the performance from a 2 to 5 years perspective. The fact that BHEL continues to build upon its order book provides strong visibility into future growth. Over that, economies of scale shall also help the company ramp up its profitability in the future. While we maintain our positive view on the stock from a 2 to 3 years’ perspective, the return expectations will have to be lowered. Volatile raw material prices and manpower issues also remain our key concerns with respect to the company’s future performance.

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