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BHEL: Firing on all cylinders
May 29, 2007

Performance summary
  • Sales grow 30% YoY in FY07; lower by 3% as compared to our estimates

  • Net profits up 44% YoY in FY07; higher by 6% as compared to our estimates

  • Operating margins expand by 1.4%, led by lower raw material and other costs (as percentage of sales)

  • Strong performances recorded by both the power and industry divisions

  • Order backlog stood at Rs 550 bn (3.2 times FY07 sales) at the end of March 2007

  • Board recommends final dividend of Rs 6 per share (dividend yield of 0.2%) and bonus issue in the ratio of 1:1 (one additional share for every one equity share held by members on the record date i.e., June 1, 2007)

Financial performance: A snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Sales 55,189 69,197 25.4% 132,282 172,375 30.3%
Expenditure 43,240 53,325 23.3% 108,900 139,466 28.1%
Operating profit (EBDITA) 11,949 15,872 32.8% 23,382 32,909 40.7%
Operating profit margin (%) 21.7% 22.9%   17.7% 19.1%  
Other income 2,133 2,860 34.1% 5,308 7,615 43.5%
Interest 195 47 -75.9% 587 433 -26.2%
Depreciation 640 762 19.1% 2,459 2,730 11.0%
Profit before tax 13,247 17,923 35.3% 25,644 37,361 45.7%
Tax 4,567 6,419 40.6% 8,852 13,214 49.3%
Profit after tax/(loss) 8,680 11,504 32.5% 16,792 24,147 43.8%
Net profit margin (%) 15.7% 16.6%   12.7% 14.0%  
No. of shares         244.7  
Diluted earnings per share (Rs)         98.7  
P/E ratio (x)         27.6  

What is the company’s business?
Bharat Heavy Electricals Limited (BHEL) is India's largest public sector engineering company with market leadership in supply of equipments to the energy-related/infrastructure sectors. The company has installed equipments for over 80,000 MW of power generation in the country, which includes capacities set up by utilities, captive and industrial users. Revenues from the power sector form around 73% of the company's total revenues, with the remaining being contributed by the industrial segment. The company has strong ties with the power generation major, NTPC, and historically, has bagged over 70% of the contracts floated by the former.

What has driven performance in FY07?
Growth across the board: BHEL’s power segment (72% of FY07 total sales) was yet again at the forefront in driving the company’s overall sales growth during the fiscal. This segment grew its sales by 27% YoY during FY07, led by high (by historical standards) addition to the country’s generation capacity. Power generation sets manufactured by BHEL contributed to 73% of the power generated in India during the fiscal (593 m units), and accounted for 65% of the country’s power generating capacity of 125,414 MW, indicating their more efficient performance relative to sets made by other equipment companies. FY07 saw the company recording an order inflow of Rs 356 bn, 88% YoY higher than the Rs 189 bn of orders that were booked in FY06.

Continued demand for power generating units from both the central and private sector generation companies, as also some key international assignments, perked up the order inflow for the company during the year. While power sector orders grew by 155% YoY, orders from the industry segment recorded growth of 27% YoY. However, BHEL’s international orders, which had jumped six times in FY06, recorded a 43% YoY decline during FY07. International orders formed 5% of the company’s total order book in FY07 (18% in FY06).

In light of the anticipated growth in demand, the company is planning to raise its equipment manufacturing capacity to 15,000 MW by the end of 2012. This should involve a capital expenditure of Rs 32 bn. In the interim, its capacity is expected to touch 10,000 MW by the end of 2007, from 6,000 MW currently (at an estimated cost of Rs 12 bn).

Segment-wise performance…
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Power            
Revenue 44,254 54,220 22.5% 108,939 138,575 27.2%
% share 71.5% 70.3%   72.8% 72.0%  
PBIT margin 24.8% 32.2%   21.7% 25.8%  
Industry            
Revenue 17,624 22,917 30.0% 40,680 53,763 32.2%
% share 28.5% 29.7%   27.2% 28.0%  
PBIT margin 20.0% 24.3%   15.9% 16.3%  
Gross Total*            
Revenue 61,878 77,137 24.7% 149,619 192,338 28.6%
PBIT margin 23.4% 29.9%   20.2% 23.2%  
* Excluding inter-segment adjustments            

At the end of March 2007, the company’s order backlog stood at Rs 550 bn, which is over 3 times its total sales in FY07. While such a large backlog definitely provides strong visibility into company’s growth over the next few years, a lot will be dependent on the execution of the company’s capacity expansion plans, as any delay in the same will jeopardise the sustenance of growth.

Lower raw material costs aid margins: BHEL’s raw material costs declined as percentage of sales during FY07, thus aiding the improvement in operating margins. These costs declined from 58.6% of sales in FY06 to 57.3% in FY07. Based on segments, while PBIT margins for the power division expanded from 21.7% in FY06 to 25.8% in FY07, those for the industry segment improved from 15.9% to 16.3%.

Margin expansion, higher other income aids bottomline: Apart from the expansion in operating margins, BHEL’s FY07 net profits also benefited from higher other income (up 44% YoY) and lower interest outgo (down 26% YoY). As a consequence, the company’s net margins expanded to 14%, higher than 12.8% that we had estimated.

What to expect?
At Rs 2,755, the stock is trading at a multiple of 15.9 times our estimated FY09 earnings. BHEL has continued on a strong growth path and, with the kind of backlog that it has currently, there is enhanced visibility into the future. The company has also embarked on a strategic plan, whereby it plans to grow its sales at a compounded annual rate of 20% to touch US$ 10 bn by 2012 (US$ 4.3 bn in FY07). While we do not expect this to be a difficult task considering the kind of potential that the sector beholds for the next decade, execution is and will remain a key issue, especially with the company (like its peers in the sector) finding it difficult to attract and retain quality talent given the increased levels of competition from domestic and MNC peers. We shall soon update our research report ion the company.

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