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BHEL: Powering those who power us!

Jun 1, 2006

Performance summary
Public sector engineering major, BHEL, has announced strong results for the fourth quarter and fiscal ended March 2006. The company's topline and net profit growth during the fiscal is almost in line with our estimates. One of the biggest positive to have emerged from the fiscal's numbers is the sharp expansion in operating margins, which have jumped from 14.9% in FY05 to 17.6% in FY06. The expansion in margins has been largely due to lower staff costs, in the wake of employee rationalisation owing to the VRS. At the end of March 2006, BHEL's order backlog stood at a whopping Rs 376 bn, almost 3 times FY06 sales.

Financial performance: A snapshot
Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Sales 43,047 55,157 28.1% 94,911 132,892 40.0%
Expenditure 35,062 43,208 23.2% 80,774 109,510 35.6%
Operating profit (EBDITA) 7,985 11,949 49.6% 14,137 23,382 65.4%
Operating profit margin (%) 18.5% 21.7% 14.9% 17.6%
Other income 2,143 2,133 -0.5% 4,862 5,308 9.2%
Interest 388 195 -49.7% 814 587 -27.9%
Depreciation 619 640 3.4% 2,189 2,459 12.3%
Profit before tax 9,121 13,247 45.2% 15,996 25,644 60.3%
Extraordinary income/(expense) - - (180) -
Tax 3,778 4,567 20.9% 6,282 8,852 40.9%
Profit after tax/(loss) 5,343 8,680 62.5% 9,534 16,792 76.1%
Net profit margin (%) 12.4% 15.7% 10.0% 12.6%
No. of shares 244.7 244.7 244.7 244.7
Diluted earnings per share (Rs) 39.0 68.6
P/E ratio (x) 28.1

What is the company's business?
Bharat Heavy Electricals Limited (BHEL) is India's largest PSU engineering company with market leadership in supply of equipments to the energy-related/infrastructure sectors. The company has installed equipments for over 90,000 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 NTPC, and historically, has bagged over 80% of the contracts floated by the former.

What has driven performance in FY06?
Power division shows the way: Led by strong accretion to order book, BHEL's power division clocked a revenue growth of 45% YoY during FY06 to lead the overall growth for the company. The fiscal saw the company add 13 utility and 15 captive/industrial sets of 2,365 MW. This took the installed capacity of the company made sets to 76,741 MW, almost 65% of India's total installed generating capacity of 118,561 MW. In order to meet the requirements of the government's plan of electrifying entire India by 2012, BHEL is in the process of enhancing its manufacturing capacity from 6,000 MW to 10,000 MW. The company has also entered into technology tie-ups for….

Segment-wise performance…
4QFY05 4QFY06 Change FY05 FY06 Change
Power
Revenue 35,224 44,254 25.6% 75,039 108,939 45.2%
% share 71.3% 71.5% 69.2% 72.8%
PBIT margin 23.6% 24.8% 21.4% 21.7%
Industry
Revenue 14,170 17,624 24.4% 33,470 40,680 21.5%
% share 28.7% 28.5% 30.8% 27.2%
PBIT margin 13.9% 20.0% 11.5% 15.9%
Total*
Revenue 49,394 61,878 25.3% 108,509 149,619 37.9%
PBIT margin 20.8% 23.4% 18.4% 20.2%
* Excluding inter-segment adjustments
* Excluding inter-segment adjustments

On the industrial division front, the company has recorded a revenue growth of 22% YoY, benefiting from the strong capex cycle in the domestic market. At the end of the fiscal, the company's order backlog stood Rs 376 bn, almost 3 times its sales in FY06. Notably, the company has garnered its largest ever export orders worth Rs 33 bn during the fiscal. One of the prominent contracts that the company won in the international marketplace in FY06 was for developing 500 MW (in four phases) of capacity for Kosti Power Plant in Sudan. The company has also spread its wings across other regions like South America, Indonesia, Oman, Ethiopia and Europe, which shall help in diversifying the revenue base from the Indian market.

Lower staff costs aid margins: Lower staff costs on the back of the VRS to employees continue to help BHEL perk up its operating margins. This was seen in FY06 as well, when staff costs declined to 14.1% of sales from 17.4% of sales in FY05. Steady raw material costs also helped matters. Based on segments, while PBIT margins for the power division was almost as FY05 levels, those for the industry segment expanded to 15.9%, from 11.5% in FY05. While we had expected employee rationalisation and efficient cash conversion to help the company shore up its profitability in the fiscal, the actual expansion is higher than our estimates.

Lower interest, tax rate aid bottomline: Apart from the robust performance on the topline and operating margins front, lower interest expenses have aided BHEL's net profit growth during FY06. Also, a decline in the effective tax rate from 39% in FY05 to 34% has come as a positive.

What to expect?
At the current price of Rs 1,930, the stock is trading at a price to earnings multiple of 17.2 times our estimated FY08 earnings. The board has recommended a final dividend of Rs 2 per share, thus taking the total dividend for FY06 to Rs 14.5 per share (including Rs 8.5 per share as special dividend). The yield based on the full year dividend arrives at 0.8%.

The company's FY06 performance is in line with our estimates. As far as the future growth is concerned, we are positive on the continuation of the reforms process in the Indian power industry, which shall directly benefit the company in terms of orders and profitability (since power plant technology is getting more complex in order to rake in better efficiencies from fuel). The only thorn in the company's growth prospects can be the government's delay in implementing its planned capacity expansion schedule, which has been the case in the past. Perhaps the major cause of concern is the valuations.

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