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Is the future sanguine for Voltas and BHEL? - Views on News from Equitymaster

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Is the future sanguine for Voltas and BHEL?
Jun 28, 2013

The past two years have been testing times for even the strongest players in the capital goods sector. Understandably their stock prices also got hammered as investors got uncomfortable with the lack of visibility. We discuss the cases of Voltas and BHEL here.

Voltas has been 'under the weather' for quite some time and justifiably so. It has suffered considerable cost overrun on Sidra project leading to negative margin on the project. Adding to the woes is gloomy investment scenario in Middle East and India!

Things do not seem to be going right for the Tata company as execution issues still prevail. Bidding margins for the projects have declined from 6-7% earlier to meager 3-4%; particularly in international market. Voltas' order book has declined by 12.2% YoY and 13.4% YoY for FY12 and FY13 respectively. Further, influx of competitors in air conditioning segment is likely to hurt its earnings. These concerns warranted a relook at our estimates. Hence, as per our lowered FY16P EPS estimates; revised target price for Voltas is Rs 120. The stock currently trades at a 23% discount to its 5 year TTM average PE of 17.5x. We, however, feel the current price level factors in the concerns and see good value in the stock in the long-term given its strong balance sheet, execution expertise and diversified business segments.

BHEL has suffered a fate similar to Voltas. BHEL's order backlog has fallen by 17.6% YoY and 14.9% YoY in FY12 and FY13 respectively resulting in poor revenue visibility for the next 2-3 years. The backlog is expected to decelerate further due to over capacity in power sector. BHEL's margins are expected to diminish as competition has changed the margin picture in capital goods space. Just to validate our argument, BHEL's share in XIIth 5 year plan has come down to 35%-40% as compared to being more than 50% and 70% in XIth 5 year plan and Xth 5 year plan respectively. We, therefore, have revised our estimates and have lowered our target multiple to 12x; resulting in target price of Rs 249 based on FY16P EPS. The stock currently trades at a 70% discount to its 5 year TTM average PE of 20.5x. Our revised band might appear conservative as it factors in sufficient margin of safety for the investors.

While things do not look upbeat for next couple of years, it is to be noted that BHEL with its product depth and operational efficiency has managed to arrest a steep fall in margin. Lean manufacturing, design to cost and better working capital management shall help BHEL in averting the worst possible scenario of a steep correction in its margins and returns.

What should investors do?

We maintain our Buy recommendation on Voltas and BHEL given the sharp decline in prices and historically low P/E multiples. From these levels, the stocks shall be able to offer a CAGR of 13-15%. We, however, would like to gently remind you that performance of these companies is highly dependent on how soon the investment cycle turns and how effectively the government tackles power sector woes. Therefore, we recommend that your allocation to these two stocks should not be more than 3-4% of your portfolio. As for BHEL, we recommend that Investors who already hold the stock can average the stock at the current price.

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