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BHEL: Well begun is half done!
Jul 29, 2006

Performance summary
Power generation equipment major, BHEL, has begun FY07 on a robust note. For 1QFY07, the company has reported 37% YoY and 85% YoY growth in topline and bottomline respectively. Strong performance by both the power and industry divisions has aided growth in the topline. Further, lower staff and other costs have aided the strong expansion in operating margins during the quarter.

Financial performance: A snapshot
(Rs m) 1QFY06 1QFY07 Change
Sales 19,365 26,564 37.2%
Expenditure 17,650 23,382 32.5%
Operating profit (EBDITA) 1,715 3,182 85.5%
Operating profit margin (%) 8.9% 12.0%  
Other income 931 1,201 29.0%
Interest 123 131 6.5%
Depreciation 576 639 10.9%
Profit before tax 1,947 3,613 85.6%
Tax 668 1,246 86.4%
Profit after tax/(loss) 1,279 2,367 85.1%
Net profit margin (%) 6.6% 8.9%  
No. of shares 244.7 244.7  
Diluted earnings per share (Rs)*   73.1  
P/E ratio (x)*   26.9  
* On a trailing 12-month basis

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 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 74% 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 80% of the contracts floated by the former.

What has driven performance in 1QFY07?
Growth, growth everywhere! The strong topline growth during the first quarter has been led by robust performances by both the business divisions. While the Power division (74% of 1QFY07 revenues) grew by 36% YoY, the Industry division raked in a growth of 34% YoY growth (see table below). In line with it’s past five years’ performance, the company has earned around 14% of estimated FY07 revenues in the first quarter.

Segment-wise performance…
  1QFY06 1QFY07 Change
Power      
Revenue 16,087 21,828 35.7%
% share 73.6% 73.9%  
PBIT margin 13.4% 18.7%  
Industry      
Revenue 5,774 7,706 33.5%
% share 26.4% 26.1%  
PBIT margin 7.6% 4.7%  
Total*      
Revenue 21,861 29,534 35.1%
PBIT margin 11.9% 15.1%  
* Excluding inter-segment adjustments

Strong accretion to the order book and execution of a part of the earlier backlog has led growth for the company during the quarter. As a matter of fact, during the quarter, BHEL garnered orders worth Rs 45 bn (almost 6 times order bookings in 1QFY06), with a majority of 73% coming in for the power segment. Also, at the end of the quarter, the company had an outstanding order book of Rs 393 bn, which was almost 2.7 times its total FY06 revenue. Out of this backlog, segregation based on the power, industry and export segments is 74%, 16% and 10% respectively. While this huge backlog provides visibility in terms of growth, investors also need to keep in mind the execution risks involved, considering that a large part of the backlog will be executed in a period of 24 to 26 months. Any adverse change in the economic or political environment can led to pressure on performance deliveries.

In line with the huge anticipated demand for setting up generation capacities in the tenth (2002-07) and eleventh (2007-12) five-year plans, BHEL is in the process of expanding its capacity from 7,700 MW currently to 10,000 MW. However, it is important to note that this is largely a two shift capacity while the company has also included a third shift for certain critical tools, in order to meet its contractual obligations.

Key orders in 1QFY07
Project Client Size (Rs m) Capacity (MW) Duration (Months)
Lignite based power project Gujarat 12,000 250 37
Transformers Egypt 800 NA NA
Captive power plant Gujarat 1,130 111 14
Hydro power projects (2) Andhra Pradesh 820 59 26
230 kV substations Bangladesh 550 NA NA
220 kV substations Afghanistan 2,200 NA NA
Power projects (2) Rajasthan 8,420 445 30
Project from Tata Power Maharashtra NA 250 NA
230 kV substations Ethiopia 460 NA 18

Lower staff and other costs aid margins: BHEL continues to benefit from reducing staff costs (as % of sales) on the back of its voluntary retirement scheme for excess employees. The benefits of the same were visible in 1QFY07 as well, when staff costs declined to 17.7% of sales, from 21.2% of sales in 1QFY06. Marginal reduction in raw material and other costs has also helped matters. Based on segments, while PBIT margins for the power division expanded from 13.4% in 1QFY06 to 18.7% in 1QFY07, those for the industry segment contracted by 290 basis points to 4.7%. We estimate the company to earn operating margins of 17.8% in FY07 (17.6% in FY06) and the performance for the first quarter indicates that the company is moving in that very direction. The management has indicated that it expects metal prices to stabilise at the current levels, thus leading to benefits on the raw materials front. However, rising crude prices and their consequent impact on freight rates continues to be a cause of concern.

All falls to the bottomline: Strong growth in topline and expansion in operating margins has helped BHEL rake in a superlative net profit growth during 1QFY07. We expect the company to improve its net margins to 12.9% in FY07, from 12.6% in FY06. The company earned 8.9% net margins in the first quarter.

What to expect?
At Rs 1,968, the stock is trading at a price to earnings multiple of 16.3 times our estimated FY08 earnings, which we believe are fair valuations. While we have no issues with respect to BHEL’s strong growth in the future, we remain cautious with respect to valuations considering the execution risks involved in long gestation projects.

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