Pros and Cons of Investing in BHEL Right Now

The stock of Bharat Heavy Electricals Ltd (BHEL) has been one of the outperformers in the Indian stock market in line with the public sector index outperforming.

From about Rs 57 per share back in December 2021, the stock is up nearly 6 times in the two and a half years since. It has nearly tripled over the last one year. It's up about 48% in 2024 so far.

This is an outstanding performance by any standard. Investors have no cause for complaint. In fact, BHEL has emerged as one of the market's top picks.

Retail investors, high-net-worth individuals, and institutions alike all seem to have it in their portfolios.

PSU stocks in the Indian stock market have emerged as significant wealth generators largely driven by increased capital expenditure (capex) and government-led initiatives favouring PSU companies.

Additionally, robust order acquisitions from the private sector, combined with limited liquidity in these stocks due to substantial government holdings, have created a supply-demand imbalance, pushing stock prices even higher.

However, can this outperformance of PSU's continue even from here?

In this editorial, we will consider the pros and cons of BHEL as a potential investment.

Read on...

Pros

#1 Dominant Market Position

Bharat Heavy Electricals is an integrated power plant equipment manufacturer.

It's engaged in design, engineering, manufacture, erection, testing, commissioning and servicing of a wide range of products and services.

The company is the market leader in terms of manufacturing power equipment utility sets and accounts for more than 53% of India's installed conventional capacity.

Established in 1964, BHEL is the flagship engineering and manufacturing company of the government of India.

The company services core sectors of the economy such as power transmission, industry, transportation, renewable energy, oil and gas, and defence.

BHEL has executed 1,000+ coal, hydro, gas, and nuclear-based utility sets. As of end of FY24, the total electricity capacity is 168 GW out of which 135 GW is from coal-based power projects.

Power demand in India has been touching all-time high levels with peak demand of 250 GW during May 2024.

In this scenario , energy security becomes very important, underscoring the need for thermal capex alongside building capacities for renewables.

#2 Strong Manufacturing and Engineering Base

Considering its significant business integration and wide range of products, especially in power equipment, BHEL can deliver up to 20 GW in a year.

The company has the infrastructure and resources to operate in more than 150 project sites in India and abroad.

BHEL has a presence across India through its 16 manufacturing units, two repair centres, and eight service centres. It's strength in project execution is also driven by its large, competent and experienced workforce.

The company has been spending sizably on research and development (R&D) - a critical area for better product design, increasing acceptance, cost reduction, and efficiency in the competitive electrical equipment EPC landscape.

#3 Strong Growth Prospects

BHEL has a strong orderbook worth Rs 1.35 trillion (tn) as of Q1FY25 which is almost 6 times the company's FY24 revenues.

The company received major orders for building two 1,600 mega-watt power plants in Raipur and Mirzapur respectively.

It also received orders for supply of transformers from the railways for locomotives and two units of 175 mega-watt air cooled generators for a thermal power plant in Botswana.

BHEL's management says that it expects revenue to compound at the rate of 12-15% in the medium term. The company has also guided for order wins of Rs 25 bn for the year.

The company also has a lot of projects in the pipeline and the opportunity can be close to Rs 650-700 bn potential order inflow over the next few years.

BHEL is sitting on a record order book and once execution picks up, the company can see very strong growth in its revenues and profitability.

Cons

#1 Long Execution Period for Orders

The orders typically have a gestation period of four-to-five years. It could take even longer, as has been the case historically, especially in power projects.

This could result in lower revenue generation despite the large order book.

The execution proportion, calculated as revenues to opening order book, remained rangebound at 20-25% over FY20-24.

Management expects a faster execution of new orders from FY25, led by the push in the power sector. However, it's important to monitor this.

#2 Elongated Working Capital Cycle

During FY24, BHEL's net working capital cycle continued to be elevated at 104% of sales.

The company's gross current assets continue to be elevated above 700 days.

This can be attributed to significant receivables, contract assets due to back-ended payment structure in legacy contracts, and inventory required to be maintained for working on several projects simultaneously.

About 43% receivables and contract assets are due from large central public sector undertakings (PSUs), which provides comfort to an extent.

BHEL has been dealing with state PSUs for decades and expects the track record of receivables being realised to be maintained.

#3 Competition in Power Sector and New Business Segments

The power plant equipment market witnessed intense competition from foreign and domestic players.

There has been significant unutilised capacity and subdued addition to thermal power capacity in India over the last few years.

In the power equipment and emission control equipment space, BHEL has a larger market share in comparison to its peers.

Until the company establishes itself in railway, defence, and energy storage segments, its prospects are likely to continue to hinge on the conventional power sector.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...