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Sep 29, 2003

With the prospects for the economy looking good and the continued focus on development of infrastructure, the prospects for engineering companies are also looking good. In this article letís take a look at the businesses of engineering majors ABB and BHEL and their growth prospects. BHEL, the largest engineering company in India, is a market leader in power generation equipment and has installed around 65% of Indiaís power generation capacity. It has strong presence in industrial operations like manufacturing equipments for transmission, transportation, telecommunication and renewable energy. Whereas ABBís power business consists of manufacturing T&D equipment and servicing of power plants. It is the leading player in automation technologies in the country. ABB has plans to enter the retail segment, providing branded transformers etc.

Letís have a look at the revenue mix of these companies in FY03.

Power business remains as major contributor of revenues for both the companies. However, BHEL commands higher margins in this segment as compared to ABB, because it is into manufacturing of generation equipment and it is the only domestic player with experience in manufacturing coal boilers. Moreover, it has strong relationship with NTPC, which also enables it to earn higher margins. Though ABB is well known for its T&D solutions like transformers, it is unable to extract premium pricing for the same. So it remains a low margin business for ABB.

(Rs m) FY03 ABB BHEL
Net Sales 8,229 53,720
Percentage of total revenues 61.2% 67.1%
PBIT 608 12,026
PBIT margin 7.4% 22.4%

Automation business contributes around 39% to ABBís total revenues. The margins are higher from this segment because the customers for its power and automation segment are more or less common. This enables the company to club a lot of intelligent systems and solutions to the projects adding a lot of value. This proves to be a one-stop shop for its customers and provides the company an edge over its competitors. BHEL on the other hand, is into traditional industrial business where margins have always been lower because of high competition.

(Rs m) FY03 ABB BHEL
Net Sales* 5208 26370
Percentage of total revenues 39.0% 32.9%
PBIT 573 2614
PBIT margin 11.0% 9.9%

Orderbook gives a peek into the expected performance of a company in the near future. BHELís orderbook stands at Rs 204 bn currently, which is 2.8x FY03 revenues. Apart from its traditional business, BHEL has joined hands with NTPC to take up running and maintenance jobs of power plants, besides EPC and other projects in the power sector. All this is likely to add to the stability of revenues for the company going forward. ABB outstanding orderbook on the other hand, stood at Rs 10.7 bn at the end of June 2003 (0.9x FY03 revenues).

In order to improve the financial muscle, BHEL is looking to strike an alliance with the Export-Import Bank of India for floating international financial services company. The joint venture company will take up funding of BHELís overseas projects, which will enable BHEL to bag large international orders. It is targeting to enhance its export turnover to 17% of its total sales from the present 13.5% in the next five years. ABB too has stated that it will focus on exports to enhance growth.

(Rs m) FY03 ABB BHEL
Net Sales 11,758 78,147
PAT 814 5,983
Net profit margins 6.9% 7.7%
Market cap/Sales (x) 1.7 1.2
P/E (x) 24.9 15.7
Debt to equity (x) 0 0.1

At the current price of Rs 480, ABB trades at P/E multiple of 24.9x, FY03 earnings. BHEL, on the other hand, trades at a price level of Rs 385, a P/E multiple of 15.7x, FY03 earnings. Though valuations are on the higher side for both stocks, prospects are bright for both the companies. However, in our view, too much growth expectation has already been factored into the current stock valuations.

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