Is BHEL a Stock Worth Buying Now?

Bharat Heavy Electricals Ltd (BHEL) as it is popularly known as, is one of the hottest stocks in the market right now.

The stock has doubled in the last one year alone, with a majority of the gain coming post April 2023.

In fact, the stock is up an impressive 6x since the lows of March 2020, when it had crashed to Rs 20 per share.

A gain of more than 6x in under four years is quite impressive to say the least, especially for a large stock the size of BHEL.

This is much better than the Sensex as well as the BSE SmallCap index, which have gained 2.5x and 4x respectively during the same time period.

BHEL has certainly outperformed them by a huge margin.

However, it was not always like this. BHEL may have been a huge wealth creator over the 3-4 years.

But for the decade prior to that, it had been a huge wealth destroyer. Yes, that's correct.

The PSU that one doesn't seem to get enough of these days, had eroded as much as 90% of its wealth between December 2010 and December 2020.

Just to put things in perspective, the stock was trading at close to the Rs 300 mark back in December 2010 and had plunged to just Rs 30 per share by the time the decade came to a close.

As I said earlier, that's a huge wealth destruction of close to 90%.

But why did this happen?

Why did the stock plunge 90% in the 10 years between December 2010 and December 2020? And then why did it go up more than 6x over the last 3-4 years?

Well, the company crashed 90% during the decade because of deteriorating fundamentals.

You see, the company recorded its highest ever EPS in March 2012 of around Rs 19 per share. It has been all downhill since then.

From Rs 19 in FY12, the EPS plunged to negative Rs 4 per share in FY20.

Put differently, the company recorded a loss in FY20 of around Rs 15 billions (bn). This was in sharp contrast to the Rs 70 bn in profits it earned at its peak in FY12.

It is this deterioration in the company's profits that led to the stock price plunging from Rs 300 in December 2010 to just Rs 30 per share a decade later in December 2020.

Needless to say, the stock's valuation also collapsed.

Just to give you an idea, investors were willing to pay Rs 7 for every Re 1 sitting on the books of the company as book value back in 2010.

By December 2020, this premium had crashed and turned into a discount of a huge 60%. This means that now, investors were willing to pay not even the full one rupee but just 40 paise for every Re 1 in book value of BHEL.

In fact, in March 2020, when stocks across the board had crashed due to the Coronavirus pandemic, Mr Market was willing to pay just 20 paise for every Re 1 book value of the company.

So, a 600% premium over book value in 2010 and then a huge 80% discount in 2020. Mr Market does swing from one extreme to another.

Anyways, thanks to the advantage that we have of looking into the past, we know that March 2020 was a great time to invest in BHEL. The stock is up more than 500% since then and looks ready to go up even more from here.

However, why has the stock gone up so much in a short span of time? What has changed over the last 2-3 years?

Well, while the broader market has helped, BHEL's share price performance also has to do with the improvement in its own fundamentals.

Please note that while BHEL had crashed 90% between December 2010 and December 2020, it had a couple of things going for it.

These are the company's rock-solid balance sheet and the competitive advantage or the moat that it has in the form of its technical know-how and execution capability.

The company has remained a debt free company for many years now. In fact, its debt-to-equity ratio never spiralled out of control even during its darkest period.

Secondly, BHEL's expertise in its core area of operations is perhaps second to none.

In fact, BHEL is one of the few companies in the world having the capability to manufacture the equipment for entire range of power plants-thermal, gas, hydro and nuclear, with proven capabilities to execute large sized projects.

Therefore, BHEL's financial as well as technical strength was never in doubt.

So, what really was the problem with BHEL? Why did its performance deteriorate?

A high fixed cost structure, large dependence on the power sector and working capital issues were some of the key challenges that were weighing company's performance as well as its share price down.

Well, the working capital issues seemed to have been resolved and resolved for good.

Its sales to working capital ratio had plunged to a low of 1 in FY16. It currently stands at around 4, which I believe is a massive improvement and one of the best in recent memory.

However, large dependence on the power sector continues as nearly 80% of the company's current order book comprises orders from the power sector.

Last but not the least, there is a lot of improvement required on the operating margins front also as they are nowhere close to the 15-20% highs seen a decade ago.

To put things in perspective, operating margins stood at just 5% in FY23. In contrast, they averaged a huge 20% between FY12 and FY14.

There is no doubt that orders are flying thick and fast and that the external environment has turned quite conducive for the company.

Besides, it has certainly taken some concrete steps to improve its own operations and financial management further.

In fact, if you listen to the management commentary at the end of the FY23 results, you are likely to come away impressed.

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The top management is highly optimistic about the company's future. And I don't think they are wrong with the way the things are going.

Given the investments that are being made in power, railways, defence, private industry, things are definitely looking up for BHEL.

However, the question is how much of the improvement is already reflecting in the company's current share price?

If you ask me, quite a lot to be honest. I believe I made a mistake by not considering BHEL as investment worthy earlier.

You see, I'd like to have some sense of the company's earnings capacity or its earnings power so that I can value the company and understand if the current stock price is higher or lower than this intrinsic value.

However, this exercise is difficult for BHEL as its historical earnings are all over the place. Its profits over the last 10 years have varied from a high of Rs 35 bn to a loss of Rs 27 bn.

I could have taken the mid-point of these two numbers to arrive at the earnings power. While this would have been the right thing to do mathematically, it would have made no sense logically.

Just because company's profits have swung from positive Rs 35 bn to negative Rs 27 bn, doesn't mean that it is capable of earning the average of these two numbers in a normal year.

It is this difficulty in arriving at a reliable earnings power that forced me to stay away from the stock. Therefore, I am not sad that I missed the stock because to be honest, it fell outside of my circle of competence.

However, now that some stability has been restored, can we take a fresh look at the stock? Should we consider it for investment now?

Yes, we can but I don't think the risk-reward equation is as attractive right now as it was a couple of years ago.

Suppose you are looking to double your money in BHEL over the next four years and are willing to give it a PE multiple of 20x on its earnings four years from now.

This means that BHEL will have to record an EPS of around Rs 13 per share or make a profit of anywhere between Rs 40-50 bn.

The company recorded a profit of around Rs 4.7 bn in FY23. This implies that it will need to grow its profits by 10x over the next four years. Now, I am not saying this is impossible, but it isn't easy either.

Happy Investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)