BHEL: Recovery still some time away

Margin pressures might cap near-term earnings

Weak order execution and margin pressures, which have been looming over power and industrial equipment maker BHEL, led to disappointing results in the September quarter as well, significantly impacting its stock. BHEL’s share price has fallen 17 per cent in the past month and touched a 19-month low on Tuesday. While the UDAY package for reviving the financial health of state electricity boards (SEBs), as well as price renegotiation with RasGas (that could lead to lower prices of imported gas) are positives, the near-term outlook  remains muted.

Sluggishness in order clearance due to customer delays and increased share of implementing orders with longer execution cycle impacted BHEL’s revenues, which fell 3.4 per cent year-on-year (y-o-y) to Rs 6,193 crore in the September quarter, the 12th consecutive quarter of revenue decline. Pressures from competitive pricing and a near 11 per cent increase in raw material cost due to increase in content of imported raw material, saw BHEL post loss at operating level. Share of super critical orders, or orders which require BHEL’s technology collaborator to guarantee the performance of equipment, has increased from 55 per cent in FY15 to 65 per cent in FY16.

BHEL, which collaborates with Alstom and Siemens for super critical equipment technology, is bound by a joint development undertaking (JDU), which makes it mandatory for BHEL to source critical components from technology collaborators. With the management of BHEL indicating the share of super critical orders are likely to remain at current levels, margins might remain under pressure.

“BHEL plans to tackle these pressures by pursuing aggressive volume growth and expanding market share to 70-75 per cent. While this may well lead to high sales growth in FY17/18, we fear Ebitda (earnings before interest, taxes, depreciation and amortisation) margins may settle at 9-10 per cent as the new normal (from 16-18 per cent at peak). FY16 earnings will remain weak as new order execution shifts to FY17/18,” JM Financial’s analysts said earlier this month.

It was the other income at Rs 373 crore (up 90 per cent y-o-y) that restricted the net loss at Rs 205 crore. That apart, 83 per cent y-o-y decline in order inflow for the September quarter was another significant let down. But, the trend might change soon. BHEL is the lowest bidder for 8.3 gigawatts (Gw) of orders. It is also targeting another 4 Gw of orders by end-FY16, and renegotiating contracts worth 1.4 Gw (Rs 2,500 crore). Overall, BHEL, which has secured contracts worth Rs 22,000 crore in the first half of FY16 (up 60 per cent y-o-y), has revised its order inflow for FY16 to Rs 50,000 crore (20-22 Gw versus 17 Gw earlier). Recent order wins worth Rs 4,500 crore from Andhra Pradesh SEBs suggest it is well-positioned to achieve the targets.

Analysts believe rapid expansion in volumes and contract renegotiations should partly make good for erosion in Ebitda margins over the medium-term, while improvement in the health of SEBs and recovery from BHEL’s debtors (Rs 37,000 crore) are long-term triggers.