BHEL: Earnings estimates slashed on weak execution

Margins hit multi-year low of 4.2% in Q1, improvement unlikely even if order inflows pick up from FY16

The current financial year is likely to remain challenging for capital goods maker Bharat Heavy Electricals (BHEL). With the logjam in the power sector showing no sign of ending any time soon, the company is likely to suffer from lower operating leverage and weak margins. Following the sharp 20 per cent fall in revenue in the June quarter, analysts have downgraded the company's estimated earnings for the current year and next. The Street does not expect any improvement in the company's order inflows and revenue growth.

For the past seven quarters, BHEL has seen revenues fall, which has led to operating margins declining to multi-year lows of 4.2 per cent. Goldman Sachs has cut the company's earnings estimate by 12 per cent, 13 per cent, 17 per cent over FY15-17 on weak execution. The brokerage has cut order inflow estimate for FY15 to Rs 32,000 crore from Rs 38,000 crore. Hence the 12-month target price, based on 15 times FY18 price/earnings discounted back, has been cut to Rs 238 (from Rs 275).

While future order flows are a concern, there is stress in the current order book as well. The company has a current order book of Rs 97,400 crore, of which orders worth Rs 12,000 crore are slow moving . Prabhudas Lilladher says 12 per cent of the order book, which include names like Indiabulls, Visa Power, Monnet Ispat, Abhijeet Power and Bajaj Hindusthan, are impacting execution. Even as the company believes it has a strong position in near-term orders (4 Gw), analysts expect margins to come under pressure on heightened competition. ICICI Securities expects monetisation of current order-book to witness issues. Hence, the brokerage does not expect execution and profitability to pick meaningfully in near- to mid-term. Even if ordering improves, analysts do not expect significant improvement in margins, as competition remains strong.

The stock has moved up 43 per cent over the past six months on hopes of reforms in the power sector. According to Prabhudas Lilladher, a pick-up in ordering in the power sector is likely to take time. The brokerage believes muted order inflow and a reducing backlog will lead to negative operating leverage on expanded capacities and a high competition will impact margins. The company also faces higher risk of rising bad debt on account of slow moving orders.