Concerns far from over for BHEL

Analysts are worried about deteriorating working capital, depleting cash balance, pressure on margins and execution delays, which may result in an 8-10% fall in earnings in FY14

The Bharat Heavy Electricals Ltd (BHEL) stock, which is trading near its seven-year low, is viewed as a contrarian investment by many market experts as they believe that at some stage the company’s growth rates will improve and concerns will ease. However, it appears the contrarians might have to wait longer, as none of these are likely to materialise any time soon.

BHEL, which reported slightly better-than-expected (provisional) numbers for FY13 on Monday, has also seen some uptick in the order intake. However, most analysts are still cautious because of the challenging outlook.

Deteriorating working capital, depleting cash in the books, falling operating profit margins, slowdown in demand, lower order book and execution issues because of client side delays are key concerns for the company.

In terms of valuations as well, although the stock trades at just 7.5 times FY13 earnings, due to the lower earnings expectations, it will result in higher PE of 10 times for FY14 and 13.5 times for FY15. In this backdrop, the stock is expected to remain under pressure despite the underperformance in the last one year.

Meanwhile, for the March quarter, the company’s order intake came at Rs 20,900 crore, which is much higher than analysts’ expectations of Rs 14,000-16,000 crore. For the year ending March, BHEL booked Rs 31,528 crore of new orders, taking its order book to Rs 1,15,000 crore. Though the order book stands at 2.3 time its FY13 revenues, it is still lower compared to its recent history. Also, within these orders, analysts believe there are sticky projects which have longer duration in terms of execution.

“The company reported a robust 42.6 per cent increase in order intake. However, slow execution on account of client deferrals (due to slowdown in investment cycle) and various problems in the power sector continue to remain an overhang on the stock. Also, we still expect BHEL’s margin to gradually decline over the next few years due to tough competition,” says Amit Patil, who tracks the company at Angel Broking.

No wonder, despite a large order book, the provisional numbers indicate a mere one per cent growth in revenue for FY13 and an eight per cent fall in net profits to Rs 6,485 crore. More important, the company is losing to competition in terms of pricing and costs, which should result in further fall in margins and profits.

“We think this is just the start of a bad earnings cycle for the company, as orders won during a time of rising competition and lower utilisation will have further impact on margins and working capital cycle. We are building in 180 basis point and 290 basis point year-on-year contractions in Ebitda margin in FY14 and FY15,” says Amar Kedia of Nomura Research, in a note.

Although manpower costs also increased in FY13, there are bigger concerns on the execution front which have led to deterioration in BHEL’s working capital and erosion in its cash balance.

“BHEL’s cash balance declined further to Rs 3,500 crore in the December quarter, compared to Rs 5,300 crore at the end of the September quarter and Rs 6,700 crore at the end of March 2012, as working capital pressures have sustained and advances continue to be weak,” wrote Sumit Kishore, analyst at J P Morgan, in his note on the company.

Due to execution issues and delays in payment, the company’s receivables have already reached around Rs 40,000 crore, huge on a turnover of Rs 50,015 crore for FY13. Although the management is expecting a reduction in receivables, analysts remain cautious, given the poor environment in the power sector.