Diversification helps L&T score over BHEL

With power sector woes far from over, analysts expect L&T to outperform going ahead

L&T’s diversification has worked well in the current difficult times whereas BHEL has been impacted due to its fortunes being strongly linked with the power sector. This is also reflecting in their share prices and performance for the September 2012 quarter. Given that the trend in unlikely to change any time soon, analysts believe L&T will continue to outperform and the stock remains their preferred pick in the capital goods space.

L&T’s diversification gains
Both L&T and BHEL are known for their strong execution capabilities. However, the woes of the power sector and slowing economic growth are reflecting visibly on BHEL’s performance. In spite of its huge order book, BHEL could hardly convert these into revenues due to client side issues (including lack of fuel and policy clarity). Over the last four quarters, the company’s revenues have remained flat.

And if analyst estimates are any indication, revenues for the current financial year are expected to remain flat or could even decline marginally. L&T, too, is facing its share of problems, but it is still in a better position given the business diversification. About a quarter of L&T’s order book comes from the power sector as against about 80 per cent in the case of BHEL. That apart, L&T has better mix of public/private sector clients along with relatively higher proportion coming from the export markets. “In our view, presence of L&T in diverse business opportunities ranging from heavy engineering, construction, power, machinery and industrial products, etc lends it a great benefit of diversification. It de-risks L&T’s business model from slowdown in any particular industry, which makes it one of the best options in capital goods space to play the anticipated policy rate easing and consequent decline in cost of capital theme,” says Misal Singh, director institutional research, Religare Capital Markets.

No wonder, BHEL saw its new order inflow decline by 78 per cent year-on-year in the September quarter, while L&T reported a 30.3 per cent growth as a result of better inflows from construction, hydrocarbons and industrial sectors.

BHEL: Balance sheet issues
The trend in new orders and progress of existing projects is bound to reflect on growth visibility. Currently, BHEL has an order book of Rs 122,000 crore or about two and a half time its current turnover. Whereas L&T has an order book of Rs 158,000 crore, which is equal to three times its standalone turnover. If one adjusts for the orders that face the risk of delay/cancellation in the case of BHEL (a significant risk feel analysts), L&T has got higher visibility. BHEL’s management, too, has indicated that existing orders from the private sector could face execution delays at the customers’ end.

DIVERGENT TRENDS
In Rs crore	BHEL	% change	L&T	% change
Order book	122,300	-24.0	158,528	11.0
Order inflows	3,153	-78.0	20,967	30.3
Execution rate (q-o-q)	13,853	NA	15,539	NA
Order book/revenue (x)	2.6	NA	3.0	NA
Power as % order book	80.0	NA	25.0	NA
Revenues	10,400	1.0	13,195	17.3
Opertaing profit margin (%)	18.0	200 bps	10.7	30 bps
Net profit	1,275	-0.1	1,137	42.0
% change is year-on-year Source: Analyst reports

Besides, analysts are also watching the balance sheet issues that are cropping up for BHEL. For instance, inventory levels are rising and clients are delaying their payments (debtor turnover ratio in FY12 at 264 days as against the 241 days in FY11), leading to higher working capital requirements.

In 2011-12, the additional working capital requirement (trade receivables plus inventory minus trade payables) more-than-doubled to about Rs 8,000 crore compared to 2010-11. In fact, for the first time in many years BHEL reported a negative cash flow from operating activities in FY12—cash balance also fell 30 per cent to Rs 6,700 crore. “Due to slowdown of order inflow and increasing exposure towards working capital intensive EPC, BHEL’s working capital has come under pressure. But, for L&T the risk is different. It’s order inflow is growing but orders are not like BHEL orders, so advances from these orders are certainly supporting the increasing working capital requirements of L&T. Also, L&T has the cushion of monetising its SPVs when time requires to meet its working capital requirements. This comfort BHEL hardly enjoys,” says Rabindra Nath Nayak, who tracks the firm at SBICAP Securities.