FPO, slowdown in orders cloud BHEL's future

Though current valuations look reasonable, the stock will remain under pressure unless the recent trend of a decline in order inflow reverses.

Despite the 28 per cent fall in the share price of Bharat Heavy Electricals Limited (BHEL) in the past year and the fact that the stock is trading at historically low valuations, analysts believe it could witness further pressure. They say it is due to the coming follow-on public offer (FPO) and worry on the outlook for the Indian power sector.

The news of the FPO had a negative ruboff on BHEL’s share price, down by three per cent in the last two trading sessions. Analysts say there are expectations that the FPO price would be lower than the current ruling share price, in addition to the five per cent discount that retail investors could get.

“In our view, the FPO will remain an overhang on the stock – investors would wait to see the pricing of the FPO before entering the stock,” says Ankur Sharma, analyst at MF Global Sify Securities, in a recent note on the company. The stock is currently trading at 13 times its 2011-12 earnings, and reflects the cut in earnings’ estimates and lower growth. While the valuations look reasonable, in light of the FPO and the recent slowing in order inflow and revenue growth, a trend reversal is unlikely to happen soon.
 

SLOWING GROWTH
in Rs  crore	FY11	FY12E	FY13E
Revenue	42,246	47,958	50,806
Ebitda (%)	20.3	20.6	19.3
Net profit	6,011	6,732	6,717
EPS (Rs )	121.2	137.5	137.2
PE (x)	14.1	12.4	12.4
P/BV (x)	4.1	3.4	2.8
E: Estimates                  Source: HSBC Global Research

The Cabinet Committee on Economic Affairs has approved the sale of a five per cent government holding in the power equipment major. The FPO, slated around Diwali (in October) this year, is expected to fetch the government around Rs 4,000-4,300 crore, based on the current ruling prices. After the issue, the government’s holding would drop to 62.7 per cent or about Rs 53,300 crore at current prices.

SLOWDOWN
The upcoming FPO would not have any impact on earnings. However, the bigger worry in terms of growth outlook remains, on account of the overall slowing in the capital goods space, particularly in power equipment. Part of this is reflected in the company’s first quarter results. It reported lower than expected growth in revenue at just about 10 per cent, as about Rs 500-600 crore receipts were delayed due to logistic-related challenges. More noticeable was the fall in order intake, which dived 77 per cent to Rs 2,500 crore as some of the larger projects such as those of NTPC, Rajasthan SEB and one from an IPP (Independent Power Producer) got deferred by a few months.

EARNINGS PRESSURE
After the results and considering the industry-wide slowing, analysts have cut the order intake expectation for the current and next years. This reflects their view on the issues haunting the power sector such as land acquisition, funding (higher costs) and fuel (security and costs), which could remain in the focus for some more time. This will also put pressure on the earnings. For instance, in a recent report on the company by HSBC Global Research, analysts said they’d cut their estimates for revenue by four to six per cent and earnings per share (EPS) by six per cent for 2012-13, on the reduction in order inflow estimates. Also, they expect an annual EPS growth of three per cent over 2011-14 versus 29 per cent annual growth over 2008-11.

As the earnings visibility is shrinking, the valuation multiples are also being lowered. “We have reduced the two-year forward PE (price to earnings) multiple on the company from 17 times to 16 times, as the order inflow has gone substantially below our expectations of Rs 8,000 crore. Also, we have reduced our two-year forward EV to Ebitda from eight times to seven times,” says Rabindra Nath Nayak, senior analyst at SBI Cap Securities.

Meanwhile, the company’s current order book is robust at Rs 1,59,600 crore or about four times its 2010-11 revenue. In the current year, analysts are expecting revenue growth of 12-14 per cent, with similar growth in earnings. However, while valuing a stock such as BHEL, the flow in new orders, which helps indicate the long-term growth trajectory, gets higher importance. Analysts say pressure on the stock will, thus, remain until the current weak trend in new orders reverses for the better.