Operating leverage kicks in for BHEL

Rs 78 cr profit ahead of estimates; biggest surprise is sharp decline in slow-moving orders

Bharat Heavy Electricals Limited (BHEL) took investors by surprise with its first quarter (Q1) results. Against Bloomberg estimate of Rs 4,368 crore, BHEL posted revenues of Rs 5,622 crore in the June 2016 quarter, up 29 per cent year-on-year (y-o-y). And, just as the Street was bracing for losses, BHEL closed Q1 with a net profit of Rs 78 crore; a 54 per cent y-o-y increase. This was without taking the help of other income, which at Rs 249 crore was down 49 per cent y-o-y in the June quarter. The Rs 41 crore of provisions written back in Q1 also helped.

What’s comforting is that gross profit (difference between revenue and raw material cost) margin was recorded at 37 per cent, in line with estimates, while operating margins at 1.3 per cent returned to positive zone in Q1. Consequently, BHEL’s stock saw its highest single day spurt of 15 per cent in Wednesday’s trade. Despite BHEL’s stock delivering 50 per cent gains in the past three months, analysts feel the positive management commentary on slow-moving orders will further fuel the rally.

Three key projects totalling Rs 35,600 crore (30 per cent of order book) which until now were classified as slow-moving could start contributing to BHEL financials in the coming months. With this, the share of slow-moving orders will fall from 40-45 per cent in the past few years to 10-11 in FY17. This should lead to a further improvement in operational performance. Consequently, operating margins, too, might recover by Q3 of FY17, although reclaiming the historic 22-25 per cent might not happen in a rush.

As the operational outlook improves starkly, Rohit Natarajan of IDBI Capital says there could be a huge delta (upward revision) in BHEL’s earnings estimates. Analysts, thus, expect a re-rating in BHEL’s stock. The order book as on June 30, 2016 stood at Rs 1,08,000 crore, providing earnings visibility for at least four years. There are concerns, too. High debtor levels — a huge pain point for BHEL — reduced by Rs 1,600 crore to Rs 34,000 in Q1. While this is a positive, debtors of over 365 days remain stiff at Rs 6,000 crore. According to BHEL’s management, debtor pattern of this nature was the norm in the past and might continue to remain so. Analysts were expecting BHEL to post losses under the new accounting norms, which require companies to adjust their receivables to present-day value. Analysts say that with this adjustment not done in Q1, they do not rule out a possible write-down of debts in the subsequent quarters of FY17.

For now, the positive commentary could overshadow the concern on accounting norms.