Testing times ahead for BHEL

Performance to feel heat of slowdown in order inflows & rising competition

Despite better-than-expected results posted by engineering giant BHEL, analysts do not see any major respite for its share price. This is because structural issues in terms of slowdown in new orders, pricing pressure, increasing competition and oversupply in the industry remain. These will keep the pressure not just on growth in revenue, but also on earnings. Part of this is already reflecting in its financial performance.

On Wednesday, BHEL announced results for the financial year ending March 2012, wherein revenues grew a mere 13.7 per cent, almost half of the 26.7 per cent growth recorded in 2010-11. In fact, for the March quarter, revenues grew in single digit (up 7.5 per cent year-on-year) as compared to a y-o-y increase of 19 per cent in the December 2011 quarter and 23.7 per cent in the September 2011 quarter. This indicates that growth is slowing, a trend analysts believe may continue for a few more quarters as visibility is coming down.

BHEL’s order book has fallen and new order inflows have also weakened significantly, compared to the past year. As of end-March 2012, the order book of Rs 1,36,000 crore was 2.8 times its 2012-13 estimated revenue, much lower than its historical ratio of over three times. On top of this, there is a rise in proportion of slow-moving projects or projects where execution delays are expected, due to clients facing challenges related to availability of fuel, funding and clearances, among others. Analysts, thus, expect revenues to remain flat or decline marginally in FY13, as well as in FY14.

The outlook for margins, too, is not encouraging. For the three months ending March 2012, BHEL’s operating profit margins improved 275 basis points to 20.63 per cent. However, analysts say these gains are due to a 45 per cent decline in other expenses, which should otherwise have been higher, in line with growth in revenues. They believe margin gains are unlikely to be sustained and expect operating profit margins to slip 100-150 basis points over the next two years as pricing pressure continues.

Put together, these issues will cast a shadow on BHEL’s earnings, which are expected to come under pressure over the next two years. In this backdrop and despite the fall in valuations, most analysts remain cautious on the stock, which they believe could get re-rated only if issues (pertaining to state electricity board reforms, improvement in fuel availability and pick-up in new projects) in the power sector get resolved.