 "B P Rao")
On the surface, it looks like a perfect setting for a revival even as Bharat Heavy Electricals Ltd, or BHEL, is battered by major financial woes. A historic slump in fresh orders amid rising competition, incessant delays in execution and huge receivables from customers have hit revenue growth and pulled down annual profits to a decadal low for the country's largest power equipment manufacturer. So, when the firm bagged a Rs 7,900-crore order from the NTPC Ltd last month for supplying India's first high-end power generation sets and that too through international competitive bidding, it was a welcome surprise.
This comes on the back of other positives too: a strong focus on cost cutting to save margins, expanding vendor base, minimising employee cost, design optimisation to suit the customers and an elaborate diversification drive in non-core areas to sustain cash flow by offsetting the slump in activity at new power projects. The overall strategy to beat the slowdown has been in the works for quite some time and the green shoots of revival have started appearing - the company has emerged as the lowest bidder for power projects of an estimated 8,000 Megawatt (Mw) of the total 17,000 Mw being finalised. No wonder, then, BHEL's stock has jumped 83 per cent on BSE from its 52-week low of Rs 100.35 on August 20 last year to Rs 182.90 on Thursday. In the same period, the benchmark Sensex gained 20 per cent.
But is this enough? Would the strategy of waiting for activity on power projects to revive and relying on measures like cost cutting and diversification in the interim, suffice to help the public sector giant regain its market share that is being fast clawed by technologically advanced and low-cost Chinese and Korean manufacturers? The answer depends on how deep are the real financial woes of the company. At least two key issues merit consideration here - the company's diversification drive and huge outstandings due from customers.
Following the introduction of the power-sector reforms in 2003 that kicked off an exponential growth in power capacity addition, BHEL benefited from high volumes in a monopoly market. Over the next decade since, earnings have grown at a compounded annual growth rate of 36 per cent to touch Rs 6,614 crore in 2012-13. A growth of 21 per cent has taken revenues to Rs 49,546 crore. BHEL has been spending most of its cash in two areas - dividend payments and expansion of manufacturing facilities. The company has spent over Rs 8,900 crore in the past decade to expand its manufacturing capacity by 15,000 Mw per annum. A bulk of this capacity growth through brown-field expansion has paid off for the company.
Slow to diversify
The strong capex cycle is one of the key reasons BHEL did not focus much on diversifying, according to equity research firm Barclays. "In the past decade, the company has spent only 2 per cent of its operating cash flow generated in long-term investments. The low allocation largely reflects the company's slow pace of diversification," Barclays says in its latest report on the capital goods sector. It adds that even the current diversification attempts are low quality diversification efforts. "BHEL is investing in businesses which we view as having weak return on equity (RoE) potential. Investing in power plants, metro coach business and solar business are all poor uses of cash."
Among the chief concerns of the company today are dues of around Rs 40,000 crore from customers. Data suggests that this is not new for the company and historically, too, receivables have been high, given the huge exposure to public sector orders. But earlier the company was able to offset its negative impact on cash with advances received on new orders. With the drying up of new orders now, mainly due to the slowdown in the power sector, the cushion of advances has been affected. While on the one hand receivables have jumped over the years, advances from fresh orders have declined.
BHEL did not respond to a detailed questionnaire from Business Standard seeking comments. A senior company executive, however, said the company is willing to enter into newer areas of high-margin business. "Solar or metro business might be low margin but there is enough market in these fields. Besides, these businesses are related to our core businesses. Although if something more lucrative comes up, we will jump into it," says the executive.
Securing business
The company has just signed an agreement with five other PSUs to float a joint venture for setting up the country's first solar-based 4,000 Mw Ultra Mega Power Project in Rajasthan. BHEL has a 26-per cent stake in the Rs 30,000-crore project. "The objective of the investment is to get equipment business for BHEL. It is the same philosophy [with which] we entered joint ventures in the past with power-generation companies," Chairman and Managing Director B P Rao had said in a post results conference call on February 5.
Experts say solar cell manufacturing has been in tough terrain primarily due to the fast pace of technological changes. "Several players that established the manufacturing units have shut shops due to financial distress, some of them located in special economic zones are eligible for fiscal incentives. Margins are under pressure in this segment," says Dipesh Dipu, associate professor-Energy, Administrative Staff College of India. He adds that external markets, particularly Africa, may hold the key for future growth of BHEL.
Going forward, the silver lining for BHEL lies in the signs of a pickup in the public sector orders, including the large order from NTPC. This accounts for a bulk of its business. Also, there has been a continuous reduction in cost of materials, which constitutes 70 per cent of the overall annual expenses of Rs 40,000 crore, in the past three years despite the decline in per Mw sale price of power equipment. Cost of materials consumed as a percentage of sales declined from 61 per cent in 2011-12 to 58 per cent in 2012-13 and further to 56 per cent in the first nine months of the current fiscal. According to Dipu, BHEL may have been impacted by the slowdown in the sector, causing lower equipment bookings, but the company will benefit in the long run as power demand picks up.
