Ample replacement order opportunity can perk up BHEL

CEA identified power generation plants that need replacement to comply with new environmental norm

In an otherwise quiet day of trade, BHEL's stock was among the top gainers, up about 4.4 cent reacting positively to the Central Electricity Authority (CEA) observations. The government body has identified power generation plants with capacities totalling to 72 gigawatts (GW) which need replacement to comply with the new environmental norms notified in December 2015. One GW is 1,000 megawatts.

The new norms specify for reduced sulphur dioxide and nitrogen oxide emissions among others. To be compliant with these norms, the power plants need to install flue-gas desulfurisation units. However, given certain constraints, the CEA has identified about 72GW of power plants where installation of this unit is not feasible and hence these plants need to be refurbished to meet the emission norms.

Failure to do so may result in a shut down or phasing out of the plants. Therefore with CEA identifying the plants which require refurnishing, it provides an opportunity for BHEL, the country's largest power equipment maker, to strengthen its order book. It comes at a time when the order inflows for Greenfield thermal plants are thinning. It would also cushion BHEL's financials which is just about beginning to normalise after a very dismal FY16 performance.

Analysts at Jefferies note that the new emission norms may restrict the thermal power plant market to 4-5 players, where BHEL should take a reasonable share. The current order book of BHEL stands at Rs 98,400 crore and analysts at Macquarie believe that only Rs 55,000 crore of the order book may be executable for now.

Nonetheless, they also believe that the likely revenue potential for BHEL (including replacement demand) at Rs 32,500 crore could surprise and exceed the current analysts' expectation. BHEL's management has guided for 12-15 GW of order inflows in the FY18.
 

This includes replacement orders as well. Strong order inflow is important to support the improvement in financials which gathered momentum in December quarter. While revenues grew by 19 per cent year-on-year to Rs 6,325 crore, operating profit margins (which fell to the negative zone in FY16) rose to 3.5 per cent in December quarter. Compared to the peak operating profit margins of 11-15 per cent, the current levels still look weak, but nonetheless it at least infuses optimism on strong improvement in order execution.

The immediate monitorable for now, is how close BHEL is to bagging the 4,000 megawatt Yadadari thermal plant order, where environmental clearances is a concern. While clarity on this is expected in the coming months, a positive outcome could improve the upside for BHEL's stock. Now trading at 24x FY18 earnings, BHEL trades at a discount to BSE Capital Goods index trading at 30x FY18 earnings.