Improving working capital, project execution key to rally in BHEL's stock

Bharat Heavy Electricals Ltd (BHEL) is India’s largest engineering and manufacturing enterprise, operating across energy, industry, and infrastructure sectors. The investment path for the stock is based on a large order backlog, continued strong order inflows, and rising power demand, which should push demand for BHEL’s equipment and services.

BHEL has historically held over 70 per cent market share in power projects. In addition, it has new revenue streams from railways (Vande Bharat train sets), pumped-hydro storage plants, domestic defence production, nuclear steam turbines, and potentially in areas like coal gasification. However, it has issues with very high receivables and there is also a question mark about its capability to improve speed of execution.

By September, it had over Rs 1.1 trillion backlog orders, which is roughly 6 times its annual sales. But it also has close to 580 debtor days. This implies it could have an upcycle of several good fiscal years but it must find ways to collect receivables. Analysts expect raw material costs to ease. This should lead to a turnaround which is why the stock is performing well.

BHEL reported consolidated net revenues of Rs 5,100 crore (down 1.5 per cent year-on-year or Y-o-Y) during the July-September quarter (Q2) of financial year 2023-24 (FY24). It reported an Ebitda loss of Rs 390 crore versus a loss of Rs 240 crore in the year-ago period. The rising losses at Ebitda level was partly due to higher raw material costs. Major order wins in Q2FY24 include the 2x800 MW Lara super thermal power project (STPP) from NTPC, 2x800 MW STPP Bandhaura, Mahan from Adani Power, and 12x240 MW Dibang multipurpose hydropower project from NHPC. Currently, around 25 gigawatt (GW) of thermal power projects are under construction and another 25GW of projects are under tendering, and the Ministry of Power has indicated an additional requirement of 30GW of projects.

A rise in debtor days to 581 in Q2FY24, from an already high 567 days Y-o-Y has led to stresses on the working capital cycle.

Some of its ongoing projects under construction have back-ended payment terms which add to working capital stress. However, upcoming projects have better payment terms.

The contribution to revenue from the (non-power sector) industry segment is 20 per cent for Q2FY24. The outstanding order book for the industry is around 24 per cent of total order book. BHEL’s entry into Vande Bharat train sets, large pumped-hydro storage plants, naval guns, and other defence equipment, will push the company’s diversification.

It is unusual for a stock that has registered rising losses to see a sharp rise in price, but BHEL is up 95 per cent in the last 12 months on the expectation of a turnaround. The stock scaled to a record high of Rs 157.70 in intra-day trade on the BSE on Tuesday, before closing 2.56 per cent higher at Rs 156.15.

The upside is fairly obvious - visibility of several years’ worth of orders and better payment terms which should lead to less working capital issues and much stronger margins. However, the company has to accelerate its project execution speed considerably and will need to work to reduce debtor days from the current extreme levels. Most analysts are positive on the stock but the price has risen to the point where the turnaround may be discounted.