When stringent cost-cutting catapulted net profit nearly 50% year-on-year in the March quarter of FY19, a ray of hope appeared for BHEL's investors. The stock vaulted in response and is now 22% up from the mid-May level. Nevertheless, it is trending down again — slowly.
Weakness in the power sector and limited capital expenditure (capex) in thermal power plants tripped the rally. Most brokerages have ticked off thermal capex as being in a long soporific state.
According to a JM Financial Services Ltd report, the next round of thermal capex is required only by FY23, implying another 24 months of stagnant order flows. Under-utilised thermal capacity, with 25 gigawatts (GW) stranded for want of power-purchase agreements and another 48 GW or so under construction, will take the plant-load factor up to 70-75% by FY25 (60-65% currently).
Unsurprisingly, BHEL’s order flows dimmed to ₹23,000 crore in FY19 from ₹40,900 crore in FY18. One hope is that many projects deferred due to elections in FY19 may see fruition in the current year.
On a positive note, the balance-sheet stress has been easing. Trade receivables receded slightly in FY19. Employee-benefit expenses have also stabilized after two years of increases.
Unfortunately, the drag from state electricity companies, which make up almost two-thirds of debtors, will not change soon. Also, a qualitative deterioration in customer profiles has been seen in the humungous order book of a little over ₹1 trillion.
The recent new orders pile pressure on working capital needs as they come with lower advances of 0-5% (10-15% earlier). So, a ramp-up in execution may bring revenue traction and the benefits of operating leverage. But the increase in working capital required and short-term borrowings may counter-balance these gains.
Fuelling the problem is heightened competition from domestic operators given the paucity of orders. “Even with peak inflows of 15–16GW a year, we see BHEL struggling to receive orders of even 7–8 GW, despite the assumption of a 90% market share.
This would lead to a sustained struggle to maintain margins with limited earnings-per-share growth potential," according to the JM report.
Analysts reckon that a gradual improvement in the Ebitda margin cannot be ruled out, though it would continue in single-digits (annual) for the next couple of years.
Given the over-capacity in the company and the sector, and BHEL’s lack of vision in diversifying risk, its market capitalisation plummeted nearly two-thirds to ₹25,437 crore, from a hefty Rs65,789 crore five years ago.
BHEL's return on equity has shrunk to between 2& and 4% from FY16 and FY18. Besides, to steer this power-sector juggernaut into new areas such as renewables would take a while. For now, the power switches for the stock looks to have tripped again.