Buy Bharat Heavy Electricals Ltd For Target Rs.29.5 - HDFC Securities
Bharat Heavy Electricals Ltd (BHEL) is an integrated power plant equipment manufacturer with a strong market share of 53% in installed capacity of conventional power (BTG: Boilers, Turbines and Generators) segment within India and presence in 84 countries around the globe. Till date, BHEL has installed around 11 GW power generating capacity in overseas markets. BHEL is one of the few companies in the world manufacturing the entire range of power plant equipment. It caters to all fuel types viz. Thermal, Hydro, Oil & Gas, Solar, and Transmission. Its business diversity in industries such as transportation, defence and emission control helps the company to mitigate segment associated risk.
Although, working capital needs are putting pressure over the net cash availability, BHEL’s focus on controlling material cost, focus on cash collection, and efforts on exploring new opportunities to diversify revenue streams should improve the situation. Order book remained unchanged (due to a tendency to postpone investment on COVID 19 related demand contraction) at Rs 1,09,000cr during FY20, same as FY19 with 81% being executable.
BHEL started to suffer from 2015 due to competition from China, overcapacity in power industry, slowdown in addition of power capacities and shift in focus to renewable source of energy. Even now most of these negatives continue to impact BHELs’ operations though threat of China competition has significantly reduced.
Policy support from government for Aatmnirbhar Bharat is encouraging as it has led to increased interest among various local manufacturers to indigenise critical components, which will in turn be beneficial for the company. Company’s prudence in taking strategic financial decisions, various initiatives taken in recent times, including “Make In India”, Collaborative Manufacturing, improvement in operational and execution efficiencies through implementation of IT based solutions for project monitoring, together will help in offsetting the adversities to come. However, given the ongoing challenges in the operating environment, timely execution of orders and realisation of receivables will be key monitorables.
Valuations and Recommendations:
High receivables had been a persistent problem for BHEL. In current environment, cash-flow of its major clients are weak and that will not help in solving the perennial problem. BHEL continues to trade at lower multiples than other engineering majors on account of this issue as well as lack of sufficient order acquisition visibility post execution of current order-book. The demand scenario in the BTG/EPC market is unlikely to materially improve in the next 1-2 years.
Reduced competitive intensity due to exit/reduced operations of a few players over the past few years may lead to better margin profile of new orders. With more retirements out of existing employee base over the next few years we expect EBITDA margin can improve but not dramatically.
BHEL earns low single-digit ROE for many years and has limited scope to meaningfully reduce its Net Working Capital in the near term. Its new initiatives in terms of contract manufacturing with global OEM will take time to show up in its financials.
We expect BHEL to stage a turnaround in FY22. We assign a P/E multiple of 14x FY22E EPS for calculating its fair value resulting in price of Rs.29.5 over the next two quarters.
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