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Behemoth to Live On JM Financial Institutional Securities Limited JM Financial Research is also available on: Bloomberg - JMFR , Thomson Publisher & Reuters, S&P Capital IQ, FactSet and Visible Alpha Please see Appendix I at the end of this report for Important Disclosures and Disclaimers and Research Analyst Certification. With the opening up of 60GW of opportunities amidst limited competition, BHEL is poised for the next cycle of growth and performance, a situation previously seen during the first decade of the 2000s. The concurrent emergence of non-thermal power opportunities (pumped-hydro, nuclear, spares) and gradual scaling up of the industry business kills the commonly held view of zero-terminal value of the thermal business and its implications for the company. Changing our valuation methodology to SOTP-based considering the tapering of thermal business beyond 2030 and industry business – following growth in the non-power business – we expect the company to deliver Revenue/EBITDA/PAT CAGR of 35%/127%/145% over FY23-26E supported by healthy ordering, improving execution and the benefit of operating leverage. We maintain a BUY rating on the stock with an SOTPbased TP of INR 225, indicating a potential upside of 15% from current levels.

? How big and real are the current opportunities? The demand for power in India continues to grow (7MFY24: energy/peak, 8.5%/12.7%) - significantly higher than all earlier growth rates (FY05- 15/FY15-20: energy/peak, (6.1%/5.4%)/(3.9%/4.4%)). Amidst this, supplies remain constrained, leading to a rebalancing of energy strategy between energy security and sustainability. Presently 27GW of thermal power projects are under construction, 12GW have been bid out, 19GW are under clearances and another 30GW are at the planning stage with a target of adding 88GW by FY32.

? Is BHEL the only player in the market? In the earlier cycle, in addition to BHEL, other manufacturers had a combined capacity of 9-11GW. However, in the recent bids ( 2x800 MW NTPC Singrauli-III, 3x800 MW NLC Talabira STPS, 1x800 MW DBCR TPP Ext, Yamunanagar, Haryana), BHEL is the only bidder as per the industry sources.

? What is the best-case scenario for capacity addition? India will need to add 6-7GW of capacities every year for a net addition of 87,910MW of power generation capacity by FY32. BHEL commissioned a maximum of 12,215 MW of thermal power projects in FY16.

? What is the visibility of improvement in margins? The company has INR 70-80bn of fixed expenses, constituting the cost of manpower, part of miscellaneous expenses and others. With increasing execution rate, we believe that the high operating leverage and limited competition will improve EBIT margin in the power business from FY25 onwards – from 8% in FY23 to 18%/ 21% in FY26/ FY29 – like it did in the earlier cycle (22%/ 25%/ 24% in FY06/ FY08/ FY10).

? Is the terminal value of the power sector zero? By 2030, 50GW of thermal capacities will exceed their design life requiring retirement/ replacement/ major R&M. Further, scalable opportunities in non-thermal power – pumped-hydro power (akin to hydropower, where BHEL has around 45% market share); nuclear power (48% market share; likely to play an active role in Small & Modular Reactor technology) and spares & services (to grow at least 2x by FY30) – are likely to significantly compensate gradual tapering of thermal opportunities.

? When will the account receivables moderate and cash position improve? Trade receivables/ contract assets were at INR 74.93bn/INR 301bn as of 30th Sep’23 vs. INR 65.44bn/INR 297bn as on 31st Mar’23. With the commissioning of 20GW of under-construction projects in the next 12-18 months, we believe stress on receivables will ease Mar’25 onwards. The decrease in debtor days along with better payment terms (minimum 10% advance) will translate into 44% CAGR in the cash balance during FY23-26 vs. -10% CAGR during the preceding 5 years.

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