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Hitachi Energy’s 3QFY24 result was weaker than our expectations. The company reported 23%/72%/401% YoY growth in revenue/EBITDA/PAT on a low base of last year. Revenue growth was supported by a strong order book, while margin improvement was driven by moderating supply chain issues. EBITDA margin remained flat QoQ. We expect the company to be a key beneficiary of the uptick in spending across transmission, renewables, data centers, as well as the railways. We also expect its strategy to grow the share of services and exports to aid margin improvement. We roll forward our valuation to Mar’26 and revise our TP to INR4,500. The stock is currently baking in the possibility of potential HVDC wins as well as margin improvement. At 86x/54x P/E on FY25E/FY26E earnings, it is trading at a 20% premium to Siemens and at a 10% discount to ABB on FY26E. We retain our SELL rating on the stock and would look for better entry points. The key risk to our recommendation would come from sharper-than-expected improvement in margins over the next 1-2 years.

Miss on all parameters

Hitachi Energy’s 3QFY24 result was below our expectations due to lower-than-expected ramp-up in execution and weaker-than-expected margins. Revenue grew 23% YoY, driven by a healthy order book of INR75.5b. The order inflow during the quarter moderated sequentially to INR12.4b, due to an exceptionally large order awarded in 2QFY24. Gross margin contracted ~540bp YoY to 35.1%, while sequentially it was flattish. The staff cost stood at 9.5% of sales and was largely flattish both YoY and QoQ; it was in line with the past quarter trends. Other expenditure declined 470bp YoY to 20.2% of sales. EBITDA margin was at 5.3% in 3QFY24, up 150bp YoY, led by easing of supply chain issues and moderation in other expenses; however, margins were largely flat sequentially. Interest expenses grew 5% YoY, while other income declined 69% YoY. PAT grew 401% YoY, due to the low base of last year and was driven by moderating supply chain issues. However, it was sharply below our estimates.

Will be a key beneficiary of the strong order pipeline

Order inflow during the quarter stood at INR12.4b, flat YoY. Data centers and renewables contributed significantly to the orders, while transmission and rail segments remained flat. Service orders were up by over 70% YoY, led by utilities and industries. Export order inflow grew by more than 60% YoY, on the back of transformers and HV products. The European and African markets drove the ordering for transformers, while demand for power quality solutions drove the ordering from LatAm, Africa, the US and Europe. The order pipeline is strong, and we expect Hitachi Energy to be a key beneficiary of this order pipeline across HVDC projects, renewables, data centers, and transmission projects both in domestic and international markets. Feasibility studies for the Leh-Ladakh HVDC project are likely to get over by Mar’24, and the finalization of Badla HVDC is expected in 1-2 months.

 Improving exports & services, and easing supply chain issues to augur well

The share of exports and services has improved to 25% and 10% of the order book, respectively, at present with incremental orders generating from both segments. Exports have also reached 30% of sales for 9MFY24. The company has now been able to manage supply chain issues related to chip shortages that it was facing over the last few quarters. Revenue recognition from the Mumbai HVDC project will also start ramping up from 4QFY24, and this project is likely to be completed by Jun’25. We expect an improving share of exports & services, and an execution ramp-up to provide operating leverage benefits to the company, thereby supporting margin improvement in the coming quarters.

Further improvement in margins is awaited in the coming quarters

We expect a margin improvement of 10% by FY26 to be driven by ~190bp improvement in gross margin during FY23-26, and ~290bp improvement in other expenses over the same period. Though there is still a component of IT fees paid to the ABB Group (0.7% of sales for FY23), which will get over by 1HFY25, there will be a corresponding spend by Hitachi Energy once it shifts the systems on its own. The total payment (royalty, tech fee, trademark fee, IT, and group management fee) by Hitachi Energy to the group companies remained high and stood at 8.7%/6.8% for FY22/23. Hence, operating leverage and the increasing share of exports & services play a big role in shaping up the margin trajectory.

Financial outlook

We expect Hitachi Energy's sales/EBITDA/PAT to post 19%/48%/68% CAGR over FY23-26. We bake in a gradual margin improvement for the company to 10% by FY26E led by better gross margin and operating leverage benefits. This would enable the RoE to expand sharply to 22% by FY26E. We expect OCF/FCF to improve over the next three years on an improved working capital cycle.

Valuation and view

The stock is currently trading at 86x/54x P/E on FY25E/FY26E earnings. This is trading at a 10% discount to ABB and 20% premium to Siemens on FY26 estimates. Though we believe that the company is ideally positioned to participate in a strong prospect pipeline on renewables and can potentially win HVDC orders in upcoming tenders, the stock price is already factoring in these potential positives. Our EBITDA margin estimate of 10% by FY26 from 9MFY24 levels of 4.7% also factors in the corresponding reduction in other expenses from lower related-party royalty and tech fees. We roll forward our valuation to Mar’26 and maintain our SELL rating with a revised TP of INR4,500 (INR4,150 earlier). We would look for better entry points in the stock.

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