Bhel’s turnaround in order flows may be a flash in the pan

After dismal order flows of less than Rs2,000 crore each in the first two quarters of the current fiscal year, the country’s largest public sector power equipment maker Bharat Heavy Electricals Ltd (Bhel), sprung a pleasant surprise with order flows of about Rs12,000 crore in the December quarter. Even better, it matched analysts’ revenue and profit expectations.

Although the stock rose by 1.6% on Thursday on favourable news and a positive mood on the Street, it may be too early to rejoice. After all order flows are lumpy in this sector and the third quarter accretion maybe a flash in the pan. On a cumulative basis, the nine-month order flow of Rs15,750 crore in fiscal year 2018 (FY18) is sharply lower when compared to the year-ago period. Therefore, Bhel would have to ramp-up orders in the fourth quarter to be able to sustain order flow growth and keep the order book at the current level of Rs1.02 trillion.

All this fuss about order flows is justified given that the company has steadily seen revenue falling (see chart) due to poor orders coming in from the power sector, which accounts for about 80% of its revenue. Moreover, a year back, a significant portion of the company’s order book was slow-moving.

After notching up Rs47,963 crore in FY12, Bhel’s annual revenue steadily declined to Rs28,222 crore in FY17, leading to a fall in profits and drop in the stock price that consistently underperformed benchmark indices.

So, the 5% year-on-year jump in net revenue during the December quarter that along with stringent cost-control measures translated into an operating profit growth of 32% was a welcome change. This was in spite of a 53% jump in other expenses that was due to higher one-time provisioning.

Further, the management (in the conference call) appeared confident of raking in strong orders in the current quarter, which should see the year pull through a strong order book at the end of FY18.

In fact, Bhel’s stock performance would hinge largely on order flows in the forthcoming quarters. Will the power sector that is weighed down with overcapacity dish out large orders for firms such as Bhel? If not, will the government take steps to resuscitate this behemoth by a strategic shift into new areas?

Another critical factor is the company’s profitability. The December quarter’s operating margin of 4.5% came nearly 100 basis points higher than the year-ago period, but has not been consistently improving. Large orders that got stuck for want of liquidity or clearances or even stalled projects, can adversely impact the profit margin.

In other words, consistent order flows and profitability are the need of the hour for investors to gain confidence in Bhel. At Rs95, the stock trades at about 19 times estimated FY19 earnings, which although expensive may look reasonable if the company can ramp- up net profit as it did in the December quarter.