BHEL: Recovery still some time away

Weak order execution and margin pressures, which have been looming over power and industrial equipment maker BHEL, led to disappointing results in September '15 quarter (Q2) as well, significantly impacting its stock. BHEL's share price has fallen 17% in the last one month and touched a 19-month low on Tuesday.

While the UDAY package for reviving the financial health of state electricity boards (SEBs) as well as price renegotiation with RasGas (that could lead to lower prices of imported gas) are positives for industry, the near-term outlook for BHEL remains muted.

Sluggishness in order clearance due to customer delays and increased share of implementing orders with longer execution cycle impacted BHEL's revenues which fell 3.4% year-on-year to Rs 6,193 crore in Q2, the 12th consecutive quarter of revenue decline. Pressures from competitive pricing and a near 11% increase in raw material cost due to increase in content of imported raw material, saw BHEL post loss at operating level. Share of super critical orders, or orders which require BHEL's technology collaborator to guarantee the performance of equipment, has increased from 55% in FY15 to 65% in FY16.

BHEL, which collaborates with Alstom and Siemens for super critical equipment technology, is bound by a Joint Development Undertaking (JDU) which makes it mandatory for BHEL to source critical components from technology collaborators. With the management of BHEL indicating that share of super critical orders likely to remain at current levels, margins may remain under pressure.

"BHEL plans to tackle these pressures by pursuing aggressive volume growth and expanding market share to 70-75%. While this may well lead to high sales growth in FY17/18, we fear EBITDA margins may settle at 9-10% as the new normal (from 16-18% at peak). FY16 earnings will remain weak as new order execution shifts to FY17/18," said JM Financial's analysts earlier this month.

It was the other income at Rs 373 crore (up 90% year-on-year) that restricted the net loss at Rs 205 crore.

That apart, 83% year-on-year decline in order inflow for Q2 was another significant let down. But, the trend may change soon. BHEL is lowest bidder for 8.3 gigawatts (GW) of orders. It is also targeting another 4GW of orders by end-FY16, and renegotiating contracts worth 1.4GW (Rs 2,500 crore). Overall, BHEL, which has secured contracts worth Rs 22,000 crore in H1'FY16 (up 60% year-on-year), has revised its order inflow for FY16 to Rs 50,000 crore (20-22GW versus 17GW earlier). Recent order wins worth Rs 4,500 crore from Andhra Pradesh SEBs suggest that it is well-positioned to achieve the targets. Analysts believe that rapid expansion in volumes and contract renegotiations should partly make good for erosion in Ebidta margins over the medium-term, while improvement in the health of SEBs and recovery from BHEL's debtors (Rs 37,000 crore) are long-term triggers.

While a recovery is expected from FY17, most analysts remain bearish/neutral as they believe the near-term gains are priced in given the stock's FY17 PE of 18.