Despite increased competition, we expect Bharat Heavy Electricals Ltd (Bhel) to maintain at least 50% market share in India’s thermal power capacity addition in the medium term. We believe that new entrants are likely to occupy the space vacated by overseas firms. After capacity expansion to 20GW by end FY12, Bhel will control around 10% of global thermal capacity addition; and Bhel’s capacity will be on a par with many Chinese firms. This will provide sizeable cost advantages, which will be difficult for a new firm to replicate initially.
This, we believe, will enable the company to sustain or even improve margins in the medium term.
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We expect robust order intake during the next 12-18 months, driven largely by supportive equity markets, which will enable financial closure for projects in the private sector. The National Tariff Policy stipulates that Central and state sector companies award projects by 11 January for being eligible for Central Electricity Regulatory Commission methodology of tariff determination. Also, bulk ordering of 11 supercritical sets by NTPC Ltd and Damodar Valley Corp. is expected in the first half of FY11.
A change in the visa norms stipulates that Chinese workers coming to India on business visa cannot seek employment. As per reports, at least 3,000 Chinese technicians have left the country. Thus, this stance taken by the government increases the uncertainty for private developers to award incremental projects on engineering, procurement and construction basis to Chinese suppliers.
For FY09-12, we expect Bhel to report earnings compounded annual growth rate (CAGR) of 28%, in line with revenue CAGR of 28%. For FY12, we estimate net profit at Rs7,480 crore, (14% above consensus).
Adjusted earnings before interest, tax, depreciation and amortization (Ebitda) margin expanded by 167 basis points (bps) during FY09-12.
This is despite a 505 bps reduction in staff costs as a percentage of revenues. Thus, we have factored in possible liquidated damages and impact due to lower margins on initial supercritical projects, among other things.
Other income CAGR will only be 3.3% till FY12, given decline in customer advances as execution improves and order intake stagnation. We have calculated working capital at 13.4% of revenues in FY12, against -6.7% in FY09, largely due to lower customer advances.
We are concerned about stagnation or decline in order intake from the power segment for Bhel, which would affect the long-term (beyond FY13) growth profile. The concern is due to two factors. One, average order intake of 15.4GW per annum in FY08-10. Two, targeted 12th Plan (FY13-17) capacity addition at 100GW, of which Bhel’s market share is expected at 50-60%. Thus, order intake per annum should stabilize at 10-12GW in FY12-13 and, possibly, grow in line with electricity consumption, thereafter.
Based on our earnings estimate, Bhel quotes at PER of 26.4x estimated FY10, 20x estimated FY11 and 15x estimated FY12. We upgrade the stock to buy with a price target of Rs2,752 per share (18x estimated FY12).