Bhel: more risk than reward

It is uncertain if “other expenses” would remain low in coming quarters. Management was unable to estimate rise in employee expenses due to Seventh Pay Commission award


Graphic: Santosh Sharma/Mint
Graphic: Santosh Sharma/Mint

Shares of state-owned power equipment maker Bharat Heavy Electricals Ltd (Bhel) zoomed 15% on Wednesday as its June quarter results beat Street forecasts. But ground realities have hardly changed to warrant such euphoria and there is more risk visible ahead than reward.

What swept investors off their feet is the reported Rs.71 crore operating profit, when forecasts for the quarter ranged from a loss of Rs.100-400 crore. However, this was because of a 23% drop in “other expenses”, compared with a year ago. It includes write-back of provisions made in the earlier quarters. Even so, the fact that it posted a profit is a huge improvement, compared with an operating loss of Rs.183 crore posted in the year-ago period.

Lower other expenses also offset the massive 870 basis points (bps) drop in gross margin. One basis point is one-hundredth of a percentage point.

In any case, the 29% revenue growth from a year ago was heartening, considering that in the March quarter, revenue had contracted by 21%. The power segment that contributes two-thirds of the total saw a robust pick-up in execution. The industry segment revenue rose, too, and it marked a sharper improvement in profit growth.

Alongside, other income, too, rose during the quarter to fuel net profit growth by 54% to Rs.78 crore.

True, the performance beat rings in a note of optimism. But it may be short-lived as Bhel is still not out of the woods. For one, it is uncertain if “other expenses” would remain low in the forthcoming quarters. Further, the management was unable to estimate the rise in employee expenses, as a result of the Seventh Pay Commission award. The June quarter did not reflect any change. More serious is its rising debtor days, which, in value terms, is equal to its annual revenue!

The situation is unlikely to improve soon as the huge order book is full of long-cycle orders, slow-moving orders and some that may not commence. Poor pace of execution will keep working capital needs high—it is at present about 60% of net sales.

Besides, it is known that Bhel has not been able to get significant orders for several quarters. The June quarter’s tally was a pathetic Rs.3,000 crore. Analysts are hopeful FY17 should close with an inflow of Rs.40,000-50,000 crore of fresh orders, just a bit above the previous year. With the existing power plants operating at an average plant load factor of 60-65%, it would be long before new capacity needs come up. And remember that Bhel’s gains in the power sector come almost in the last leg of capex investment.

So, there seem to be more downward risks than upsides at the stock’s current price of Rs.151, which discounts the FY18 estimated earnings a rich 20 times.

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