The Bharat Heavy Electricals Ltd (Bhel) stock is up 5% since Monday, following a bullish report by CLSA Research that sparked off renewed interest in the company. The report titled Orders at five-year high spews optimism that power equipment bids turned the cycle after five years, confirming the beginning of a new power capex cycle in fiscal year 2016 itself.
More importantly, Bharat Parekh, analyst, CLSA Research, says in the report that Bhel swept away nearly three-fourths of the orders and forecasts a 40% year-on-year jump in order inflows for fiscal year 2016. With barely a week to go for Bhel’s flash results, this was enough to kick the stock out of its slumber. Note that Bhel’s shares were languishing for many quarters, underperforming the broader markets, as order inflows had dried up and order book was shrinking.
But is this enough? Bhel’s performance has been pathetic in the last couple of quarters. The firm’s revenue started contracting almost immediately after it hugely increased capacity a few years ago, in the hope of sizzling business in the power generation segment. Things deteriorated in the domestic economy and Bhel’s operating margin, which can be a proxy for industrial activity in the country, kept sliding quarter after quarter.
Bloomberg’s consensus forecast for fiscal year 2016 is an operating loss with an operating margin of -4.3%, although the fourth quarter margin will be significantly better than the earlier quarters in the year.
Some analysts say that new orders may come in at lower profit margins than earlier. A Religare Capital Markets Ltd report on capital goods says Bhel’s gross margins could remain under pressure because of rising revenue from low-margin engineering, procurement, contracting business and super critical projects, both of which churn out lower profit margins. Add to this weakness in the end-user industries, which can lead to slow project execution and higher working capital that would add to dragging down profit in the final analysis.
So, if the operating performance is better than expected in the forthcoming flash results, the stock may sizzle as the mood seems set. However, the fact is that at Rs.116.55, Bhel trades at a rich valuation of 19 times fiscal year 2017 estimated earnings per share, higher than the average valuation since March 2010. Yes, with the fiscal year 2016 results, there could be stronger conviction the cycle is now turning in favour of Bhel. But it’s still a long haul to impressive revenue and profit growth.
The writer does not own shares in the above-mentioned companies.