BHEL reported weaker–than-expected results for Q3’09. Though net sales jumped 21.3% to Rs60.2 billion, the net profit margin declined 240 bps due to the lagged effect of higher raw material prices and increased staff costs.
With new orders worth Rs152 billion in Q3’09, BHEL maintains its numero uno position in the power equipment sector.
Its current order book stands at Rs1,135 billion, which represents 5.3x of FY08 revenue and provides strong revenue visibility for the near-to-medium term. Thus, we expect a 23–25% revenue growth for FY10 and FY11.
Metal prices have fallen sharply in the last six months and are likely to remain under pressure due to the continuing global slowdown. This will help the company to boost its margins by 2-3% as metals account for ~30% of the raw material costs.
Further, we expect a lower salary cost growth in the coming years as it has already made a provision for the increase in staff costs.
Hence, we believe that BHEL’s operating margin is likely to increase to 17-18% in the near-to-medium term, from 15.7% in FY08, led by a strong revenue growth visibility and operating leverage benefits.
BHEL has witnessed a robust growth in new orders over the past 5 years. However, capacity expansion could not match the pace of the new order growth. Thus, the Company plans to double its capacity by FY12.
We expect the implementation of the new capacity to increase the execution rate of the outstanding orders, which will further boost the top line.
BHEL is trading at a premium valuation (LTM P/E–24.5x) as compared to the BSE-Capital Goods index (P/E–14.9x), due to its high earnings visibility, a strong balance sheet, and a healthy order book.
The road ahead
We expect the company to report a healthy earnings growth of 8–9% and 38–40% for FY09 and FY10, respectively. Thus, we expect the stock to outperform the broader market despite the weak economic indicators.
At the current market price (CMP), the stock is trading at a forward P/E of 23.1x and 16.7x the FY09 and FY10 earnings, respectively.
Based on our DCF valuation, we have arrived at a target price of Rs. 1,550 (assuming a 16.4% WACC and a 5% terminal growth rate).
The target price provides an upside potential of 7% from the CMP, and we believe that most of the positives have already been factored in. We give a HOLD rating to the stock.