Our discussions with numerous industry experts suggest that capacity addition plans at BHEL’s four key plants – Trichy, Haridwar, Bhopal and Hyderabad – are ahead of schedule. This should allay concerns about execution for FY3/10.
BHEL’s Trichy plant (the company’s largest plant) should achieve enhanced capacity of 10,000MW (up from 5,750MW earlier) for its boiler in the next 1–2 months.
Trichy is the main facility for large boilers (for thermal power), including super-critical projects, and accounts for 25% of revenues.
Haridwar, which is mainly focused on turbines for large-sized thermal plants, is expected to increase capacity from the current 5,250MW to 7,000MW by the end of this month and to reach 10,000MW by December 2009.
The incremental 5GW of capacity is entirely for thermal power plants. The entire jump in the order backlog in the past couple of years has been on the thermal power side.
The capacity addition that is expected for the thermal side by December 2009 will be about 70%; the earlier-rated capacity on thermal side was 7GW.
In the last round of capacity additions in December 2007, when capacity rose from 6.5GW to 10GW, bulk of the new capacity added was on the hydropower side.
We believe the Street is not fully building in the margin expansion from raw material and operating leverage in FY3/10. We expect a 10–15% earnings upgrade by the Street, driven by a stronger top line and higher margins.
40% of BHEL’s contracts are fixed price contracts. We had thus assumed a 250bp gross margin hit in FY3/09, given the earlier increase in material costs.
With steel prices having corrected significantly, we expect improvement of about 150bp in FY3/10. We have assumed less improvement to factor higher sub-contracting.
We also expect BHEL to gain significant operating leverage in staff costs in FY3/10 given we expect staff costs to rise by only 4% in FY3/10 vs a rise of 38% in FY3/09 (due to the effect of the sixth pay commission).
We expect EBITDA margin expansion of 570bp in FY3/10 vs consensus expectations of only a 220bp improvement. Our 12-month price target is Rs1,935 based on a PER methodology.