BHEL has an order book of around Rs1 trillion, the highest in its history. Almost 85% is from Central and State utilities, making it one of the least risky in the Indian capital goods universe.
Its FY08 margins have contracted due to wage increases. With the additional provisioning required, this would continue in FY09.
However, from here on further provisioning would not be much. This, coupled with falling commodity prices, should help shore up margins.
Competition from China has been around for some time. BHEL now faces the prospect of local competition, particularly from the L&T-Mitsubishi combine. This implies fresh projects at lower margins than so far enjoyed.
The stock trades at 15.7x, the higher end of the valuation range for capital-goods companies.
However, in this uncertain environment, it offers relatively lower earnings risk. This, coupled with a proven track record and a difficult-to-replicate business model, justifies the premium.
We initiate coverage on the company with a HOLD and a target price of Rs1,446.