Shares of government-owned BEML Ltd are on a roll. An outlier in the gloomy equity market, the stock rose 22% since 1 September, while the Nifty 100 increased a mere 5% in the same period. Besides, investors have netted a hefty 71% returns in a year.
The moot question is whether the rally is sustainable. While the company and analysts are confident of a 24% revenue growth in FY20, risks to profitability and earnings growth exist. These arise from the nature of the ₹8,900-crore order book, expected to touch ₹10,000 crore by the fiscal year-end.
Although BEML does not disclose its order book break-up, analysts say rail and Metro-rail orders comprise a little more than half the total. Also, the Q1 FY20 revenue break -up shows about 87% from rail and Metro-rail (43% in FY19 and 19% in FY17).
Indeed, this segment has short-term entry barriers. Only a couple of such manufacturers exist, and the government mandates that railway coaches be made in India. But stiff competition among incumbents is impacting pricing. A report by JM Financial Services Ltd says, “High competitive intensity has led to a decline in Metro-rail coach realisations ( ₹76 million each for Mumbai Metro-Rail Line-2/7 won by BEML versus ₹100 million a coach for Line-3 won by Alstom)."
Further, wafer-thin price difference between the lowest and second-lowest bidders hinders margin improvement, which is already low (FY19: 6.8%). Elara Securities Ltd highlighted that any sharp rise in raw material costs may pare the margin, given that the import content in the rail and Metro-rail segment is 40%.
Besides, the firm’s dependence on sectors sensitive to government policy, such as mining and construction, and defence, could delay orders and approvals. For instance, Q1 order flows were 25% lower year-on-year. This could impact timely execution and be a drag on revenue, which in turn, could dent margins.
Be that as it may, the robust order book provides about a two-year revenue assurance. Analysts forecast 18-20% earnings growth in the next two years, assuming steady execution and profitability.
At ₹925, the BEML stock—pricing in the positives—quotes at 22 times its estimated FY21 earnings. The next trigger would come from development, if any, from the government’s plan to divest 26% equity.