Bharat Heavy Electricals Ltd’s (BHEL’s) shares have risen 20% from a 52-week low of ₹56.20 in early February. Lower valuations, along with a pickup in order books and operating margins, have helped the stock. But note that BHEL is still at about half the levels it was two years ago.
At a price-to-earnings multiple of around 12 on FY21 estimated earnings, the stock trades way below its decadal average of 20. Even the 0.6 times book value is near historical lows.
The stock is getting some support on the premise that fresh orders, revenue and margins can only improve. December quarter Ebitda (earnings before interest, tax, depreciation and amortization) margin at 3.6% is better than the year-ago period’s 1.6%. FY19 forecast from brokerage firms ranges from 4.5% to 5.6%.
Investor optimism about margin expansion stems from multiple factors. In the near term, with cost reined in over the last three years, BHEL’s margins will get a fillip. Staff costs, the big bane that dragged the power equipment maker’s margins down when the economic slowdown struck about five years ago, had bloated as a proportion of sales. Now, after the sharp employee reduction, costs are trending lower. Also, provisioning and other related expenses have hit a trough.
On another front, increase in executable order book, which has nearly doubled in the past year, brings good tidings. Revenues are expected to expand and operating leverage will aid margins. One might recall that three-fourths of BHEL’s power sector orders accrued from state government distribution companies (power discoms) and a few long-gestation projects. This resulted in delayed payments, elongated working capital cycle and high debtors position. This is slowly changing after three quarters of revenue contraction until Q2 FY18.
Going by history, analysts are hopeful of a revival in power sector orders after elections. In FY19, order flows are estimated at about ₹30,800 crore, which represents a 25% contraction from the previous year.
According to a report by SBICap Securities Ltd, “Peak deficit looks unavoidable in FY26 given slow effective capacity addition. Lack of sufficient hydro and gas based power makes coal addition inevitable. Hence, ordering should start in FY21/22." After the elections, orders from the union government should pick up, offsetting dependence on state power discoms.
Having said all this, a valuation rerating would hinge on order flows as well as revenue traction, which is still several quarters away. Only then would BHEL be truly powering up.