Graphic: Naveen Kumar Saini/Mint
Graphic: Naveen Kumar Saini/Mint

Why divestment can break the shackles around Bharat Heavy Electricals

  • Bhel has been expanding into new sectors such as e-mobility, electric vehicle (EV)-charging, transportation and defence
  • Despite talk of entering into these new businesses, the Bhel stock had been languishing at near-15-year lows

Under the spotlight of disinvestment, power equipment manufacturer Bharat Heavy Electricals Ltd (Bhel) may be just beginning to lighten up. The stock surged 22% on Friday to close at 54.35, which took the market value of the company to about 19,000 crore. This should fetch the government decent sums if a significant chunk is divested.

Nevertheless, risks to growth look skewed on the downside in its thermal power business. Hence, Bhel has been expanding into new sectors such as e-mobility, electric vehicle (EV)-charging, transportation and defence. The company plans to target 50% of its revenues from these new businesses over the next five years. This appears to make it an interesting candidate for private sector firms.

Of course, despite talk of entering into these new businesses, the Bhel stock had been languishing at near-15-year lows. But needless to say, the firm’s prospects in new business areas, such as EV-charging, will be far better under a private owner.

On the power equipment business though, which has been its forte, Bhel is facing growth challenges. New projects have been slow in taking off. Besides, there have been delays in existing projects, even as competition is getting keener from the likes of Larsen and Toubro Ltd.

In addition, the tight liquidity conditions in the economy have been a concern, which is why Bhel’s order book of about 1 trillion has not improved significantly.

Delay in execution has meant that revenue growth is slowing. “The structural macro challenges in the thermal power sector are expected to impact BHEL’s medium-term growth and margin prospects," said ICICI Securities in a recent note to clients.

Bhel’s receivables have been mounting and are quite significant at 38,000 crore, which is further dragging down return ratios. The management is stepping up efforts in improving its outstanding dues. Any improvement in working capital and recoveries may even be another catalyst for investors.

“The company’s net cash position of 5,500 crore as of Mar’19 and receivable book of 38,000 crore provide valuation support given that its total market capitalization itself is 19,000 crore (less than 0.5x receivables)," said Emkay Global Financial Services Ltd in a note to clients.

Losing its public sector tag can help in better receivables management, going forward.

Given the market conditions in the power sector, Bhel’s valuations have sunk to lows of about 12 times lately. In 2016, its price-earnings valuation was north of 30 times. That could change if conditions in the power sector improve. “Liquidation of receivables and finalisation of large orders, which have been pending, will be the re-rating catalyst for the stock," said ICICI Securities.

Given Bhel’s business model, though, it may not be surprising if investors find the stock interesting if it does indeed become a privatization candidate.

Delays in execution have meant that revenue growth has been slowing. “The structural macro challenges in the thermal power sector are expected to impact BHEL’s medium-term growth and margin prospects," said ICICI Securities in a recent note to clients.

Additionally, BHEL has been seeing its receivables mount. This has been dragging down its operating efficiencies. BHEL’s receivable levels have also been quite significant at about 38,000 crore, which is further dragging down return ratios. The management is stepping up efforts in improving its outstanding dues. Any improvement in working capital and recoveries may even be another catalyst for investors. “The company’s net cash position of 5,500 crore as of Mar’19 and receivable book of 38,000 crore provide valuation support given that its total market capitalization itself is 19,000 crore (less than 0.5x receivables)," said Emkay Global Financial Services in a note to clients.

Losing its public sector tag can help in better receivables management going forward as well.

Given the market conditions in the power sector, BHEL’s valuations have sunk to lows of about 12 times lately, a massive de-rating. 2016, its price-earnings valuation was even north of 30 times earnings. That could change if conditions in the power sector start to improve. “Liquidation of receivables and finalisation of large orders, which have been pending, will be the re-rating catalyst for the stock," noted ICICI Securities in the client note.

Given BHEL’s business franchise, though, it may be no surprise that investors may find the stock interesting if it does indeed become a privatization candidate.

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