BHEL: Buy

---

BHEL timed its first phase of capacity expansion to go on stream by January 2008, thus enabling higher order intake.

---

The company continues to dominate the sub-critical equipment segment.

Vidya Bala

An investment can be considered in the stock of Bharat Heavy Electricals (BHEL). Strong order-book, ongoing capacity expansion to meet Twelfth Plan target, entry into new business segments and efforts to tackle competition in the super-critical plants are factors that enhance prospects for earnings growth over the medium term. However, given the near-term capacity constraints, order book growth could slow down over the next year.

Invest with a perspective of at least three-four years so as ride the growth that the company is likely to witness through enhanced capacities as well as order inflows from newer segments.

At the current market price of Rs 1,879, the stock trades at 22 times the expected earnings for FY09. The current volatility in the market has resulted in valuations that are attractive compared to average historical valuations. Consider buying in lots to benefit from any declines linked to the broad market.

Comfort in order-book

BHEL has been continuously bagging orders in the current year resulting in a backlog of Rs 72,700 crore, about 3.4 times its expected revenue for FY 2008.

The increased order flow is mainly due to the upcoming deadline for utilities to award orders under the Eleventh Plan. Further, BHEL timed its first phase of capacity expansion (from 6,000 MW to 10,000 MW) to go on stream by January 2008, thus enabling it to accept new orders without capacity constraints.

Once the Eleventh Plan target is met, there may be some lull in orders before projects under the Twelfth Plan are awarded. This may result in some momentary slowdown in order flows in FY-09. However, the orders on hand would ensure that revenue growth remains healthy.

BHEL is also preparing to meet long-term demand. Its second phase of expansion to 15,000 MW is slated to be ready by December 2009. The company also plans to double its transformer capacity to 38,500 MVA over the same period. While there would be more private players in the utility space, Central and State utilities will continue to be the major contributors towards achieving the Twelfth Plan target. As BHEL still remains a favoured supplier for the Government, the company is likely to continue bagging orders, especially in the sub-critical boiler segment.

Testing waters

BHEL has not had any major breakthrough in the super critical plants technology, given the acute competition it faces from Chinese players. This is despite its technology tie-ups with Alstom and Siemens for boilers and turbines respectively. Of the projects bagged so far, Chinese players have been scoring over BHEL in 'pricing' due to the huge capital cost advantage that they possess.

While this may be a major issue to reckon with, BHEL's advantage may lie in its being a local company, capable of providing repair and maintenance services, and a ready supply of spares. Further, as the quality of equipment from Chinese players is yet to be tested over a longer period (super critical plants are a relatively new phenomenon in India), some local utilities may prefer a known player such as BHEL. However, there is still no evidence of any such preference for the company over overseas players.

BHEL's strategy of acquiring minority stakes in projects by Government utilities is an encouraging move. The company has started off with a joint venture with the Tamil Nadu Electricity Board for setting up 2 x 800 MW supercritical thermal power project.

While this means that the company would essentially produce for captive consumption, it would provide a good platform to make a mark in the super critical segment and gain qualification to supply to third parties. Given the company's rich cash position and low debt, such a move appears a viable choice to clinch some market share in this segment.

New domains

In the sub-critical space, the company continues to dominate the industry in terms of order flows. BHEL now produces 270 MW and 600 MW boilers targeted to compete with Chinese boilers in the sub-critical space.

This apart, the company has forayed successfully into the advanced class gas turbine segment, winning its firm commercial order from Reliance Industries. It has since, in quick succession, won two more such orders in Gujarat.

BHEL also has capability to produce equipment and sub-assemblies for onshore drilling rigs. It recently won a three-year contract from ONGC to supply wellhead assemblies and other critical spares for oil exploration. With increasing activity in this area, we expect BHEL to supplement its income from these allied activities.

Risks

The first phase of expansion by BHEL witnessed some delay. Any such drag in implementing the second phase could slow revenue growth. BHEL's market share in the private utilities space has been about 25 per cent, essentially indicating that its strength remains in Government utilities' orders. With increasing private participation, BHEL faces the risk of intense competition and possible slowdown in order flows

CALL: STRONG BUY ON DECLINES BELOW RS1800