ambit capital - bharat heavy electricals ltd. (bhel) - value trap (company insight) (sell)

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Value trap Strong IPP interest for the Odisha and Tamil Nadu UMPPs has increased investor interest in BHEL, given that equipment bids are reserved for domestic companies. However, we expect delays in these projects, owing to a lack of clarity on energy charges. Long-term order inflow visibility for BHEL remains poor (~22GW in FY14-17 vs ~50GW in FY10-14) alongside risk from competition from Chinese players; the Chinese are now allowed to open service centres. Given BHEL’s poor inflows, declining execution and softer EBITDA margins, we cut our FY14 and FY15 EPS estimates by 14% and 3%, respectively and our TP to `124 (0.8x FY15 P/B) from `130. Continued RoE decline to 11% in FY16 (from 24% in FY13) should keep valuation multiples low. SELL.

Competitive position: MODERATE Changes to this position: STABLE

Order finalisation in Odisha and Tamil Nadu UMPP may take time Nearly all the IPPs submitted technical bids for the Odisha and Tamil Nadu (TN) UMPPs. We expect delays in awards of these projects given the non-clarity on energy charges—Odisha has a cap of `0.356/unit and TN has no clarity on escalation in the energy cost. Given challenges and high leverage for most IPPs (net D:E of 3.5x at end-FY13), we expect delays in the awards of these projects.

No improvement in order inflow visibility Already ~148GW orders are under construction out of the target capacity addition of ~200GW in the next ten years. Given the issues in domestic coal (thermal PLF in FY14 so far declined to 64% from five-year average of 75%) and leveraged balance sheet (net debt to equity in March 2013 for top-10 developers was 3.5x), the enquiries from the private sector are almost NIL from ~50% share in capacity addition in the last three years.

Chinese players can open service centres - a blow to Indian players After imposing an import duty of 21% on BTG sets, India is now encouraging Chinese companies to open factories in India. In October, India signed an agreement with China, allowing Chinese companies to open service centres in India. This is a blow for the domestic industry, as companies which hitherto did not order Chinese sets fearing poor servicing will start ordering them. Already 18GW of Chinese sets are running and ~40GW are under construction.

Value trap; no respite from RoE decline We cut our TP and FY14 EPS estimate, as we cut our revenues and order intake assumptions. BHEL is trading at 12x FY15 P/E, a 15% discount to the sector P/E and 20% discount to its five-year average. Present discount should widen given that earnings post 2014 should stagnate and RoE will continue to decline to 10% in FY16, much lower than the cost of equity considered. Our implied valuation of 0.8x FY15 book implies, BHEL’s worsening competitiveness and no recovery in RoEs and EBITDA margins.

BHEL SELL

COMPANY INSIGHT BHEL IN EQUITY December 09, 2013

Key financials

Year to March FY12 FY13 FY14E FY15E FY16E Revenue (` mn) 483,552

489,158 397,874 408,805 439,951

EBITDA margin (%) 20.6 19.4 14.5 13.3 12.5

EPS (`) 29.0 27.3 15.7 14.4 14.7

RoE (%) 31.1 23.9 12.1 10.3 9.8

ROCE (%) 27.2 20.3 9.6 8.2 7.7

P/E (x) 5.9 6.3 10.9 11.9 11.6

P/B (x) 1.6 1.4 1.3 1.2 1.1

Source: Company, Ambit Capital research

Capital Goods

Recommendation Mcap (bn): `419/US$6.8 3M ADV (bn): `1.2/US$0.2 CMP: ` 171 TP (12 mths): ` 124 Downside (%): 28

Flags Accounting: AMBER Predictability: RED Earnings Momentum: RED

Catalyst

Disappointment in order inflow in 2HFY14

Performance (%)

Source: Bloomberg, Ambit Capital research

Analyst Details

Bhargav Buddhadev +91 22 3043 3252 [email protected]

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BHEL

9 December 2013 Ambit Capital Pvt. Ltd.

Order finalisation in Odisha and Tamil Nadu UMPP may take time BHEL’s stock price has rallied by ~15% since the last week of November 2013 when the news came of several companies (nine for Odisha and eight for Tamil Nadu) bidding to be pre-qualified in the Odisha and Tamil Nadu UMPP (4GW each). Given that these UMPPs have to procure BTG equipments from domestic manufacturers ONLY, each UMPP is a potential opportunity of ~`240bn (~73% of FY13 order inflows and ~23% of present order book), assuming the entire award is on an EPC basis and assuming that the average realisation is `60mn/MW. This is clearly a very big opportunity for BHEL, given that it is equivalent to ~100% of the 8GW orders (see exhibit below). We have that assumed BHEL will emerge as the winner in one of the two UMPPs in FY15.

Exhibit 1: BHEL is a strong contender for the following projects coming up over the next six months

Configuration MW size Type of package Name of the customer

2x500 1,000 Steam generator package Neyveli Lignite

500x1 500 BTG NTPC Unchachar

2X800 1,600 STG package NTPC Darlipalli

6x116 696 Pranahita Lift irrigation scheme

3x33+3x33+1x8 206 Hydro turbine Shahapur Kandi hydro project for PSPCL

2x800 1,600 ESP package NTPC Lara

NA 2,445 NA Three other projects

Total 8,047

Source: Company, Ambit Capital Research

However, power sector consultants highlight the delays in the award for both the UMPPs given issues pertaining to the energy cost cap of `0.356/unit of power in the Odisha UMPP and lack of clarity on fuel escalation costs in the TN UMPP.

Meeting the energy cost of `0.356/unit in Odisha UMPP a tall task: The RFQ document for the Odisha UMPP has capped the fuel cost (Odisha UMPP has a captive mine allocated to the project) at `0.356/KWH. The RFQ states, “Since the Bidder is expected to source fuel from captive coal mines allocated for the project, the fuel charge payable to the concessionaire shall be `0.356 per kWh in accordance with the provisions of Clause 26.2.2 of the draft PPA”. A leading industry consultant highlighted that “this is a tough task.” In order to meet this energy charge, the mining cost has to be restricted to ~`700/MT given the thumb rule of 0.5kg of coal required in generating 1KWH power. This is a tall task given that the cost of mining for Coal India is at `800-1,000 per MT (see Exhibit 3). Note that even countries like Indonesia where the strip ratio is very favourable has a mining cost of `500-600/MT.

Consultants suggest that developers are unlikely to bid in the Request for Proposal (RFP) round unless clarity emerges on the energy cost. This might take time (a minimum of three months or possibly might also get delayed to until the new government gets elected). This is because, soliciting a deviation in the RFQ is a long-drawn process, as it requires convincing the Ministry of Power, consultants (E&Y, feedback, etc), and regulator (CERC).

Tamil Nadu UMPP has no clarification on the energy escalation cost: The RFQ document for the Cheyyur UMPP has not clarified on the escalation allowed on the energy cost (to be quoted in dollars) every year. The RFQ only mentions that the fuel charge to be offered by the bidder shall not exceed an amount that reflects ***% of the price of fuel computed with reference to the average API 4 Index (South Africa) for a period of 180 days immediately preceding the date of bid in accordance with clause 26.2.2 of the draft PPA forming part of the bidding document.

UMMPs have to procure BTG equipments from domestic manufacturers ONLY

Award of orders for both UMPPs could get delayed given lack of clarity in the energy cost

To meet mining cost of `700/MT is a tall task given Coal India’s cost of `800-1,000/MT and Indonesia’s cost of `500-600/MT where strip ratio is the best

Final award of the UMPP will take time as soliciting a deviation in the RFQ is a long process

RFQ for Tamil Nadu UMPP does not offer any clarification on energy escalation

BHEL


Speaking with companies which had bid in the pre-qualification round, we understand that unless the escalation is linked to the global indices, developers will not bid in the final round. This is because of the historical high volatility in the Indonesian and South African coal prices (see Exhibit 2 below). Also, given the ill-fate of incumbents like Adani and Tata Power, which have been making losses in projects based on imported coal, we fear that no developer will bid without opting for 100% escalation in energy cost.

Exhibit 2: Indonesian and South African coal prices have been extremely volatile

Source: Bloomberg, Ambit Capital research

Exhibit 3: Meeting mining cost of `700/MT is a tall task as the range of Coal India’s mining cost is `800-1000/MT

Source: Coal India, Ambit Capital research

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Indonesian coal price 4,200 Kcal ($/tonne)

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Coal India average Production cost (INR/MT)

Mining cost capped for captive mine in Orissa UMPP(INR/MT)

Given the fate of developers who have bidded on imported coal without opting escalation, we fear if developers will bid without 100% escalation in energy cost

BHEL


Power sector yet to get out of the woods Industry ordering declined by 50% over FY08-13 Issues of coal linkages, environment clearances, land acquisition and fund constraints given leveraged balance sheets of developers have resulted in delay of new projects awards and slowdown in the pace of executing under-construction projects. Whilst industry-wide ordering halved to `47bn at the end of FY13 as compared to `94bn in FY09, BHEL’s pace of execution (as seen in Exhibit 5) has considerably slowed down despite doubling capacity to 20GW in four years and a healthy order book (order book coverage for BHEL has only declined by 20% in FY13 as compared to 3.4x of one year sales in FY07).

Exhibit 4: Whilst industry ordering has declined by 50% over FY08-13…


Exhibit 5: …the pace of executing projects has also materially slowed down


The various challenges faced by the developers are:

(a) Shortage in domestic coal availability (all-India thermal PLF so far in FY14 has declined to 64% from the five-year average of 75%),

(b) Levered balance sheet (average net debt to equity in March 2013 stood at 3.5x), and

(c) Frequent back-downs from state electricity boards (SEBs) given their financial distress. This is corroborated from the consistent fall in the peak deficit since the time the banking sector has stopped funding SEBs, given their dismal financial health. Peak deficit in September 2013 declined to 3% vs 9.1% a year ago.

Banks now wary of lending to the power sector The share of the power sector in banks’ sectoral share of stressed loans is the second highest at ~10%, after infrastructure which is ~15%. Given that the share of total stressed loan as a percentage of system-wide credit is 10%, there is a risk of ~10% of the bank’s net worth getting eroded (tier-1 capital required is 10% ) if these stressed loans were to turn bad.

Thus, banks going forward will be very sceptical of funding power projects. Also, high leverage on the developer’s balance sheet coupled with a bouquet of stressed projects is making banks uncomfortable to lend further to the sector. Thus, banks will not be comfortable sponsoring the UMPPs unless issues on the energy costs are addressed completely.

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MW commissioned by BHEL % YoY growth

Industry wide ordering has halved to `47bn at the end of FY13 compared to FY09

Share of power sector in bank’s sectorial share of stressed loan is the second highest at 10%

Hence banks will be sceptical of sponsoring UMPPs unless issues on the energy cost are addressed

BHEL


Exhibit 6: Share of power in banks’ total credit has increased to 8.8% in September 2013

% of bank credit Mar'11 Mar'12 Mar'13 Sept'13

Total Infrastructure 14.2% 14.7% 15.0% 15.3%

Power 7.3% 7.7% 8.5% 8.8%

Telecommunication 2.5% 2.2% 1.8% 1.7%

Roads 2.5% 2.6% 2.7% 2.8%

Other infrastructure 1.9% 2.2% 1.9% 2.0%

Source: RBI, Ambit Capital research

Exhibit 7: Share of power sector stressed assets in banks’ gross credit is alarming at 10%

Source: RBI, Ambit Capital research

This has impacted BHEL’s performance The stress in the sector has affected BHEL’s performance, with revenue CAGR, EBITDA CAGR and PAT CAGR declining to 7%, 5% and 4.5% over FY11-13 as compared to 26%, 43% and 40% over FY09-11. Consequently the RoCE has declined from 32.4% in FY09 to 20.3% in FY13 and the RoE has declined from 26.3% in FY09 to 23.9% in FY13.

Exhibit 8: Revenue and EBITDA growth have been trending downwards for BHEL (in ̀ mn)


Exhibit 9: Consequently, RoCE and RoE have been taking a hit (in %)


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% of loans restructred in the sector

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BHEL


Exhibit 10: Also BHEL’s revenues and EBITDA in recent quarters has declined significantly…


Exhibit 11: …given consistent decline in its order book


Changing estimates for FY14 and FY15

BHEL’s performance so far in 1HFY14 has been disappointing, with revenue growth declining 19% YoY, EBITDA margins crashing to 5.2% (down 1100 bps YoY), order intake (`59.6bn) declining 42% YoY and order book (at `1,023bn) as on 30 September declining 16% YoY. Consequently, we are downgrading our FY14 EBITDA and EPS estimates by 16% and 14% respectively.

Exhibit 12: Change in estimates

Old estimates New estimates % Change In ̀ bn FY14E FY15E FY14E FY15E FY14E FY15E Comments

SELL SELL

TP(`) 129 124 -4.0% Driven by downgrade in revenue and EBITDA margin

Order book (̀ bn) 1,168 1,185 1,190 1,181 2.0% -0.4% Order book is increasing despite cut in order intake on account of downgrades to our revenues i.e lower execution

Order Intake 336 439 314 410 -6.3% -6.5%

Whilst there are RFQs worth 15GW in the market, finalisation is not happening owing to delays from customers; hence, we are downgrading our order intake assumptions

BHEL market share (%) 50% 50% 50% 50%

Revenues 441 410 397 408 -9.9% -0.5% We are increasing our execution cycle to 51 months from 45 earlier given delays in receiving project approvals, as the Government appears to have entered into inertia given the ongoing state elections and upcoming Union elections

Power 310 254 266 253 -14.2% -0.5%

Industry 118 143 118 143 0.0% 0.0%

Exports 19 23 19 23 0.0% 0.0%

EBITDA 68 54 58 54 -14.7% -0.1%

EBITDA margin 15.5% 13.4% 14.5% 13.3%

Impact of operating leverage. Due to cut in revenues, staff cost as a percentage of revenues has increased by 100bps in FY14 and 50bps in FY15

PBT 66 53 57 52 -13.6% -1.9%

Trickle -down impact of EBITDA. PAT 44 36 38 35 -13.6% -2.8%

EPS (` per share) 18.3 14.8 15.7 14.4 -14.2% -2.8%

CFO 73 63 95 45 30.1% -28.6% Improvement in CFO in FY14 is due to cut in revenues. In FY15 the CFO has declined as compared to FY14 because there is an increase in the working capital investment of ``3.3bn given the increase in revenues as compared to the decrease of `45bn in working capital investment in FY14

FCF 62 54 84 34 35.4% -37.0%

Source: Ambit Capital research

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Order intake growth (% YoY growth)

Order book growth (% YoY growth)

BHEL


Key assumptions and estimates We expect BHEL’s revenues and PAT to decline at a 3.5% CAGR and 19% CAGR over FY13-16 driven by the assumptions shown in the table below:

Exhibit 13: Key assumptions and estimates

Figs in ` bn FY13 FY14 FY15E FY16E Comments

Key assumptions

Order inflows 438 314 410 481 We assume 31% and 17% growth in FY15 and FY16 as we assume BHEL to emerge as the winner in one of the two UMPP orders in FY15 and assume ordering cycle to improve in FY16 as the XIII Five-year Plan ordering kick starts

Power 309 141 201 229

We assume industry ordering to improve to 11GW and 15GW in FY15 and FY16 respectively as compared to 7.5GW in FY14. On market share we assume BHEL to maintain market share at 50% in FY15 and decline to 40% in FY16 given higher competition from Chinese as they start opening factories in India

Order intake (MW) 8,200 3,750 5,500 6,000

Industry 110 143 171 206 We expect higher growth in captive boilers given BHEL's rising focus in this segment as opportunities is shrinking in the utility boiler segment. We model a recovery in the orders from the international business, because FY12 was an aberration on account of the global slowdown. The average order inflow over the past five years has been `26bn annually.

Exports 16 19 23 27

Order backlog 1,280 1,190 1,180 1,210 We assume order backlog to remain flat despite a pick-up in order intake. This is because the revenue execution is broadly in line with the order intake. Order backlog in years (x) 2.5 2.9 2.8 2.7

Key estimates

Sales 489 398 409 440 Based on the assumption highlighted above, we expect revenues to decline at an annualised rate of 3.5% over FY13-16 (vs FY19-13 CAGR of 22%).

Sales (YoY growth) (%) 1.2 -18.7 2.7 7.6

EBITDA 95 58 54 55 We expect margins to contract by 490bps in FY14 and by 120bps in FY15, owing to the execution of low-margin orders which were taken under an Intensely competitive environment in FY11 and FY12.

EBITDA margin (%) 19.4 14.5 13.3 12.5

EBITDA (YoY growth) (%) -4.9 -39 -5.9 1.4

Interest expense 1.3 1.1 1.2 1.3 BHEL is virtually a debt-free company

PBT 95 57 53 54 Tax rate (%) 29.80% 33.0% 33.0% 33.0% We have assumed marginal tax rate from FY14 onwards.

Adj. PAT 67 39 35 36 Trickle down impact of EBITDA.

PAT (YoY growth) (%) -5.9 -42.4 -8.7 2.2

Cash flow from operations (CFO) 23 95 45 35

CFO has improved in FY14 on account of reduction in revenues. This has resulted in working capital investment declining by 45bn. However, in FY15 and FY16 the CFO deteriorates due to increase in working capital investment by `3.3bn and `15bn as revenue increases by 3% and 8% for FY15 and FY16 respectively.

Cash flow from investments -17 -11 -12 -13 We model maintenance capex.

Free cash flow 5 84 34 23 Source: Ambit Capital research

BHEL


Allowing Chinese to open service centre is a ‘U’ turn Chinese power-equipment makers such as Shanghai Electric and Dongfang may soon open service centres in India to service their clients; a move that could be a precursor to them setting up manufacturing operations here. This is on the back of India and China signing an agreement in October allowing Chinese equipment makers to open service centres in India.

This step not only neutralises the recent 21% import tax which was levied on imported equipments, but also allows them to qualify for bidding in UMPPs assuming these players start contemplating setting up manufacturing facilities in India. Note that India allows 100% foreign investment in the sector.

The lack of local service centres for Chinese companies had made some power plants to suspend operations, as they had to send faulty equipment to China for repair. Such centres in India would help in timely services to plant owners and help to optimize maintenance and operation costs. Ashok Khurana, director general of the Association of Power Producers in India, stated that Chinese equipment makers have a large customer base in India and it makes sense for them to have service centres in India.

Exhibit 14: Share of Chinese in the XI plan power projects commissioned


Exhibit 15: Share of Chinese in the 148GW under construction (Figs represent GW and in bracket market share)


Chinese, 19/(34%)

BHEL, 25/(46%)

Other Indian, 3/(5%)

Other Foreign, 8/(15%) Chinese

42/(30%)

BHEL, 66/(46%)

Other Indian ,

24/(17%)

Other Foreign, 11/(7%)

BHEL


Valuations: Value trap BHEL is trading at 10.4x FY15 P/E. Whilst BHEL’s FY15 PE multiple is at a discount of 20% as compared to its five-year one-year forward P/E, this discount has narrowed from 50% in September 2013. This seems to have been driven primarily by the improving market sentiments towards the BSE Capital Goods index which is up 47% and has outperformed BSE Sensex by 15% since September 2013. BHEL’s stock price since Sept 2013 is up 41%.

However, on the fundamental side, neither the 2QFY14 results have shown any improvement nor there is a pick-up in the investment capex cycle. As highlighted earlier, the power sector is yet to come out of the woods. We fear the investment capex cycle could take at least two years to pick up, because orders for ~148GW have already been placed as compared to commissioning target of ~88GW and ~100GW in the XII and XIII Five-year Plan respectively. Also, the investment capex cycle across key sectors for captive power market like cement, steel and refineries is likely to be weak in the next three years (see the exhibit below).

Exhibit 16: Capacity addition in cement in the next three years is likely to be lower compared to FY10-13

Source: Ambit Capital Research

Exhibit 17: Capacity addition in refining in the next three years is likely to be lower compared to FY10-13


Historical low valuations; but no reason to BUY yet Consequently, as shown in the Exhibit 19 and 20, BHEL’s stock price has seen a severe de-rating since the highs of ‘07 until September 2013. However since September 2013 then the stock has moved up 70% given the renewed interest in capital goods sector. At CMP, the stock is trading at one-year forward P/E and P/B of 11.9x and 1.2x which is a 20% and 75% discount as compared to five years ago. Given the structural challenge facing the BTG industry i.e. dearth of orders, no visible signs of consolidation and rising threat of competition from Chinese equipment manufacturers (with Chinese companies being allowed to open service centres in India), we do not expect multiples to improve.

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Exhibit 18: BHEL’s FY15 P/E multiple is trading at 25% discount to five-year average one-year forward P/E

Source: Bloomberg

Exhibit 19: BHEL’s FY15 P/B multiple is trading at a 75% discount to five-year average one-year forward P/B

Source: Bloomberg

Our cash flow model based on declining competitiveness We have valued BHEL through a free cash flow (FCFF) model.

Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

FY14-24: We model each year in detail and assume revenue CAGR of 12% (FY08-13 revenue CAGR was at 19%) and we also assume that operating margins would gradually decline to 9.2% by FY23 (from 19% in FY13), given the rising competition from Chinese, Korean and domestic manufacturers.

FY24 onwards: We have assumed a terminal growth rate of 3% and EBITDA margin of 9.2% from FY24 onwards.

We expect BHEL’s RoCE to decline from 20% in FY13 consistently to around 10% by FY24 on the back of our assumption of a gradual fall in operating margins. Based on these assumptions and assuming a WACC of 13.5%, our FCFF model values the business at `124/share.

Exhibit 20: Assumptions on DCF valuation

Present value of cash flow for the explicit period 201,219

Present value of cash flow in perpetuity 49,193

Total 250,41

Less Net Debt (cash) (52,215)

Value for equity holders/Enterprise value 302,626

No. of shares 2,448

Price per share 124

Source: Ambit Capital

Exhibit 21: DCF chart (Sajid to insert)


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Relative valuation

Exhibit 22: Relative valuation

P/E P/B EV/EBITDA ROE

Currency Share Price

M Cap (US$mn) FY14 FY15 FY14 FY15 FY14 FY15 FY14 FY15 EPS CAGR

(FY13-16)

Indian Peers

BHEL INR 168 6,527 10.9 11.9 1.3 1.2 6.3 6.7 12.1% 10.3% -18.5%

Thermax INR 685 1,296 24.5 21.8 3.9 3.4 13.2 11.7 16.3% 16.7% 15.1%

Cummins INR 460 2,024 21.0 17.6 4.8 4.2 18.1 14.8 24.1% 25.7% 7.5%

Greaves Cotton INR 65 252 9.5 8.3 1.9 1.7 5.6 5.0 21.3% 21.5% 13.2%

Crompton greaves INR 125 1,249 17.7 10.7 2.0 1.8 9.4 6.5 12.0% 17.6% NA

Voltas INR 116 609 17.6 13.2 1.7 1.6 13.3 10.0 9.9% 12.5% 38.0%

Average 16.9 13.9 2.6 2.3 10.9 9.1 15.9% 17.4% 11.7%

Divergence from domestic peers -35% -14% -50% -48% -27% -24% Foreign peers

Alstom EURO 25.6 7,903 9.1 8.2 1.4 1.3 6.4 5.9 15.7 15.9 9.3%

B&W USD 32.5 3,602 14.0 13.5 3.3 2.9 8.1 7.5 22.9 18.7 13.0%

Dongfang HKD 14.3 32,808 10.3 10.2 1.2 1.1 6.2 5.9 13.0 11.9 3.3%

Average 11.1 10.6 2.0 1.8 6.9 6.4 17.2 15.5 8.5%

Divergence from Foreign peers -2.1% 11.9% -33% -32% -9% 4%


On a relative basis, BHEL is trading at a steep discount to its domestic peers. However, this is fair given that it is the only company amidst peers which is seeing an EPS decline Also, RoE for BHEL is likely to decline to 10.3% in FY15 as compared to 24% in FY13. Our target price on BHEL is `124/share which implies 0.8x FY15 P/B. We believe the stock should be trading below book given stagnation in EPS (EPS CAGR over FY14-16 of -3% and RoE of 9.8% in FY16).

Key risks to our SELL stance Pick up in ordering: This looks challenging given that the number of projects

under construction is equivalent to 125GW as compared to the target of adding 200GW in the next decade.

Diversification into other sectors: If BHEL is able to diversify away from the

power sector into other sectors like transportation, railways, transmission and distribution and defence then our SELL stance is at risk (as our issue with BHEL has been its overdependence on the power generation sector). However, given that BHEL has technological gaps in other sectors relative to its peers, we believe BHEL will need to enter into technological tie-ups before it tastes success in other sectors.

BHEL


Catalyst Disappointment in order inflow in 2HFY14: We have assumed order intake of `369bn in 2HFY14 which is a 15% growth YoY despite BHEL reporting 55% YoY decline in 1HFY14. BHEL is in the advanced stage of negotiation in 8GW worth of orders. Any disappointment on this front will be negative for the stock price.

Exhibit 23: flags on the cover page

Segment Score Comments

Accounting AMBER

Company’s cash conversion (CFO/EBITDA) cycle has deteriorated from 85 days in FY12 to 25 days in FY13. However, in FY13, the company performed better than its peer group: (a) number of transactions with related parties was low, (b) the ratio of contingent liabilities remained low and (c) loans and advances as a percentage to net worth was also among the lowest amongst its peers.

Predictability RED Q2FY14 results were lower than our estimates both on revenue growth and EBITDA margins. Management has stopped giving any guidance sighting uncertain macro environment

Earnings Momentum RED Given that the reported 2Q earnings came below consensus estimates; consensus FY14 earnings have seen a downgrade of ~10% post results.


BHEL


Balance sheet

Year to March (̀ mn) FY12 FY13 FY14E FY15E FY16E

Cash 67,343 78,451 125,476 145,563 154,376

Debtors 265,305 293,703 241,995 248,643 265,176

Inventory 135,255 118,690 103,556 100,801 108,481

Loans & advances 31,055 30,535 27,252 28,000 30,134

Other current assets 96,970 110,172 89,386 91,841 98,838

Investments 59 59 59 59 59

Fixed assets 62,821 70,359 70,980 70,514 70,010

Miscellaneous 15,495 15,558 15,558 15,558 15,558

Total assets 674,303 717,527 674,262 700,979 742,632

Current liabilities & provisions 416,534 385,917 340,140 343,967 362,232

Debt 3,688 26,236 3,688 3,688 3,688

Other liabilities 50 46 47 47 47

Total liabilities 420,272 412,199 343,875 347,702 365,967

Shareholders' equity 4,895 4,895 4,895 4,895 4,895

Reserves & surpluses 249,135 300,432 325,491 348,381 371,769

Total networth 254,030 305,327 330,386 353,276 376,664

Net working capital 112,050 167,183 122,048 125,318 140,397

Net debt (cash) (63,655) (52,215) (121,788) (141,874) (150,687)


Income statement


Operating income 483,552 489,158 397,874 408,805 439,951

% growth 13.7 1.2 (18.7) 2.7 7.6

Operating expenditure 383,847 394,332 340,043 354,371 384,744

EBITDA 99,705 94,826 57,832 54,433 55,207

% growth 15.5 (4.9) (39.0) (5.9) 1.4

Depreciation 8,032 9,572 10,173 12,123 13,093

EBIT 91,672 85,254 47,659 42,310 42,114

Interest expenditure 531 1,276 1,194 1,226 1,320

Non-operational income / Exceptional items 12,531 11,329 11,005 11,411 12,844

PBT 103,672 95,307 57,470 52,496 53,637

Tax 32,800 28,376 18,965 17,324 17,700

Reported PAT 70,873 66,931 38,505 35,172 35,937

Adjustments (190) 41 - - -

Adjusted PAT 71,062 66,890 38,505 35,172 35,937

DPS (̀ ) 3.7 5.4 4.7 4.3 4.4


BHEL


Cash flow


PBT 103,672 95,307 57,470 52,496 53,637

Depreciation 8,021 9,572 10,173 12,123 13,093

Interest 531 1,276 1,194 1,226 1,320

Tax (31,971) (28,376) (18,965) (17,324) (17,700)

(Incr) / decr in net working capital (85,229) (55,133) 45,135 (3,270) (15,078)

Others (2,030) (287) - - -

Cash flow from operating activities (7,006) 22,359 95,006 45,252 35,271

(Incr) / decr in capital expenditure (15,834) (17,110) (10,793) (11,657) (12,589)

(Incr) / decr in investments 54 - - - -

Others 9,965 - - - -

Cash flow from investing activities (5,815) (17,110) (10,793) (11,657) (12,589)

Issuance of equity - - - - -

Incr / (decr) in borrowings 1,798 22,548 (22,548) - -

Others (18,697) (16,689) (14,640) (13,508) (13,869)

Cash flow from financing activities (16,899) 5,858 (37,187) (13,508) (13,869)

Net change in cash (29,721) 11,107 47,026 20,086 8,813


Valuation parameters

Year to March (%) FY12 FY13 FY14E FY15E FY16E

EPS (`) 29.0 27.3 15.7 14.4 14.7

Book value per share (`) 103.8 124.7 135.0 144.3 153.9

P/E (x) 5.9 6.3 10.9 11.9 11.6

P/BV (x) 1.6 1.4 1.3 1.2 1.1

EV/EBITDA (x) 3.7 3.9 6.3 6.7 6.6

EV/Sales (x) 0.8 0.7 0.9 0.9 0.8

CFO/EBITDA 25% 54% 197% 115% 96%


BHEL


Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking & Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal, CFA Oil & Gas (022) 30433202 [email protected]

Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Banking & Financial Services (022) 30433205 [email protected]

Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 [email protected]

Nitin Jain Technology (022) 30433291 [email protected]

Pankaj Agarwal, CFA Banking & Financial Services (022) 30433206 [email protected]

Pratik Singhania Real Estate / Retail (022) 30433264 [email protected]

Parita Ashar Metals & Mining (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Real Estate (022) 30433201 [email protected]

Ravi Singh Banking & Financial Services (022) 30433181 [email protected]

Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile / Healthcare (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 [email protected]

Utsav Mehta Telecom / Media (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

E&C = Engineering & Construction

BHEL


Explanation of Investment Rating Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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