Buy BHEL
Published on Thursday, November 12th, 2009 at 11:58 AMAuthor: insightt95in (166 Articles)
BHEL
BUY
Price: Rs2,216 Target Price (Sep 10): Rs2,750
Competition concerns overstated
* BHEL had sailed through stiffer competition with Chinese earlier (see Page 7), and have maintained/
improved margins.
* Domestic competition like L&T will occupy space vacated by Chinese vendors as they have been
marginalized in India and there is scope for market expansion.
* L&T will compete with 16-18% operating margins (except for first few orders) due to higher risk, long
gestation in power projects than in construction projects, despite its guidance of 12-13% blended
margins. Lower margins for L&T could only be a function of higher outsourcing as it may not be as
integrated as BHEL.
* Only Rs87 bn orders won in EPC out of order inflow of Rs1,099 bn in last 2 years for BHEL, where we
argue a case for margin expansion.
Is pricing war from L&T more than Chinese? – NO
* BHEL’s pricing differential with Chinese was more than 15-20%, whereas it is not more than 5% in most bids
against L&T (see Exhibit) – less than 1.5% in Mahagenco (3×660 MW) EPC order.
* Supercritical machines, per se are operationally better and hence, should command premium to sub-critical,
except for the outflow of initial 7-8 machines to technology supplier (applicable to both BHEL and L&T).
* We think even L&T will compete with 16-18% operating margins, as power is inherently a higher risk,
long gestation business, much different from short-gestation, lower risk construction business and hence,
should command better margins. L&T however has guided for 12-13% blended margins. We think lower
margins for L&T could only be a function of higher outsourcing as it may not be as integrated as BHEL.
* Chinese will been marginalized in India due to:
- curbs on Business Visas
- disappointing equipment performance
- IPR issues with OEM, and
- proposed mega power policy changes mandating
domestic manufacturing for supercritical sets
* BHEL had sailed through stiffer competition from
Chinese earlier and have maintained/
improved margins
Despite competition margins will not decline
* L&T will compete with 16-18% operating margins (except for first few orders) due
to higher risk, long gestation in power projects than construction projects.
* Only Rs87 bn worth orders won in EPC out of order inflow of Rs1,099 bn in last 2
years for BHEL, where we argue a case for margin expansion.
* BHEL’s capacity expansion from 10GW to 15GW will result in robust sales growth,
lower outsourcing and hence, higher operating leverage.
* BHEL has established vendor base and can command favorable terms on large
business volumes (4x more than any other competitor).
* BHEL is the most integrated manufacturing company with fungible capacities. It
has unmatched service network with – 14 manufacturing divisions, 4 Power Sector
regional centres, over 100 project sites, 8 service centres and 18 regional offices.
* Natural advantage in spares business to keep margins afloat.
Positioned to grow strongly
* Earnings visibility on ~Rs1,280 bn order book;
management raised order inflow guidance to Rs550 bn
in FY10; we have built Rs480 bn inflow.
* Capacity expansion in phases at boiler plant and
complete expansion to 15GW (from 10 GW) by Mar’10
to result in higher operating leverage.
* Vendor base enhancement underway. MOU/ Bonus
schemes for existing vendors.
* Future-ready technological tie-ups with
Forgemasters for large castings & forgings and with GEHitachi
for nuclear reactor technology exploration.
* Chinese not-allowed by tech collaborators to bid for
bulk supercritical (7,260 MW – 11x 660 MW) tenders in
565/593 OC steam cycle; not likely to bid for 5x 800
MW bulk tender also.
* Proposed mega power policy to mandate domestic
manufacturing in supercritical technology.
* Reiterate Buy with Sep’10 target price of Rs2,750.
* Key risk is increasing private orders where it may have lower margins.
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