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We remain 'underweight' on Bharat Heavy Electricals Ltd (BHEL) and maintain our DCF-based Q2FY15 price target of Rs 110 per share. Our estimates include a declining post-tax Ebit through FY17 on account of margin contraction as well as declining revenue, assuming investments in the domestic power sector don’t pick up meaningfully. Our target implies a multiple of 7.3x/8.0x FY14/15 earnings.
Valuations can remain cheap in the absence of improvement in ordering environment. A return to over Rs 40,000-crore inflow run-rate is a risk to our medium-term growth and margin assumptions. Other upside risks include fresh private sector coal block allocation, faster clearances and award of projects/UMPPs despite elections, BHEL’s ability to cushion margin fall by reigning in employee costs and order inflow surprise from nuclear/defence/railways.
Recent favourable developments point towards improvement in the visibility on award of competitively bid coal blocks to the private sector and eligible government companies over the next two quarters.
Captive blocks do improve power project bankability and could whet the appetite of levered IPPs to join the capex party — this poses an upside risk to our base case forecast on order inflows over FY15-FY16 (~Rs 35,000 crore pa) for BHEL, which currently do not factor fresh BTG order opportunities from Greenfield private sector projects.