Q3 better, though not sufficient to move the needle: Bharat Heavy Electricals Ltd (BHEL) Q3 PAT (profit after tax) fell 41% to R6.9 bn, although it came in 9% above our estimate. Beat on Ebitda (earnings before interest, taxes, depreciation and amortisation) was even higher at 19% driven by 2ppt lower material costs to sales ratio than expected. However, net sales continued to fall (16% y-o-y, in line with HSBC estimate) with similar deficit in order backlog at the start of the quarter. Power segment sales fell 12%, while industry segment fell by a huge 28%. Order backlog was down 12% y-o-y to R1,006 bn.
New order outlook is improving though already in the price: During Q3 , BHEL booked R72 bn of new orders and indicated it is well positioned for booking 3.3GW of new orders during Q4 FY14. Our estimates factor R290 bn of new orders during FY14, while the company has achieved R117 bn in 9M FY14. Management expects about 17GW of new orders to be finalised over the next 12 months, which is meaningfully higher than the past two years. We though anticipate only 12-14 GW ordering over next 12 months with BHEL cornering 55-60% share, suggesting limited room for a positive surprise.
Receivables remain a key concern area: Debtors at about R430 bn were up 13% sequentially, with 50% of the debtors now above 12 months old. Nearly 20-25% of the order book is also still slow moving. This poses a big risk to our FY15 earnings, if some of these bad debts need to be written off.
Retain Underweight (V) rating with an unchanged TP (target price) of R160: We continue to value BHEL at 11.6x FY16 earnings (10% discount to L&T), while it is currently trading at 13.0x FY15 earnings. The lower-than-peer valuation in our view is justified given its 7-8ppts lower ROE (return on equity) profile and a single-product-focused business. We continue to value BHEL at a 20% discount to L&T?s E&C business valuation multiple. We think this 20% discount is justified despite the improving business outlook, as BHEL?s earnings should remain depressed (-20% CAGR over FY13-16e) as against L&T?s EPS (earnings per share) CAGR (compound annual growth rate) of 10%. L&T?s average ROE over the next three years is also high at 15.7% as against 9.3% for BHEL. Finally, we believe L&T?s potential to benefit from the current business cycle is much higher than BHEL due to its diversified business presence as against BHEL?s single-product business. We value L&T?s E&C business at a forward P/E (price-to-earnings ratio) multiple of 14.5x. Our target P/E multiple for BHEL remains unchanged at 11.6x. Our DCF (discounted cash flow) model accords BHEL a fair value of R161. However, we prefer to value the company using a P/E approach as it captures the business cyclicality of an industrial stock like BHEL.
Key upside risks: Higher-than-expected order inflow; significant improvement in margins on super-critical equipment post-indigeni- sation; and a swift revival in industrial capex (capital expenditure).
