BHEL: Why it’s better to hold this stock

Power demand in India has been touching all-time high levels with peak demand of 240 GW during September. In this scenario , energy security becomes very important, underscoring the need for thermal capex alongside building capacities for renewables. Consequently, as per National Electricity Plan report put out in May 2023, incremental thermal capacity of about 24GW is being planned by the end of 2032 with another 8–9 GW contingency capex planned, in case renewables capex falls short of targets. Power equipment manufacturer BHEL (Bharat Heavy Electricals Ltd), being a dominant player in supplying thermal power equipment, has been a beneficiary of this theme.

The stock of BHEL has rallied by about 114 per cent in the last one year, driven by the optimism around revival in thermal ordering activity as well as  opportunities in Defence and Railway space on the industrial side. The stock’s trailing P/E is around 94 times on account of the recent rally in the stock and low base earnings due to margin pressure; the stock is priced around 28 times its FY25 earnings considering jump in earnings expected by then as per Bloomberg consensus estimates. While opportunities in thermal space look real, too much focus on this moves attention away from the company’s concentrated revenue stream, execution issues and margin pressures, which may continue in the near to medium term.

Diversification of revenue streams is necessary for company’s long-term sustainable growth and one needs to wait and watch on this front. In the medium term upside in thermal business can support the stock. For these reasons, existing investors can continue to hold the stock while fresh positions need not be considered at this juncture. 

Business

Conferred with Maharatna status, capital goods PSU BHEL is engaged in the design, engineering, manufacture, construction, testing, commissioning and servicing of a wide range of products and services in power and industry segment, which contribute about 79 per cent and 21 per cent respectively.

Within power segment, the company supplies power plant equipment such as turbo generators, boilers, turbines, and accessories, and erects all types of plants based on gas, coal, hydro, nuclear and solar power. Though it supplies such equipment for other generation sources, thermal comprises dominant share for the company. Its industry segment caters to diverse sectors such as process industries, railways, power transmission and distribution, and defence. In railways space, the company has manufacturing capabilities across locomotives, coaches, and propulsion systems while in defence, BHEL has capabilities in several areas like guns for naval ships, systems, and power equipment, including steam and gas turbines for ships, armored vehicles, missile systems and systems for aerospace.

The principal raw materials used by the company include steel, including cold-rolled grain-oriented steel and cold-rolled non-grain-oriented steel, copper, castings and forgings, tubes and pipes.

Wait and watch

During FY23, BHEL received orders worth  ₹23,600 crore comprising ₹13,400 crore for the power segment i.e. down by around 26 per cent YoY, ₹9,500 crore on the industrial side i.e. up by 68 per cent  and export orders of ₹700 crore. The company currently has an order book of around ₹1,01,461 crore comprising 68 per cent of orders from power segment and 27 per cent from Industrial segment while d the rest are export-based orders.

The order book got boosted by order inflows of around ₹15,600 crore which led by a large order in Q1FY24 worth ₹9,600 crore of delivery of 80 Vande Bharat train sets in a joint venture, along with Titagarh Wagons Ltd. However,  slow moving orders comprise around 20 per cent of the order book which are largely characterised by the lack of environmental clearances, legal and financing issues, among others.

Management, since 2015, has been reiterating its attempts to diversify the revenue stream.  But it still hasn’t materialised as power segment still comprises 75-80 per cent of revenue. Further, on account of the revival in thermal ordering activity, power segment will comprise the lion’s share in BHEL’s revenue for the time being. Management highlights opportunities to the tune of about 4 GW annually for the next 4-5 years. While this might boost the company’s revenue and profits in the near term, one needs to keep track of the company’s diversification attempt as it will become important forgrowth further on when opportunities in thermal dry up.

Performance

Amid boom in thermal power generation space, the company saw an increase in revenue at a CAGR of around 21 per cent reaching ₹47,598.95 crore during FY2009-12. However, BHEL found itself in a tough position post then on account of stiff competition, thermal equipment demand getting stalled and the company’s inability to diversify in segments within industrial space. During FY2013-19, the company saw its revenue falling around 40 per cent and its EBITDA margins contracting from around 20 per cent to 7 per cent.

In FY23, revenue grew nearly 10 per cent to around ₹22,136 crore on account of strong execution while the EBITDA margin dipped by 40 bps and remained subdued at around 3.2 per cent on account of spike in raw material prices. Consequently, the company’s PAT margin too contracted from 2 per cent to around 1.4 per cent during the period while PAT remained stable at around ₹452 crore. Going forward on account of thermal opportunities coming up, the revenue can grow more than 16 per cent CAGR during FY23-25 as per Bloomberg consensus estimates, while PAT can grow by around 72 per cent CAGR during the period driven by operating leverage, softening raw material costs and strong topline growth.

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