A Powerful Opportunity - Bharat Heavy Electricals

Most of the investors may be amazed to see Bharat Heavy Electricals (BHEL) as our choice scrip. It is quite obvious since it rarely happens in Dalal Street Investment Journal that a recommendation is repeated in such a short span. But there are compelling reasons backing our recommendation for this stock. Recently, the management of BHEL has stated that it aims to achieve a business target of Rs 45,000 crore till 2011-12 and hence with this sort of certainty and visibility in the earnings, we are but driven to spur investors to look at BHEL afresh.

Along with the long-term factors like increased investment in the power sector, the company’s strong financial performance for FY09, despite the present difficult macro-environment, also indicates the strength of its core business. The other compelling reasons include its high earning visibility on account of a strong order book of Rs 1,17,000 crore, better expected order inflows for next year, debt-free status in the current tight liquidity situation, expected improvement in the margins and capacity expansion plans. On the valuation front, BHEL is fairly placed. The CMP of Rs 1,517 discounts its FY09 earnings by 24.40x (EPS of Rs 62.10). The strong P/E despite weak markets and the grim economic outlook also indicate the strong growth expected from the company. [PAGE BREAK]

With its capacity of 10,000 MW of power generation systems per annum, BHEL is India’s largest engineering enterprise in the energy-related infrastructure sector. Its strong order book of Rs 1,17,000 crore (4.25x of FY09 revenues) is also an indication of the same. The additional creditable factor is that despite the current scenario of economic volatility its order inflow has also been strong which was Rs 59,687 crore in FY09. With expected orders of Rs 60,000 crore, the inflows are expected to be strong in FY10 too.

Further, BHEL is increasing its capacity to 15,000 MW by 2009 and 20,000 MW by 2011, thereby completing its five-year capex plan of Rs 4,200 crore funded through internal accruals. The important factor is that while other companies have stalled their capex plans, BHEL spent Rs 1,106 crore as capex (52 per cent increase over FY08). On the operational front, margins shrunk in FY09 on account of higher raw material prices till Q3FY09 when the company used the high price inventory. But the management has categorically stated that with raw material prices coming down and new purchases being made at lower levels, margins are expected to improve. While Q4FY09 margins have already improved by at least 150-200 basis points, further improvement is expected in FY2010.

The financial performance of the company has been strong in the past and it has carried forward this momentum in FY09 too. For FY09, its topline stood at Rs 27,505 crore and bottomline at Rs 3,039 crore as against Rs 21,401 crore and Rs 2,859 crore respectively in FY08. As regards FY10, the management expects a topline of Rs 32,000 crore and with improved margins the bottomline is estimated at Rs 4,240 crore (EPS of Rs 86.60). Considering this, we recommend that the investors should buy the scrip with a revised target of Rs 1,775 in the next one year.