At a time when the Street is confident about thermal-power ordering for Bharat Heavy Electricals Ltd (BHEL), Nomura has downgraded its rating on the shares of the largest government-owned power generation equipment manufacturer.
Nomura has cut its rating on BHEL shares to ‘reduce’ from ‘neutral’ and trimmed its target price to Rs 61 from Rs 79 to bake in the slower pace of cash generation. The global brokerage firm has also cut its EBITDA (Earnings before interest, taxes, depreciation and amortisation) estimate by 13 percent and 4 percent for FY24 and FY25, respectively, to factor in the delayed order inflow and still weak gross margins.
Over the past one year, BHEL shares have zoomed 62 percent in comparison to the benchmark Nifty 50’s 12 percent gain.
Nomura attributes this outperformance of BHEL to expectations of a strong recovery in thermal power tendering and the progress in recovery of receivables, and, hence, revival in cash flows.
“While we believe that thermal-power tendering prospects remain strong, we are unsure of EBITDA margin and cash-generation prospects,” it said.
Operating cash flow has turned negative in FY23, with a substantial rise in contract assets due to weak gross margins at 30 percent, compared to the pre-pandemic levels of 40 percent, owing to a rise in contract assets. This has led to a rise in total debtors by Rs 3,100 crore YoY to Rs 36,300 crore, Nomura explained.
BHEL reported an operating cash flow outflow of Rs 740 crore, compared to a positive operating cash flow of Rs 660 crore in FY22.
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Besides a negative operating cash flow, Nomura said that BHEL’s recent order wins look aggressive, with it having to cut bid price to match an offer by another bidder, which is likely to limit the scope of gross margin recovery.
According to the global financial services company, BHEL’s stock is currently trading at the higher end (16 times) of its long-term EV/EBITDA, which appears expensive, unless there is a marked improvement in profitability.
What other brokerages believe
Nuvama Institutional Equities sees a limited upside potential in BHEL, despite factoring in 4–5 GW of fresh order inflow and margins expanding to 6 percent by FY25. The brokerage firm has retained its ‘hold’ rating on the stock with a hike in target price to Rs 85 from Rs 80.
While the government focus has shifted towards renewables, most analysts believe thermal ordering will revive, keeping in mind the government’s target of having 500 GW of installed renewable energy by 2030.
BHEL is one of the largest heavy engineering and manufacturing companies in India in the energy-related/infrastructure sector. It caters to the core sectors of the Indian economy, like power generation and transmission, industry, transportation, telecommunications and renewable energy.
About the thermal pipeline, the company said in its conference call that it is favourably placed and is looking at 3.7 GW orders. Additionally, projects worth 6 GW are currently under the bidding process for FY24 and projects worth 9 GW are expected to be announced in FY25-26.
According to Nuvama Institutional Equities, there has been a recovery in the thermal sector after a gap of 4-5 years. This recovery is primarily driven by an increase in power demand, which is positively impacting the company's business prospects. Additionally, the company is also benefiting from the scale- up in sectors such as railways, defence, green hydrogen, and others.
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However, the brokerage firm believes the revenue mix of BHEL may continue to be dominated by the power sector in the near future.
BHEL’s management affirmed a structural turnaround in the power equipment market. It also gave a strong outlook for the industry segment, and stated its objective of making it over 50 percent of the business in the medium term.
Prabhudas Lilladher has upgraded its rating on the stock to ‘reduce’ from ‘sell’, with a hike in target price to Rs 67 from Rs 36 to build in a gradual revival of thermal tendering and execution pace.
Meanwhile, ICICI Securities highlighted that strong thermal ordering outlook for FY24 and thereafter bodes well for order inflows and profitability in a low-competition environment.
With an increase in industrial activity, demand for power is on an increasing trend. This will, in turn, increase the demand for new coal-based power plants.
BHEL could be a strong beneficiary of this demand leading to an annual ordering of more than Rs 35,000 crore from FY24-26, highlighted Antique Stock Broking.
It believes BHEL will witness a meaningful reversal in its ordering cycle over the next 3-4 years, led by both industry (non-power) and power segments.
“Supported by strong ordering, improving execution, and benefit of operating leverage, BHEL's earnings are anticipated to climb up five -fold over FY24-26,” according to Antique Stock Broking.
Hence, the brokerage firm has maintained its ‘buy’ rating on the stock with a target price of Rs 110, which is 20 times its FY25 EPS. ICICI Securities has also maintained its ‘buy’ recommendation on the stock, with a target price of Rs 100.
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