BHEL - UBS Warburg

Broking House - UBS Warburg
Recommendation - Buy
Chinese competition a hurdle but Orders to boost growth.

In its report dated 18th December 2006 UBS Investment Research (UBS) initiates a Buy coverage on Bharat Heavy Electrical Limited (BHEL) with CMP of Rs2496.25 and a target price of Rs 2,950.

UBS throws light that BHEL focuses on the Indian power equipment business, which accounted for 65% of revenue and 79% of PBIT for FY04. Its main customer is National Thermal Power Corporation (NTPC), accounting for over 50% of revenue. BHEL also services the power transmission, captive power plant, industrial equipment, and the transportation segments. Actual/deemed exports accounted for 24% of revenue in FY04, and the company has added several new markets to its portfolio. It is 68%-owned by the Government of India.

UBS mentions that Lanco Infratech won the Sasan ultra mega project (UMPP) by quoting a levelised tariff of Rs1.19/Kwh. NTPC''s bid was at Rs2.1/Kwh. Of Lanco''s bid, Rs0.9/Kwh are fixed (NTPC at Rs1.2 /Kwh) and Rs0.3/Kwh is fuel cost (Rs0.9/Kwh). UBS further points out that fixed cost is a total of E&C (coal and power), interest, returns, and depreciation. BHEL is NTPC''s equipment supplier and Dongfeng, for Lanco.

UBS mentions that Dongfeng''s equipment costs are Rs1.7-1.8cr/MW whereas for BHEL, costs are higher by 25-30% at Rs2.2-2.4cr/MW, which is expected given the issue of reliability of Chinese equipment raised by few customers. Although the event could call for lower prices, and lower BHEL''s long term (LT) margins, UBS thinks there is a case for higher prices by BHEL, if not by 25%.

UBS highlights that lowering LT margin by 200bps lowers fair value by 11%. Near term, UBS retains that FY06-09E EPS CAGR of 30% given visibility and since UBS does not have UMPP in our estimates. UBS also retains their view on BHEL given expected visibility on orders, and profits. UBS will take a more objective view after management meetings.

Finally, UBS makes us aware that BHEL is its top pick in the engineering space. The key assumptions of DCF according to UBS are WACC of 12.1%, revenue growth of 20% over FY09-14E, and terminal g of 5%.

Thanks HK