Bharat Heavy Electricals rating: Sell — Covid-19 impacted execution in Q1

Bharat Heavy Electricals (BHEL) witnessed 56% y-o-y drop in revenues to Rs 20 bn implying continued weak execution. The company reported Ebitda loss of Rs 10.6 bn as material costs increased 830bps y-o-y to 65.9%; however, 48% y-o-y drop in other expenditure due to focus on cost reduction and lower provision partially mitigated losses.

Given subdued execution, high raw material and fixed expense, we estimate a net loss of Rs 1.5 bn in FY21e and cut FY22e earnings by 10%. Given the macro challenges, weak balance sheet and uncertainty regarding strategic initiatives that can meaningfully substitute thermal power equipment, we downgrade the stock to Sell (from Reduce) with a revised TP of Rs 24 (previously: Rs 27).

Execution impacted by lockdown: Overall execution was weak in Q1FY21 due to the lockdown. The lack of urgency to execute thermal projects and the focus on renewables by the government is likely to impact overall growth prospects of BHEL. We expect execution weakness to continue in near to medium term.

Delay in order finalisation indicates lack of urgency at client-end: BHEL is L1 in NTPC Talcher 2x 660MW and some FGD orders. It is also hopeful of finalisation of orders from SCCL Adilabad, NLC Talabira, NTPC Lara, NTPC Singrauli, and orders from Nuclear Power Corporation. Order intake fell 62% y-o-y to Rs 15 bn in Q1FY21 and orderbook stands at Rs 1.1 trn. We believe, apart from NTPC Talcher, other orders may be postponed to FY22e.

High receivables impacting working capital: Debtors remained high at Rs 353 bn impacted by delay in collection from certain SEBs and private sector. Retention money has decreased marginally to Rs 154 bn from Rs 157 bn in March 2020. This continues to be a major issue in terms of weakening of the return on capital employed.

Downgrade to SELL: Macro challenges in thermal power may further impact execution and revenue growth prospects. Order intake outlook is weak and most of the order finalisation is getting delayed. High receivables at Rs 353 bn and risk in terms of state and private sector is expected to impact ROCE. Absence of any meaningful alternative to thermal power and weak balance sheet are likely to impact return on capital.