Over the last fortnight, capital goods giant Bharat Heavy Electricals Ltd (Bhel) has been in the news as it has commissioned several thermal units. For the year ended 31 March 2016, the firm also boasts the highest number of projects commissioned in the last five years. What’s more, it has an order book that is four times its trailing annual revenue. Simply put, it means that Bhel’s Rs.1.1 trillion order book is enough to generate revenue for the next four years.
But all this has mattered little to investors. In the past year, the company’s stock is down by over 50%. Why?
Nearly half of Bhel’s orders are from the power sector, where projects are stranded for want of clearances. Obviously, projects are moving at a slow pace, leading to cost overruns.
On the industrial side, too, clients are in no hurry to get projects off the ground. Recent macroeconomic data echoes the same. Manufacturing activity in the country is down and gross fixed capital formation during the March quarter contracted from a year ago by 1.9%, making it the lowest in two years.
Besides, analysts concede that most of the recent orders were at low margins because of the stiff competition in the industry. All these factors mean that there will be challenges to revenue and profit traction.
The company’s March quarter performance bears testimony to this. Revenue declined by 22% year-on-year and operating margin at 3.6% was way below 7% that the Street had forecast. The management too appears worried about such projects. The quarter’s profit was below expectation partly due to provisions made towards doubtful debts and liquidated damages.
That’s not all. The next three years may be challenging for order inflows too. Data from the Centre for Monitoring Indian Economy paints a rather gloomy picture for power equipment manufacturers. The annual plant load factor for India’s thermal and nuclear power stations is down from 78% in fiscal year 2008 to about 62% in FY16. What’s worse is that the peak energy deficit is also dropping, indicating that there is no demand for power.
These circumstances undermine the need for more power capacity. According to a note by Emkay Global Financial Services Ltd, “Bhel accounts for about two-thirds of the industry’s power equipment capacity of 30 GW (gigawatts), whereas order inflows over the next two to three years, is unlikely to cross 12-15 GW.” This implies stiff competition and weak pricing power, impairing profit margins.
Given these challenges, it is not surprising that a huge order backlog and a steep 55% jump in order inflows, even in the recent March quarter, failed to cheer investors and power the stock. Macro challenges are likely to tell on Bhel’s profitability and are too steep to tide over in the near term.