bhel - 2009-04-05 - j.p.morgan

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Asia Pacific Equity Research05 April 2009

Bharat Heavy Electricals (BHEL)Neutral

Previous: Overweight

BHEL.BO, BHEL IN

Too much premium for predictability, downgrade toNeutral

Price: Rs1,531.85

Price Target: Rs1,300.00Previous: Rs1,400.00

India

Engineering

Shilpa KrishnanAC

(91-22) 6639-3010

[email protected]

Sumit Kishore

(91-22) 6639-3007

[email protected]

J.P. Morgan India Private Limited

800

1,400

2,000

Rs

A pr -0 8 J ul -0 8 O ct -08 J an -09 A pr -09

Price Performance

BHEL.BO share price (Rs

NIFTY (rebased)

YTD 1m 3m 1

Abs 9.3% 10.9% 8.8% -17

Rel 3.4% -9.2% 3.4% 15.

See page 19 for analyst certification and important disc losures, including non-US analyst d isclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm mhave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making thinvestment decision.

BHELs provisional results for FY2009 showed strong execution andsigns of easing material cost pressures. 4Q PAT was however 16.5%

lower than estimates (FY2009: Rs30.4B, 4Q: Rs12.5B) due to a sudden

gratuity provision of Rs6B. We are disappointed that managementhad not anticipated or guided for this liability earlier.

We lower our estimates for FY2010 by 7%. We now have sales andPAT growth of 21.4% and 29.6% and EBITDA margin improvement of

290bps. Non-recurrence of gratuity provisions and end of wage hike

provisions account for the margin expansion.

During the meltdown, BHELs outperformance and premium

multiples arose from predictability of growth (at least the topline) ina difficult environment. An OB of ~Rs1180B guarantees visibilitythrough 2012. This OB remains relatively immune to cancellations due

to the predominance of govt utility power projects with guaranteed

returns. The companys ability to allay market fears of execution

bottlenecks was also an important contributor to outperformance.

However, the return of risk appetite will likely see markets placing alower premium to this predictability. In our view, L&T (OW) might

outperform BHEL in a rising market, as it has done in past rising

markets. We revisit our 'everything goes right' DCF model originally

published 15 months back and believe our new Mar-2010 PT of Rs1,300

(down from Rs1400 earlier, terminal growth rate (g):6%, WACC: 11.5%,terminal year: FY17), implying 16.2-x FY2010 earnings, is fair for the

stock. We downgrade the stock to Neutral. Key upside risk to our PT is

stronger than expected margin improvement and a rise in investor

preference for safe growth stocks.

BHEL (Bloomberg : BHEL IN; Reuters: B HEL.BO)

Rs. in millions, year-end March

FY08 FY09E FY10E FY11E

Sales 193,046 254,879 309,409 386,403 52-week range (Rs) 984.1-1934Net profit (adjusted) 25,892 30,390 39,400 49,242 Market cap (Rs B) 749.9EPS (Rs) 52.9 62.1 80.5 100.6 Market cap (US$ B) 14.9DPS (Rs) 15.3 17.9 23.2 29.0 Shares o/s (MM) 489.5Net sales growth (%) 12.0 32.0 21.4 24.9 Free float (%) 32.3

Net profit growth (%) 8.1 17.4 29.6 25.0 Avg. daily value (Rs MM) 2396.0EPS growth (%) NM 17.4 29.6 25.0 Avg. daily value (US$ MM) 47.5ROE (%) 26.5 23.8 28.5 29.3 Avg. daily volume (MM ) 1.70ROCE (%) 45.2 34.9 43.1 44.4 Exchange rate (Rs/US$) 50.4BVPS (Rs) 220.1 255.9 309.4 376.4P/E (x) 29.0 24.7 19.0 15.2P/BV (x) 7.0 6.0 5.0 4.1EV/EBITDA (x) 16.3 12.2 12.1 9.0

Source: J.P. Morgan estimates, Company data.

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Shilpa Krishnan(91-22) [email protected]

Table 2: Indian Capital Goods: Valuation co mps & estim ates


Company Rating CMP Target price Mkt cap P/E(x) EV/EBITDA(Rs) (Rs) (US$ bn) FY09E FY10E FY11E FY09E FY10E FY11EBHEL N 1,532 1,300 14.9 24.7 19.0 15.2 12.2 12.1 9.0ABB N 440 500 1.8 16.5 14.4 12.1 10.4 8.8 7.1Siemens UW 272 188 1.8 17.9 15.2 12.5 8.2 7.0 5.4Crompton Greaves N 131 120 0.8 9.6 8.8 8.2 4.7 4.3 3.7Larsen & Toubro OW 717 880 8.4 14.3 12.1 11.0 11.3 10.1 9.4Punj Lloyd N 107 130 0.6 15.3 6.1 6.4 6.1 5.7 5.2

Source: J.P. Morgan estimates, Company data. Note: P/E and EV/EBITDA estimates for Siemens and ABB have been fiscalized.

Tracking multiples and stock performance over time

Historically, BHELs P/E multiple has shown a high correlation to the revenue

visibility provided by its order book. However, over the last 5 quarters, the focus has

shifted from order book to execution. Concerns on execution, coupled with weak

market sentiment have led to a decline in multiples despite the continued OBexpansion (Figure 1 & 2).

Another commonly used multiple for BHEL is the EV/OB (Figure 3). Barring the

FY06-08 phase when markets were exceptionally bullish, BHEL has traded at an

EV/OB ranging from 0.3x (FY00) to 0.6x (current).

From the movement of these multiples over cycles, we conclude that BHELs

multiples, which appear cheap vis--vis recent history, are currently at

normalized mid-cycle levels. With limited potential for OB expansion from present

high levels, we believe multiples too might remain at current levels or drift lower.

Figure 1: BHEL: Analyzing correlation between P/E and OB visibility (trailing 12-months)

Year-end March

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Figure 2: BHEL: Analyzing corr elation between P/E and OB visibi lity (1-year forward)

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Figure 3: BHEL: EV/OB trend

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Tracking BHELs performance vs. L&T over time

BHELs P/E multiple vs. L&T has been at an average premium of ~60% over the last

2 decades (Figure 4, 5). However, in our experience, L&T has tended to outperform

analysts EPS estimates much more sharply, as compared to BHEL, during periodsof economic boom. Thus, what appears to be a premium multiple in hindsight, is

misleading. From our experience, BHEL tends to trade at 10-15% premium to L&T

over the cycle with two exceptions: 1) During the peak of the markets (Eg: 2008), we

found L&Ts multiples outstripping those of BHEL, as L&T is perceived to be a

bigger growth play during such times and 2) When markets are weak, BHELs

premiums to L&T tend to expand, as BHEL is always considered a safer growth

stock than L&T

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Figure 4: 1-yr forward P/E: BHEL & L&T

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Figure 5: 1-yr forward P/E(x): BHEL's historical premium/ (discount) to L&T

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BHELs absolute performance vs L&T and relative performance vs Sensex offers

interesting conclusions, in our view. Since 1996, BHEL has outperformed the Sensex

and L&T in bear market. L&T has underperformed the Sensex in bear markets (see

charts for FY96-98, FY00-03, and FY08-now).

In the bull markets of 03-07, both L&T and BHEL massively outperformed the

Sensex. L&T marginally outperformed BHEL. In the bull rally in 98-99 too L&T had

outperformed BHEL.

Thus, historically, performance of L&T>BHEL>Sensex in bull markets andperformance of BHEL>Sensex>L&T in bear markets. BHEL has had a positive

impact on a portfolio irrespective of market movement, but L&T has had an

even more positive impact during bull markets. During bear markets, L&T is

the stock to avoid, in our view.

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Figure 6: Pri ce Performance: L&T, BHEL & Sensex (96-98)

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Figure 10: Price perfor mance: L& T, BHEL & Sensex (08-now)

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Financials: growth drivers in place

Revenues: demand in place, capability to supply is theconstraint

BHEL has an order backlog of ~Rs1180B as on 31Mar 2009, providing earnings

visibility through FY12. ~84% of OB is accounted by power sector, ~9% by industry

and balance 7% by exports. State & Central government orders constitute ~85-90%

of the order book; balance is from private sector players. This OB remains relativelyimmune to cancellations due to the predominance of govt utility power projects with

guaranteed returns.

In FY09 BHEL has reported Rs597B of new orders (+18.7% YoY). In our view

FY10, would be the peak year of 12th Plan (FY13-FY17) ordering; the country is

targeting capacity addition of ~95GW in the next plan period.

The average execution period of projects is ~36months. The margins are higher in

BTG/ product orders and are lower in EPC orders. The EPC orders include BOP and

civil work where value addition and profit margins are lower. The composition of

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order book in the 10th plan period (FY03-07) had a higher chunk (70:30) of EPC

orders. Over the past many quarters BHEL has been booking more product orders,

bringing the composition of EPC to BTG orders down to around 50:50.

BHEL follows percentage completion method of booking revenues on orders. Given

that demand is in place, execution capacity is the only constraint. Current capacity is

10GW, increasing to 15GW by Dec-2009 and 20GW by Dec-2011. We are not

unduly concerned that capacity constraints would pose a serious risk to growth,

barring one-off quarterly fluctuations in execution and revenue recognition.

Figure 11: BHEL: Order booking, Order backlog and visibility trend for BHEL

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Operating margins: the contribution of operating leveragelikely to be lower going ahead

There are 3 important determinants of margins: pricing, material cost and operating

leverage.

Competitive pressures on pricing unlikely to be felt near term: In our view,

power plant equipment prices have been firm over the past few years, mainly owing

to reduced Chinese competitive pressures as a result of the RMB appreciation vs

INR. However, competition from L&T is likely to be stronger going ahead. This

might impact margins beyond FY12, as revenues through FY12 are already secured.

Easing material cost likely to be a positive margin contributor: As of now, 60%of the orders are on cost-plus basis and balance 40% are fixed price contracts. In

FY09, raw material, erection and engineering expenses were 60.3% of net sales,

~100bps higher than FY08. Typically BHEL maintains an inventory of 3-4 months

for indigenous materials and 6 months for imported materials. Commodity prices

were at their peak in Sep-q, thus the maximum impact on margins was felt during the

Sep & Dec quarters where OPM declined 420bps and 300bps respectively. The raw

material cost pressures have eased out considerably in 4Q09 in our view.

Operating leverage-led margin gains unlikely through FY12, barring the near-

term impact of cessation of wage-arrear provisioning: Operating leverage was the

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most important contributor to margin expansion between FY02-07 (Figure 12).

While BHELs capacities were underutilized, the company was overstaffed. Increase

in capacity utilization via more shifts and minor de-bottlenecking, coupled with thereduction of staff strength from 68K to 43K contributed greatly to the reduction of

fixed overheads, even as revenue continued to grow.

Figure 12: BHEL: Operating leverage in employ ee and other expenses

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Source: J.P. Morgan estimates, Company data. Note: [a] Other expenses include sales & admin expense, power & fuel, stores & spares and stock variation.

Going forward, employee numbers are slated to rise to 53K (currently 46K), while

manufacturing capacity is slated to double to 20GW (currently 10GW). In our view,

these factors would result in an absolute increase in fixed overheads, and fixed

expenses as % of sales are likely to remain flat at best.

In FY10, we expect a 290bps margin improvement as provisions for wage arrears are

done with. We believe overall employee cost would decline in absolute terms (Table

2). The implementation of 6th

Pay Commission recommendations would result in40% increase in per employee wages. We have not factored in margin improvement

on account of commodity price decline for FY10, and we shall wait for June-q results

to review our assumptions.

Table 3: BHEL: Emplo yee cost estim ates


FY2007 FY2008 FY2009E FY2010E FY2011E

No of employees (yr-end) 42,124 43,636 46,000 50,000 53,000Per employee wages (Rs, based on average employees) 559,216 608,137 699,357 979,100 1,077,010% increase 9 15 40 10Employ ee cost (Rs mn) 23,690 26,077 31,344 46,997 55,466Wage arrears provision (Rs mn) 800 5,140 19,000 0 0Other provisions (Rs mn) 0 2,000 0 0 0Total employee cos t (Rs mn) 24,490 31,217 50,344 46,997 55,466


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Table 4: BHEL: P&L statement


FY08 FY09E FY10E FY11E FY12EGross Sales 214,977 275,050 334,496 417,733 426,598Less: Excise duty (21,322) (20,171) (25,087) (31,330) (31,995)Net Sales 193,655 254,879 309,409 386,403 394,603Other op income 4,927 6,200 6,200 6,200 6,200(Inc)/Dec in WIP 8,273 10,754 10,754 10,754 10,754Raw material consumption (114,895) (153,701) (186,484) (232,889) (239,964)Staff cost (31,459) (50,344) (46,997) (55,466) (56,513)Other expenses (21,906) (26,245) (33,359) (38,959) (42,562)Total Expenditure (159,987) (219,536) (256,085) (316,559) (328,284)EBIDTA 38,595 41,544 59,524 76,044 72,519Other income 9,035 7,295 5,554 5,849 7,387EBIDT 47,630 48,839 65,077 81,893 79,907Interest (354) (300) (300) (300) (300)Depreciation (2,972) (3,239) (5,081) (6,984) (8,653)PBT 44,304 45,300 59,697 74,609 70,953Tax (15,711) (14,910) (20,297) (25,367) (24,124)

Repor ted PAT 28,593 30,390 39,400 49,242 46,829EPS 58.4 62.1 80.5 100.6 95.7

13,962 13,495 11,754 12,049 13,587Growth (%)Net Sales 31.6 21.4 24.9 2.1PAT 6.3 29.6 25.0 (4.9)

Key ratios (%)Raw Materi al to Sales 59.3 60.3 60.3 60.3 60.8Excise duty to sales 9.9 7.3 7.5 7.5 7.5Staff Cost to sales 16.2 19.8 15.2 14.4 14.3Other exp to sales 11.3 10.3 10.8 10.1 10.8EBIDTA marg in 19.9 16.3 19.2 19.7 18.4Effective tax rate 35.5 32.9 34.0 34.0 34.0


First-cut analysis of FY2009 provisional results

BHELs provisional results for FY2009 showed strong execution and signs of easing

material cost pressures. 4Q PAT was however 16.5% lower than estimates (FY2009:

Rs30.4B, 4Q: Rs12.5B) due to a sudden gratuity provision of Rs6B. In a television

interview, management said that that at the last minute they had to provide for

gratuity increase as well as the recent hike announced by the finance ministry as a

result they had to provide for about Rs 19B instead of Rs 13B anticipated earlier. We

are disappointed that management had not anticipated or guided for the Rs6B

gratuity provision earlier. Management continues to guide towards a 20-25% revenue

growth and 25-30% PAT growth in FY2010.

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Table 5: BHEL: Mar-q & FY09 detailed estimates post provisional results


9M09 9M08 %YoY FY09E FY08 %YoY 4Q09E 4Q08 %YoYGross Sales 169,551 135,378 25.2 275,050 214,977 27.9 105,499 79,599 32.5Less: Excise duty (12,610) (13,744) (8.3) (20,171) (21,322) (5.4) (7,561) (7,578) (0.2)Net Sales 156,941 121,634 29.0 254,879 193,655 31.6 97,938 72,021 36.0Other op income 3,144 2,463 27.6 6,200 4,927 25.8 3,056 2,464 24.0(Inc)/Dec in WIP 9,793 4,342 125.5 10,754 8,273 30.0 961 3,931 (75.5)Raw material consumption (101,977) (72,952) 39.8 (153,701) (114,895) 33.8 (51,724) (41,943) 23.3Staff cost (27,053) (19,799) 36.6 (50,344) (31,459) 60.0 (23,291) (11,660) 99.7Other expenses (16,653) (13,191) 26.2 (26,245) (21,906) 19.8 (9,592) (8,715) 10.1Total Expenditure (135,890) (101,600) 33.8 (219,536) (159,987) 37.2 (83,646) (58,387) 43.3EBIDTA 24,195 22,497 7.5 41,544 38,595 7.6 17,349 16,098 7.8Other income 5,908 7,258 (18.6) 7,295 9,035 (19.3) 1,387 1,777 (21.9)EBIDT 30,103 29,755 1.2 48,839 47,630 2.5 18,736 17,875 4.8Interest (226) (312) (27.6) (300) (354) (15.3) (74) (42) 76.2Depreciation (2,334) (2,145) 8.8 (3,239) (2,972) 9.0 (905) (827) 9.4PBT 27,543 27,298 0.9 45,300 44,304 2.2 17,757 17,006 4.4Tax (9,636) (9,813) (1.8) (14,910) (15,711) (5.1) (5,274) (5,898) (10.6)

PAT 17,907 17,485 2.4 30,390 28,593 6.3 12,483 11,108 12.4EPS 36.6 35.7 2.4 62.1 58.4 6.3 25.5 22.7 12.4

Key ratios (%)Raw Material to Sales 65.0 60.0 60.3 59.3 52.8 58.2Excise duty to sales 7.4 10.2 7.3 9.9 7.2 9.5Staff Cost to sales 17.2 16.3 19.8 16.2 23.8 16.2Other exp to sales 10.6 10.8 10.3 11.3 9.8 12.1EBIDTA marg in 15.4 18.5 16.3 19.9 17.7 22.4Effective tax rate 35.0 35.9 32.9 35.5 29.7 34.7


Table 6: BHEL: Key model revisions


2009E 2010E 2011E

Revenues old 250,115 314,444 388,492Revenues new 254,879 309,409 386,403Revision (%) 1.9 (1.6) (0.5)YOY growth (%) 32.0 21.4 24.9

EBITDA old 41,170 58,400 78,231EBITDA new [a] 38,148 56,616 73,714

Revision (%) (7.3) (3.1) (5.8)YOY growth (%) (7.0) 48.4 30.2

EBITDA margin(%) old 16.5 18.6 20.1EBITDA margin(%) new 15.0 18.3 19.1

Revision (bps) (149.3) (27.4) (106.0)

Adjusted PAT old 32,859 42,216 54,727Adjusted PAT new 30,390 39,400 49,242

Revision (%) (7.5) (6.7) (10.0)

YOY growth (%) 17.4 29.6 25.0

Diluted EPS old (Rs) 67.1 86.2 111.8Diluted EPS (Rs) new 62.1 80.5 100.6

Revision (%) (7.5) (6.7) (10.0)


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Table 7: BHEL: Reported or ders in Mar-q

Date Descrip tion Size (Rs. Mn.)

27-Feb-09 BHEL received the first-ever order for Steam Generators for New Rating 700 MWe Nuclear Sets. The order has been placed onBHEL by Nuclear Power Corporation of India limited (NPCIL) for Kakrapara Atomic Power Project (KAPP) in Gujarat. For the firsttime in India, NPCIL is installing two units of 700 MWe rating at KAPP, the highest rating developed indigenously, based onPressurised Heavy Water Reactors, the other order has been placed on L&T.Valued at Rs.3,450 Million, the order envisages manufacture and supply of 4 Steam Generators, for use in the Primary cycle of theNuclear Power Plant for one Reactor of 700 MWe unit rating.

3,450

23-Feb-09 Outbidding Chinese equipment suppliers under international competitive bidding, Bharat Heavy Electricals Limited (BHEL) has wonan order for the main plant package at the upcoming Malwa Thermal Power Project (TPP) in Madhya Pradesh, involving two new-rating units of 600 MW each. Valued at Rs.31,500 Million, the order for the greenfield power project has been placed on BHEL byMadhya Pradesh Power Generating Company Limited (MPPGCL).

31,500

9-Feb-09 BHEL has bagged four major contracts from various customers for the supply and installation of main plant equipment for thermalpower projects. The projects, with a cumulative capacity of 3,250 MW, are located in Madhya Pradesh, Uttar Pradesh, Tamil Naduand Maharashtra. Cumulatively valued at around Rs.70,000 Million, the contracts have been placed on BHEL by NTPC Ltd.(2000MW), NLC Tamil Nadu Power Limited (1000MW) and Mahagenco (250MW).

70,000

Source: Company reports.

Working capital: a near term concernNet working capital may have gone up from negative Rs5B as on March-08 to

Rs31.7B as of Mar-09, in our estimate. The following factors have been responsible

for the increase in our view-

Higher inventory due to execution pressures. Inventory days have gone up

sharply from their FY07 levels (100 days) to around ~156 days in FY09.

Although we expect marginal decrease in the collection period, liberal credit

terms to vendors led to higher working capital pressure, in our view

Sharp rise in loans & advances

Customer advance as a percentage of turnover may have gone up significantly as

well - this offsets higher working capital need to some extent

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Table 8: BHEL: Working capital details and key efficiency metrics


FY04 FY05 FY06 FY07 FY08 FY09E FY10E FY11ECurrent assets :Inventories 21,039 29,161 37,444 42,177 57,364 92,242 113,336 141,539Sundry debtors 46,085 59,721 71,681 96,958 119,749 148,838 185,118 231,184Cash & Bank Balances 26,596 31,779 41,340 58,089 83,860 55,513 66,988 89,783Loans & advances 10,392 12,297 11,999 11,409 11,863 35,000 30,000 10,000Others 135 472 845 1,997 4,211 10 10 10Total cur rent assets 104,247 133,430 163,308 210,630 277,047 331,604 395,453 472,516

Current liabilities :Sundry Creditors 17,380 20,997 28,041 35,390 43,851 44,464 57,099 70,689Advances (customers) 31,330 45,849 54,792 77,755 113,946 151,951 180,628 213,044Others 3,259 4,359 5,245 5,834 7,967 8,365 8,784 9,223

Provisions :Taxation 1,282 1,228 1,477 980 (2,015) (2,015) (2,015) (2,015)Dividends 830 1,256 490 2,937 3,060 10,164 13,177 16,469

Others 9,287 10,770 13,156 21,305 31,399 31,399 31,399 31,399

Total cur rent liab ili ties 63,369 84,459 103,200 144,201 198,208 244,329 289,072 338,809

Net curren t assets 40,878 48,971 60,108 66,429 78,839 87,275 106,381 133,707Net cur rent assets (ex-cash) 14,282 17,192 18,768 8,340 (5,021) 31,761 39,393 43,924

Inventory turnover (x) 3.6 3.1 3.2 3.6 3.0 2.3 2.5 2.4Inventor y (days) 101 119 114 100 121 156 149 150

Receivables/Sales (%) 53 58 49 52 56 55 55 55Collecti on period (days) 194 211 180 189 204 202 202 202

Payables/purchase (%) 23 23 23 23 25 21 21 21Average credit received (days) 83 86 86 84 93 75 75 75

Custom er advances as % of turn over 36 44 38 41 53 57 54 51


Working capital pressures may be responsible for BHELs negative FCF in FY09, in

our view. BHEL has generated negative FCF only twice since FY95. See Table 8 for

contribution of net-working capital components to FCF

Table 9: BHEL: Contribution of change in working capital components to FCF


FY05 FY06 FY07 FY08 FY09E FY10E FY11EDecreas e/ (Incr ease) in cur rent asset s (24,001) (20,317) (30,573) (40,646) (82,904) (52,374) (54,268)-Inventory (8,122) (8,283) (4,733) (15,187) (34,878) (21,094) (28,203)

-Sundry Debtors (13,637) (11,959) (25,278) (22,791) (29,090) (36,280) (46,065)-Loans & advances (1,905) 298 590 (455) (23,137) 5,000 20,000-Others (337) (373) (1,152) (2,214) 4,201 0 0

Increase/ (Decrease) in curr ent liabil ities 21,090 18,741 41,001 54,007 46,121 44,743 49,737-Sundry Creditors 3,617 7,044 7,349 8,462 613 12,635 13,590-Advances (customers) 14,519 8,943 22,964 36,191 38,005 28,677 32,416-Others 1,100 886 589 2,133 398 418 439-Provisions 1,855 1,868 10,100 7,222 7,105 3,013 3,292

Decrease in net curr ent assets (ex-cash) (2,910) (1,576) 10,428 13,361 (36,783) (7,631) (4,531)FCF 4,160 12,253 28,057 27,497 (28,210) 15,376 31,829


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The working capital pressures are on expected lines considering the impact of the

ongoing credit crunch; however we believe that in FY10 and FY11 the incremental

impact of increase in WC on FCF would be muted.

BHEL continues to have a strong balance sheet with FY09 estimated net-cash of

Rs55B.

Table 10: BHEL: Balance Sheet


FY 2005 FY 2006 FY 2007 FY 2008 FY 2009E FY 2010E FY 2011E

Share capital 2,448 2,448 2,448 4,895 4,895 4,895 4,895Reserves and surplus 57,821 70,566 85,435 102,847 120,360 146,583 179,356Share ho lder s equ ity 60,269 73,014 87,883 107,742 125,255 151,478 184,251Secured loans 5,000 5,000 - - - - -Unsecured loans 370 582 893 952 893 893 893Total Borr owin gs 5,370 5,582 893 952 893 893 893

Total Capit al 65,639 78,596 88,776 108,694 126,149 152,371 185,144

Gross Fixed Assets 36,289 38,221 41,351 44,435 56,015 73,015 89,015(Less) Acc. Depreciation 26,193 28,528 31,171 34,031 39,111 46,095 54,749Capital work in progress 953 1,846 3,025 6,580 10,000 8,000 7,000Net Fixed Assets 11,396 11,668 12,913 16,393 26,412 34,528 40,975Investmen ts 90 83 83 83 83 83 83Cash and Bank Balances 31,779 41,340 58,089 83,860 55,513 66,988 89,783Net Current Assets ex-cash 17,192 18,768 8,340 (5,021) 31,761 39,393 43,924Total Assets 65,639 78,596 88,776 108,694 126,149 152,371 185,144

Net Debt (26,409) (35,757) (57,196) (82,908) (54,620) (66,095) (88,890)


We estimate capex of Rs45B over the next three years for ongoing capacity

expansion from 10GW to 15GW, followed by further expansion to 20GW. This can

easily be met through internal accruals (estimated 90B of retained earnings from

FY10-12), in our view. We have forecasted strong operating cash flows for BHEL

over FY10-12 as impact of incremental working capital pressures is muted.

Table 11: BHEL will d eliver stro ng pos itive FCF from FY10-12


FY2007 FY2008 FY2009E FY2010E FY2011E FY2012E

EBIT 31,999 33,215 35,344 53,324 69,844 66,319D&A 2,730 2,972 3,239 5,081 6,984 8,653Tax 13,214 15,711 14,910 20,297 25,367 24,124Decrease in WC 10,428 13,361 (36,783) (7,631) (4,531) (84)Operat ing CF 31,944 33,838 (13,110) 30,476 46,929 50,764

Capex (3,887) (6,340) (15,100) (15,100) (15,100) (15,100)Inves tin g CF (3,887) (6,340) (15,100) (15,100) (15,100) (15,100)FCF 28,057 27,497 (28,210) 15,376 31,829 35,664


Business mix and competitive analysis

The order inflow mix between power & industry segments has shifted in favor of

power sector over the last few years. In the 90's the mix was ~50:50 and now the

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power to industry mix is 80:20. Management expects share of industrial segment to

increase to 30% going forward, once their forays into transportation and private

sector transmission begin to contribute to sales. We have neither factored in capexfor these new ventures nor modelled revenues for the BHEL's foray into

transportation/transmission currently, as we await more clarity.

Figure 13: BHEL: Power & Industry segment order inflows

Rs. in billions, year-end March

0

100

200

300

400

500

FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09E

0

20

40

60

80

100

Power (LHS) Industry (LHS) Power as % of total (RHS)


A similar trend is observed in the revenue composition also.

Figure 14: BHEL: Power & industry segment revenue compositionRs. in billions, year-end March

0

50

100

150

200

250

FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09E

0

20

40

60

80

100

Power (LHS) Industry (LHS) Power as % of total (RHS)


Competitive analysis

In the power segment, BHEL receives bulk of its order from central government

owned utilities (NTPC, DVC) and the State Gencos (earlier known as SEBs). BHEL

has a share of approximately 75% of central power orders and 83% of SEB orders in

the 11th Plan which would be completed till FY12, in our view.

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Table 12: Share of orders of likely to be commissioned or already commissioned 11th Plan powerprojects

In MW

Sector Orders Placed on Total Market share (%)Central BHEL 16,256 76

Others 5,240 24State BHEL 18,235 83

Others 3,766 17Private BHEL 2,040 12

Others 15,566 88Total BHEL 36,531 60

Others 24,572 40Grand Total 61,103

Source: J.P. Morgan estimates, Infraline.

Other players that supply to Indian utilities include: Chinese equipment suppliers

mainly Dongfang and Shanghai Electric estimated market share of 20-25%,

Hyundai 5% and a slew of other players Siemens, L&T-Mitsubishi, Toshiba,Alstom accounting for the rest of the market share. Chinese players have had the

most visible market share gain over the past 5 years, especially with private utilities

such as Reliance Power, Lanco, Jindals and Sterlite. Government owned utilities

have, by-and-large, persisted with BHEL. BHELs advantage arises from a long-

standing manufacturing presence in India, which has made it cost competitive and

also provides an advantage in the supply of spares and services.

The government has recently initiated measures to favour domestic manufacturers.

For the forthcoming tenders of supercritical projects (11 plants envisaged), bidding

would be restricted to players with domestic manufacturing. We view L&T as

potentially the strongest competitor to BHEL, once its domestic manufacturing JV

with Mitsubishi commences manufacturing (slated for late FY11).

A brief background of BHEL

BHEL is currently the largest engineering and manufacturing enterprise in India in

the energy sector. The company has been earning profits continuously since 1971-72

and paying dividends since 1976-77. BHEL's operations are organized around three

business sectors, namely Power, Industry - including Transmission, Transportation,

Telecommunication & Renewable Energy - and Overseas Business (which

constitutes ~7% of OB, we have not modeled overseas business separately as the

revenue streams can be classified under power & industry).

As per company reports, BHEL has-

Installed equipment (boiler, turbine and generators) for over 90,000 MW ofpower generation -- for Utilities, Captive and Industrial users.

Supplied over 2,25,000 MVA transformer capacity and other equipmentoperating in Transmission & Distribution network up to 400 kV (AC &

DC).

Supplied over 25,000 Motors with Drive Control System to Power projects,Petrochemicals, Refineries, Steel, Aluminum, Fertilizer, Cement plants, etc.

Supplied Traction electrics and AC/DC locos to power over 12,000 kmRailway network.

Supplied over one million Valves to Power Plants and other Industries.

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BHEL: Summary of Financials

Profit and Loss statement Cash flow statement

Rs in millions, year-end Mar FY07 FY08 FY09E FY10E Rs in millions, year-end Mar FY07 FY08 FY09E FY10E

Gross Revenues 187,390 214,010 275,050 334,496 EBIT 31,999 33,215 35,344 53,324

% change Y/Y 29% 14% 29% 22% D&A 2,730 2,972 3,239 5,081

Gross Margin (%) 18% 19% 21% 17% Tax 13,214 15,711 14,910 20,297

EBITDA 33,718 41,007 57,148 56,616 Decrease in WC 10,428 13,361 (36,783) (7,631)

% change Y/Y 31% 22% 39% -1% Operating CF 31,944 33,838 (13,110) 30,476

EBITDA Margin (%) 18% 19% 21% 17%

EBIT inc OI 39,311 52,450 67,404 63,289 Capex (3,887) (6,340) (15,100) (15,100)

% change Y/Y 35% 33% 29% -6% Change in investments 0 0 0 0

EBIT Margin (%) 21% 25% 25% 19% Investing CF (3,887) (6,340) (15,100) (15,100)

Net Interest 433 354 300 300 FCF 28,057 27,497 (28,210) 15,376

Earnings before tax 37,159 44,304 45,300 59,697% change Y/Y 45% 19% 2% 32% Change in equity 0 2,448 0 0

Tax 13,214 15,711 14,910 20,297 Change in debt (4,689) 59 (59) 0

as % of EBT 36% 35% 33% 34% Net Interest paid (433) (354) (300) (300)Net Income (preexceptionals) 23,945 28,594 30,390 39,400 Other income 8,323 14,415 13,495 11,754

% change Y/Y 42% 19% 6% 30% Deferred tax asset (2,614) (4,028) 1,000 1,000

Shares Outstanding 244.76 489.52 489.52 489.52 Dividend & div tax paid (6,925) (8,734) (10,164) (13,177)

EPS (pre exceptionals) 97.8 58.4 62.1 80.5 Misc. adjustment (7,582) (9,559) (3,110) (2,177)

% change Y/Y 42% -40% 6% 30% Financial CF (11,307) (1,726) (137) (3,901)

Change in cash 16,749 25,771 (28,347) 11,475

Opening cash balance 41,340 58,089 83,860 55,513

Closing cash balance 58,089 83,860 55,513 66,988

Balance sheet Ratio Analysis

Rs in millions, year-end Mar FY07 FY08 FY09E FY10E %, year-end Mar FY07 FY08 FY09E FY10E

Cash and cash equivalents 58,089 83,860 55,513 66,988 EBITDA margin 18% 19% 21% 17%

Accounts receivable 96,958 119,749 148,838 185,118 Net profit margin 14% 13% 12% 13%

Inventories 42,177 57,364 92,242 113,336

Others 1,997 4,211 10 10 Sales per share growth 29% 14% 29% 22%

Current assets 210,630 277,047 331,604 395,453 Sales growth 29% 14% 29% 22%

Net profit growth 42% 19% 6% 30%

Investments 83 83 83 83 EPS growth 42% -40% 6% 30%

Net fixed assets 12,913 16,393 26,412 34,528

Others 0 0 0 0 Interest coverage (x) NA NA NA NA

Total assets 223,625 293,523 358,099 430,064 Net debt to total capital -26% -28% -15% -15%

Net debt to equity -65% -77% -44% -44%

Liabilities Sales/assets 0.8 0.7 0.8 0.8

Payables 35,390 43,851 44,464 57,099 Assets/equity 2.5 2.7 2.9 2.8

Others 108,812 154,357 199,865 231,973Total current liabilities 144,201 198,208 244,329 289,072

Total debt 893 952 893 893 ROE 30% 26% 24% 28%

Other liabilities 52,493 63,891 80,791 94,379 ROCE 45% 45% 35% 43%

Total liabilities 197,587 263,051 326,014 384,344

Shareholders' equity 87,883 107,742 125,255 151,478

BVPS 359.1 220.1 255.9 309.4


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All Data As Of 03-Apr-09

Quant Return Drivers (a Score >50% indicates company ranks 'above average') J.P. Morgan Composite Q-Score

Score 0% (worst) to 100% (best) vs Industry Raw Value

Value

P/E Vs Market (12mth fwd EPS) 33% 1.5x

P/E Vs Sector (12mth fwd EPS) 24% 1.2x

EPS Growth (forecast) 86% 24.7%

Value Score 50%

Price Momentum

12 Month Price Momentum 69% -16.5%

1 Month Price Reversion 85% 10.9%

Momentum Score 75%

Quality

Return On Equity (forecast) 93% 29.7%

Earnings Risk (Variation in Consensus) 76% 0.09 Quant Return Drivers Summary (vs Country)

Quality Score 94%

Earnings & Sentiment

Earnings Momentum 3mth (risk adjusted) 85% -16.71 Mth Change in Avg Recom. 7% -0.12

Net Revisions FY2 EPS 72% 0%

Earnings & Sentiment Score 48%

COMPOSITE Q-SCORE* (0% To 100%) 69%

Targets & Recommendations** EPS Revisions** Historical Total Return (%)

Consensus Growth Outlook (%)

Closest in Country by Size (Consensus. ADV = average daily value traded in US$m over the last 3 mths)

Code Industry ADV PE FY1 Q-Score*500325-IN 48.91 17.3 41%

500312-IN 5.37 8.8 21%

532555-IN 4.65 19.1 85%532454-IN 8.40 14.4 73%500209-IN 6.46 13.9 62%

500103-IN 9.74 22.8 60%500875-IN 2.13 21.0 48%

500112-IN 23.27 7.9 43%

532540-IN 3.00 10.7 49%

500696-IN 2.10 22.7 96%530965-IN 0.65 10.4 38%

Source: Factset, Thomson and J.P. Morgan Quantitative Research. For an explanation of the Q-Snapshot, please visit http://jpmorgan.hk.acrobat.com/qsnapshot/Q-Snapshots are a product of J.P. Morgans Global Quantitative Analysis team and provide quantitative metrics summarized in an overall company 'Q-Score.'Q-Snapshots are based on consensus data and should not be considered as having a direct relationship with the J.P. Morgan analysts recommendation.* The Composite Q-Score is calculated by weighting and combining the 10 Quant return drivers shown. The higher the Q-Score the higher the one monthexpected return. On a 14 Year back-test the stocks with the highest Q-Scores have been shown (on average) to significantly outperform those stocks with the

lowest Q-Scores in this universe. ** The number of up, down and unchanged target prices, recommendations or EPS forecasts that make up consensus.

23,012

48,994

33,889

Information Technology Services

Q-Snapshot: Bharat Heavy Electricals Ltd.

EPS Momentum (%)

I N D U S T R Y

85%

80%

86%

28,985

63%

47%

Oil Refining/Marketing

Oil & Gas Production

Electric Utilities

USD MCAP

Tata Consultancy Services Ltd.

Hindustan Unilever Ltd.

Reliance Industries Ltd.

60%

Bharat Heavy Electricals Ltd.

Indian Oil Corp. Ltd.

15,525

13,669

10,499

13,439

10,172

9,221

Regional Banks

Tobacco

14,203

Oil Refining/Marketing

39%

Oil & Natural Gas Corp. Ltd.

NTPC Ltd.

ITC Ltd.

State Bank of India

Bharti Airtel Ltd.

Household/Personal Care

vs Country

25%

20%

38%

82%

71%

83%

81%

Wireless Telecommunications

Information Technology Services

Electrical Products

11%

Name

Infosys Technologies Ltd.

11 9

-16

40

-20

-10

0

10

20

30

40

50

1Mth 3Mth 1Yr 3Yr

(LocalCurrency%)

0

5

10

15

20

25

30

Up Dn UnchangedConsensusChanges(4wks)

Targets Recoms

0

5

10

15

Up Dn Unchanged

ConsensusChanges(4wks)

FY1 FY2

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

-1 Mth -3 Mth

(%)

FY1 FY2

HIGH/STRONGER

0%

25%

50%

75%

100%

0% 25% 50% 75% 100%

LOW/WEAKER

C

O

U

N

T

R

Y

15.034.3 23.9

-44.4

27.0 24.9

-60.0

-40.0

-20.0

0.0

20.0

40.0

EPS Actual To FY1 EPS FY1 To FY2 EPS FY2 To FY3 Cash Flow FY1 To FY2 Dividends FY1 To FY2 Sales FY1ToFY2

0%

25%

50%75%

100%

VALUE PRICE QUALITY EARNINGS

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Other Companies Recommended in This Report (all prices in this report as of market close on 02 April 2009)Larsen & Toubro (LART.BO/Rs717.25/Overweight)

Analyst Certification:The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarilyresponsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, withrespect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this reportaccurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research

analysts compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by theresearch analyst(s) in this report.

Important Disclosures

Analyst Position: The following analysts (and/or their associates or household members) own a long position in the shares of Larsen& Toubro: Bharat Iyer, Bijay Kumar.

Client of the Firm: Bharat Heavy Electricals (BHEL) is or was in the past 12 months a client of JPMSI. Larsen & Toubro is or wasin the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment bankingsecurities-related service and non-securities-related services.

Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investmentbanking services in the next three months from Larsen & Toubro.

Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services otherthan investment banking from Larsen & Toubro.

0

705

1,410

2,115

2,820

3,525

4,230

4,935

Price(Rs)

Mar

06

Jun

06

Sep

06

Dec

06

Mar

07

Jun

07

Sep

07

Dec

07

Mar

08

Jun

08

Sep

08

Dec

08

Mar

09

Bharat Heavy Electricals (BHEL) (BHEL.BO) Price Chart

N Rs2,850

OW Rs2,850 OW Rs2,200 OW Rs1,400

OW Rs2,600 OW Rs2,111 OW Rs2,850 OW Rs1,950

Source: Reuters and J.P. Morgan; price data adjusted for stock splits and dividends.

Break in coverage May 18, 2004 - Sep 28, 2004. This chart shows J.P. Morgan's continuing coverage of this stock; the

current analyst may or may not have covered it over the entire period.

J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price(Rs)

Price Target(Rs)

03-Apr-06 OW 1149.02 2600.00

31-Jul-07 OW 1644.00 2111.00

30-Oct-07 OW 2612.10 2850.00

31-Oct-07 N 2654.55 2850.00

04-Feb-08 OW 2060.20 2850.00

04-Apr-08 OW 1754.95 2200.0023-Jul-08 OW 1597.50 1950.00

26-Oct-08 OW 1080.25 1400.00

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0

588

1,176

1,764

2,352

2,940

3,528

Price(Rs)

Mar

06

Jun

06

Sep

06

Dec

06

Mar

07

Jun

07

Sep

07

Dec

07

Mar

08

Jun

08

Sep

08

Dec

08

Mar

09

Larsen & Toubro (LART.BO) Price Chart

OW Rs1,200

OW Rs1,600

N Rs1,206.5N Rs603.5 OW Rs1,601OW Rs2,267.5 OW Rs1,750 OW Rs880

Source: Reuters and J.P. Morgan; price data adjusted for stock splits and dividends.

Break in coverage Mar 03, 2004 - Sep 28, 2004. This chart shows J.P. Morgan's continuing coverage of this stock; the

current analyst may or may not have covered it over the entire period.

J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price

(Rs)

Price Target

(Rs)

24-May-06 N 583.80 1206.50

29-Sep-06 N 633.75 603.50

19-Jul-07 OW 1164.78 1601.00

28-Oct-07 OW 2138.72 2267.50

29-May-08 OW 1354.55 1750.00

29-Jul-08 OW 1361.78 1600.00

16-Oct-08 OW 893.15 1200.00

20-Nov-08 OW 732.20 880.00

Explanation of Equity Research Ratings and Analyst(s) Coverage Universe:J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the

average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Neutral [Over the next six to twelvemonths, we expect this stock will perform in line with the average total return of the stocks in the analysts (or the analysts teams)coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of

the stocks in the analysts (or the analysts teams) coverage universe.] The analyst or analysts teams coverage universe is the sectorand/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.

Coverage Universe: Shilpa Krishnan: ABB Ltd (ABB.BO), Bharat Heavy Electricals (BHEL) (BHEL.BO), CromptonGreaves Limited (CROM.BO), GMR Infrastructure Ltd (GMRI.BO), Gammon India Ltd (GAMM.BO), Hindustan

Construction Company (HCNS.BO), IVRCL Infrastructure Ltd (IVRC.BO), Jaiprakash Associates Ltd (JAIA.BO), Larsen

& Toubro (LART.BO), NTPC (NTPC.BO), Nagarjuna Construction Company Limited (NGCN.BO), Punj Lloyd Ltd

(PUJL.BO), Reliance Infrastructure Ltd (RLIN.BO), Reliance Power (RPOL.BO), Siemens India (SIEM.BO), Suzlon

Energy Ltd (SUZL.BO), Tata Power (TTPW.BO)

J.P. Morgan Equity Research Ratings Distribution, as of March 31, 2009

Overweight(buy)

Neutral(hold)

Underweight(sell)

JPM Global Equity Research Coverage 35% 46% 19%

IB clients* 54% 54% 42%

JPMSI Equity Research Coverage 35% 51% 14%

IB clients* 75% 73% 57%

*Percentage of investment banking clients in each rating category.

For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold

rating category; and our Underweight rating falls into a sell rating category.

Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks onany securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named onthe front of this note or your J.P. Morgan representative.
http://www.morganmarkets.com/http://www.morganmarkets.com/http://www.morganmarkets.com/

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Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon

various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, whichinclude revenues from, among other business units, Institutional Equities and Investment Banking.

Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US

affiliates of JPMSI, are not registered/qualified as research analysts under NASD/NYSE rules, may not be associated persons of JPMSI,and may not be subject to NASD Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public

appearances, and trading securities held by a research analyst account.

Other Disclosures

J.P. Morgan is the global brand name for J.P. Morgan Securities Inc. (JPMSI) and its non-US affiliates worldwide.

Options related research: If the information contained herein regards options related research, such information is available only to persons whohave received the proper option risk disclosure documents. For a copy of the Option Clearing Corporations Characteristics and Risks of

Standardized Options, please contact your J.P. Morgan Representative or visit the OCCs website at

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Country and Region Specific DisclosuresU.K. and European Economic Area (EEA): Unless specified to the contrary, issued and approved for distribution in the U.K. and the EEA byJPMSL. Investment research issued by JPMSL has been prepared in accordance with JPMSL's policies for managing conflicts of interest arising

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wholesale client and retail client have the meanings given to them in section 761G of the Corporations Act 2001. Germany: This material isdistributed in Germany by J.P. Morgan Securities Ltd., Frankfurt Branch and J.P.Morgan Chase Bank, N.A., Frankfurt Branch which are

regulated by the Bundesanstalt fr Finanzdienstleistungsaufsicht. Hong Kong: The 1% ownership disclosure as of the previous month endsatisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for persons licensed by or registered with the Securities

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General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorganChase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any

disclosures relative to JPMSI and/or its affiliates and the analysts involvement with the issuer that is the subject of the research. All pricing is as

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Other Disclosures last revised January 30, 2009.

Copyright 2009 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold orredistributed without the written consent of J.P. Morgan.

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