BHEL’s worsening order inflow shows up policy bottlenecks

The 7% drop in order inflows compared with the year-ago period looks rather ominous for BHEL’s performance in the next 12-18 months

All eyes were on the order inflows clocked in the December quarter by the country’s largest capital goods maker, Bharat Heavy Electricals Ltd (BHEL). For this would not only influence earnings forecasts for the company but also provide insights on the trend for the sector.

Unfortunately, the 7% drop in order inflows compared with the year-ago period looks rather ominous for BHEL’s performance in the next 12-18 months. Investor hopes were dashed, all the more so because two big (660MW*2) orders, along with some others totalling Rs5,850 crore, were cancelled, which reinforces concerns on policy bottlenecks on land acquisition, coal linkages and volatile spot prices of coal.

Total nine-month order inflow of Rs. 13,360 crore for fiscal 2012 (up to end-December 2011) is a mere one-fifth of the management target of about Rs. 66,000 crore. A Motilal Oswal Securities Ltd report says, “The situation is unlikely to improve in the near term, putting our FY12/13 order-intake assumptions also at risk.” A report by Barclays Capital Ltd says order inflows for the year will be Rs. 42,550 crore, nearly 30% lower than fiscal 2011.

Shrinking order inflows and cancellations are worrisome for BHEL and its peers. This could see a U-turn in the capital goods stocks, which have been on an uptrend since January in anticipation of better times. BHEL’s stock fell nearly 3% to Rs. 273.61 on Friday after the results were announced.

The only silver lining in BHEL’s performance is the 19% year-on-year (y-o-y) growth in net sales to Rs. 10,743.1 crore-- a mark of sustained strength in project execution. In spite of this, the meagre 2% growth in net profit suggests poorer profitability.

Even at the operating level, there was a 360 basis points dip in operating margin from a year before to 19.4%, on account of higher other expenses due to increase in freight expenses and provisioning for contractual obligations. One basis point is a hundredth of a percentage point. The strong execution and billing, which is not backed by adequate order inflow, shows up in the poor book-to-bill ratio (see table).

Moreover, BHEL seems to be stuck in a quagmire of declining advances and higher receivables, seen in its increasing working capital requirement and reducing cash on the books. This declined to about Rs. 5,000 crore in the quarter, from Rs. 7,900 crore in the September quarter and Rs. 9,600 crore in March.

The road ahead for BHEL, whose core business hinges on the power sector, is tough. One must not be surprised by earnings downgrades until fiscal 2013 and a contraction in the price-to-earnings multiple for the stock.