Bhel

In 1Q09, revenue growth - the key parameter - surprised the Street positively. We believe input costs, order inflows and competition issues will resurface in the medium term, which may constraint PEs. We downgrade to Sell after the stock's recent rally. We cut our target price to Rs1,540 (from Rs1773.35), which implies 18x FY10F PE.

Revenue growth of 34% allays execution concerns, albeit temporarily
BHEL's 1Q09 revenue growth of 34% yoy did not surprise us (we projected growth of 31 vs 22% by Bloomberg consensus), and we maintain our full-year growth estimate at 31% yoy. Capacity constraint has been a cause for concern, but 1Q09 performance has allayed concerns for now . Management believes that BHEL is in a comfortable position to execute contract orders for the next 39 months. We had already built this into our model, so again no surprise for us.

The key now is costs – wage revisions and material costs
To meet the proposals of the Sixth Pay Commission, BHEL has raised total provision charges over 4Q07-4Q09 to Rs19bn, of which Rs5.9bn had been provided until 4Q08. The balance Rs13bn is to be provided for in FY09, of which we believe Rs4.7bn pertains to earlier years. Adjusting for that, we believe our FY09 staff cost forecast of Rs38.5bn is adequate. The increase in steel prices has not affected 1Q09 margins, but we believe it will hurt margins in the coming quarters.

Order inflows strong so far, but may slow; competition rises
Although 1Q09 cheered most in terms of revenue growth, we believe the larger concern of longerterm growth in BHEL persists. The entry of new players (L&T, Toshiba-JSW, BGR-Foster Wheeler and Cethar Vessels) could eat into BHEL's market share, hurting order inflow and margins. BHEL's order flow has been strong, thanks to the state and central PSE projects to be implemented under the 11th five-year plan, a scenario which we believe will change for the negative.

Risk-return looks unfavourable
BHEL trades at 17.5x FY10F PE. We believe the stock's valuation already factors in higher earnings estimates (Bloomberg consensus EPS of Rs96 for FY10 vs our forecast of Rs86.20) and possibly even earnings upgrades, which we think are unlikely because of cost pressures. The better-than-estimated 1Q09 performance should do little to prop up the share price. We see no catalysts in the medium term, hence we downgrade to Sell (from Hold). We cut our DCF-based target price to Rs1,540 (implying 18x FY10F PE) as we raise our risk-free rate assumption.