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MOSL: CAPITAL GOODS - BTG ordering - Emerging from the 'Eclipse' - BHEL has the highest leverage




Motilal Oswal Securities Ltd.


10 Dec 2013





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CAPITAL GOODS: BTG ordering: Emerging from the 'Eclipse' BHEL has the highest leverage; L&T and TMX key beneficiaries Powergen capex: Emerging from the 'Eclipse' Our statistical analysis of the macro data-points on demand and supply dynamics in the power sector suggests that the new cycle of powergen capex could commence over the next 12-15 months. Despite aggressive assumptions on capacity additions and PLF; the electricity generation CAGR till FY19 when juxtaposed with aggregate FY13 demand stands at 8.8% and compares with last 10-years electricity consumption CAGR of 6.2%. Thus, we believe that SEBs will, sooner than later, start planning about capacity additions. 'Timing the recovery' remains the key moving variable. However we believe that what matters is not 'timing the project awards', but the time when markets believe that project awards 'could possibly' commence. And that time is now. Expect 20GW of project awards, interplay of structural factors During FY12 and FY13, power BTG project awards stood at just ~10GW pa, including 13GW of cumulative capacities being awarded under the bulk tender, and compares with annual run-rate of 25-30GW pa during FY07-10. Going forward, we believe that the pipeline is showing initial signs of recovery with projects of ~20GW likely to be awarded in 12-15 months. This could be a Tipping point, particularly for the equipment manufacturers, given that industry capacity for super-critical boilers and turbines stands at ~21-24GW pa. An important driver has been the 'Case 2' Bidding Document (approved in Sept 2013) with bidding for 9.3GW has already been initiated. The trend of increased project awards could possibly be supported by interplay of structural factors: i) Improved demand planning by distribution companies ii) Ensuring financial viability of the Distribution business models iii) Coal mine allocations post gap of 5 years, etc. Metamorphosis: Disciplined competitive 'aggression' From a market structure that was threatened by: i) intense competition from Chinese, Koreans and Japanese companies ii) and, possibility of ~5-6 players in the domestic market, BTG sector is undergoing a metamorphosis. Imported products have witnessed erosion of competitiveness, while the domestic players are witnessing disciplined 'aggression'. Business models from state gencos around vendor financing have witnessed muted bidding interest and unviable bids; and thus its again back to basics. How to Play the Theme: BHEL best positioned as cyclical factors support recovery BHEL is strongly exposed to cyclical factors: i) Contribution margins at ~40-41% vs expected EBIDTA margin of 11.9% in FY14, leading to a meaningful operating leverage ii) Core NWC stable at ~200 days; cyclical factors of Retention money (at ~200 days in FY14E vs 55-60 days in FY07-09) and customer advances (deteriorated from 63% of revenues in FY09 to 34% in FY13) that impacted reported NWC are expected to normalize, as we expect BTB to increase from 2.2x currently to 3x in FY15/16E. We expect Free Cash Flows to improve from ~INR16-19b in FY13/14E to ~INR75-88b in FY15/16E, leading to a meaningful increase in net cash from INR63b in FY13 to INR174b in FY16E (~43% of current market cap). We upgrade the stock to Buy with a Price target of INR210/sh (14x FY16E).

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