BHEL's Q2FY18 results (Underperformer) - Weak execution and provisions drive down margins

Q2FY18 result highlights

• BHEL’s Q2FY18 results were sharply below estimate led mainly by lower execution and higher provisions, offset partly by higher other income. PAT grew 5.9%yoy to Rs1.2bn, below estimate of Rs1.7bn.
• Revenue (net of excise duty) declined 4.2%yoy to Rs63.8bn (est Rs69.6bn) and was impacted by lower order backlog and slow-moving orders in the order backlog. While gross margin remained steady qoq at 40.1% (+450bp yoy), BHEL reported an EBITDA loss of Rs954m during Q2FY18 due to lower fixed cost absorption and higher provisions for wage revision and contractual liabilities (increase of Rs6.3bn yoy). Industry segment margin declined 610bp yoy to 0.2% due to lower revenue and lower margin in solar EPC projects.
• Other income grew 147%yoy to Rs4.9bn (est: Rs1.8bn) led by MTM forex gain of Rs1.9bn.
• Receivables increased by Rs11.4bn during H1FY18 to Rs330bn due to on-going changes in work orders to incorporate impact of GST. 
• Order inflow declined 1.2%yoy to Rs18.7bn (down 30%yoy in H1FY18 to Rs36.7bn) and order backlog declined 6.1%yoy to Rs970bn. Slow moving/stalled orders stood at Rs396bn (flat qoq). This includes the Yadadri project worth Rs180bn which has become operational in Oct-17 with a revised order value of Rs204bn. The outstanding slow-moving orders in the power sector now stand at Rs216bn.
• BHEL is favourably placed in 5GW orders worth ~Rs267bn. The current bid pipeline for thermal and hydro projects totals to 8GW.  

Key positives: Improvement in gross margins by 450bp yoy to 40.1%.

Key negatives: Lower than expected execution and higher provisions.

Impact on financials: Downgrade in FY18E/FY19E earnings by 5.5%/2.8%.

Valuations & view

BHEL’s executable order backlog has improved to 78% of total vis-à-vis ~55% in Q2FY17. While this is positive, the execution of these and even the balance orders (net of ~Rs80bn orders likely to be terminated) is a pre-requisite to simply sustain the company’s current revenue level. Any delays in execution would pose a material risk to our earnings estimate for FY18/FY19. With existing coal based plants operating at a suboptimal utilization (industry PLF of 60% in FY17) we see weak prospects for new thermal capacity additions. We maintain our Underperformer rating on BHEL with a revised price target of Rs70 (PE of 20x FY19E EPS).