BHEL's Q1FY19 results (Neutral) - Lower than expected execution

Q1FY19 result highlights

• BHEL’s Q1FY19 PAT grew 92.5%yoy to Rs1.6bn (est: Rs980m) led by lower employee costs, even as execution was below estimate.
• Revenue grew 6.8%yoy to Rs59.4bn (est: Rs63.1bn) led by growth in revenue from power segment (up 6.9%yoy) which was partly offset by lower revenue from industrial segment (down 9.2%yoy). For FY19, the management targets revenue of Rs300bn in very good scenario and Rs320bn in excellent scenario (as per MOU signed with the government). 
• Gross margin jumped 210bp yoy to 43.3% (est: 45%) led mainly by a better revenue mix during the quarter as also cost reduction initiatives and higher domestic sourcing. BHEL has, however guided for a likely increase in RM costs at ~60% of sales in FY19 (56.7% in Q1FY19).
• EBITDA grew 41.6%yoy and EBITDA margin expanded 120bp yoy to 4.8%, above estimate of 3.8%, due to lower than expected employee cost at Rs14.2bn (est: Rs16bn). Employee cost largely remained flat yoy despite wage revision due to reduction in head count from 39,044 employees in June 2017 to 36,829 employees in June 2018. BHEL has guided for increase in FY19 employee costs at Rs62bn (Rs60bn in FY18).  
• Order inflow grew 151%yoy to Rs43.7bn (est: Rs33bn) and order backlog as on June 2018 grew 15.4%yoy to Rs1.2trn (4x TTM sales). BHEL is favourably placed in orders worth Rs169bn (Power segment: Rs140bn, Industrial segment: Rs13bn and International market: Rs16bn) and has a further tender pipeline of 8-10GW.  

Key positives: Lower employee costs and strong order wins.

Key negatives: Lower than expected execution.

Impact on financials: Downgrade of 16.6%/11.9% in FY19E/FY20E EPS due to lower than expected revenue, higher raw material costs and lower other income.

Valuations & view

BHEL’s strong order backlog and improved share of executable orders has enhanced revenue and earnings visibility for FY20. While the outlook for investments in new coal based power capacity still remains challenging due to low utilization (~63%) of the installed capacity base, BHEL’s market share gains and diversification efforts have led to steady order wins for the company. While we expect 10%/34% revenue/earnings CAGR for BHEL over FY18-20, valuations at 28.1x/17.9x FY19E/FY20E do not offer margin of safety against delay in execution which would pose a material risk to our earnings estimate for FY19/20. As a result, we maintain our Neutral rating with a revised target price of Rs79 (20x FY20E earnings).