BHEL's Q3FY18 results (Underperformer) - Execution disappoints but margins inch up

Q3FY18 result highlights

• BHEL’s Q3FY18 earnings were broadly in line with estimate. PAT grew 63.8%yoy to Rs1.5bn (in line).
• Revenue (net of excise duty) showed a moderate growth of 4.8%yoy to Rs66.3bn (est: Rs71.1bn). Gross margin grew 390bp yoy and 110bp qoq to 41.2% led by cost reduction initiatives and higher domestic sourcing by the company.
• EBITDA grew 32%yoy to Rs3bn (est: Rs3.2) and EBTIDA margin grew 100bp yoy to 4.5% (est: 4.4%) led by decline in employee cost by 5.8%yoy to Rs13.4bn (est: Rs14.3bn). Lower employee cost was due to lower head count yoy from 40,302 in Q3FY17 to 38,052 in Q3FY18.    
• Other income had a moderate growth of 1.3%yoy to Rs1.4bn but it was below estimate of Rs1.6bn due to MTM forex loss of Rs720m and lower interest income of Rs1.3bn (Rs2bn in Q2FY18).
• Effective tax rate stood at 19.3% below our estimate of 27.5% due to withdrawal of liability of Rs150m. The tax rate would get normalised from Q4FY18 onwards.
• Receivables increased by Rs20bn qoq to Rs350bn due to increase in collectibles post implementation of GST.
• Order inflow for 9mFY18 grew 2.3xyoy to Rs157.5bn and order backlog grew 3.7%yoy to Rs1trn. Slow moving/stalled orders stood at Rs210bn as against Rs396bn in Q2FY18. According to the management, stressed orders worth Rs43bn (5,140MW) can get revived in the near term. 
• The current bid pipeline for thermal & hydro projects totals to 10GW.   

Key positives: Improvement in gross margins by 390bp yoy and 110bp qoq to 41.2%.

Key negatives: Lower than expected execution.

Impact on financials: Upgrade in FY18E/FY19E earnings by 9.7%/6.9% due to better the expected gross margins in Q3FY18 and lower than expected interest cost and depreciation. Introduced FY20E earnings.

Valuations & view

BHEL’s executable order backlog has improved to 79% of total vis-à-vis ~44% in Q3FY17. While this is positive, the execution of these 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 estimates for FY18/FY19/FY20. 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 FY20 based price target of Rs78 (PE of 18x FY20E EPS).