Euphoria over power sector reforms ignores severe concerns on fuel shortage, says Nomura and downgrades BHEL to ‘reduce’. It sees the current rally as an excellent opportunity to exit the stock
Revival of new orders in the power equipment sector is unlikely and the euphoria on SEB (State Electricity Boards) restructuring ignores severe concerns on fuel shortage, says the Nomura Equity Research. BHEL outperformed the Sensex by about 20% over the past three weeks on the back of the new restructuring plan for SEBs. While the plan is likely improve the health of the power sector, it does not change the outlook for new equipment orders, in Nomura’s view, as fuel supply concerns continue:
• As per estimates, despite building in an optimistic 620 million tonne increase in coal supply per annum over FY12-17F (at 18.3% CAGR), the annual order inflow for BHEL is unlikely to exceed 6GW per annum
• In contrast, a realistic assessment suggests that actual coal increase will be less than 377 million tonnes (at 12.5% CAGR) implying 32GW of existing orders will have to be cancelled; BHEL faces risk to about 28% of its order book.
• Further, rising competition and falling utilisation during times of negligible order pipeline could have a cascading effect on margins.
BHEL is expensive even on best-case coal supply outlook, argues Nomura. It maintains its estimates which build in the best-case coal outlook and, despite that, it arrives at a DCF-based (discounted cash flow) target price of Rs199 per share.
Nomura factors in deteriorating margins (down to 12-14% post FY14 from 21% currently) and medium-term order inflow of about 6GW per annum. Given about 20% potential downside, the brokerage firm downgrades BHEL to ‘Reduce’ and sees the current rally as an excellent opportunity to exit the stock. Instead, Nomura recommends playing the SEB reform story through power lenders such as PFC (Power Finance Corporation) and REC (Rural Electrification Corporation).
The most critical warning from Nomura in this context is that coal supply estimates indicate limited incremental equipment opportunity over FY13-17F. Fuel supply for power plants has not kept pace with the significant capacity addition that developers in India are planning. Nomura has been highlighting its concerns for a while, and still emphasises that coal availability will be the key bottleneck apart from land and environmental clearances in deciding the finalisation of new projects. In the best-case scenario, Nomura estimates that coal supply can increase to 1.09 billion tonnes per annum from 469 million tonnes per annum currently (for the power sector). Despite building these numbers, the brokerage firm thinks that there is scope for only 22GW of additional equipment ordering over the next two to three years.
Whatever little order inflow comes up in the power equipment sector, post the challenges in the coal sector, will face the litmus test of severe competition in the domestic market. Compared with a near-monopoly status in the past in the context of NTPC orders, BHEL’s market share has fallen to just 36% in the recently concluded bulk tendering for NTPC orders (both the phases put together). Ironically, this is despite the preferential treatment given to BHEL. It was awarded 2-4 units in all the orders subject to it matching the lowest bid. Nomura sees a bigger threat looming in the future, since NTPC does not have any more similar tenders lined up and, moreover, all the future tenders will have no preferential treatment for BHEL.
Moreover, Nomura notes that the 36% share in NTPC orders is fraught with the risk of lower margins, since BHEL will get these orders by matching the prices quoted by the lowest bidder, which seems way below BHEL’s normal pricing.