Improved Order Pipeline & Execution Drive EPS/PO Upgrade

Following our meeting with Mr. Verma, DF, BHEL & Govt.’s power think tank, we raise our FY08E & FY09E earnings estimates by 3.5% & 10.3% respectively & our PO to Rs 2000 (Rs 1650). We increase our order intake estimate by 12% for FY08E, on the expectation that the improved pipeline will translate into historic order backlog of Rs 714 billion +30%YoY for FY08E.

Earnings upgrade led by improving orders & execution

We expect BHEL to win a series of orders from NTPC, DVC, Nuke Power & SEBs, which should result in an historic order intake of Rs 375 billion +5%YoY & backlog of Rs 714 billion +30%YoY in FY08E. This should reassure market worries over increasing competition. Also, we foresee improved execution at BHEL, thanks to a) operation of 3rd shift on most critical operations, b) pressure from government & customers, and c) increased capacity (10GW v/s 7GW in FY07) coming on-stream by December 2007. Consequently, we hike earnings for FY08E by 3.5% and FY09E by 10.3%.

Success at recent tenders = momentum continuing in FY08

BHEL has had a dream run at tenders opened in last 12 weeks, where it has beaten its Chinese, Czechoslovakian & European competitors. We expect continued momentum in order intake in 1H FY08 as well. Overall, our project-wise analysis indicates that BHEL likely will win orders worth Rs366bn (16GW) & it is equally poised (50:50 probability) for orders of Rs 134 billion over FY08-1H09E.

Reiterate Buy on improving pipeline and competitiveness

We expect stock to outperform as the company addresses Chinese competition, super-critical orders likely in 2007, and looks to improve competitiveness through operating leverage - 50% capacity expansion with <10% rise in labour. Our new PO is based on 22.5x 1-yr forward EPS, 10% discount to peak cycle (94-97) PER.

Price objective basis & risk

Our Price Objective of Rs 2000 is based on 1-year forward PER of 22.5x – 10% discount to peak PE in the last cycle (94-97) & 15% discount to its current multiples. BHEL currently trades at 19.9x FY09E PER vs BSE Sensex at 16.6x. However, we believe, that premium valuation is justified given BHEL’s superior market position, earnings growth (30% for BHEL vs market at 15%) and RoE (30.5% v/s market 21.8%). Regionally, BHEL trades at 19.9x FY09E v/s Asian comps at 17.8x. However we believe that premium valuation for BHEL is justified given its superior RoE (30.5% vs regional average at 18.1%) and consistency & its sustainability of growth.