Equity | India | Capital Goods

21 January 2011

Bharat Heavy Electricals

Buy Rock solid
Target price
Rs2601.00 (from Rs2981.00)
BHEL reported 3Q11 earnings in line with our estimates. We believe the inherent
advantages should allow the company to maintain its dominant position in the
Price
Rs2175.55 equipment industry, despite increasing competition. Buy maintained with a
Short term (0-60 days) revised TP of Rs2,601.
n/a
Market view Key forecasts
Underweight
FY09A FY10A FY11F FY12F FY13F
Revenue (Rsm) 267,268 335,728 420,270 497,637 551,837
Price performance EBITDA (Rsm) 42,190 62,583 83,152 93,734 101,657
Reported net profit (Rsm) 31,382 43,106 57,834 66,835 75,810
(1M) (3M) (12M)
Normalised net profit (Rsm)¹ 31,263 43,106 57,834 66,835 75,810
Price (Rs) 2314 2499 2398
Normalised EPS (Rs) 63.90 88.10 118.1 136.5 154.9
Absolute (%) -6.0 -12.9 -9.3
Rel market (%) -0.8 -7.2 -18.6 Dividend per share (Rs) 17.00 23.30 24.00 % 25.00 % 26.00 %
Rel sector (%) -4.4 -18.9 -13.3 Dividend yield (%) 0.78 1.07 1.10 1.15 1.20
Normalised PE (x) 34.10 24.70 18.40 15.90 14.00
Jan 08 Feb 09 Feb 10
3000 EV/EBITDA (x) 22.80 15.50 11.50 9.65 8.33
Price/book value (x) 8.23 6.69 5.24 4.16 3.36
2500
ROIC (%) 94.00 117.2 84.90 70.00 70.70
2000
Use of %& indicates that the line item has changed by at least 5%. year to Mar, fully diluted
1500 1. Post-goodwill amortisation and pre-exceptional items
Accounting standard: Local GAAP
1000 Source: Company data, RBS forecasts

500
BHEL.BO
Market capitalisation
Rs1.06t (US$23.30bn)
Average (12M) daily turnover
Rs1468.09m (US$32.12m)
Sector: BBG AP Electronic & Elec
RIC: BHEL.BO, BHEL IN
Priced Rs2175.55 at close 20 Jan 2011.
Source: Bloomberg
3Q11 earnings in line with estimates; on track to meet FY11 guidance
Sensex
BHEL reported 3Q11 earnings in line with our estimates, with adjusted profit for the quarter
coming in at Rs13.4bn (up 26% yoy). The company reported an order backlog of Rs1.58trn
(up 18% yoy), implying 9M11 inflow of Rs365bn. We expect the FY11 inflow guidance of
Rs600bn to be comfortably met, with NTPC likely to award supercritical orders in 4Q11.
Financing a key factor in private orders, but BHEL has its share of customers
Based on our discussions with private IPPs, we believe cheaper Chinese financing is a key
reason for them to place orders with Chinese vendors. While most private IPPs are prepared
to consider Chinese vendors, two large IPPs indicated they were unwilling to do so, citing
issues related to quality and good post-installation support. The private sector accounted for
90% of BHEL’s power sector inflows in FY10 and at least 25-30% inflow to date.

We expect pricing to be benign in state orders; favourable for margins

Our discussions with industry players indicate that a price war is unlikely as the market has
only three to four players currently. This corroborates our view that BHEL would be the only
player likely to benefit from a price war. Its recent bid for two 2x660MW projects in Rajasthan
indicates its competitiveness against private players, while the turbine pricing for the bulk
tender indicates a benign pricing environment at Rs13m/MW.

Defensive pick in a volatile market. Maintain Buy

Researched by
Power sector capex remains resilient despite the slowdown in other sectors. BHEL is the
RBS Equities (India) Limited only company in our coverage universe whose short-term growth outlook we would expect to
Institutional Team
remain unaffected even if order inflows slowed. We forecast an earnings CAGR of 21% over
Mafatlal Chambers – C Wing, Ground FY11-13. The stock trades at a PE of 16x FY12F. We build in higher risk-free rates, which
Floor, N.M. Joshi Marg, Lower Parel (E), raises our WACC assumption. This reduces our target price to Rs2,601 (from Rs2,981).
Mumbai 400 013, India. Tel : +91 022
6754 8411 Fax : +91 022 6754 8420

www.rbs.in/broking Important disclosures can be found in the Disclosures Appendix.

 Rock solid

BHEL reported 3Q11 earnings in line with our estimates. We believe its inherent
advantages should allow the company to maintain its dominant position in the equipment
industry, despite increasing competition. Buy maintained with a revised TP of Rs2,601.

3Q11 results in line with estimates

BHEL reported 3Q11 numbers in line with our estimates. Revenue for the quarter came in at
Rs90.2bn, up 25% yoy. The EBITDA margin rose 136bp yoy to 23% aided by lower staff costs
and lower raw material costs as a proportion of net sales. Other income declined to Rs1.5bn
(down 21% yoy). PBT was reported at Rs20.7bn (up 26% yoy), while adjusted profit came in at
Rs13.4bn (up 26% yoy), in line with our estimates.

Table 1 : 3Q11 & 9M11 performance (Standalone)

Rsm 3Q11 3Q10 yoy 9M11 9M10 yoy
Order inflow 122000 155860 -21.7% 365240 361135 1.1%
Order backlog 1580000 1340000 17.9% 1580000 1340000 17.9%

Net sales 90,233 72,292 24.8% 241150 196282 22.9%

Expenditure 69,516 56,675 22.7% 194,459 162,427 19.7%

as a % of net sales 77.0% 78.4% -136bp 80.6% 82.8% -211bp
Consumption of raw materials 48,098 39,416 22.0% 135832 112801 20.4%
as a % of net sales 53.3% 54.5% -122bp 56.3% 57.5% -114bp
Personnel cost 13,487 12,269 9.9% 39505 34096 15.9%
as a % of net sales 14.9% 17.0% -203bp 16.4% 17.4% -99bp
Other expenses 7,932 4,990 59.0% 19122 15530 23.1%
as a % of net sales 8.8% 6.9% 189bp 7.9% 7.9% 2bp

Operating Profit
20,717 15,617 32.7% 46,691 33,855 37.9%
OPM 23.0% 21.6% 136bp 19.4% 17.2% 211bp
Other income 1,529 1,933 -20.9% 4784 6159 -22.3%
Depreciation 1,447 1,038 39.4% 4057 2933 38.3%
EBIT 20,800 16,512 26.0% 47,418 37,081 27.9%
Interest 145 69 109.7% 242 157 54.3%
Exceptional items 650 0 650 0

PBT 20,655 16,443 25.6% 47,176 36,924 27.8%

Tax 6,623 5,717 15.8% 15044 12913 16.5%
tax rate (%) 32.1% 34.8% -271bp 31.9% 35.0% -308bp
Reported PAT 14,032 10,726 30.8% 32,132 24,011 33.8%
Adjusted Sales 85,997 72,292 19.0% 236914 196282 20.7%
Adjusted EBITDA 19,767 15,617 26.6% 45,741 33,855 35.1%
Adjusted EBITDA margin 23.0% 21.6% 138bp 19.3% 17.2% 206bp
Adjusted PAT 13,382 10,726 25.7% 31,582 24,011 31.5%
Source: Company data

Order book expands to Rs1.6trn; on track to meet FY11 inflow guidance

The company reported an order backlog of Rs1.58trn (up 18% yoy, up 3% qoq), implying order
inflow of Rs122bn for the quarter (down 22% yoy, down 10% qoq). The 9M11 inflow of Rs365bn
implies that the company now needs inflows of around Rs230bn in 4Q11 (vs Rs229bn in 4Q10) to
meet its guidance of Rs600bn for FY11. We note that the company is already the lowest bidder in
two large orders in Rajasthan that are likely to be awarded in 4Q11.

With these potential orders and the supercritical orders that NTPC is likely to award during 4Q11,
we thus believe BHEL will comfortably meet its inflow guidance. The order inflow is likely to
remain strong in FY12: management said at the 3Q11 conference call that it expected higher
inflows in FY12 than FY11.

Bharat Heavy Electricals | Company Dynamics | 21 January 2011 2

 Chart 1 : On track to meet FY11 inflow guidance (Rsbn)

1600 250

1400
200
1200

1000
150

800

600 100

400
50
200

0 0
1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11

Order book Order inf low (R.H.S)

Source: Company data

Decline in raw material costs led to margin improvement

Raw material costs declined on a yoy basis to 53.3% of net sales (down 122bp yoy), resulting in
the margin rising to 23% for 3Q11 (up 136bp yoy). However, other expenses rose sharply to
Rs7.9bn (up 59% yoy, up 26% qoq); this included a provision of Rs1bn on account of liquidated
damages. Overall for 9MFY11, the margin expanded 211bp yoy to 19.4% due to a dip in both raw
material costs and staff costs as a proportion of net sales.

Continued growth in Power and Industry

The company’s power segment registered another strong quarter with revenues growing to
Rs73bn (up 28% yoy), while the industrial segment reported revenue of Rs21.4bn (up 19% yoy)
for the quarter. Overall, for 9MFY11, power segment grew to Rs196.5bn (up 25.1% yoy), while
Industry segment reported revenues of 54.8bn (up 16% yoy).

Table 2 : 3Q11 & 9M11 segmental performance (standalone)

Rsm 3Q11 3Q10 yoy 9M11 9M10 yoy
Segment Revenues
Power 72820 57087 27.6% 196469 157058 25.1%
Industry 21429 18020 18.9% 54769 47299 15.8%
- Total 94250 75107 25.5% 251239 204357 22.9%
- Less : Inter segment revenues 1452 1247 16.5% 3674 3336 10.1%
- Net sales / Other Income 92798 73860 25.6% 247565 201021 23.2%

Segmental profits
Power 16321 13086 24.7% 41754 32587 28.1%
Industry 4542 4051 12.1% 9300 8376 11.0%
- Total 20863 17137 21.7% 51054 40963 24.6%
- (Add) / Less - Interest 145 69 109.7% 242 157 54.3%
- Other unallocated expenditure 64 625 -89.8% 3636 3882 -6.3%
- Profit Before Tax 20655 16443 25.6% 47176 36924 27.8%

PBIT Margins
Power 22.4% 22.9% -51bp 21.3% 20.7% 50bp
Industry 21.2% 22.5% -129bp 17.0% 17.7% -73bp
- Total 22.1% 22.8% -68bp 20.3% 20.0% 28bp
Source: Company data

Competition heating up for private orders

The end-user industry for power equipment is split vertically into two categories: private IPPs and
state and central utilities. For private IPPs, the competition is between BHEL and Chinese
vendors. In state utilities, it is between BHEL and new joint ventures such as Larsen & Toubro-
Mitsubishi and BGR Hitachi.

Our discussions with industry players suggest that decisions to use Chinese vendors are now

Bharat Heavy Electricals | Company Dynamics | 21 January 2011 3

 typically based more on equipment delivery timing than on price, which had been the appeal in the
past. The price differential between BHEL and Chinese vendors has narrowed, but there is still a
12-month gap in delivery in favour of the Chinese. However, with BHEL expanding its capacity
from the current 15GW to 20GW by 2012, it should be able to offer better lead times. Our
discussions also suggest the cheaper financing available to these private players from China
Eximbank is another key factor in their decision-making.

In the state and central utilities, price is key. However, a price war is unlikely as the market has
only three to four players currently. The recent Rajasthan orders indicate BHEL’s competitiveness
against private players, while the turbine pricing for the bulk tender indicates a benign pricing
environment. In FY10, the private sector accounted for 90% of power sector inflows for BHEL and
in current year this accounts for c25-30% of order inflows.

BHEL best placed among domestic players

There has been an increase in competition in the domestic sector with a number of new players
entering the market. However, we remain confident in BHEL’s inherent advantage. We believe it is
likely to remain the main player for public sector orders. As mentioned earlier, BHEL is likely to
compete with other domestic private players for public sector orders from whom we feel it unlikely
to face significant threat for two key reasons: 1) BHEL enjoys a cost advantage as it has fully-
depreciated capacity and is undergoing brownfield expansion for new capacities; and 2) BHEL
has a strong vendor base which is unmatched by any private players. In addition, the company’s
strategy of establishing JVs with state utilities is likely to provide stability to inflows.

However, we feel that margins for the company may not remain at current levels in the event of
aggressive pricing by private players. In such a scenario, we believe BHEL can compete given its
inherent cost and market positioning advantages. However, we do not expect a significant dip in
margins over the next three years, as we believe its current order book consists of higher margins
projects. In addition, our discussions with industry players indicate that a price war is unlikely as
the market has only three to four players. In that case, the other main reason BHEL’s margins
might dip could be the absorption of super-critical technology.

Defensive pick in a volatile market: Buy maintained

Power sector capex has remained resilient despite the slowdown in other sectors. In addition,
NTPC has recently signed a power purchase agreement for an additional 67GW, which effectively
takes care of its expansion for the 12th and 13th Five Year Plan and augurs well for BHEL in the
medium term. BHEL is the only company in our coverage universe where the short-term growth
outlook growth remains unaffected even if order inflows slow down. We expect the company to hit
a CAGR of 21% over FY11-13F. The stock trades at 16xFY12F. We also build in higher risk free
rates which increases our WACC. This combined reduces our TP to Rs2,601(from Rs2,981).

Chart 3 : PE band chart Chart 4 : EV/EBITDA band chart

3,500 3,500

3,000 3,000
2

2,500 2,500

2,000 2,000

1,500 1,500

1,000
1,000

500 500

-
-
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

BHEL EV/EBITDA (5 x)
EV/ EBITDA (10 x) EV/EBITDA (15 x)
BHEL PER (15 X) PER (20 X) PER (25 X)

Source: Bloomberg, RBS forecasts Source: Bloomberg, RBS forecasts

Bharat Heavy Electricals | Company Dynamics | 21 January 2011 4

Income statement

Rsm FY09A FY10A FY11F FY12F FY13F

Revenue 267268 335728 420270 497637 551837
Cost of sales -194522 -244603 -309757 -368263 -406843
Operating costs -30556 -28542 -27360 -35639 -43337
EBITDA 42190 62583 83152 93734 101657
DDA & Impairment (ex gw) -3343 -4580 -5700 -5985 -6284
EBITA 38848 58003 77452 87749 95373
Goodwill (amort/impaired) n/a n/a n/a n/a n/a
EBIT 38848 58003 77452 87749 95373
Net interest -307.1 -335.0 -335.0 -335.0 -335.0
Associates (pre-tax) n/a n/a n/a n/a n/a
Forex gain / (loss) n/a n/a n/a n/a n/a
Exceptionals (pre-tax) 118.9 0.00 0.00 0.00 0.00
Other pre-tax items 9829 8239 6700 9447 14832
Reported PTP 48489 65907 83817 96861 109870
Taxation -17106 -22800 -25983 -30027 -34059
Minority interests n/a n/a n/a n/a n/a
Exceptionals (post-tax) n/a n/a n/a n/a n/a
Other post-tax items 0.00 0.00 0.00 -0.01 0.01
Reported net profit 31382 43106 57834 66835 75810
Normalised Items Excl. GW 118.9 0.00 0.00 0.00 0.00
Normalised net profit 31263 43106 57834 66835 75810
Source: Company data, RBS forecasts year to Mar

Balance sheet

Rsm FY09A FY10A FY11F FY12F FY13F

Cash & market secs (1) 103147 97901 113589 161930 220150
Other current assets 265864 331447 409526 483445 539967
Tangible fixed assets 26274 39450 44354 49691 53394
Intang assets (incl gw) n/a n/a n/a n/a n/a
Oth non-curr assets 18926 16071 26071 26071 26071
Total assets 414211 484869 593539 721138 839582
Short term debt (2) n/a n/a n/a n/a n/a
Trade & oth current liab 233573 280237 335906 401862 448927
Long term debt (3) 1494 1278 1443 1645 1880
Oth non-current liab 49756 44180 52929 61853 72079
Total liabilities 284823 325695 390278 465360 522885
Total equity (incl min) 129388 159174 203262 255778 316697
Total liab & sh equity 414211 484869 593539 721138 839582
Net debt -101653 -96624 -112146 -160285 -218270
Source: Company data, RBS forecasts year ended Mar

Cash flow statement

Rsm FY09A FY10A FY11F FY12F FY13F

EBITDA 42190 62583 83152 93734 101657
Change in working capital 12444 -24495 -13661 960.9 768.8
Net interest (pd) / rec 307.1 335.0 335.0 335.0 335.0
Taxes paid -17106 -22800 -25983 -30027 -34059
Other oper cash items -307.1 -335.0 -335.0 -335.0 -335.0
Cash flow from ops (1) 37528 15288 43508 64668 68367
Capex (2) -12983 -17549 -10405 -11700 -10700
Disposals/(acquisitions) 0.00 0.00 0.00 0.00 0.00
Other investing cash flow -440.5 -275.0 -10000 0.00 0.00
Cash flow from invest (3) -13423 -17824 -20405 -11700 -10700
Incr / (decr) in equity 0.00 0.00 0.00 0.00 0.00
Incr / (decr) in debt 541.9 -216.5 164.3 201.2 234.0
Ordinary dividend paid -9736 -13344 -13745 -14318 -14891
Preferred dividends (4) n/a n/a n/a n/a n/a
Other financing cash flow 4376 10851 6165 9490 15209
Cash flow from fin (5) -4818 -2710 -7416 -4627 552.9
Forex & disc ops (6) n/a n/a n/a n/a n/a
Inc/(decr) cash (1+3+5+6) 19287 -5246 15688 48341 58219
Equity FCF (1+2+4) 24545 -2261 33103 52968 57667
Lines in bold can be derived from the immediately preceding lines. year to Mar
Source: Company data, RBS forecasts

Bharat Heavy Electricals | Key Financial Data | 21 January 2011

Standard ratios BHEL ABB Ltd Larsen & Toubro

Performance FY09A FY10A FY11F FY12F FY13F FY10F FY11F FY12F FY11F FY12F FY13F
Sales growth (%) 35.8 25.4 25.6 18.6 10.9 -0.80 27.8 14.5 17.7 25.1 14.6
EBITDA growth (%) 12.8 48.3 32.9 12.7 8.45 -40.7 90.7 26.0 15.3 22.0 17.7
EBIT growth (%) 12.8 49.3 33.5 13.3 8.69 -45.2 107.0 28.1 14.8 22.3 17.9
Normalised EPS growth (%) 9.30 37.9 34.2 15.6 13.4 -49.1 111.5 29.9 18.8 24.1 19.2
EBITDA margin (%) 16.1 19.0 20.1 19.1 18.7 5.05 7.54 8.30 12.7 12.4 12.7
EBIT margin (%) 14.8 17.6 18.8 17.9 17.6 4.25 6.88 7.69 11.6 11.3 11.7
Net profit margin (%) 11.9 13.1 14.0 13.6 14.0 2.92 4.83 5.48 8.52 8.45 8.79
Return on avg assets (%) 8.76 9.66 10.8 10.2 9.76 3.51 6.55 7.17 8.27 8.54 8.63
Return on avg equity (%) 26.4 29.9 31.9 29.1 26.5 7.25 14.0 16.0 18.8 20.1 20.4
ROIC (%) 94.0 117.2 84.9 70.0 70.7 10.2 17.0 17.9 21.0 21.4 21.0
ROIC - WACC (%) 82.2 105.5 73.1 58.2 58.9 -1.05 5.70 6.58 9.16 9.51 9.12
year to Mar year to Dec year to Mar

Valuation
EV/sales (x) 3.68 2.95 2.31 1.85 1.56 2.49 1.97 1.71 2.24 1.79 1.58
EV/EBITDA (x) 22.8 15.5 11.5 9.65 8.33 49.3 26.1 20.6 17.6 14.4 12.4
EV/EBITDA @ tgt price (x) 27.8 18.8 14.0 11.9 10.4 32.9 17.5 13.8 19.1 15.7 13.4
EV/EBIT (x) 24.8 16.7 12.3 10.3 8.88 58.7 28.6 22.2 19.3 15.8 13.5
EV/invested capital (x) 19.5 10.6 7.60 6.70 5.89 6.97 5.78 5.10 5.03 4.20 3.49
Price/book value (x) 8.23 6.69 5.24 4.16 3.36 6.17 5.46 4.74 4.72 4.03 3.43
Equity FCF yield (%) 2.30 -0.21 3.11 4.97 5.41 -0.02 -0.22 1.38 2.15 2.65 2.74
Normalised PE (x) 34.1 24.7 18.4 15.9 14.0 87.3 41.3 31.8 26.9 21.7 18.2
Norm PE @tgt price (x) 40.7 29.5 22.0 19.1 16.8 58.9 27.9 21.5 29.2 23.6 19.8
Dividend yield (%) 0.78 1.07 1.10 1.15 1.20 0.27 0.27 0.32 0.82 0.87 1.03
year to Mar year to Dec year to Mar

Per share data FY09A FY10A FY11F FY12F FY13F Solvency FY09A FY10A FY11F FY12F FY13F
Tot adj dil sh, ave (m) 489.5 489.5 489.5 489.5 489.5 Net debt to equity (%) -78.6 -60.7 -55.2 -62.7 -68.9
Reported EPS (INR) 64.1 88.1 118.1 136.5 154.9 Net debt to tot ass (%) -24.5 -19.9 -18.9 -22.2 -26.0
Normalised EPS (INR) 63.9 88.1 118.1 136.5 154.9 Net debt to EBITDA -2.41 -1.54 -1.35 -1.71 -2.15
Dividend per share (INR) 17.0 23.3 24.0 25.0 26.0 Current ratio (x) 1.58 1.53 1.56 1.61 1.69
Equity FCF per share (INR) 50.1 -4.62 67.6 108.2 117.8 Operating CF int cov (x) -176.9 -112.7 -206.4 -281.7 -304.7
Book value per sh (INR) 264.3 325.2 415.2 522.5 647.0 Dividend cover (x) 3.76 3.78 4.92 5.46 5.96
year to Mar year to Mar

Priced as follows: BHEL.BO - Rs2175.55; ABB.BO - Rs743.40; LART.BO - Rs1656.15

Source: Company data, RBS forecasts

Valuation methodology
Economic Profit Valuation Rs m % Disc ounted Cash Flow Valuation Rs m %
Adjusted Opening Investe d Capital 207183 .3 18 Va lu e of Pha se 1: Explicit (2011 to 2013) 19738.8 2
NPV of Economic Pro fit During Explicit Perio d 76492 .6 7 Va lu e of Pha se 2: Value Driver (2014 to 2023) 259679.5 22
NPV of Econ Profit of Remain ing Business (1, 2 ) 205074 .4 17 Va lu e of Pha se 3: Fade (2024 to 2037) 533843.1 45
NPV of Econ Profit of Net Inv (Grth Business) (1, 3) 687835 .4 58 Terminal Value 363230.2 31
Enterprise Value 1176585 .8 100 En terprise Value 1176491.6 100
Plus: Other Assets 0 .0 0 FCF Grth Rate at en d of Phs 1 implied by DCF Va luation 11.1
Less: Mino rities 0 .0 0 FCF Grth Rate at en d of Phs 1 implied by Current Price 11.0
Less: Net Debt / Leases (as at 21 Ja n 2011) -96623 .6 -8
Equity Value 1273209 .4 108 Returns , WACC and NPV of Free Cash Flow
No. Sha re s (millions) 489 .5
Per Sha re Equity Value 2601 40% 50,000
35% 45,000
Current Sh are Price 2175
40,000
17% 30%
35,000
Sensitivity Table No of Yea rs in Fade Period 25% 30,000
15 18 20 23 25 20% 25,000
6.0% 6193.54 7341.38 8211.64 9696.39 1 0820.22 20,000
15%
WACC

7.0% 5296.51 6181.15 6841.12 7948.72 8773.51 15,000

10%
8.0% 4551.63 5234.17 5735.47 6563.49 7170.45 10,000
5% 5,000
9.0% 3930.88 4457.94 4839.23 5459.41 5907.17
10.0% 3411.74 3818.98 4109.29 4574.56 4905.59 0% 0
2013

2017

2021

2025
2011

2015

2019

2023

2027

2029

2031

2033

2035

2037

Performance Summary Pha se 2 Avg

Pha se 1 NPV of FCF ( RH S) P ha se 2 N PV o f FCF ( RH S)
2011 2012 2013 (2014 - 2023)
Pha se 3 NPV of FCF ( RH S) Tota l B usine ss ROIC
Invested Capital Growth (%) 27.6 25.8 23 .8 17.6 Grow th Business ROIC Re mai ni ng Business R OI C
Operating Ma rgin (%) 20.1 19.2 18 .8 15.1 WAC C
Capital Turnover (x) 2.6 2.4 2 .1 2.0
Source: Company data, RBS forecasts
1. In periods following the Explicit Period i.e. Phase 2 and Phase 3
2. Remaining Business is defined as Capital as at the end of Phase 1 and capex = depreciation thereafter
3. Net Investment is defined as capex over and above depreciation after Phase 1

Bharat Heavy Electricals | Performance and Valuation | 21 January 2011

Company description Buy Price relative to country

BHEL is one of India's largest engineering enterprises and also a major power plant equipment manufacturers 140

globally. The company offers a wide spectrum of equipment, systems and services in the fields of power 130

generation, transmission, industry, transportation, oil & gas, and non-conventional energy resources. It has 120

technology tie-ups with Alstom, Siemens and GE. It has scale in terms of manufacturing capacity and a strong 110
vendor base built over the years. It is also a Navratna Public Sector Unit. 100

90

80

70
Jan May Aug Dec Apr Jul Nov Mar Jun Oct Jan
08 08 08 08 09 09 09 10 10 10 11

Price relative to country

Strategic analysis Average SWOT company score: 4 Revenue by segment, 9M11

Strengths 4
BHEL is one of the lowest-cost manufacturers of power plant equipment in India. Power plants constructed by Industry
BHEL comprise almost 68% of the installed base in India, which gives it a clear advantage over rivals. 22%

Weaknesses 4 Power
Most of the critical technologies used by BHEL have been borrowed from large MNCs such as Siemens, GE and 78%
Alstom. Hence, it depends on others for its technology requirements.
Opportunities 4 Source: Company data
Power demand in India is growing at a faster pace than GDP, calling for huge capacity additions across the
country. India is expected to add 78GW until 2012, presenting a huge market for equipment suppliers.
Market data
Threats 3
Headquarters
BHEL's virtual monopoly in the power plant equipment business is threatened. BHEL is now directly competing BHEL House, Siri Fort, New Delhi 110 049
with cheaper Chinese imports and is likely to face competition from local players such as L&T and JSW, which Website
have JVs with other foreign partners. www.bhel.com
Shares in issue
Scoring range is 1-5 (high score is good)
489.5m
Freefloat
32%
Majority shareholders
Government of India (68%), FII (14%), LIC (4%)

Country view: India Country rel to Asia Pacific

The Indian market remains a remarkable marriage of high hopes and expectations, extended valuations and a 140

weakening macro-economic backdrop. As pointed out by Parul Saini, RBS's India strategist, earnings risk is rising 130
while exploding food prices can only increase the pressure on already lagging monetary policy. Thus, we have an
120
Underweight rating on India.
110
The country view is set in consultation with the relevant company analyst but is the ultimate responsibility of the Strategy Team.
100

90

80
Jan May Aug Dec Apr Aug Nov Mar Jul Oct Jan
08 08 08 08 09 09 09 10 10 10 11

MarketIndex

Competitive position Average competitive score: 4+ Broker recommendations

Supplier power 4+ 35
BHEL is close to being a fully integrated power equipment manufacturer in India. Therefore, most of the raw 30
materials used are very basic. 25
20
Barriers to entry 4+ 15
The power plant equipment EPC business is highly capital-intensive. Besides, the availability of technology is an 10
issue. Although a mature business, barriers to entry are significant. 5
0
Customer power 3- Buy H old Sell
Customer power is beginning slowly to increase in the private sector, where today many more new entrants are
making inroads.
Source: Bloomberg
Substitute products 4-
Within power plant equipment, there are substitutes given the kind of fuel being used. BHEL's strength lies in coal-
based plants, currently the mainstay of power generated in India.
Rivalry 4+
BHEL's monopoly days are likely to end, with competition coming not just from Chinese players, but also from
local players such as Larsen & Toubro and JSW.
Scoring range 1-5 (high score is good) Plus = getting better Minus = getting worse

Bharat Heavy Electricals | Strategic and Competitive Overview | 21 January 2011

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Bharat Heavy Electricals | Disclosures Appendix | 21 January 2011