We are initiating coverage Bharat Heavy Electricals Ltd. (BHEL), one of largest engineering and manufacturing enterprise of its kind in India. It is one of the leading international companies in the field of power equipment manufacturing and engaged in power generation, transmission, industry (transportation, renewable energy etc) and Overseas Business.

Strong Order Book
The robust order book of the company stands at Rs 153775 crore (4.6x FY2010 revenue) as on Dec 1, 2010. The Order intake for the Sept quarter was Rs 13506 crore as compared to June'10 of Rs. 10824. The strong order book is portraying the future growth in the revenue of the company.

Joint Venture with Toshiba
BHEL is close to wrapping up a joint venture agreement with Japan's Toshiba Corporation. The pact to formalize the proposed 50:50 venture is expected to be in place by the first quarter of the next calendar year. This will led the company to manufacture high-end transmission and distribution equipment for the Indian and export markets.

Venturing Into new business through joint ventures
BHEL has planned to make an entry into nuclear equipment, wind energy, specialized grade steel, transmission, transportation and water treatment businesses through the route of collaboration and joint ventures.

VALUATION
At the current price of Rs. 2195, the stock is trading at 22.77 times of our estimated FY11E earnings, while it is available at just 19.54x of FY12E. We thus recommend a `BUY' with a target price of Rs. 2710.

INVESTMENT ARGUMENT

Robust Order Book
The robust order book of the company stands at Rs 153775 crore (4.6x FY2010 revenue) as on Dec 1, 2010. Order book for the quarter Sept'10 was Rs 13506 crore of which the power sector orders were about Rs 11024 crore and the balance being industries and exports. The company has bagged orders worth Rs6000 crore including the 5X270 MW Nashik Power Plant of India Bulls, 3X270 MW of Amaravathi Phase II, APGenco's Rayalaseems power projects etc. Going forward, the heavy order book of the company is expected to be visible in its earnings of FY10 & FY11.

JV with Toshiba Corporation
BHEL is close to wrapping up a joint venture agreement with Japan's Toshiba Corporation. The pact to formalize the proposed 50:50 venture is expected to be in place by the first quarter of the next calendar year. This will help BHEL to manufacture high-end transmission and distribution equipment for the Indian and export markets.

Capex Cycle
On a yearly basis, India Inc is estimated to incur capital expenditure of about Rs 6 lakh crore in 2010-11 reasonably higher compared to the last two fiscal years when it stagnated around Rs 4.6 lakh crore levels. The capex cycle has already begun can be gauged from the sharp rise in India's capital goods index the average monthly growth in the index at 46% has been impressive. The beneficiaries of this increase in investments will be the engineering and capital goods companies. BHEL enjoys leadership and strong capex in the power equipment space which plays good on the power sector capex.

Robust Industrial Growth
IIP growth has increased by 28.37% to 9.5% in April-November 2010 from 7.4% in April - November 2009 and the growth in capital goods is by 13.63% Y-o-Y to 12.5% in April-November 2010 from 11% in April - November 2009. It is estimated that their lies a growing demand for industrial production due to the future expansion plans by government and the capacity addition in power sector to meet the domestic demand of the country. And since L&T has a major of 94% orders from domestic market, it clearly portrays the inflow of orders for the company.

Foray into non banking financing for Power Projects
BHEL is exploring the possibility of formation of a separate finance company as a joint venture with a strategic partner to finance power projects. For the same purpose the company has appointed CRISIL to work on the proposal. The main idea behind this JV is to use the surplus cash reserves in the balance sheet increasing its exposure in power sector.

Venturing into new businesses via JV and Collaboration
BHEL has planned to make an entry into nuclear equipment, wind energy, specialized grade steel, transmission, transportation and water treatment businesses through the route of collaboration and joint ventures.

Joint Venture with NTPC Balance of Plant
BHEL Power Projects Pvt Ltd a 10% subsidiary of BHEL has entered into a 50:50 JV with NTPC to increase the domestic manufacturing capacities in the Balance of Plant (BoP) segment. It will help in justifying the anticipated shortage in the BoP segment.

Nuclear Equipment Segment through JV
The company has tied up with Alstom and this being a tri-partied JV, the process of getting approval with Atomic Energy Department is pending. The joint venture of Bharat Heavy Electricals Ltd with Nuclear Power Corporation of India Ltd(NPCIL) is likely to be approved by the Union cabinet soon. The new company is to provide engineering, procurement and construction services in the nuclear power sector. Each of the three is expected to hold 33% equity stake. The JV would not require much capital investment and it would function as a front-end company, responsible for marketing and engineering. BHEL would be responsible for manufacturing order received from the new company with the help of Alstom. BHEL would use its Bhopal and Hardwar facilities to enhance its equipment capacity for the nuclear sector. BHEL's boiler capacity at Tiruchirapalli would also be used for catering to the nuclear sector.

Capacity Expansion
The company has realized the capability to deliver 15,000MW pa and the capacity expansion program is underway to reach 20,000MW pa by 2012. Currently, 74% of the total power generated in the country is through BHEL. This capacity expansion is in line with the government project power for all.

Technological Enhancement
BHEL would focus on low Carbon Path Technologies such as Ultra Supercritical, IGCC, and Solar Power etc against backdrop of climate change. BHEL would play a lead role in 'development and deployment' of advanced Ultra Supercritical Power Plant under the proposed National Mission for Clean Coal(Carbon)Technologies. This will help BHEL to avoid project delay due to various reasons through enhancement in its technology.

Regular Research & Development
BHEL plans to increase R&D spend to at least Rs. 900 crore by 2011-12. Greater standardization of components and sub-systems that will drive cost competitiveness and faster delivery is being pursued. Technology development efforts undertaken by BHEL have led to the filing of patents and copyrights at the rate of nearly one a day, significantly enhancing the company's intellectual capital to almost 1,300 patents and copyrights filed, which are in productive use in the company's business. Since R&D and technology development are of strategic importance to the company as it operates in a competitive environment where technology is a key driver BHEL ensures the regular investment in R&D to be the leader in its industry.

Credit Rating
CRISIL assigns BHEL with AAA/stable rating which clearly shows that the company will continue to generate robust cash accruals, given its healthy order book and operating track record. The company's sound financial risk profile will enable it to withstand economic downturns, and maintain a credit risk profile that is consistent with the current rating category.

RISK CONCERN

Rising Competition
Considering the growing power demand, many domestic companies have announced their intent to tie-up with leading international players from China, Japan, Europe etc. to set up manufacturing bases in the country. This could escalate intensity of competition for BHEL in long-term.

Government Policies
Most of the business areas in which BHEL operates, the growth prospects are dependent on policy decisions at the national level as also on the prevailing business trends.

Delayed Execution
BHEL has to execute over 12,600 mw of projects in 2010-11 and 9,600 mw of projects in 2011- 12. In this context, the execution capacity of BHEL becomes a critical issue for achieving the targeted capacity addition, especially in 2010-11.