Bhel DCF

Global Equity Research
India
ELECTRICAL EQUIPMENT Electrical Equipment
Bharat Heavy Electricals Ltd

Prizes priced in
We believe Bharat Heavy Electricals Ltd (BHEL) is likely to face greater competition in Twelfth Five-Year Plan (2012-17) ordering activity as the bulk of Eleventh FiveYear Plan (2007-12) ordering has already been completed. BHEL is trading at 17x FY10E EPS of INR82.3. We initiate coverage with a NEUTRAL rating and a 12-month price target of INR1,422, implying potential upside of 3.5%. India is set to commission more than 78,000MW of power plants over the next five years and we believe BHEL will be a major beneficiary of this investment. The bulk of Eleventh Five-Year Plan ordering is complete, while the Twelfth FiveYear Plan will attract greater competition, in our view, due to a higher share of private sector capacity. Thus, while we estimate a revenue CAGR of 21% over FY07E-12, we forecast a slowdown to just a 12% CAGR over FY12-17. With current P/E at 17x FY10E EPS of INR82.3, we believe BHEL factors in shortterm upside, but ignores long-term risks of slower growth. We value the stock at INR1,422, using a DCF methodology (terminal year FY17E, a RoE of 33% and a growth rate of 5%. We initiate coverage with a NEUTRAL rating.
Initiation of Coverage
Stock Rating: Sector View: Ticker: Price (13-Mar-2009): Price Target:
INDIA BSE 30 SENSITIVE:
NEUTRAL BEARISH BHEL.NS INR 1371.00 INR 1422.00 8756.61
Satish Kumar
91.22.4037.4183 skumar@nomura.com Mumbai
Amar Kedia
91.22.4037.4182 amar.kedia@nomura.com Mumbai
FY Mar (INR) 2008A 2009E 2010E Market Data
Revenue (m) Net profit (m) EPS EPS growth (%) DPS P/E EV/EBITDA Dividend yld (%)
193,046 247,099 308,874 28,485 58.2 18.8 12.3 23.7 12.9 0.9 31,642 64.6 11.1 13.7 21.4 11.2 1.0 40,278 82.3 27.3 17.4 16.8 8.7 1.3
Market cap Market cap (US$ mn) Shares outstanding (mn) 6-mo daily T/O (US$ mn) Free float (%) Foreign shareholding (%)
675366 13524 489.5 14 32.30 22.80

15/3/09 0.17 0.16 0.15 0.14 0.13 0.12 0.11 0.10 0.09 0.08
3000 2800
Analyst Certification
We, Satish Kumar and Amar Kedia, hereby certify (1) that the views expressed in this Company Report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Company Report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Company Report.
Financial Summary
2600
3-Yr EPS growth(%) PEG (3-Yr CAGR) P/B ROE (%) Debt to capital (%) Dividend payout (%)
43.0 0.5 6.0 27.9 0.0 24.1
2400 2200 2000 1800 1600 1400 1200 1000
800 0.07 MAM J J A SO ND J FMAM J J A S OND J FM BHARAT HEAVY ELS. IN:BHH/IBOMSEN(R.H.SCALE) Source: DATASTREAM
March 18, 2009 Nomura Financial Advisory and Securities (India) Private Limited
http://www.nomura.com
ANY AUTHORS NAMED ON THIS REPORT ARE RESEARCH ANALYSTS UNLESS OTHERWISE INDICATED. PLEASE SEE IMPORTANT DISCLOSURES BEGINNING ON PAGE 29 gl
March 18, 2009
Table of Contents
Coverage summary ............................................................................................ 3 Investment highlights ........................................................................................... 4 Investment risks .................................................................................................. 7 We value stock using DCF methodology ................................................................ 8 Business outlook: challenges ahead..................................................................... 10 Regulatory changes in the power sector: impact on BHEL ........................................ 14 Competition expected to increase ................................................................... 16 Financials ....................................................................................................... 19 Company background ...................................................................................... 24 Trough valuation and sensitivity to key value drivers ................................................ 26 Appendix: Eleventh Five-Year Plan power capacity additions ............................... 27
Nomura Equity Research
March 18, 2009
Coverage summary Exhibit 1. BHEL estimate summary

Ticker BHEL BHEL IN Nomura rating NEUTRAL Price (INR) 1371 Target price (INR) 1,422 Potential upside (%) 3.5 P/E (x) 13.5 ROE (%) 26.5 Operating margins (%) 17.3 FY09E 64.6 EPS (INR) FY10E 82.3 FY11E 101.2
Source: Company data, Nomura estimates; Price as of 13 March 2009
Exhibit 2. Indian electrical equipment rating summary

Ticker India BHEL ABB India Siemens India Average BHEL IN ABB IN SIEM IN INR INR INR INR NEUTRAL Not rated Not rated Not rated 1371 356 211 121 13.5 10.3 10.5 7.1 10.4 26.5 35.3 36.7 31.4 32.1 17.3 11.2 9.7 8.5 12.7 64.6 27.0 17.3 13.9 82.3 30.9 18.9 15.4 101.2 34.5 20.1 17.0 Currency Nomura rating Price P/E (x) ROE (%) Operating margins (%) FY09E EPS FY10E FY11E
Crompton Greaves Ltd CRG IN
Source: Bloomberg consensus estimates for non-rated companies, Nomura estimates for others; Prices as of 13 March 2009
Exhibit 3. Global electrical equipment valuation comparison

Ticker India BHEL ABB India Siemens India Crompton Greaves Ltd Average Non-Japan Asia ex-India Dong Fang Electrical Machinery Co. Harbin Power Equipment Co. Doosan Heavy Engg and Construction Shanghai Electric Group Co. Ltd Average Japan Mitsubishi Heavy Industries Hitachi Industries Average Europe Siemens AG ABB Ltd Alstom Schneider Electric SA Average North America General Electric Jacobs Engineering Group Cummins Inc Average
Source: Brook Hunt, Nomura estimates *Prices as of 13 March 2009
Currency Nomura rating INR INR INR INR NEUTRAL Not rated Not rated Not rated
*Price 1371 356 211 121
P/E (x) 13.5 10.3 10.5 7.1 10.4
ROE (%) 26.5 35.3 36.7 31.4 32.1
Operating margins (%) 17.3 11.2 9.7 8.5 12.7
EPS CAGR (%) 25.2 13.0 7.6 10.8 14.1
BHEL IN ABB IN SIEM IN CRG IN
1072 HK 1133 HK 034020 KS 2727 HK
RMB RMB W RMB
REDUCE BUY Not rated REDUCE
15 5 59000 2
6.5 5.6 10.5 8.9 7.9
26.9 23.9 5.1 16 18
9.1 8.3 11.5 11.6 10.1
38.9 2.6 17.5 -32.6 6.6
7011 JP 6501 JP
JPY JPY
NEUTRAL Not rated
272 253
36.9 n.a. 36.9
4.5 2.2 3.4
8 7.3 7.7
2.2 n.a.
SIE GR ABBN VX ALO FP SU FP
EUR US$ EUR EUR
Not rated Not rated Not rated Not rated
44.4 15.5 39.7 46.5
9.1 15.1 8.8 9.2 10.5
12.4 30 31.8 15.6 22.5
6 16.5 10.1 14.6 11.8
4.1 -2.5 0.5 11.5 3.4
GE US JEC US CMI US
US$ US$ US$
Not rated Not rated Not rated
9.6 40.4 22.5
8.1 11.0 10.7 9.9
21 17.6 30.9 23.2
16.5 5.9 13 11.8
9.9 -8.0 18.3 6.8
March 18, 2009
Investment highlights
Eleventh Five-Year Plan: Power capacity addition of 78,577MW envisaged According to data from the Central Electricity Authority (CEA), Indias per capita power consumption is only 670 units, which is well below the global average of 2,400. Peak power shortages are as high as 17-19%. The Indian government has a stated objective of power for all by 2012 and has planned for capacity addition of 78,577MW in the Eleventh Five-Year Plan (2007-12), which is expected to take Indias power consumption to 1,000 units per capita in 2012. Execution of capacity addition seems to be on track In the three preceding five-year plans, total capacity added has lagged planned capacity addition. In contrast, however, the Eleventh Five-Year Plan target seems to be on track, since around 75,000MW (by 31 December 2008) of capacity has already been ordered or commissioned, which, we believe, provides good visibility for achieving the target within the plan period.
Exhibit 4. Power capacity addition as per five-year plans

Eighth FiveYear plan (1992-97) Target addition (MW) Addition achieved (MW) Actual addition as percentage of target
Source: Nomura research
Ninth FiveYear plan (1997-2002) 40,245 19,015 47.2
Tenth Five- Eleventh FiveYear plan (2002-07) 41,110 21,180 51.5 Year plan (2007-12) 78,577
30,538 16,423 53.8
Robust ordering for Eleventh Five-Year Plan boosted BHELs order backlog BHELs order backlog increased to INR1.1tn at end-3Q FY09, because of the rapid pace of orders in FY08 and FY09. The increase in orders was accompanied by EPS growth of 76% in FY06 and 46% in FY07. However, if we adjust for extraordinary tax write-backs, the increase in income in FY08 is only 9%.
Exhibit 5. BHEL order book versus EPS growth

(x) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09E FY10E Orderbook coverage ratio EPS grow th (%) 100 80 60 40 20 0 (20) (40) (60)
Source: Company data, Nomura estimates
March 18, 2009
We believe order flow will slow down in FY10 Owing to robust ordering activity, 75,000MW of the 78,577MW power capacity targeted under the Eleventh Five-Year Plan has already been commissioned or ordered. Thus, only another 3,000MW of capacity remains to be ordered, which we expect will be done by end-FY09. As a result, we expect ordering activity to slow down in FY10 and FY11 since Eleventh Plan projects would have been ordered by then and ordering for Twelfth Plan projects is likely to start only in the later part of FY11 and FY12.
Exhibit 6. Bulk of Eleventh Plan power capacity already ordered

Capacity (MW) Planned Commissioned Under construction/ordered Yet to be ordered
Thermal 58,644 8,439 47,205 3,000
Hydro 16,553 3,173 12,970 410
Nuclear 3,380 220 3,160 0
Revenue growth to slow down from FY12 Our revenue assumptions for BHEL are derived from Indias planned power capacity additions in the Eleventh and Twelfth Five-Year Plans. While the Eleventh Plan envisages capacity additions of 78,577MW, the exact amount of planned capacity for the Twelfth Plan is yet to be decided; currently, 167,000MW of power projects have been proposed for the Twelfth Five-Year Plan. According to our estimates, BHELs total revenue over FY08-12 is likely to be around INR1,600bn, which implies power capacity additions of 78,000MW on the assumption of a 70% market share for BHEL and a realisation of INR24mn/MW. Similarly, we estimate total revenue of INR3,200bn for the Twelfth Plan period, which implies capacity additions of 167,000MW during this period, which is equivalent to the current project proposal for the Twelfth Five-Year Plan. Thus, our revenue CAGR estimate for FY07E-FY12 is 21% and for FY12-FY17 is 12%, suggesting a perceptible slowdown, once the current high growth period ends. We expect earnings CAGR of 25.5% over FY09-11 We expect the companys revenue to increase at a CAGR of 22.5% and EPS to rise at a CAGR of 25.5% over FY09-11, driven by capacity additions and margin expansion. In December 2007, the company expanded its capacity to 10,000MW from 6,000MW; it plans to increase this to 15,000MW by December 2010. We believe this capacity expansion will help the company overcome the execution delays that have hampered some of its projects. High revenue growth will lead to increased operating leverage and thus, we expect operating margins to expand from 17.4% in FY08 to 18% in FY10. We are ~3% and ~8% lower than Bloomberg consensus EPS estimates for FY09 and FY10 respectively.
March 18, 2009
Growth reflected in stock price performance BHEL has been among the best performing stocks on the BSE Sensex for 2006 and 2007. The stock appreciated 65% in 2006 and 124% in 2007 and was among the best performing stocks in the NIFTY for these two years, which moved up by 39.8% and 53.2% respectively. Even in 2008 it outperformed the market by 5%. We believe this performance has been driven by strong growth in order backlog and in earnings. The strong order backlog has provided long-term earnings visibility, while high earnings growth, along with greater capacity utilisation, has led to high ROEs. The stock is trading at 17x FY10E EPS and 14x FY11E EPS. At these valuations we believe it factors in strong earnings visibility and 25% EPS growth over the next two years. The company aims to have revenue of US$10bn by FY12. We factor this management guidance in our numbers. Long-term concerns remain We believe that BHEL faces the following key long-term risks: Increasing competition will force the company to decrease its prices. BHELs current price quotes are 10-15% higher than prices quoted for similar equipment by Chinese companies such as Dong Fang Electrical Machinery and Shanghai Electric Group. Increasing private sector participation in power generation would lead to higher competition and lower prices, since private sector projects will be awarded on tariffbased bidding. We expect 50% of the total thermal power projects likely to be commissioned in the Twelfth Plan period to be in the private sector. Nearly 45% of the thermal power capacity likely to be commissioned in the Twelfth Plan period would use supercritical technology, where BHEL does not have any advantage over existing players like Larsen and Toubro (L&T). The Ministry of Power is currently considering a proposal to change the tariff structure of the Central Electricity Regulatory Commission (CERC), whereby timely execution will be rewarded by extra 0.5% guaranteed RoE to the developers. If this change is implemented, they will have greater incentive to opt for suppliers who can ensure timely supply of equipment. The steep fall in Chinese power demand and the high probability of idle power capacity could force Chinese equipment players to be more aggressive in the Indian market. We value the stock using DCF and initiate with a NEUTRAL rating We initiate coverage of BHEL with a NEUTRAL rating and a 12-month price target of INR1,422. At our price target, the stock would be valued at 14x FY11E EPS. We use discounted cash flow methodology to value the stock. Our key assumptions are a terminal growth rate of 5% and cost of equity of 13%. The terminal year operating margin is 17.2%.
March 18, 2009
Investment risks
Downside risks Lower-than-expected power capacity additions would reduce orders for the power equipment industry, affecting BHELs estimated order inflows and revenues. A slowdown in power sector investments for various reasons, including non-availability of funds, could negatively impact order inflows and revenues for BHEL. Earlier-than-expected competition from Chinese equipment manufacturers could also affect pricing, order inflows and margin assumptions for BHEL. Upside risk An increase in BHELs market share in orders from private players could pose upside risk to our numbers.
March 18, 2009
We value stock using DCF methodology

We value BHEL using the discounted cash flow (DCF) methodology with FY17 as the terminal year. Our key assumptions are: A terminal growth rate of 5%. Cost of equity of 13%. Terminal year operating margin of 17.2% and RoE of 33%, which compares with an operating margin of 17.2% and RoE of 27.9% reported in FY08.
Exhibit 7. BHEL DCF valuation

FY09E Pre-tax profit Depreciation Chg in debtors Chg in inventory Chg in loans & advances Chg in current liabilities Chg in provisions Total tax paid Cash flow from operations (a) Capital expenditure Cash flow from investing (b) Free cash flow (a+b) Debt raised/(repaid) Dividend (incl. tax) Other financing activities Cash flow from financing (c) Net chg in cash (a+b+c) Cash at year end in balance sheet Free cash flow to equity Cost of equity (%) Terminal growth rate (%) Tax rate in terminal year (%) Terminal value PV of terminal value Total value of equity NPV per share
Source: Nomura estimates
FY10E 61,966 5,534 30,126 14,471 4,894 35,472 6,169 21,688 37,963 15,000 15,000 22,963 9,707 9,707 13,256 90,646 22,963
FY11E 76,237 6,524 37,446 20,944 (86) 46,093 8,016 26,683 51,883 15,000 15,000 36,883 11,942 11,942 24,941 115,587 36,883
FY12E 88,827 7,514 27,503 13,119 3,811 34,302 5,965 31,090 61,087 15,000 15,000 46,087 13,915 13,915 32,172 147,759 46,087
FY13E 103,785 8,669 32,844 15,459 4,409 39,685 6,901 36,325 70,003 20,000 20,001 50,002 16,258 16,258 33,745 181,504 50,002
FY14E 110,062 9,989 30,217 14,061 4,714 42,425 7,378 38,522 82,341 20,000 20,001 62,340 17,241 17,241 45,099 226,603 62,340
FY15E 123,789 11,309 33,843 16,312 4,740 42,664 7,419 43,326 86,960 20,000 20,001 66,959 19,391 19,391 47,568 274,171 66,959
FY16E 134,221 12,629 31,587 15,225 4,677 42,092 7,320 46,977 97,796 20,000 20,001 77,795 21,025 21,025 56,770 330,941 77,795
FY17E 149,189 13,784 34,745 16,747 4,880 43,923 7,638 52,216 105,945 15,000 15,001 90,944 23,370 23,370 67,574 398,515 90,944
48,680 4,544 26,572 6,253 4,350 31,524 5,482 17,038 36,018 15,000 15,000 21,018 7,626 7,626 13,392 77,390 21,018 13.00 5.0 33.0 1,193,644 449,001 694,089 1,422
March 18, 2009
Exhibit 8. BHEL P/E chart

3,500 3,000 2,500 2,000 1,500 1,000 500 0 Mar-01 Jul-01 Oct-01 Jan-02 May-02 Aug-02 Nov-02 Feb-03 Jun-03 Sep-03 Dec-03 Apr-04 Jul-04 Oct-04 Jan-05 May-05 Aug-05 Nov-05 Mar-06 Jun-06 Sep-06 Dec-06 Apr-07 Jul-07 Oct-07 Feb-08 May-08 Aug-08 Nov-08
Source: Company data, Nomura estimates, Bloomberg
BHEL BHEL at P/E 20
BHEL at P/E 10 BHEL at P/E 25
BHEL at P/E 15
Peer valuations The stock is trading at a premium to its Chinese counterparts although it operates in a similar environment and has a similar growth profile.
Exhibit 9. Global electrical equipment valuation comparison

Ticker India BHEL ABB India Siemens India Crompton Greaves Ltd Average Non-Japan Asia ex-India Dong Fang Electrical Machinery Co Harbin Power Equipment Co Doosan Heavy Engg and Construction Shanghai Electric Group Co Ltd Average Japan Mitsubishi Heavy Industries Hitachi Industries Average Europe Siemens AG ABB Ltd Alstom Schneider Electric SA Average North America General Electric Co Jacobs Engineering Group Cummins Inc Average
Source: Brook hunt, Nomura estimates *Prices as of 13 March 2009
Currency Nomura rating INR INR INR INR NEUTRAL Not rated Not rated Not rated
*Price 1,371 356 211 121
P/E (x) 13.5 10.3 10.5 7.1 10.4
ROE (%) 26.5 35.3 36.7 31.4 32.1
Operating margins (%) 17.3 11.2 9.7 8.5 12.7
EPS CAGR (%) 25.2 13.0 7.6 10.8 14.1
BHEL IN ABB IN SIEM IN CRG IN
1072 HK 1133 HK 034020 KS 2727 HK
RMB RMB W RMB
REDUCE BUY Not rated REDUCE
15 5 59,000 2
6.5 5.6 10.5 8.9 7.9
26.9 23.9 5.1 16 18
9.1 8.3 11.5 11.6 10.1
38.9 2.6 17.5 -32.6 6.6
7011 JP 6501 JP
JPY JPY
NEUTRAL Not rated
272 253
36.9 n.a. 36.9
4.5 2.2 3.4
8 7.3 7.7
2.2 n.a.
SIE GR ABBN VX ALO FP SU FP
EUR US$ EUR EUR
Not rated Not rated Not rated Not rated
44.4 15.5 39.7 46.5
9.1 15.1 8.8 9.2 10.5
12.4 30 31.8 15.6 22.5
6 16.5 10.1 14.6 11.8
4.1 -2.5 0.5 11.5 3.4
GE US JEC US CMI US
US$ US$ US$
Not rated Not rated Not rated
9.6 40.4 22.5
8.1 11.0 10.7 9.9
21 17.6 30.9 23.2
16.5 5.9 13 11.8
9.9 -8.0 18.3 6.8
March 18, 2009
Business outlook: challenges ahead

India set to add 78,577MW in Eleventh Five-Year Plan The Eleventh Five-Year Plan has seen robust ordering activity so far. We believe this means the target for capacity additions in this plan period will be met. The Tenth Five-Year Plan (2002-07) saw the addition of 21,180MW which was only 51% of the target additions of 41,110MW. This was mainly because most orders were placed only towards the latter half of the plan period (in FY04 and FY05). In contrast, in this plan ordering has been on track and so far around 65,000 MW of capacity has been commissioned or ordered.
Exhibit 10. Power capacity additions as per five-year plans

8th plan (1992-97) Target additions (MW) Addition achieved (MW) Actual additions as percentage of target
9th plan (1997-2002) 40,245 19,015 47.2
10th plan (2002-07) 41,110 21,180 51.5
11th plan (2007-12) 78,577
30,538 16,423 53.8
Robust order inflow in FY07, FY08 and FY09 BHEL saw strong order inflows for FY04-FY08 because of robust ordering activity during this period. The companys order inflow in FY08 was INR502,650mn, 40% higher than its order inflow in FY07. As is evident from the table below, order inflows doubled in FY07 and order intake was strong in FY08 as well. To date, FY09 has also been a good year, tracking the overall order inflow target of INR500,000mn.
Exhibit 11. BHEL surging order inflows

FY04 Order inflow (INRmn) Source: Company data 158,690 FY05 178,771 FY06 189,740 FY07 356,460 FY08 502,650 FY09 (nine months) 429,980
Order inflow to taper down in the coming years Nearly all the capacities to be commissioned under the Eleventh Five-Year Plan have been ordered. Only 3,000MW by NTPC is pending.
Exhibit 12. Bulk of Eleventh Plan capacity already ordered

Capacity (MW) Planned Commissioned Under construction/ordered Yet to be ordered
Thermal 58,644 8,439 47,205 3,000
Hydro 16,553 3,173 12,970 410
Nuclear 3,380 220 3,160 0
Some merchant power plants (MPP) orders are also pending and some ultra-mega power projects (UMPPs) are yet to be awarded. However, given BHELs track record in the private sector, we consider it highly unlikely that the company can enjoy the same success rate it
10
March 18, 2009
had for orders from National Thermal Power Corporation (NTPC) (NATP IN, INR 172, NEUTRAL) and state electricity boards (SEBs). We expect order inflow to slow down in FY10 as ordering for the Eleventh Plan would be completed by then and ordering for the Twelfth Plan will only start from FY11. Twelfth five year plan will be a challenge for BHEL The Twelfth Five-Year Plan is likely to prove to be a major challenge for BHEL. To date, the company received most of its orders from the central or state sector, where competition was limited and BHEL was able to set prices. More than 50% of the power capacity additions targeted under the Twelfth Plan will be by private players. BHELs share in electrical equipment orders placed by the private sector in the Eleventh Plan is about 12%. BHELs overall market share in thermal power equipment is down to 60% for the Eleventh Five-Year Plan. This calculation does not include 3,000MW of yet-to-beplaced orders by NTPC, which will probably go to BHEL, in our view.
Exhibit 13. Breakdown of order inflows in the Eleventh Plan period

Sector (MW) Central BHEL Others State BHEL Others Private BHEL Others Total BHEL Others 2007-08 1,250 740 2,680 1,200 750 0 4,680 1,940 2008-09E 1,750 0 870 392.2 500 2,261 3,120 2,653.2 2009-10E 1,990 1,320 3,942 374 250 3,520 6,182 5,214 2010-11E 5,765 1,260 5,452 1,200 0 3,145 11,217 5,605 2011-12E 5,501 1,920 5,291 600 540 6,640 11,332 9,160 Total BHEL market share (%) 16,256 5,240 18,235 3,766 2,040 15,566 36,531 24,572 76
83
12
60
The Twelfth Plan envisages much greater private sector participation. In the thermal power segment, where BHEL dominates in India, around 62% of the overall capacity additions will be by private players. Of the total coal-based thermal capacity shelf of 98,400 MW (including seven UMPPs) expected under the Twelfth Plan, the private sector is expected to set up nearly 50%. BHELs record so far in gaining orders from the private sector has been very disappointing chiefly because of BHELs higher prices and execution delays. BHEL has only a 12% share in private sector projects under the Eleventh Plan. Consequently, we believe the possibility of BHELs market share in the private space improving significantly during the Twelfth Plan period is rather low since independent power producers (IPPs), UMPPs or even regulated RoE plants would focus on timely execution since it would determine the total viability of the power project. In its new policy, CERC indicated an 0.5% extra RoE for developers if a project is commissioned on time, which puts a premium on timely execution capabilities.
11
March 18, 2009
We believe two scenarios could play out for BHEL in the Twelfth Plan: BHEL concentrates on state and central sector projects and gets only a few private sector projects. Assuming that BHEL gets all the state and central projects, it would have a market share of around 60% or 58,000MW in coal-based plants, which is less than its current share. BHEL lowers its prices and competes with other players. This would lead to a drop in realisation per MW, which can, in turn, affect margins. Project execution has to improve The Ministry of Power has laid the maximum blame for delays in the commissioning of power plants under the Tenth Plan on BHEL. For its part, BHEL blamed individual utilities for the delays. While it is possible that both the utilities and BHEL were responsible, we believe that BHEL has been stretched because of its lack of capacity. Supercritical orders: tie-up with TNEB ensures orders The company has tied up with Alstom SA of France for supercritical boiler technology. The technology transfer agreement with Alstom is contingent upon BHEL getting bulk orders for this technology. BHEL has been trying to negotiate bulk orders based on supercritical technology from NTPC, but the pricing of these orders has not been agreed upon. BHEL has now entered into an agreement with the Tamil Nadu Electricity Board (TNEB), where BHEL would take an equity stake in TNEB-run supercritical power projects and supply the necessary equipment. The company is also in talks with other SEBs for a similar arrangement. This helps allay concerns that the technology transfer agreement with Alstom may not work due to the lack of bulk orders. However, competition is rather stiff for supercritical orders Taking the Twelfth Plan project shelf as our reference, 46% of thermal power projects in the Twelfth Plan seem to be based on supercritical technology. This includes UMPPs, which will be awarded on tariff-based bidding. The companies in the fray for supercritical orders in India are BHEL, the JV between L&T and Mitsubishi Heavy Industries and Chinese equipment companies such as Dong Fang Electrical Machinery Co. and Shanghai Electric Group Co. Ltd. Therefore, contrary to sub-critical projects under earlier five-year plans, when BHEL had little or no competition, there is likely to be significant competition for supercritical orders in the Twelfth Plan. Order book will test BHELs execution capability BHEL expanded its capacity to 10,000MW in December 2007 and plans to expand it to 15,000MW by December 2009. While this should help improve its execution abilities, capacity expansion cannot reduce cycle time.
12
March 18, 2009
We believe BHEL will have to face following challenges in the Twelfth Plan period: Availability of manpower: BHEL has gone on record saying that it needs around 20,000 people in the next four to five years to ramp up. It is unclear how this requirement will be fulfilled at the current, or even at an improved (after wage revision), salary structure. Vendor development: BHEL depends on its vendors for the supply of several key items. To adhere to its project timelines, BHEL will have to convince these vendors to make investments to develop additional facilities. Remaining plant items: Outside agencies are responsible for BHELs ash-handling systems, pumps, coal-handling plants, etc. In many cases these agencies are rather small and have not ramped-up to cater to BHELs considerable order book.
13
March 18, 2009
Regulatory changes in the power sector: impact on BHEL

There have been various regulatory changes since the inception of the Electricity Act of 2003 in the Indian power sector. The basic emphasis has been to increase competition in the sector and attract more private players. Some of these changes could have a negative impact on BHEL. We have analysed some important regulatory changes and their possible impact on BHEL. Amendment in purchase preference policy for public sector enterprise greater competition Public sector companies in India come under the purchase preference policy. The policy stipulates that in the case of competitive bidding for another central public sector enterprise (CPSE) project, BHEL will be awarded the project even if its quote is up to 10% higher than the lowest bidder. This policy acted as entry barrier for private players in the Indian power equipment sector since it offered BHEL a clear advantage. This purchase preference policy was extended to 2008 in a Cabinet meeting held in June 2005. However, the Cabinet stipulated that the size of the contracts for which the preference policy would apply should not exceed INR1bn. Since most power projects are higher than INR1bn, we believe the Cabinets directive deprives BHEL of its competitive edge and encourages greater private participation in the sector. New tariff policy lower margins for BHEL The power sector tariff policy was amended in 2004 to foster competition in the sector. The main provision of the policy is to promote tariff-based bidding for power projects. The policy states: All future requirement of power should be procured competitively by distribution licensees, except in cases of expansion of existing projects or where there is a state-controlled/owned company as an identified developer and where regulators will need to resort to tariff determination based on norms, provided that the expansion of generating capacity by private developers for this purpose would be restricted to one-time additions of not more than 50% of the existing capacity. Even for public sector projects, the tariff of all new generation and transmission projects should be decided on the basis of competitive bidding after a period of five years or when the Regulatory Commission is satisfied that the situation is ripe to introduce such competition. At present, the tariff for a central sector generator is determined by the CERC, which assures the developer a 14% guaranteed post-tax return on equity, while all other costs are a pass through in tariff. We believe this method breeds inefficiency in the system since the generator has no incentive to optimise costs, which, in turn, means that a power equipment manufacturer can make good margins. If the tariff policy amendment is implemented, we believe there will be pressure on generating companies to optimise costs. This would mean lower margins for equipment manufacturers such as BHEL, in our view.
14
March 18, 2009
MPPs lower prices for BHEL As per the new National Electricity Policy, effective 2003, 15% of new capacity would be sold outside long-term power purchase agreements (PPAs). Power plants so set up are known as MPPs. Unlike traditional utilities, MPPs compete for customers and absorb full market risk. However, there are no guarantees that they would have a minimum offtake for their output. They must respond to market needs. Typically, the risk of an MPP is carried on the promoters balance sheet. States are liable to provide support in terms of land, rehabilitation and settlement of displaced people, water linkage, power connection during construction, clearance for land and coal mine and environmental clearances. However, MPPs are expected to search for customers, besides seeking open access from the central transmission utility based on customer profiles. MPPs will need to minimise their project cost which will, in turn, mean that power equipment prices will become much more competitive in India. Recent changes in tariff structure premium on execution As per a new CERC proposed tariff structure, utilities can earn a premium of 0.5% on a fixed RoE of 15.5% if the project under execution comes onstream on time. The net present value (NPV) of this extra saving for a 1,000MW plant with a life of 30 years and set up at a cost of INR40mn at 70:30 debt equity, would be INR0.5bn. This CERC formula has put a premium on execution and is an opportunity as well as a threat for BHEL an opportunity because utilities can share the incentive with BHEL and a threat because they can penalise execution delays with a stricter imposition of liquidated damages.
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March 18, 2009
Competition expected to increase

Indias ambitious power capacity addition plans have created a significant opportunity for power equipment manufacturers in the Indian market. Apart from China, which is likely to order 126GW of equipment in the next three years, as per industry sources, no other market offers a similar opportunity for power equipment manufacturers. In India, the power equipment sector has almost been a BHEL monopoly, but we believe competition will increase as a result of this significant opportunity. BHEL has had a near monopoly For the past five decades, BHEL has had a near monopoly in the Indian power equipment market. Around 70% of the installed capacity in India has been manufactured by BHEL, according to management. The company is extremely competitive in the 210MW, 250MW and 500MW sets, in our view, since it has been setting up these units in India for a long time and knowledge of local requirements gives it an advantage over competitors in the sub-500MW categories. Government support has helped BHELs cause As a public sector unit (PSU), BHEL has always received government support. This is reflected in the fact that no other power generation equipment company has come up in India since independence. We expect BHEL to continue to receive government support, at least in the foreseeable future since it is one of only two domestic companies (the other being L&T) with the experience and capability to supply power equipment to support Indias power needs. However, increased visibility has attracted other players The large potential and increased visibility in the Indian power sector has attracted different players. Players from China, Korea and Europe are now showing an active interest in Indian markets. Domestic engineering and construction major L&T is also foraying into the power equipment sector in a JV with Mitsubishi Heavy Industries. The JV plans to draw on the experience of Mitsubishi and should gain bulk orders, which would mark the beginning of serious competition in the Indian power equipment market, in our view. In FY08, another Indian company, Thermax (TMX IN, INR 156, not rated), announced a tie-up with Babcock and Wilcox (unlisted) to manufacture sub-critical boilers. Chinese companies are the chief threat to BHEL China has around 90,000MW of power plant equipment production capacity, as per industry sources. At present, China is adding large power capacity every year and Chinese power equipment manufacturers do not need to target India aggressively. However, once additions in China slow down, these companies would look to enter India in a major way. Our industry checks suggest that Chinese equipment is at least 10-15% cheaper than that of BHEL. If Chinese companies enter the Indian market, BHEL would have to reduce prices.
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March 18, 2009
IPPs clearly favour Chinese equipment IPPs such as Reliance Energy [RELI IN, INR 443, not rated] and Lanco Infratech [LANCI IN, INR 114, not rated] have favoured Chinese equipment manufacturers in the past chiefly because of lower capital cost and faster and timely delivery of equipment. Doubts on quality of Chinese equipment misplaced Industry sources indicate that there have been doubts that the quality of Chinese equipment could be inferior compared with equipment manufactured by BHEL, because of the low plant load factor (PLF) of Chinese power plants. The table below shows the performance of Chinese power plants over the years.
Exhibit 14. Chinese power plants performance linked to demand scenario in China
National average (%) Thermal (%) Hydro (%) Scenario 1997 54.40 58.40 36.30 Balance 1998 51.40 54.90 37.90 1999 50.10 53.90 36.50 2000 51.60 55.30 37.20 2001 52.40 55.90 35.90 2002 55.50 60.20 37.50 2003 59.90 65.80 37.00 2004 62.30 68.40 38.50 2005 61.90 67.00 41.80 2006 59.60 64.30 39.20 Balance 2007 57.20 60.70 40.30 Balance 2008 53.40 56.10 41.30 Balance 2009F 50.20 53.30 40.90 Balance 2010F 50.20 53.20 40.90 Balance
Balance Oversupply Oversupply Balance
Balance Shortage Shortage Shortage
Source: Industry sources, Nomura estimates
We believe the following factors are responsible for the poor performance of Chinese thermal sets: There was no extra requirement for power from 2006 since demand and supply in the Chinese power market was balanced. In China, thermal sets are used for peak load as well (unlike India) and hence, overall PLF is likely to be low. There is more than 100GW of less than 135MW inefficient capacity in China, which are scheduled to be replaced over next few years. These capacities run on low PLF. Chinese companies have inherent disadvantages in India Chinese companies have standardised their production lines for 300MW and 600MW turbines, while Indian demand (mainly by NTPC) is for 500MW. The CEA and the Ministry of Power have now decided to allow 300MW sets to be used by SEBs and hence we believe BHEL will face competition on SEB and NTPC orders. Chinese companies mainly follow American standards of manufacturing; however, major Indian power generators, such as NTPC follow European standards. Hence, unless there is significant order visibility, it is economically and technologically unfeasible for Chinese companies to change their production methods. Indian SEBs are sceptical of Chinese equipment quality and after-sales services. Although companies like Dong Fang have supplied a significant number of sets in India, they are still setting up service centres.
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March 18, 2009
The Indian Minister of State for Power, Mr Jairam Ramesh, has gone on record saying that he is uncomfortable with the growing presence of Chinese equipment in India. The Ministry of Power and the Ministry of Heavy Industries seem to be showing a clear preference for BHEL. However, the changing global scenario does not augur well for BHEL Chinese power demand has fallen by an average 10% in the last four to five months, according to industry sources. Given the slowdown in the economy, we believe orders for new plants will slow down and Chinese power equipment manufacturers would turn to India for sales. BHEL has no technology of its own. It has never been a technology developer. At a time when India may be the only significant power equipment buyer, it is unclear how BHEL will compete given its technological disadvantage. It will also be interesting to see why the GEs and Alstoms of the world will give newer technology to BHEL when they themselves will have limited markets elsewhere. Depreciating Indian currency could come to BHELs rescue In the last one year, the Indian rupee has depreciated by nearly 28% against the US dollar. In the same period the renminbi has remained more or less steady. This makes BHEL more competitive against Chinese equipment suppliers.
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March 18, 2009
Financials
Strong earnings growth since FY05 BHELs earnings have grown rapidly over the past couple of years backed by high order inflow and utilisation of idle capacity. Key costs, such as employee costs, grew 16.5%, while revenues grew 26.5% providing the leverage that resulted in margins improving from 13.4% in FY05 to 17.2% in FY08. We believe the rise in margins can also be attributed to superior cost management and a reduction of major non-operational costs. As shown in the table below, other expenditure as a percentage of sales has decreased nearly 5% from the FY05 level.
Exhibit 15. BHEL margin improvement was led by declining other expenditure
FY01 Other expenditure as percentage of sales
Source: Company data, Nomura research
FY02 8.1
FY03 14.3
FY04 13.5
FY05 12.2
FY06 8.8
FY07 8.6
FY08 8.5
8.7
Large order intake led to strong order backlog BHELs order inflows have surged over the past three years because of the Indian governments emphasis on improving the power deficit in India. This has led to an increased book-to-bill ratio.
Exhibit 16. BHEL flat order book expected until FY10

(INRmn) 600,000 500,000 400,000 300,000 200,000 100,000 0 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Order inflow
Order book coverage
(x) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Order backlog likely to come down We expect BHEL to have strong order inflow in FY09 and we estimate that its year-end order book should be in the range of INR1,100bn. However, we expect the order backlog-to-revenue ratio to come down in FY10 since most of the orders for Eleventh Plan capacity additions would have been placed by then. We expect ordering activity to pick up again in FY11 and FY12, but believe that it will not be significant enough to sustain the high revenue coverage ratio of FY08 and FY09.
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March 18, 2009
Exhibit 17. BHELs order book coverage is past its peak

(x) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 4.4 3.4 2.9 2.3 1.6 0.9 1.9 2.8 4.5
4.2 3.7 3.3
3.2
FY09E
FY10E
FY11E
Increased capacity will help improve execution BHEL has installed manufacturing capacity of 10,000MW by the end of FY08 and will expand this capacity to 15,000MW by the end of FY10. This should help the company deal with some execution delays and should also lead to strong revenue growth in FY09 and FY10, in our view. The company has plans to increase its capacity to 20,000MW by end-FY12. leading to strong revenue and profit growth over FY09-11 We expect this capacity expansion and an increase in margins to lead to a revenue increase at a CAGR of 22.5% and EPS growth at a CAGR of 25.5% over FY09-11. High revenue growth will lead to increased operating leverage and thus, we expect operating margins to expand from 15.4% in FY09E to 17% in FY10. Rise in staff cost should be muted over FY09 Our calculations indicate that overall staff cost for FY09 (including provisions) would be in the range of INR44.3bn, while growth in staff cost will be muted at 8% in FY10 and 10% in FY11 at INR53bn. Industry segment can come under pressure BHEL classifies the industrial segment as its power transmission and distribution (T&D) segment and exports. The segments share of total revenues in FY08 was 26% and we expect BHEL to maintain this share at around the same level in future. While there is an opportunity of US$45bn in the Indian T&D equipment market, in our view, which should ensure steady growth for this sector, we believe there will be pressure in the industrial systems and export markets owing to the global slowdown. However, we do not expect the industry segment to be a drag on BHELs revenue.
20
FY12E
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
March 18, 2009
Exhibit 18. BHEL share of the industrials segment has been stable recently
FY08 Revenue from power sector (INRmn) Revenue from industrial sector (INRmn) Share of industrial segment in total revenues (%)
FY07 103,189 41,022 28.4
FY06 81,421 31,111 27.6
FY05 75,827 34,231 31.1
FY04 60,094 29,806 33.2
159,187 60,107 27.4
Revenue growth to slow down from FY12 Our revenue assumptions for the company are derived from Indias planned power capacity additions in the Eleventh and Twelfth Five-Year Plans. While the Eleventh Plan capacity additions target of 78,577MW is in place, the exact amount of planned capacity for the Twelfth Plan is yet to be decided; 167,000MW of tentative power project shelf has been proposed for the Twelfth Five-Year Plan. According to our estimates, BHELs total revenue over FY08-12 is likely to be around INR1,600bn, which implies power capacity additions of 78,000MW on the assumption of a 70% market share for BHEL and a realisation of INR24mn/MW. Similarly, we estimate total revenue of INR3,200bn for the Twelfth Plan period, which implies capacity additions of 167,000MW during this period, which is equivalent to the current project shelf for the Twelfth Five-Year Plan. Thus, our revenue CAGR estimate for FY07E-FY12 is 21% and for FY12-FY17 is 12%, suggesting a perceptible slowdown, once the current high growth period ends.
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March 18, 2009
Exhibit 19. BHEL income statement

Year-end 31 Mar (INRmn) Net sales Growth (%) Operating expenses Operating profit Other income EBITDA Depreciation Expenses capitalised EBIT Interest paid Associates Non-recurring items (net of taxes) Pre-tax profit Tax (current + deferred) Profit after tax Minority interests Preference dividend Net profit Adjusted net profit Growth (%)
FY07 172,375 28.9 -142,188 30,188 8,236 40,235 -2,730 0 37,505 -433 0 0 37,072 -13,086 23,986 0 0 23,986 23,986 43.1
FY08 193,046 12.0 -168,127 24,919 14,448 47,639 -2,972 0 44,667 -354 0 0 44,313 -15,828 28,485 0 0 28,485 28,485 18.8
FY09E 247,099 28.0 -209,092 38,007 15,650 53,657 -4,544 0 49,113 -433 0 0 48,680 -17,038 31,642 0 0 31,642 31,642 11.1
FY10E 308,874 25.0 -256,055 52,819 15,115 67,934 -5,534 0 62,400 -433 0 0 61,966 -21,688 40,278 0 0 40,278 40,278 27.3
FY11E 386,093 25.0 -317,377 68,716 14,478 83,194 -6,524 0 76,670 -433 0 0 76,237 -26,683 49,554 0 0 49,554 49,554 23.0
Exhibit 20. BHEL balance sheet

Year-end 31 Mar (INRmn) Current assets Investments Associates Net fixed assets Other non-current assets Total assets Current liabilities Total debt Other liabilities Total liabilities Share capital Reserves & surplus Shareholders' funds Minorities Total equity & liabilities
FY07 203,912 90 0 12,008 6,737 222,747 126,218 5,370 0 131,588 2,448 88,711 91,158 0 222,746
FY08 231,288 90 0 29,036 6,737 267,151 148,884 5,370 0 154,254 2,448 110,331 112,779 0 267,033
FY09E 281,855 90 0 39,492 6,737 328,174 185,891 5,370 0 191,260 2,448 134,349 136,797 0 328,057
FY10E 344,601 90 0 48,958 6,737 400,386 227,532 5,370 0 232,902 2,448 165,049 167,496 0 400,398
FY11E 427,846 90 0 57,434 6,737 492,107 281,641 5,370 0 287,011 2,448 202,660 205,108 0 492,119
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March 18, 2009
Exhibit 21. BHEL cashflow statement

Year-end 31 Mar (INRmn) Pre-tax profit Depreciation Tax paid Chg in working capital Other operating activities Cash flow from operations (a) Capital expenditure Chg in investments Chg in associates Other investing activities Cash flow from investing (b) Free cash flow (a+b) Equity raised/(repaid) Chg in minorities Debt raised/(repaid) Dividend (incl. tax) Other financing activities Cash flow from financing (c) Net chg in cash (a+b+c)
FY07 37,072 2,730 -13,086 -810 130 26,035 -3,129 -7 0 0 -3,136 22,899 0 0 -213 -5,780 0 -6,123 16,776
FY08 44,313 2,972 -15,828 1,172 0 32,629 -20,000 0 0 0 -20,000 12,629 0 0 0 -6,865 0 -6,865 5,764
FY09E 48,680 4,544 -17,038 -168 0 36,018 -15,000 0 0 0 -15,000 21,018 0 0 0 -7,626 0 -7,626 13,392
FY10E 61,966 5,534 -21,688 -7,850 0 37,963 -15,000 0 0 0 -15,000 22,963 0 0 0 -9,707 0 -9,707 13,256
FY11E 76,237 6,524 -26,683 -4,195 0 51,883 -21,524 0 0 0 -21,524 30,359 0 0 0 -11,942 0 -11,942 18,417
Exhibit 22. BHEL key ratios

Year-end 31 Mar (%) Adjusted EPS (INR) Adjusted EPS growth EBITDA growth EBITDA margin Pre-tax margin ROE ROCE Net debt/equity (%)
FY07 49.0 43.1 40.4 23.3 21.5 29.2 42.8 -57.9
FY08 58.2 18.8 18.4 24.7 23.0 27.9 41.6 -52.0
FY09E 64.6 11.1 12.6 21.7 19.7 25.4 37.7 -52.6
FY10E 82.3 27.3 26.6 22.0 20.1 26.5 39.6 -50.9
FY11E 101.2 23.0 22.5 21.5 19.7 26.6 40.0 -53.7
Exhibit 23. BHEL valuations

Year-end 31 Mar (x) PER PCE Price/book Yield (%) EV/net sales (x) EV/EBITDA
FY07 28.2 25.3 7.4 0.8 3.6 15.5
FY08 23.7 21.5 6.0 0.9 3.2 12.9
FY09E 21.3 18.7 4.9 1.0 2.4 11.2
FY10E 16.8 14.7 4.0 1.3 1.9 8.7
FY11E 13.6 12.0 3.3 1.6 1.5 6.8
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March 18, 2009
Company background
BHEL is Indias leading manufacturer of power equipment, having commissioned 66% of the power plants currently operational in the country. The company has four main divisions: 1) production units; 2) industrial sector; 3) power sector and 4) industrial systems group. Exhibit 24 lists BHELs main manufacturing units. In addition to these six units, BHEL has eight other units specialising in repairs and maintenance and the production of power plant auxiliaries. The companys technology tie-ups with international players are shown in Exhibit 25.
Exhibit 24. BHELs production units

Unit Trichy Hyderabad Hardwar Bhopal Jhansi Ranipet
Equipment manufactured Boilers and valves Turbines Turbines and motors Transformers, turbines and motors Industrial locomotive and motors Boiler auxiliaries
Exhibit 25. BHELs technical collaborations

Company Power Machines, KWU GE, Siemens Alstom
Supplies technical know-how for Steam turbines Gas turbines Super-critical boilers
Power sector The power sector is BHELs construction and commissioning agency, and has four divisions, one each for the eastern, western, southern and northern regions. These divisions are headquartered in Kolkata, Mumbai, Chennai and Noida, respectively. The power sector sources equipment from the companys production units, maintains the supply chain according to the production schedule, sub-contracts work and equipment as necessary and is responsible for commissioning projects. It takes critical inputs in laying out plants and sourcing non-BHEL equipment from Project Engineering Management (PEM), Delhi. PEM is an important coordination centre for BHEL, as it is responsible for the following critical functions: It determines the rating of various equipment based on customer specifications. Orders for production or purchase of equipment can be issued only after the rating has been determined. It finalises the piping layout of power plants. This is an important function, since power plants have several kilometres of piping, and any malfunction can bring the plant to a standstill.
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March 18, 2009
It designs civil foundations. It orders most of the non-BHEL items required, such as small drives and pumps. Industrial sector This division has been formed to address the needs of industrial customers. It sources equipment from various production units. The divisions commercial wing, regional operational division (ROD), has offices in important cities. ROD identifies industrial requirements and puts in bids in the tendering process on behalf of the industrial sector. The industrial sector accounted for 25% of BHELs revenue in FY05. We expect this proportion to decline to 20% in the coming years because of higher growth in power sector.
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March 18, 2009
Trough valuation and sensitivity to key value drivers

Trough valuation BHEL to trade above its historical lows During the last downcycle BHEL was trading at a band of 10x one-year forward earnings, while it is currently trading at around 17x FY10E EPS. However, since then the power scenario in India has undergone significant changes and is in dire need of capacity additions. Hence, we believe it is unlikely that BHEL will witness a significant P/E de-rating from current levels. The present scenario is better than last downcycle as the order book coverage ratio is 4x the last down cycle . Hence, a significant derating of the stock to historical low PEs of 6x is extremely unlikely, in our view. Order book as key value driver The order backlog of BHEL is the key value driver for the stock. The re-rating of the stock was primarily driven by its bulging order book. Please see the chart below.
Exhibit 26. Order book and P/E chart

60 50 40 30 20 10 0
Oct-99 Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Apr-99 Apr-00 Apr-01 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Oct-08
BHEL 1yr fw d P/E
Order book coverage ratio
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
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March 18, 2009
Appendix: Eleventh Five-Year Plan power capacity additions

The Indian government has set a target of providing power to all by 2012. According to the National Electricity Plan, electricity demand in 2011-12 would be 1,038bn units (BU), and peak demand would be 152,746MW. This would require an increase in installed capacity at a rate of 9.5% per year.
Exhibit 27. Eleventh Plan capacity additions

Fuel type Hydro Thermal Nuclear Renewable energy sources Total
Source: Central Electricity Authority
11th Plan size as per assessment made by CEA based on status of projects (MW) 15,585 50,124 3,160 8,000 76,869
Of a total of 68,869MW additions planned through conventional sources for the Eleventh Plan (2007-12), 31,345MW is already under construction, according to the CEA. Eleventh Plan requires significant investments Large capacity addition plans will require significant funds. The Indian government wants greater participation from private players to share the costs. The power generation sector requires funds to the tune of INR3,900bn or US$100bn to meet capacity addition targets for the Eleventh Plan. We believe this investment will provide a significant opportunity for players across the value chain in the power sector. Ultra-mega power projects Besides the projects planned under the Eleventh Plan, the government has also initiated the concept of UMPPs. These projects are estimated to be large projects of 4,000MW each, to be awarded on a tariff-based bidding process. Two projects Sasan UMPP and Mundra UMPP have already been awarded to developers. Tariffs quoted in the bidding of these two projects were extraordinarily low and the success of these projects could mark the beginning of significant private participation in the sector, in our view. The government has planned an additional five projects, the benefits of which would be realised only in the Twelfth Plan.
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March 18, 2009
Twelfth Five-Year Plan we expect momentum to continue Demand for electricity is expected to remain robust in the Twelfth Plan (2012-17) as well. Demand projections for the Twelfth Plan are listed below.
Exhibit 28. Generation requirement for 2016-17E

GDP growth (%) 8 9 10
Source: Report on Working Group on Power for Eleventh Plan
GDP/electricity elasticity 0.8 0.9 0.8 0.9 0.8 0.9
Electricity generation required (BU) 1,415 1,470 1,470 1,532 1,525 1,597
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March 18, 2009
Important Disclosures: Bharat Heavy Electricals Ltd (BHEL.NS)

Rating and Price Target Chart:
INR 1371.0 (13-Mar-2009)
Neutral / Bearish
CHART IS NOT APPLICABLE
Valuation Methodology: We value the company using a discounted cash flow (DCF) methodology. Our key assumptions are a terminal growth rate of 5% and a cost of equity of 13%. Our terminal operating margin estimate is 17.3%. Risks Which May Impede the Achievement of the Price Target: Downside risks include (1) slippage in capacity additions, (2) a potential slowdown in power sector investments and (3) an earlierthan-expected competitive threat from China. An upside risk would be an increase in BHEL's share in private sector projects.
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March 18, 2009
Important Disclosures Continued:
Company Name Bharat Heavy Electricals Ltd
Ticker BHEL.NS
Price INR 1371.00
Price Date 13-Mar-2009
Stock / Sector Rating Neutral / Bearish
All share prices mentioned are closing prices unless otherwise stated.
ISSUER SPECIFIC REGULATORY DISCLOSURES Online availability of research and additional conflict-of-interest disclosures: Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG and THOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS and BLOOMBERG. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://www.nomura.com/research or requested from Nomura Securities International, Inc., on 1877-865-5752. If you have any difficulties with the website, please email researchportal@nomura.co.uk for technical assistance. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Distribution of Ratings: Nomura Global Equity Research has 1370 companies under coverage. 32% have been assigned a Strong Buy or Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 35% of companies with this rating are investment banking clients of the Nomura Group*. 47% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 62% of companies with this rating are investment banking clients of the Nomura Group*. 21% have been assigned a Reduce or Sell rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 14% of companies with this rating are investment banking clients of the Nomura Group*. As at 06 January 2009. *The Nomura Group as defined in the Disclaimer section at the end of this report. Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America for ratings published from 27 October 2008: The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to price target defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. Stocks: A rating of "1", or Buy, indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of "2", or Neutral, indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of "3", or Reduce, indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of RS-Rating Suspended indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://www.nomura.com/research); Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Sectors: A "Bullish" stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A "Neutral" stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A "Bearish" stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Explanation of Nomuras equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009: Stocks: Stock recommendations are based on absolute valuation upside (downside), which is defined as (Price Target Current Price) / Current Price, subject to limited management discretion. In most cases, the Price Target will equal the analysts 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. 30 Nomura Equity Research
March 18, 2009 A rating of "1", or "Buy" recommendation indicates that potential upside is 15% or more. A rating of "2", or "Neutral" recommendation indicates that potential upside is less than 15% or downside is less than 5%. A rating of "3", or "Reduce" recommendation indicates that potential downside is 5% or more. A rating of "RS" or "Rating Suspended" indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Stocks labeled as "Not rated" or shown as "No rating" are not in Nomura's regular research coverage. Sectors: A "Bullish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A "Neutral" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A "Bearish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008): Stocks: A rating of "1", or "Strong buy", indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. A rating of "2", or "Buy", indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of "3", or "Neutral", indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. A rating of "4", or "Reduce", indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of "5", or "Sell", indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. Stocks labeled "Not rated" or shown as "No rating" are not in Nomura's regular research coverage. Nomura might not publish additional research reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or other information contained herein. Sectors: A "Bullish" stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A "Neutral" stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A "Bearish" stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008: Stocks: Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. A rating of "1", or "Strong buy" recommendation indicates that upside is more than 20%. A rating of "2", or "Buy" recommendation indicates that upside is between 10% and 20%. A rating of "3", or "Neutral" recommendation indicates that upside or downside is less than 10%. A rating of "4", or "Reduce" recommendation indicates that downside is between 10% and 20%. A rating of "5", or "Sell" recommendation indicates that downside is more than 20%. Sectors: A "Bullish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A "Neutral" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A "Bearish" rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Price targets Price targets, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any price target may be impeded by general market and macroeconomic trends, and by other risks related to company or the market, and may not occur if the company's earnings differ from estimates.
31
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Global Equity Research

ELECTRICAL EQUIPMENT Electrical Equipment

Bharat Heavy Electricals Ltd

NEUTRAL BEARISH BHEL.NS INR 1371.00 INR 1422.00 8756.61

675366 13524 489.5 14 32.30 22.80

43.0 0.5 6.0 27.9 0.0 24.1

2400 2200 2000 1800 1600 1400 1200 1000

March 18, 2009

Nomura Equity Research

March 18, 2009

Coverage summary Exhibit 1. BHEL estimate summary

Source: Company data, Nomura estimates; Price as of 13 March 2009

Exhibit 2. Indian electrical equipment rating summary

Crompton Greaves Ltd CRG IN

Exhibit 3. Global electrical equipment valuation comparison

*Price 1371 356 211 121

P/E (x) 13.5 10.3 10.5 7.1 10.4

ROE (%) 26.5 35.3 36.7 31.4 32.1

Operating margins (%) 17.3 11.2 9.7 8.5 12.7

EPS CAGR (%) 25.2 13.0 7.6 10.8 14.1

BHEL IN ABB IN SIEM IN CRG IN

1072 HK 1133 HK 034020 KS 2727 HK

RMB RMB W RMB

REDUCE BUY Not rated REDUCE

6.5 5.6 10.5 8.9 7.9

26.9 23.9 5.1 16 18

9.1 8.3 11.5 11.6 10.1

38.9 2.6 17.5 -32.6 6.6

NEUTRAL Not rated

36.9 n.a. 36.9

4.5 2.2 3.4

SIE GR ABBN VX ALO FP SU FP

EUR US$ EUR EUR

Not rated Not rated Not rated Not rated

44.4 15.5 39.7 46.5

9.1 15.1 8.8 9.2 10.5

12.4 30 31.8 15.6 22.5

6 16.5 10.1 14.6 11.8

4.1 -2.5 0.5 11.5 3.4

US$ US$ US$

Not rated Not rated Not rated

9.6 40.4 22.5

8.1 11.0 10.7 9.9

21 17.6 30.9 23.2

16.5 5.9 13 11.8

9.9 -8.0 18.3 6.8

Nomura Equity Research

March 18, 2009

Exhibit 4. Power capacity addition as per five-year plans

Ninth FiveYear plan (1997-2002) 40,245 19,015 47.2

30,538 16,423 53.8

Exhibit 5. BHEL order book versus EPS growth

Source: Company data, Nomura estimates

Nomura Equity Research

March 18, 2009

Exhibit 6. Bulk of Eleventh Plan power capacity already ordered

Thermal 58,644 8,439 47,205 3,000

Hydro 16,553 3,173 12,970 410

Nuclear 3,380 220 3,160 0

Nomura Equity Research

March 18, 2009

Nomura Equity Research