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Are BHEL, EIL, SAIL Priced to FAIL?

First thing, SAIL is outside my circle of competence, and I have already written on BHEL and Engineers India (EIL)…so I won’t talk about these businesses here.

Rather I have a few questions for you, in case you are competent to answer them.

Before I ask those questions, here is what I see of these stocks over the past 10 years…




Source: Yahoo Finance

Here are some assumptions that I can make on these stocks…

  • Very obvious, these stocks are at their multi-year lows, thanks to Mr. Market’s bad mood.
  • Investors are extremely scared of these businesses, thanks to their string of poor performances over the past few years.
  • Investors are also scared of the owner – government – that seems to be in a tearing hurry to sell its stake in these companies to raise petty cash to meet a part of its huge deficit.
  • At P/E of less than 10x and P/BV of less than 2x, these businesses are being priced to extinction (almost), despite the spick-and-span balance sheets they’ve had over the past many years. Maybe investors see the future to be extremely bleak for these businesses. Maybe investors see demand and staying power of these businesses diminishing in the future.
  • Investors are extremely scared of these businesses just because everyone else is.

Now I have six questions for you – in case any of these companies fall under your circle of competence. Here they are…

  1. Are these companies really going to die?
  2. Is the pressure on their respective businesses short term, or do you see these companies fade into oblivion in the future?
  3. Agreed that the government is a poor capital allocator, but is the concern so big that these businesses are priced to extinction?
  4. Would you give any weight to their strong balance sheets, product quality, and past track record, despite the P&L concerns surrounding them?
  5. If you were to do a pre-mortem – going 10 years into the future and looking back from there – would your curse yourself or praise yourself for owning these businesses in your portfolio (in case you own them now or are looking to own them in the near future)?
  6. Why you would not touch these businesses at these or even lower prices?

Warren Buffett often says, “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

These stocks are definitely not popular. But should we get interested?

Without offering any recommendations – you know why I’m saying so :-) – let me and other tribesmen know your answers (supported by your own understanding of these businesses) in the Comments section below.

We are all waiting to deploy some cash, while avoiding the mistakes. :-)

Disclaimer: I already own some BHEL and EIL in my portfolio. You don’t need to…simply because your willingness to lose money, your circle of competence, and your time horizon is different than mine.

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Comments

  1. Hi Vishal,
    I am more of a novice and my comments might seem obvious to others. Here are my 2 cents:
    I think, we have to look at these companies more from future point of view and how geared up they are to adapt to the changes happening in their respective industries. They have certainly been battered by govt irrational activities and fear of unpredictability and hence seems lucrative. But only if these companies have concrete plan to tackle the changes happening in their industry, will they improve from here. So we need to dig into managements action plan for the future and how are they planning to cope with margins pressure and increased competition.

    Regards,
    Vikas

  2. The only question is whether these companies will survive the next decade. My answer is an unwavering…. YES.

    1) The govt only intends to sell stake of around 5. That is a little needy in the time of need. Not crazy. Someday, it may buy it back.
    2) Surely, GOI has control like in case of recent dilution bids, but the management of these companies is in very good hands.
    3) Bhel, Sail and Nalco are in cyclical industries. But their managements have a proven record.
    4) Profits from these companies is dear to any ruling party or dictator. None would kill the proverbial hen laying golden eggs.
    5) However, their private peers (TS and Hindalco) have a propensity to take huge risks on their balance sheets. The real question is, with such high interest costs amidst reduced profits, increased production capacity amidst poor global demand, increasing raw material costs and reducing prices of fin goods will TS and Hindalco survive. (Survive they will, but at what expense)

    The evidence is clear that the Market is only appearing scary to the investor, else, why did this conversation not arise when EIL was at 300 and Bhel three times higher !! :)

  3. Vishal,
    I often hear the phrase ‘the co is priced for bankruptcy’. I have a question as to what this statement means in terms of the companies fin statements? Enlighten!

  4. Nishanth says:

    Vishal, too lazy to type it all over again, so I’m copying the comments I posted to another tribesman on the Stock Talk Issue of Engineers India:

    “Ashish,

    Maybe this might help. EIL has recently hit a 3 year low , due to multiple reasons. One of them is the divestment as you mentioned above. Others include 1) the stock has recently gone ex-dividend and the share price adjusts downward 2) EIL has been having a sluggish financial performance recently with not much orders getting added to the order book 3) EIL recently recommended cancellation of one of it’s major contracts carried out by Fernas Construction , on the grounds that Fernas Construction submitted false experience certificates and obtained the contract through fraudulent means.

    Now as to the 3rd reason, this should actually be a positive signal to a small investor , as it shows the management is willing to forgo a substantial contract and earnings in exchange for sticking to its ethics and principles.And we all know how rare that is in Indian companies:)

    Now the second reason is a serious reason. But is it a structural long term trend of declining earnings for EIL? I believe no.As we all know , infrastructure capex spending is on a decline in India and will be so for some time more, for sure. Will it pick up ? It should ,as otherwise our country will not grow. Will EIL benefit ? It will, for the reasons Vishal has outlined in his report above.

    Finally , is it a good time to buy ? When do you buy a good or great company ? When everybody is optimistic and happy about it and its share prices trade at all time highs? (Eg:GSK Consumer ,Asian Paints,Nestle,Colgate etc) or when everybody is pessimistic about earnings and scared that it might go even lower ? The answer is obvious , is it not?.If you are convinced through your research that EIL will overcome this earnings downturn , it makes the decision easy for you.(or vice-versa)

    We have established that EIL is a good company and will not go out of business, rather will prosper over the next 10 years in accordance with the Indian economy.And it is trading at the lowest valuations in its listed history.If you don’t buy it now , when will we buy it? Can it go further ? Absolutely. What is the bottom price ? I have no idea and i don’t care. Neither should you , the only thing you should think about is whether the market is offering this business to you at a good discount to its intrinsic value. If you feel yes, go ahead and buy.If no , sit tight.Should you sell your house and buy this business ? No , because nothing in this world is a sure bet.Can you put 10% of your portfolio into it ? Depends on your risk tolerance and comfort level , which is a personal decision.

    I established via my research that the current price or lower is a good time to buy into this business. Am I scared by short term volatility ? No. I have an intended holding horizon of 10 + years as well, so i started buying this business.

    Now , I will stop my gyan and the rest lies in your hands.All the best!!”

    At the current price of 150 , EIL is priced (according to my calculations, using median 3 year FCF) to have 0% terminal growth and just 5% growth in its FCF for the next 10 years. At the other extreme, to justify it’s current price , Colgate would have to grow it’s FCF at 26% for the next 10 years. Now please tell me , which would be an easier goal to achieve ? And if that goal is exceeded, who would the market reward? :)

    Disclosure:I am biased because I own EIL at an average price of 150 and intend to buy further.My horizon is 10+ years .

  5. My two cents below.

    Its good to see how state monopolies/state entities behave when privatisation is encouraged. We have seen the example of Telecom – MTNL, BSNL etc.

    EIL has a near monopoly when it comes to setting up petro-chem refining plants in India and significant order book comes from that.

    In my view, for EIL to go out of business/operate at significantly lower scale any one of the following will need to occur:

    1. Govt. decides to get out of energy – petrol/diesel business completely – very difficult under Indian scenario
    2. Govt. and Private players decide to hand this complex engineering to some other experienced players (domestic/foreign) – possible, but IOC tried this and failed miserably
    3. Demand for oil/petro refining falls away significantly – difficult

    I think so long as Govt. keeps a control over energy via ONGC, IOC, HPCL, BPCL, OIL, GAIL etc. etc. , being a strategic sector, EIL will continue to bag orders. It also shows in their higher margins.

    BHEL and SAIL on the other hand face far more competition in liberalized sectors such as power and steel (100% FDI allowed). So while both are large mammoths, they pretty much need to be as cost competitive as private players.

    Disclosure: Own EIL.

  6. I haven’t read about EIL or SAIL but I have read a little bit about BHEL. BHEL is facing a lot of competition from Chinese as well as Indian manufacturers of generators and other electrical equipment. Its narrow moat has been steadily eroded by the competition with companies providing equipment at a cheaper cost or with more liberal financing options. Although BHEL is the only manufacturer for large capacity generation equipment, I believe it will start getting more competitive in that space as well. Already we can see that the company’s profit margins have been significantly squeezed because of the relentless competition to gain market share at the cost of profitability among the equipment makers. And broke power generation companies aren’t helping either as they are withholding payment for lack of coal linkages to start their power plants. Until the power plants can’t be assured of fuel linkages, the power generation industry may remain in the doldrums. Also, the SEBs will have to eventually buy power at a higher rate from the power companies and pass it on to the buyers. There are a lot of things which need to go right in order to revive the industry. Until we don’t see these signs, the future does indeed look bleak. We have already seen that orders are being cancelled and the company hasn’t been able to grow its order book. But as consumers, I wonder how long can this continue because the consumption is outstripping supply at a rapid pace!

  7. Nishanth says:

    Some more thoughts on EIL – At current price, it is trading at a dividend yield of 4%. Which means, you are getting a common saving account interest rate to hold the stock , forgetting capital appreciation.If price falls, yield increases even more.Plus EIL is a debt free company , with cash and cash equivalents of 30% of it’s market capitalization.Which means when we buy the company, we are paying for only 70% of it’s real value.Even discounting cash per share of Rs 62 by half , we get a pretty good value for the current price of the business. Of course , if business model of EIL changes as per what Ashish has mentioned above , all these reasons change:)

    The risk in this business has dramatically decreased , with the decline in it’s share price of over 30%. The question is , has the current stock price discounted all these negatives and future possible disasters? Probably , probably not:).That’s for each individual tribesman to find out.

  8. I would say these companies are fairly priced by the market, definitely not distressed pricing yet.The reasons are as follows:
    SAIL – Cyclical
    BHEL – Cyclical
    EIL – Cyclical

    Now people can easily disagree with this, seeing the stable growth of these companies for past 10 years.But the hard truth is these are cyclical companies.We all know how cyclicals can be valued by the market and this is nothing surprising.In fact there may be more pain to come.

    • Rakesh,
      it depends on what you mean by cyclical…is it a ups & downs encountered in a year or in 2 years or in 3 years..? My point is that companies like SAIL will perform only when the investment demand picks up and this will happens only when current recessionary trend ends & when we start seeing green shoots in the global economy..

  9. Vikash kumar says:

    Do not want to discourage but there is something fishy? See here.

    Rgds
    Vikash

  10. Nishanth says:

    Vikash, This particular story is connected to what I was speaking about the Fernas contract.This particular engineer was assisting the CBI in their enquiries.

  11. I tried analyzing SAIL on parameters like P/BV, P/E & DY here and here.

  12. Cyclicals is the way I also understand these businesses. From what I read of cyclicals you should know when to get in and also when to get out.
    Having said so what I gather from the market is that the projects which started in the last cycle are stalled and if and when the next capex cycle comes first those projects need to move and then only will new orders flow in.
    Buying time it could well be, return time is as always hard to predict.
    At the current PE’s these seem well priced.
    Given the products they make and work they do they are unlikely to vanish.
    ABB, while the PE is absurdly high, is another stock to watch.

  13. Rajaram S says:

    BHELs main business is making boilers and other capital equipment for power generation. Now, I do believe that India’s growth will remain restricted for many years, which means power capacity addition will slow. However, India faces severe power deficit. So capacity addition will happen.

    Also, the current plants will need to replace old equipment on an ongoing basis. So all this means that BHELs market will continue to exist. Of course, Chinese competition will mean that margins will remain depressed. However, BHELs balance sheet means that the company can sustain bad years without going under. Also, being a PSU, it will be the first choice for government projects, as long as it is competitive.

    I think this would be a place where one should not loose money in the long run. And can keep collecting dividends. But one cannot depend on sudden gains. Of course, if the economy looks up, and BHEL has a few good quarters, the stock can bump up. But better not depend on these factors.

    Bottomline is that over 5 years, one may not loose money with this stock, and can collect increasing dividends over time.

  14. All valuations apart, I strongly feel any buying should ensue only when Nifty reaches the range of 5000-4500; This is not an extreme by any means, but just regular Index correction; Till then scrips could continue correction or sharply fall, more so because of the down cycles (amidst they have taken up huge CapEx. Bad Timing, it turns out).

    Some say, when FCF starts accumulating these companies will consolidate, which will indicate a correct time to buy.

    On another note, these companies (BHEL, EIL, Graphite, Ongc, Cairn, SAIL, NALCO) are all PSUs. Hence, buying them will affect the diversification factor of ones portfolio.

  15. Hi Vishal,

    I own 2117 SAIL shares @ Rs. 0.00. See here.

    That is right, it is not a typo, I paid zilch for procuring 2000 odd shares of a company which is not going to go bankrupt in next 20 leave alone 10 years coz it is backed by GOI. The country has to flop for the company to do the same and my base case is that India’s best days are ahead of em. Flip side is that since it is owned by GOI, it will not be as profitable as any other capitalist endeavor.

    While I m not sure how much capital appreciation I will receive on this but what I am certain is that Margin of safety is Huge whichever way you calculate. (Possibility of losing capital invested) and besides dividend received is bonus.

    Lot of times hard core value investors suffer from Commitment and consistency BIAS and disregard any other form of study. I for one, embrace anything that gets me successful. Writing was on the wall, SAIL was to offer OFS @ a discount as govt is hard bent on reducing fiscal deficit and didn’t want the embarrassment of LIC to their rescue. rest is mere calculations!!!

    Cheers!!!

    • Just because you made a profitable trade on a company and bought the same company on the profit money doesn’t mean its free :)

      • Hi Rakesh,

        I think you are referring to opportunity cost that i mite lose by remaining invested in this. However please understand that this is not my entire corpus, it is an investment made from the profits of special situation it created.

        b) I am probably not as gifted as you may be in calculating the intrinsic value and finding better opportunity to park my funds, but i do know this that since procuring something has cost me Rs. 0.00, whatever i get from this investment in next 40 years is BONUS.

        I like creating such free claim checks in various companies, it is like buying lottery tickets with interest coupons (dividend) all for free..

        capital appreciation and dividend on OtherPeopleMoney is ‘Free money’ my friend.. at least to me.

        • I am referring to mental account…if you make a profitable trade on a company and buy the same company for long term holding with the money,then the cost of acquisition is not zero.It could be any company X with any outcome Y.

  16. Akshay Jain says:

    Hi

    I agree with the analysis above. I have bought EIL myself. Government facing stocks have never had such bad perception. My question is can we extend the same arguement to select PSU Banks? NPA issues are not permanent in nature right?

  17. Saurav Jalan says:

    Hi Vishal,

    I would like to share some of my viewpoints on EIL :

    If the share of Turnkey projects business(revenue mix) vis a vis Consultancy and EP continues to increase as it has been in recent years(In the last 5 years starting FY 07 the share of Consulting revenue has fallen from 54% to 33% whereas the share of Turnkey Projects revenue has risen from 46% to 67%) then the inherent economics of the business becomes less attractive because of the following reasons :

    1. Depleting operating margins because of more share of Turnkey business where operating margins are 1/4th of what they are in Consulting and EP segment
    2. More cyclical nature of the business as turnkey business looks more cyclical than Consulting. Less consistency in revenues would be an outcome of that
    3. Gradual increase in working capital requirement which would lead to a reduction in net cash flow from operations( Net cash flow from operations declined by 77.21% in FY 12 over FY 11). Hence, FCF would also reduce.

    What are they doing to widen the moat in the consulting business where they enjoy healthy margins and this segment still contributes around 68% to their profits from operations(FY 12). Is it smart to focus more on a segment(Turnkey projects) where the competition is more, less operating margins, less share in profits from operations(32% FY 12) and very little moat?

    At CMP of 154 the business looks cheap to buy, but as a rational allocator of capital one should inspect other opportunities also where the quality of business looks more promising and on an improving path rather than declining one. Even if one doesn’t find any better opportunity one should be cautious in how much portfolio exposure one is willing to take in EIL.

    People who are looking to buy Philip A Fisher type of companies at Ben Graham prices wouldn’t be convinced with EIL in my view :)

    Disclaimer: I don’t have any personal investment in EIL and my viewpoints are neutral based on my understanding of the business. I would also like to read FY13 annual report to sharpen my opinion about the company.

    • Nishanth says:

      Saurav , just curious — What would be some examples of Philip fisher type of companies??

      • Saurav Jalan says:

        Hi Nishanth,
        Companies which can maintain high rate of earnings growth over a long period of time. Having products or services with a very large market potential. Some examples of businesses which falls in this category can be HDFC Bank, Titan Industries, Sun Pharma, GSK Consumer Healthcare, Nestle, HUL, Page Industries, Amul(unlisted), Parag Milk Foods Pvt. Ltd(unlisted) etc.

        Of course one could fine tune with other factors which Buffett teaches like durable competitive advantage, moat, quality of business, leadership, asset allocation etc.

        Just to give you an example. A famous investor named RJ invested around 50 crores in Titan Industries when the company started Tanishq to capture the organized jewellery market in India.That 50 crs was roughly worth 3000 crs in March 2013. More than 40% CAGR in 12 years excluding dividends! The business in still going strong and the opportunities are huge. The good thing about such companies is that we can sit on our a**e and see how wealth is getting created. Also, not only investors but the people who have become part of such quality businesses like Tanishq franchisee owners have also made hell lot of money during the same time frame.

        So, if we can find such companies at extremely cheap prices(very rare) then we could really create some serious wealth.

        There is another theme of investing where the business model might not be as good and sustainable as Titan Industries but the returns can be fabulous due to extreme end of human emotions in the markets. The same investor RJ made a 50 bagger in Praj Industries in 4 years(2004-2008). Although, I haven’t analyzed Praj Industries but I can say for sure that the business model is not as good as Titan. But that is also a way to make money by monetizing on
        the extreme end of the human emotions in a decent enough business. Although, it is easy to analyze afterwards but it requires extreme amount to courage, conviction and patience to make contrarian bets and wait for benefits to reap in the future :)

        • Nishanth says:

          True, all the above stocks are good ones…But have they ever been cheap by any measure of value since 1980 onwards? Even in the 2008-2009 crisis , they were not trading at “cheap” levels.These are all Philip Fisher type companies , but will they ever trade at Ben Graham Prices? I seriously doubt that….So , either we buy these great companies at not-so-good prices ( after due calculations, of course) ..or we buy good companies at great prices. To me , right now , the second option makes more sense , and I will wait patiently ( 10 years , if need be ) for an opportunity to get the great companies at better prices. ( Possibly , Titan Industries , now?).

          And going further back , if you see revenue mix from FY02 onwards ,LSTK has been present. And by it’s very nature, the revenues coming in are lumpy.And if you look at the 10 year prior track record of the company , you can see that it has been managed well , which is reflected in the margins and return ratios. Of course , it will fall going forward , both the ratios and profit margins.But if we buy the company at a price which incorporates these gruesome scenarios and possibly buy the company at a worst case scenario ( which envisions company going out of business) , then aren’t we having a very limited downside and a huge upside? As I repeated above ,at current price of 150 , company is priced for no growth and a 4% growth in it’s FCF for the next 10 years ( by my calcs). Isn’t this close to a extinction scenario ? It would be tough for a company which has paid dividend continuously for over 25 years to fail so suddenly , don’t you agree?

          Copying from your last sentence :”but it requires extreme amount to courage, conviction and patience to make contrarian bets and wait for benefits to reap in the future ” — Well , this is my contrarian bet on EIL :). I don’t think it will be a wealth creator on the scale of Titan or Page Industries.I’m fully aware that no PSU can be a pure profit-making organisation ,I’m looking for continual capital appreciation plus the icing on the cake , a steady stream of dividends and a sustainable business model.I believe EIL fits the bill on these accounts and hence im putting a portion of my equity portfolio in EIL ( Just FYI, EIL is the only stock I own , rest of my equity portfolio is indexed or in active funds).

          • Saurav Jalan says:

            Hi Nishant,

            All the best for your investment in EIL. I totally agree with you that the downside risk in EIL is limited at current prices and I think you are right
            about your rationale of investing in EIL.

            Actually, what I was trying to focus on was that out of more than 5000 listed companies, which are the ones which can become the next HDFC, Titan etc and are not recognised by the majority of the investors presently and hence are cheap. Once such company in my opinion in which I have personal investment for a 10+ year horizon is Bajaj Finserv. Even if I am wrong it doesn’t discard the fact that there might be other hidden gems in the universe of 5000+ listed and many unlisted companies :)

            • Nishanth says:

              Well , let’s compare notes after 5 years and see whether I was right or wrong about EIL :)

              On the other hand , picking a smaller company , which grows to be the next HDFC or Titan ? Very hard , but immensely rewarding. Two I can think of at the top of my head are Gandhi Special Tubes and Yes Bank.

  18. Dear Vishal

    We would like to hear from u also in comments sections.

  19. Rahul Rajeev says:

    I have been tracking EIL from the FPO days (2010) and i was always knew that it was good paper, but i wanted a good enough entry point – and now 150 looks good.

    But i am not very sure about BHEL – the question is entry point.

  20. Vishal,
    SAIL’s ROE has declined from 20% to 8% in the past 3 years..is it worth the bet? Our guru Buffet tells us that it is not worth investing in a business that gives ROE of less than 20%. However,..definitely people can make some money as CMP is 30% less that book value..but might not be attractive for those who is looking for multibagger stock..

    • Dear Kumaran, SAIL is a cyclical business and there ought to be large ups and downs in its financial performance, including RoE. The questions one needs to answer are – would this ROE get back to higher levels, and if yes, when. You need to be a student of cyclical industries, or an insider, to know that with some confidence. Regards.

  21. Shivam Bose says:

    SAIL at its current valuations looks attractive. The company has posted negetive FCF since last two financial years.
    This can be due to mainly two reasons. One that is SAIL is going massive expansion / modernization and Second is that steel sector is undergoing a down cycle trend. So SAIL is heavily for its expansion and on the other hand it is not able to generate enough cash for the expansion programme.

    The expansion programme is expected to complete next financial year (14-15). So SAIL will face pressures on its margins till then.

  22. Akshay Jain says:

    Can anyone help me understand what changed in EIL post 2007…Cause from 2003-2007 sales were flat? and then a massive spike till 2012

  23. Akshay Jain says:

    Hi Vishal

    I did try to do exactly that……But on the EIL website and on BSE, NSE websites – the oldest report available is of 2007, in which the sales have already grown, so I dont think the reason for flat sales in the previous years, has been mentioned there…….I just want to make sure that we do not see those days again where sales remain flat for years, so am trying to figure the change….Any particular report you think I should be referring to??

  24. Rahul Rajeev says:

    Vishal..one quick question, whats your entry price for EIL? Never mind if you want to skip the question :)

  25. Dear Vishal,
    In your analysis of EIL , Intrinsic value calculated was 235 +.
    We can see EIL now at the range of 150,while intrinsic value can change over time, but current price is close to 40% less than IV.
    Do you think in your IV calculations you are factoring risk correctly.I found the same in Opto circuit analysis.
    How would you like to address this point, I think risk impact IV significantly.
    Regards,
    Prakash

  26. Prakash says:

    No Vishal 195 was post MOS of 25%
    pasted from your post on EIL:
    ……………………………………………………………………………………………………………………………………………………
    Fair Value Range :
    The fair value range for EIL’s stock is Rs 235 to Rs 285. Assuming a margin of safety of 25% to the average of this range, the comfortable buying price for EIL’s stock comes to Rs 195 using the intrinsic values calculated above.
    …………………………………………………………………………………………………………………………………………………….
    My point in driving this to you is not only to look at IV calculations with risk factored in but also to prod you to write a Post on risk analysis in arriving at IV :)
    Please forgive me if my limited knowledge is showing.
    Regards,
    Prakash

    • My fault Prakash! I meant post-MoS IV. :-) Thank for your suggestion! Regards.

      • Nishanth says:

        Prakash, one suggestion to you. You can use Vishal’s DCF calculator which he has provided on his website. Put in the worst case assumptions you can think of ( high discount rate of 15% , no terminal growth , FCF growth of 4 or 5%). Then you see the value you get and if it’s closer to the market value or less , then buy .This itself takes care of the margin of safety , does it not ?

        Just a suggestion,again :)

        • Prakash says:

          Thanks , Vishal & Nishanth..
          Nishanth rightly said but problem at times, in taking worst case scenario is one may undervalue a growth business with slightly higher risk and arrive at IV which the stock may never touch..
          Willl be better if we go to Doctor Vishal :)and get a comprehensive post looking at all these factors.
          Regards,
          Prakash

  27. Anil Kumar Tulsiram says:

    Note: I have posted the same content on some other blog, I hope its ok, if not feel free to delete it.

    Why not to invest in NTPC rather than BHEL to benefit from turnaround in power sector?

    BHEL has sales visibility for next 2-3 years from its current order book {order book around 122K crores and current revenue run rate of around 38K crores]. So it’s clear that for its revenue to post 10% CAGR, power sector fortunes need to turn around quickly [next 12 – 18 months]. BTG (boiler turbine & generators) for most projects planned for the 12th [2012-17} and early part of the 13th plan have already been awarded, while visibility for projects beyond that remains opaque. In case of NTPC profits and revenue can grow easily at 10 % CAGR for next 5 years if they can execute 80% of their conservative target addition by FY17.
    As per my limited understanding [have not done any detailed analysis], overall revenues and profits might decline over next 2-3 years, as even if company registers quick turnaround in order book, the work on those orders may not start for next 2-3 years. So many things have to go right over next five years for BHEL to give decent return. 1) Over next five years earnings CAGR should be more 10% 2) profit margins should remain at current levels 3) BHEL should be able to maintain its existing market share. Now all the three are questionable [Not implying impossible, but there are lot of variables involved like new order inflows, competition from local players, commodities movement and most important competition from Chinese players over a period of next 5 years]. Moreover with lot of uncertainty in power sector, unless and until utility companies fortune turn, BHEL profits or revenue cannot improve. So to benefit from infra and India’s long term story, IMHO better to bet on utility company than BHEL currently.

    Now compare the same situation with NTPC. NTPC earns revenue on its existing projects, where revenue and profits increased in line with cost inflation. So its like profit is more or less guaranteed to stay at last year level and will increase to the extent of capacity addition, increase in PLF and increase in tariff in line with cost inflation. Despite capacity additions, total power generation for FY12 remained flat at 220bn units because of a) coal issues b) lower off take from SEBs and c) lower capacity addition due to land issues. Even under pessimistic scenario installed capacity is expected to increase by 40% (from current 37 GW to 54 GW by FY17 (NTPC target 66 GW). Regulated equity is only 40% of total shareholders’ funds, despite this company is reporting ROE of 13-14%, which implies that its actual ROE is much higher than 15.5% (regulated ROE) because of its own efficiencies.

    At the current price NTPC is like a bond with earnings yield of 8% on PE basis and yield of 10% on P/CF basis. Book value has grown at a CAGR of 8% since listing. So in the worst case scenario, over the next decade price should increase a rate of 8% CAGR provided one year forward P/B multiple of 1.4x is maintained. Current dividend yield of 3% with growth of 8% p.a even under worst case scenario.

  28. Anil Kumar Tulsiram says:

    Hi Vishal

    Here is my analysis of EIL on my limited understanding. I have not spent much time, so quite possible that I might have missed some crucial point. Looking forward to your comments.

    *****************************

    My limited analysis suggests that Engineers India historical growth [last 20 years] was significantly influenced by refining capacity expansion plan of PSUs. This should not be surprising as even in Q3 FY13, more than 65% of its order book from consultancy and turnkey project is from hydro-carbon sector. Its revenue have grown exceptionally during 2008-12 [2.5 times compared to 2003-07 period] and it enjoyed average ROE > 32% [more than double the average of 1998-2008]. Numbers suggest, downturn has just started for Engineers India and we should let the downturn play itself before entering the stock at current price. Of course at current price it’s quite CHEAP, but provided we can identify demand drivers for next five years. Still major chunk of the revenue are from Hydro-carbon sector. I do not know what will drive the refining capacity over next 5 years [even vague clarity is enough, but here I am unable to visualise any factor which will result in another period of growth like 2008-12]. Taking 1998-2008 period as normal and assuming that sustainable ROE is 15%, fair PB is around 2-3x. Current TTM consolidated PB is around 2.7x. I do not see any margin of safety to invest in EIL at current market prices. [I understand that PB might strictly not be a correct measure for EIL as its not asset intensive business, but still it’s better to rely on PB than PE in case of cyclical firms]
    Some details
    1) Engineers India revenue performance over next 5 years depends on refining capacity expansion plans of PSUs. As per 12th five year plan document 70 MMTPA is expected to added over next five years out of which 30 MMTPA is from private sector. If we analyse last 15 years performance 2008-12, clearly stands out as an exception. I think Engineers India recent performance [2008-12] was more driven by rapid expansion in refining capacity. Aggregate revenue for period 2008-12 is almost 2.5x of aggregate revenue of 2003-07 and profitability is 3.6x higher. If we look at refining capacity for 2007-12 periods, it expanded by 62% and in absolute numbers refining capacity increased in aggregate by 90 MMTPA. This increase is highest in any of the five year plan since 1997. Now if we look at period when refining capacity growth was mediocre, for instance during 2000-06, aggregate refining capacity increased only by 18% [from 113 to 132 MMTPA]. Revenue during 2002-07 was volatile, but essentially flat between 550-570crs or even if we look at revenue CAGR of 2000-06 it was mere 10%. Again during 1993-99, refining capacity almost double [from approximately 55 to 100 MMTPA], revenue more than doubled from 150 crs to 377crs.

    2) Average ROE for 1998-2008 was 15%, avg ROE for 2002-04 was merely 7%. As I explained above 2008-12 was exceptional period which is also reflected in avg ROE of 32% during this period.

  29. Do these companies fall under the parameters of Value Investing? I think not. But they do fall under the umbrella of “Contrarian Investing”.

    Currently, PE of Nifty is 17.57, which is near the 10 year average. Lowest being 13.30. So, there is still a decent amount of Investor Expectation in the pricing. Furthermore, in the name of correction I’d wait for nifty to reach 5000 (Nifty’s 2012 low is 4558) before starting to look for good bargains.

    Above mentioned companies are currently not good bargains. Their Stock Price has sharply reduced and so has their performance. Their performance will improve in the future, about that I am confident, but that may take very long.

    Sail posted negative EPS from 1997 to 2002. Its price took a serious beating when it fell from 1997 high of 30.50 to 1998 low of 4.90. A whopping 84% fall !! And stayed range bound for another 4 years !! Contrarian Investing also requires a lot of patience.

    So, in my opinion these companies are only fairly prices, they are not good bargains.

    Good bargains are companies which have good Financial Statements but are Low on Investor Popularity. These companies are only the latter.

  30. Hi Vishal,

    Is it correct that currently BHEL and EIL are trading at 10-yr-lowest PE value? In that case, the price is carrying least amount of investment expectation and that is a huge plus. At CMP, the Div Y% too is around 4%. Plus, RoE is good; They are being punished severely just for negative cash flows and being PSUs.

    However, SAIL is not attractive on any of those fronts. GOI too recently sold stake as it is expecting bad years for Metal Sector. Price is likely to further correct in SAIL & NALCO.

    What they have in common is fading of investor expectation, but for very different reasons !!

  31. Are there any tags/categories for your posts? I fail to find such. Can you pls clarify Vishal?

  32. A. King says:

    BHEL
    After today’s results – 8% down profit – how does the matrix stack up?
    Sure, BHEL will not go out of business. But what would you consider turn around time in terms of ROI?
    AK

  33. How about starting investing with – Dollar cost averaging for next 2 years ?

    for example if you make provision of investing 100000 in EIL.
    25% today
    25% in next significant correction
    25% in another significant correction
    25% in worst correction

  34. Vishal,

    I am invested into both BHEL and EIL with portfolio exposure of 8% and 5% and please take my answers with a pinch of salt. My answers for your six questions are below. Let me know what you think.

    1.Are these companies really going to die?
    I do not think so because of the two reasons
    a) They both have very long operating history and they have survived all kinds of business and macro cycles that happened in the past
    b) Both are considered as the best in trade as far as the business they operate in goes. There are very few companies that match their ability and scale. Most of them are price takers.
    c)Strong Balance sheet with insignificant or zero debt

    2.Is the pressure on their respective businesses short term, or do you see these companies fade into oblivion in the future?
    I do not think so. If India has to grow even at so called hindu growth rate it needs infrastructure. Imagine a world where you have all these electronic gadgets and wonderful cars but cannot use them or drive around because you do not have power or fuel to drive it. They do not produce luxury goods or services that will go out of fashion or change. They are in business that produce essential goods and or services that we cannot live without. Low price competition by domestic and international players could dent but will not wipe them out. This is where I see government being the owner as plus point instead of a negative. Government may not care if L&T is not profitable because of chinese competition but they will impose anti dumping duty and other taxes the moment their profitability is at stake. So we have some protection there.
    3.Agreed that the government is a poor capital allocator, but is the concern so big that these businesses are priced to extinction?
    Even though this is government owned, both of them can be compared with any other private companies on operating parameters and will come out with flying colours. BHEL enjoys better margins and EIL almost had negative (previous years) to very low working capital (currently) for running its business. Generally all PSUs are priced badly and that is where I think I see a big opportunity where cash making businesses (babies) are being thrown out with the bath tub.

    4.Would you give any weight to their strong balance sheets, product quality, and past track record, despite the P&L concerns surrounding them?
    I am not sure what are the P&L concerns. As long as a company is maintaining its profitability and that profitability is acceptable in terms of the capital that is employed, I am good. If the profitability does not grow or if it just drops by some percentage, I will not be concerned. I would be very concerned if they get into losses and the losses are going to continue for sometime in the future.

    5.If you were to do a pre-mortem – going 10 years into the future and looking back from there – would your curse yourself or praise yourself for owning these businesses in your portfolio (in case you own them now or are looking to own them in the near future)?
    I do not wish to own both these businesses for 10 years. I own only strong moat businesses for 10 years. Both BHEL and EIL do not have all the characterestics of a strong moat businesses. I will own a Sun TV for 10 years but not this. Reason is simple, you cannot crack Sun TV strong hold in TamilNadu even if I give 10 billion to you. Local governments and all other international players like Star are trying hard without success. I will sell BHEL and EIL whenever Mr. Market is in an euphoric mood to pay a higher price, which I think the moment he sees better order book flow and start project that flow for next 10 years.

    6.Why you would not touch these businesses at these or even lower prices?
    I continue to accummulate these at these prices. If they go lower, I will continue to buy as long as the % alloc of my portfolio does not go above the limits of 10%

    • Ravi, a quick question on the 5th point – I am doing an equity SIP in the following scrips -ITC ,
      HDFC BANK,RIL,L&T,TCS,MARUTI SUZUKI,ICICI BANK,CIL,ONGC. I feel that we can hold them for a lifetime, what according to you are businesses that you would hold for 10 years or more?

      • Rahul,

        Based on what I read and followed so far, all companies where the change is very very slow and which produces or serves something that cannot be substituted will survive a long time. We cannot be sure about autos, commodities, infrastructure kind of businesses. In these, the low cost players would be the last ones to go out of business. However, there are others like banking, essential consumer product like say razor or soap or paste which every one has to use no matter we have recession or not which has very high probability of surviving. There are victors from first group and some failures from second group but broadly this is true. In the list you gave, I would love to hold the following if the price is right for me to buy because they are excellent companies in very good industries. I would avoid all others because they belong to the first group I spoke about. ICICI Bank is an avoid for me because of their quality of assets. I prefer Axis Bank better than ICICI Bank for the value I get for the price I pay.
        HDFC BANK, TCS

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