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Safal Niveshak StockTalk #9: BHEL

Welcome to the ninth issue of Safal Niveshak StockTalk. (Download PDF Report)

After covering Opto Circuits last time, this time I’ve researched on BHEL, India’s largest manufacturer of power generation equipments. Before we dive deeper into BHEL, here is a brief overview of the sections of this report.

  1. About BHEL
  2. Safal Niveshak’s 20-Point Checklist
  3. Intrinsic Value Assumptions
  4. Risk Statement (New Section)
  5. Financial & Market Snapshot
  6. “Should I Buy BHEL?” Checklist
  7. Final Evaluation Checklist (New Section)

1. About BHEL

BHEL is India’s leading manufacturer of equipments for thermal power plants (that produce power using coal and natural gas). Its key components include the boiler, turbine and generator, which form the bulk of a power plant setup. BHEL’s equipments contribute to around 75% of India’s total power generation. The company is known for its quality equipments and good execution capabilities.

Around 79% of BHEL’s business comes from supplying equipments to power generation companies (like NTPC, Tata Power and NHPC), while the remaining 21% comes from equipments sold to industries for their internal power generation. The company also supplies its equipments in the international market, largely in the Gulf and African regions.

Over the past 10 years, BHEL has grown its sales and profits at average annual rates of 25% and 35% respectively.

2. Safal Niveshak’s 20-Point Checklist

Keeping in mind the simplicity aspect that is otherwise missing in other company analysis reports you would come across, I’ve analyzed BHEL by answering 20 important questions that span its:

  1. Business performance,
  2. Financial performance,
  3. Management quality, and
  4. Competition.

Here is the complete 20-point checklist with my explanations.

Before we move ahead, here are the symbols that I’ve placed against each checklist point and that will tell you at a glance whether I have a positive or negative view on that particular point.

   Indicates my positive view

   Indicates my negative view

Let’s get started.

A. Business

1. Can I, in simple words, explain what the company does?
Yes. BHEL is India’s leading manufacturer of thermal power generation equipments – like boiler, turbine, and generator – which are used in plants that produce electricity using coal or gas. Around 75% of India’s total power is generated using equipments supplied by BHEL.

2. Does the business have high uncertainty?
Not really. In fact, there’s a ready demand for BHEL’s products given the massive power shortage in India and the gradual addition to thermal power generation capacity. As per the 12th five-year plan (2012-17), India’s power companies (like NTPC, Tata Power, NHPC etc.) are planning to add a total of 100,000 MW (megawatt) of new power generation capacity. Even if 50% of this is achieved (which is more likely given our past track record), and 60% of that is thermal power capacity, BHEL has a huge task on hand.

The company’s current order backlog (orders received but yet to be executed, because it takes 3-5 years to execute a large power project) stands at around Rs 1,329 billion, which is almost 3 times BHEL’s annual sales last year. So the company has no dearth of orders and there’s great visibility in terms of revenue and profits for the next 4-5 years.

The only question is whether the company will be able to deliver equipments on time, both due to its own bottlenecks (large size of operations has some of them) plus the slow capacity creation by power companies (who are facing their own issues like fuel supply, land acquisition, etc.). Also, any aggressive move into other business areas – like oil & gas equipments, and solar and nuclear power equipments – can bring about some uncertainty in BHEL’s overall prospects.

3. Has the business got an enormous moat?
Not enormous, but a reasonable one…largely due to its size and past track record. As I mentioned above, BHEL-made equipments generate almost 75% of India’s total power in a year. What is more, the company’s equipments consistently rank as among the best in the market, given their long track record of helping power companies achieve high capacity utilization.

The moat is also reflected in the company’s:

  1. Clean balance sheet – Its debt free status and huge cash position
  2. Negligible sales and marketing expenses (just around 3% of gross profit) – This indicates that it is growing despite not much marketing
  3. Its low depreciation to gross profit ratio, which stands at just around 4%
  4. Consistent growth in net profit over the past 10 years
  5. Reasonable working capital requirements
  6. Rising return on assets and return on equity

Although its gross profit margin at an average of 26% over the past 5 years is lower than what value investors should expect as a durable moat (>40%), other numbers as mentioned above provide the company a reasonable moat against competitors.

4. Does the business generate strong free cash flow?
Yes. BHEL has generated positive free cash flow (FCF) for 9 of the last 10 years. While the situation has slightly worsened in the past two years, it’s largely due to an economic and industrial slowdown, that has led to some working capital build-up for the company (that has subsequently blocked cash).

Data Source: Ace Equity, Safal Niveshak Research

5. What is the bargaining power of suppliers and buyers?
As we discussed above, BHEL has a good moat and therefore a good bargaining power against its suppliers and buyers. Its large size and therefore large raw material requirements give it a good bargaining power against suppliers. Then given that it supplies a majority of thermal power equipments in India, and is known for its quality products, it also enjoys some kind of pricing power with respect to its clients.

Anyways, I see this bargaining power reducing in the future given that the company is increasingly facing competition from new local and international (especially Chinese) manufacturers. But that isn’t going to happen at least over the next 4-5 years.

B. Financial Performance

6. Does the business have a consistent sales and profit growth history and is there room for future growth?
Yes. BHEL has grown its net sales and net profit at average annual rates of 25% and 35% over the past 10 years. While the growth rate slowed down a bit in the latest completed financial year (FY12), I see few reasons the company will not be able to grow at a decent pace (15%+) in the future (given its huge order backlog and execution capabilities).

Data Source: Ace Equity, Safal Niveshak Research

7. Are gross profit margins higher than 40%?
Gross profit margin (GPM) suggests the true profitability of a company’s operations. Buffett would generally like a company earning >40% margin, but this is true largely of consumer goods companies. As for BHEL, the average GPM for the last 10 years has been around 26%, which is a reasonable number, but one that suggests the prevalence of competition that is hurting its margin.

Data Source: Ace Equity, Safal Niveshak Research

8. Is its operating cash flow higher than net profits?
Largely yes! Over the past 10 years, BHEL has had 6 years when the operating cash flow was higher than net profit. However, over the past two years, the operating cash flow picture has worsened owing to a sharp rise in receivables (money owed by clients who’ve been supplied equipments but are yet to pay). While the company has not recorded any bad debts so far, the rise in receivables sucks in precious cash, which is a concern.

The good part is that BHEL still has a lot of cash on books to take care of its capacity expansion, but then the receivable position must improve for the risk to reduce from BHEL’s balance sheet.

Data Source: Ace Equity, Safal Niveshak Research

9. Is the debt to equity below 0.5 times?
Yes. BHEL is a nearly debt-free company. It’s current debt is just 0.5% of its equity suggesting that however worse the situation gets, the company will never go bankrupt with the current business.

10. Is the current ratio greater than 1.5?
Almost! BHEL’s average current ratio has been around 1.4 times over the past 10 years, which is a comfortable number. As a general rule, a current ratio of 1.5 or greater suggests that a company can meet its short-term operating needs sufficiently. However, a higher current ratio can also suggest that a company is hoarding assets instead of using them to grow the business. While this is not the worst thing in the world to do, it is something that could affect long-term returns.

11. Does the company have a good dividend history?
Fair enough. In terms of dividend payout (amount of dividend paid as percentage of net profit), BHEL has averaged around 24% over the past 10 years, which is a comfortable level of payout given the fact that the company is also generating good return for shareholders from its operating business (suggested by return on equity of 30%+).

12. Is the Altman Z score > 3?
No, the number for BHEL is 2.4. But this is largely because the company has very low level of retained earnings as it transfers a large amount to “general reserves” every year (which seems like a safety measure, as the company is adding to its reserves to meet any general contingencies in the future).

For a majority of Indian companies, the amount transferred to general reserve stands at between 10-20% of profit every year, but the numbers for most non-banking PSUs stand at over 50%. Historically, BHEL has had a 70% ratio on this front.

Anyways, read more on the Altman Z-Score.

13. How capital intensive is the business?
Not very high. BHEL’s average capital employed per year during FY03 to FY12 (10 years) has been around Rs 130 billion. Against this, the company has earned average net sales of Rs 225 billion during this very period. This suggests that the capital turnover ratio has been around 1.7 time (requires Re 1 of capital for every Rs 1.7 of sales). This makes it reasonably capital intensive. The capital intensity has risen in recent times due to high working capital (due to rise in receivables, as we discussed above).

Data Source: Ace Equity, Safal Niveshak Research

14. Has it got a high and consistent return on capital and return on equity?
Yes. BHEL’s average return on capital and return on equity have been around 37% and 25% respectively over the past 10 years, which are reasonably high numbers, and suggest the management’s good capital allocation skills.

Data Source: Ace Equity, Safal Niveshak Research

C. Management Quality

15. Is the management known for its capital allocation skill and integrity?
BHEL has been a great performer on the capital allocation front all these years. The management has guided the company well over the past few years, so the track record in terms of integrity seems fine. Even as far as the capital allocation part is concerned, we have seen how the company has continued to maintain a high return in equity (average of 25% over the past 10 years; 31% in FY12). So, overall, I’m comfortable with the management and its capability to guide the company in the future.

16. Has there been any substantial equity dilution in the past?
No, BHEL has seen no major equity dilution over the past 20 years. The company has financed a large part of its capital expenditure through internal cash generation, which is a positive.

17. Are management’s salaries too high?
Given its PSU nature, BHEL does not pay lavish salaries to its top management (though there are other perks for them to enjoy). Anyways, the combined salary plus benefits of BHEL’s top management is just 0.03% of the company’s annual profits, which is a very small number.

18. What has management done with the cash in the past?
As discussed above, BHEL has generated good amount of cash from operations in the past. A part of this has gone towards meeting the company’s capital expenditure and working capital requirements, while a good part has also gone towards dividends to equity shareholders.

Given that the company continues to generate good return on capital employed, it can be inferred that the cash has been put to profitable use by the management.

D. Competition

19. Does the business face high competition?
Yes, as is clear by an average 26% gross profit margin earned by BHEL over the past 10 years. A company that earns >40% GPM is said to stand tall against competition, which has not been the case with BHEL. Anyways, the company still enjoys some advantage over competitors as seen from its large market share in total power equipment sales in India, and a good brand name.

20. Has the management focused on market share or profitability in the past?
A combination of both, which is good.

3. Intrinsic Value Assumptions

Before I move into calculating the intrinsic or fair value range for BHEL, let me make one thing very clear.

Intrinsic value isn’t a definite figure but just a ‘calculated’ value. In fact, the calculation of intrinsic value of a business mostly throws up a highly subjective figure. And this figure changes as estimates of variable like future cash flows are revised (given that the future is unknown).

Anyways, what I have done here is rather than arrive at a single intrinsic value figure for BHEL, I have calculated the value using 5 different methods and then arrived at a ‘fair value range’ for the stock.

1. Net present value based on a 2-stage 10-year DCF
The discussion about the calculation of net present value using a discounted cash flow model (DCF) can be found in the 7th lesson of my free course on investing – Value Investing for Smart People.

I have done a 2-stage DCF analysis for arriving at the intrinsic value for BHEL.

As a reference, here is the formula for calculating the NPV:

NPV = CFi / (1+k) + CF2 / (1+k)2 + … [TCF / (k – g)] / (1+k)n-1

PV = present value
CFi = cash flow in year i
k = discount rate
g = growth rate assumption in perpetuity beyond terminal year
TCF = the terminal year cash flow
n = the number of periods in the valuation model including the terminal year

I have calculated BHEL’s future cash flow for the next 10 years, assuming 2 different rates of growth in cash flows of 10% (years 1-5), and 8% (years 6-10).

As for the discount rate, I’ve assumed it at 14%, which is what BHEL has mentioned in its last year’s annual report. For a company like BHEL, 14% is a reasonable rate of annual return, so a 14% discount rate also seems fine. Lastly, my expected terminal growth rate for the company’s cash flows – expected growth in cash flow after 10 years and till eternity – is 2%.

Based on these numbers and after reducing the net debt (debt minus cash), the present or discounted value of future cash flows for BHEL is coming at Rs 114 per share, which is also the stock’s intrinsic value using this method.

2. Earnings Power Value (EPV)
After DCF, the second most reliable measure of a firm’s intrinsic value is the value of its current earnings. This method is known as ‘Earning Power Value’ or EPV. This value can be estimated with more certainty than future earnings or cash flows, and it is more relevant to today’s values than are earnings in the past.

The formula for EPV of a company is:

EPV = Adjusted Earnings x 1/R

Here, ‘R’ is the cost of capital.

BHEL posted an adjusted EPS (earnings per share) of Rs 29.1 in the trailing 12-monthe (last four quarters) period. If the company’s profits were to stagnate and remain at Rs 29.1 per share going forward, and applying the EPV formula here, I multiply Rs 29.1 with 1/14% (14% is the approx. cost of capital for the company.

This gives me a value of Rs 209 per share, which is BHEL’s intrinsic value as per the EPV calculation.

3. Pricing relative to 10 year average P/E ratio
True value investors, as Graham has prescribed, won’t pay a price based on the stock’s latest P/E or the company’s latest earnings. They will take a much longer term view…as long as 10 years.

Here, I have attempted to estimate the intrinsic value of BHEL using the company’s last 3 years average earnings and last 10 years average P/E ratio. So the formula is:

Last 3 Years Average EPS x Last 10 Years Average P/E Ratio

BHEL’s average P/E ratio for the past 10 years has been around 23.3 times, while its last 3 years’ average EPS has been Rs 23.8 per share. Based on the formula, BHEL’s intrinsic value is coming to around Rs 554 per share.

4. Graham number
Graham number is the formula Ben Graham used to calculate the maximum price one should pay for a stock. As per this rule, the product of a stock’s price to earnings (P/E) and price to book value (P/BV) should not be more than 22.5 i.e., P/E of 15 multiplied by P/BV of 1.5.

But why did Graham specifically used a P/E of 15 and P/BV of 1.5? Why didn’t he use some other numbers?

Well, he thought that nobody should be willing to pay more than the AAA bond yield at that time. AAA bond yield at that time was 7.5%. Therefore, AAA P/E was arrived at 1/7.5 or 13.3, which was rounded up to 15. Similarly he thought that nobody should pay more than 1.5 P/BV for a stock.

Graham insisted that the product of the two shouldn’t be more than 22.5. In other words,

(P/E of 15) x (P/BV of 1.5) = 22.5

Put another way:

(P/E) x (P/BV) = 22.5

Price(sqr)/(EPS x BVPS) = 22.5

Price(sqr) = 22.5 x EPS x BVPS

Take the square root of both sides, and you get the equation for the Graham Number.

Fair Value Price = Square Root of (22.5 x EPS x BVPS)

Applying this formula, BHEL’s intrinsic value comes to around Rs 261 per share.

5. Dividend discount model
As we have discussed in the DCF method above, the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate or discount rate. Now, as per the Dividend Discount Model or DDM, dividends are the cash flows that are returned to the shareholders.

Hence, to value a company using the DDM, you calculate the value of dividend payments that you think a stock will throw-off in the years ahead. Here is what the formula is:

Intrinsic value = Dividend per share/Discount rate

The modified formula for valuing a company with a constantly growing dividend is…

Intrinsic value = Dividend per share/(Discount rate – Dividend Growth Rate)

Since BHEL has grown its dividends at a good pace in the past, we use the second ‘growing dividend’ formula for calculating the stock’s intrinsic value.

Assuming a discount rate of 14% and dividend growth rate of 2%, FY12 dividend of Rs 6.4 per share, and inputting these numbers in the above DDM formula, I get to an intrinsic value of Rs 53 per share.

Fair Value Range
I have calculated 5 different intrinsic values for BHEL using 5 different methods. So much for the ‘fixed target prices’ you hear on business channels every day as if these were the holiest numbers!

As you can see from the above calculations, the ‘target price’ isn’t such a holy number and can differ widely based on the method used to calculate it.

Anyways, based on the above calculated intrinsic values for BHEL, I can arrive at a ‘fair value range’ for the stock. Here is how I calculate it:

High End of the Fair Value Range = [Average of above four intrinsic values] Low End = [(Average of above four intrinsic values) – (0.5) x (Std Dev)]

Based on this, the fair value range for BHEL’s stock is Rs 172 to Rs 238. Assuming a margin of safety of 25% to the higher end of this range, the comfortable buying price for BHEL’s stock comes to Rs 180 using the intrinsic values calculated above.

Given that BHEL’s current price of Rs 225 is around 20% higher than the above calculated comfortable buying price, I won’t buy the stock before it falls to (or near) my buying price.

4. Risk Statement

One of the biggest concerns I have with BHEL is the potential for arrogance, which any corporation can fall for when it becomes too big in size. And BHEL is already that big an organization. Here is a specific part from the company’s chairman’s letter from last year that caught my eye, and which I believe adds to the investment’s risk:

Your company is well positioned to continue its diversification strategy to enhance shareholders’ value as we expand our offerings in new growth areas viz. Solar, Nuclear, Transportation, Transmission & Distribution, and Water. We remain positive that our diversification strategy would generate broad-based revenue streams for your company in the long run.

Given that despite its huge size, BHEL will be a starter in these “diversified” businesses raises my concern whether the company will really be able to “enhance shareholders’ value” as Mr. Chairman seems like promising!

I mean, with such a stellar track record in the thermal power generation business, and so much potential therein, what’s the need for the company to foray into things like solar, and water? Not to mention that the company has already gotten into manufacturing equipments for the oil & gas industry! So I would keep my fingers crossed on this point.

Another risk I see is the intensification of competition, especially from Chinese manufacturers who, facing slowdown in their own country and with excess capacity, might try to dump their products in India…thereby causing pricing pressure for Indian manufacturers like BHEL.

If any of these risks come to fruition, I might have to take a re-look at my assumptions for the company, including my calculation of the stock’s intrinsic valuation.

5. Financial & Market Snapshot

Data Source: Ace Equity, Safal Niveshak Research

Data Source: Ace Equity, Safal Niveshak Research

Data Source: Ace Equity, Safal Niveshak Research

6. “Should I Buy BHEL?” Checklist

7. Final Evaluation Checklist

In trying to get the odds of investing in a stock more in my favour instead of being the “man with a hammer”, here’s another checklist that gives me a 360-degree view of the company and its stock, plus my emotional status with respect to the same.

Your feedback is important
So that was my take on BHEL as part of the Safal Niveshak StockTalk initiative. I’ve tried to be as comprehensive in my analysis, while trying to keep the report very simple. Let me know what you think of this report and the improvements therein.

As you must have noticed, I’ve added two new sections to the report – Risk Statement, and a 30-Point Final Evaluation Checklist. Let me know your feedback on these.

Also let me know your feedback on the entire report in the Comments section below.

(Download PDF Report)

Disclaimer: The author of this report, or any of his family members, does not own the stock(s) mentioned herein. The opinions in this report are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stock(s) mentioned or to solicit transactions or clients. The information in this report is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. vishal,

    thanks for BHEL analysis. hope IDFC soon comes in your radar.
    quick observation on this elaborate report.
    1. low depreciation to gross profit ratio also can indicate company is not upgrading its fixed assets..
    2. thermal power generation is last century’s concept as it involves environmental pollution and present need is to look for solar, water, air and nuclear… so in that respect the chairman’s speech seems to be perfect. If it fails to diversify, BHEL may lose way and gives me case to remember HMT. But the fact is PSU diversification is always remain on paper since decision making lies somewhere else.

    • Thanks Sri! On you first point, the company benefits from depreciated assets, which acts as a moat. What is more, it is expanding its capacity that will increase the depreciation to gross profit ratio, but not beyond uncomfortable levels.

      On the second point, maybe it’s a “first conclusion bias” that leads us to think that BHEL might go the HMT way as thermal power is an idea like quartz watches. But there is a big difference in the two businesses in terms of life-cycle. The world still runs on thermal power as coal and gas are more in abundance (and easy availability) as compared to nuclear, wind, water or even solar. It’s just like you will continue to need petrol to run vehicles as ethanol (despite all the hue and cry) can’t be made available in such abundance as is required by the modern world.

      As for the non-thermal sources of power you mentioned above, their share of total power produced in India will definitely rise, but these will never become the main sources of power generation. Instead, these will always remain ancillary sources and will be used only in instances where thermal power is no able to fulfill requirement of consumers for some time.

      Just see what’s happening to companies in these renewable energy spaces. The talk about “going green” is all good, but scalability is a big issue. Plus, these industries are all prone to heating up fast (take the case of Suzlon and Moser Baer, or any such companies that were “hot” in the pre-2008 period. They all all in doldrums now, which has largely been their own making).

      My biggest issue with BHEL is undue diversification just because the thermal power capacities have seen some slowdown in the wake of the broader economic slowdown (plus industry wide issues like coal and land availability). But these are the necessary evils that Indian power industry will continue to suffer from, and BHEL will continue to get impacted owing to this. Regards.

      • Thermal power capital cost is around Rs 5 Cr per MW. Hydroelectric therefore must be around 2 to 3 times this. I recently read somewhere that solar power capital cost is now coming close to that of thermal.
        I agree with Vishal there is only too much noise about ‘go green’ or may be the thermal power industry lobby is very strong. I had heard from a thermal power executive that opposition to hydroelectric projects is funded by thermal power equipment producers. As an example, he cited the point that had some of the hydroelectric dams not been there can you imagine the kind of flooding the plains would have received. In fact pre 1980’s floods used to be common during rains and a menace leading to huge losses of life and crop.
        Yes Nuclear may be an alternative but unfortunately it has got into controversies mainly due to the Japan earthquake. In India thermal power will continue to be a major source for quite some time based on coal or gas.

    • BTW Sri, IDFC may never happen as the industry remains outside my circle of competence 🙂

    • Sanjeev Bhatia says:

      Guys, I wish to add some technical stuff here. I feel you need to clear some things here.

      Be it ANY method of power generation, TURBINE is a must. For Nuclear as well as thermal plants, BOILER is also a must. Please understand the method of steam generation. Steam is generated in all the cases (except Solar) when a turbine is rotated which is linked to alternator which generates power. So the turbine HAS to be rotated for electricity to be generated, thats one point.

      Now in Thermal Plants, coal/wood etc is used to produce steam at HP which is then used to run turbine. In Nuclear power plant, heat released from Fission of radioactive material is used to produce steam which runs turbine. So in both cases, BOILER as well as TURBINE is necessary which BHEL manufactures.

      In case of Hydroelectric Power, potential energy of falling water column is used to run turbine. This turbine is again being manufactured by BHEL. My dad served in BHEL for some time and hydroelectric power station at Jogindernagar in Himachal was commissioned by him way back in sixties… 🙂

      So BHEL is already present in these segments. Even in case of solar energy, Solar PV modules are used which BHEL is already manufacturing. So I wouldnot be worried about the Di-worseification part here.

      Thermal Power Generation is not the OLD century concept. All methods have their own pros-cons. For hydro, you need to first have a perennial water supply source. then you have to have water storage/catchment area. This severely limits the potential. Wind Energy farms again have to put in at selective places only where wind profile is feasible. Nuclear has again local resistance and high initial cost plus safety issues, so things are not that bleak for Thermal Plants as such. they can be virtually put anywhere.

      Low Dep/GP ratio does not denote anything. In engg industry, cost of obsolence is not that much. The main equipment remains the same and you don’t need to upgrade them regularly. This is another point in favour of BHEL. In any case, depreciation is just an accounting entry and not actual cash flow. This just denotes that they have taken out the cost of machinery many times over.

      hope this helps… 😀

    • PARAG M PANCHAL says:

      Vishal Khandelwal,

      I go thorough your Report for BHEL.It is very much useful for me. ON 5 th August I made huge option position on BHEL Call & Make huge loss also.Before investment need to look & understand fundamental study of company THAT I LEARN FROM YOUR RESERCH.Thanks

  2. I think there is a structural issue with regards to power for the last 2 to 3 years, lack of orders, regulations on mining etc which seem to have inhibited growth. BHEL has a reasonably strong position amongst power generation equipment producers. If capex cycle returns it may see better days and the capex cycle should be returning given the dire power demand and supply gap.

  3. vishal,

    IDFC – really disppointing but it is ok. I understand.

    coming back to BHEL,
    //he company benefits from depreciated assets, which acts as a moat. What is more, it is expanding its capacity that will increase the depreciation to gross profit ratio, but not beyond uncomfortable levels.//

    I wrote my first observation as what normally low depreciation to gross profit ratio indicates..nothing beyond. as first observation is always quick glance. it shows my serious interest to study and contribute further…
    in this case, it the company expands its capacity, it is good. That comes in detailed study…is it not…?

    on first conclusion bias, am the last person to come to any conclusion, vishal…
    BHEL is located very near to my native place and visited quite frequently for my costing exams…(ICWA), which provided opportunity to study some of its business aspects in close range. my observation is from that experience.
    second, thermal power is like winding up watches and not quartz….. still use winding up hmt made watch presented by my father, which runs perfectly since 1982…is different matter.
    my observation is related to chairman’s speech stressing the need for diversification ….i dont convey anything beyond the words convey…..hope now it clarifies….
    am yet to go through the report, btw, some of new sections introduced is really good.

  4. Vivek Trivedi says:

    Thanks Vishal once again for posting about a wonderful company i.e. BHEL in your Stock Talk series. I have also done a small research on this company and also being associated to this industries. But on few concerns (like decreasing moat due increasing competition from Indian companies as well as from Chinese ones, lowering margins, falling order booking, slowing in power sector growth, delay in govt. clearances for new power projects, coal block allocation problem for new power producer, delay in completing of projects etc.) I am losing my confidence on BHEL, although the past performance of BHEL is mindblowing. But your above analysis is giving a U turn in my losing confidence.

    And again Special thanks to Vishal for putting “7. Final Evaluation Checklist” which I thought you have given first time in your research and no can find easily in any of the reports anywhere especially the “Self Confidence & Emotional Checks”.

    Happy Investing

    • Thanks for sharing your view, Vivek! But I would suggest that before you take a u-turn on BHEL based on my view, just recheck your own assumptions, which might still be vastly different than mine . 🙂

    • Sanjeev Bhatia says:

      Hi Vivek, nice to see new and new tribesmen putting in their viewpoints.

      Some of the points you have mentioned have been discussed in my reply. Please have a look. In any case, one should form his own opinion on his own assessment because no body is infallible, not even Vishal …. 😛

  5. Reni George says:

    Good Morning Vishal
    Nice coverage on BHEL, I was also looking into the counter for some time,but still find the price little bit unacceptable,or the gut feeling lacking.Somewhere down the line,i think they are crucifying their margin,for the sake of built up of orders.Their NPM is now somewhere around 11 % which was around 15 % for last year,i think we need to check out the OPM for some quarters and look out,are they sacrificing the margins.If that be the case,then we may have to again rework the Intrinsic value for the Company.Fundamentally the other problem that i am more cautious about is the power reforms that need some urgent action from the government side.Well on this front i find deficiency on the part of government to make some great changes in the whole chain of power sectors.Year 2014 being an election year,i doubt government taking concrete steps on this front,on the contrary there may be some populists decisions being taken,which would be unfruitful .Regarding Competition I have found on the ground that some of the firms are not happy with the chinese products,the L&T Power division has also not taken the form as expected by the management,that was the reason that Ravi Uppal(L&T Power Division) was dropped from the list of people,that intended to take place of Mr.Naik(L&T Knowledge City Being based at Baroda and Ravi Uppal sitting here,i gathered the information from Known sources in L&T Knowledge city)so competition wise I will give a additional point to BHEL.The Major concern for me might be the Margin going forward.
    Note: I have initiated a small Buy position somewhere near April 2012 around 200 Levels,will wait for a Quarter or two more,for further Buy.
    Vishal Thanks for this writing,it has given me some more insight,which will be really fruitful for all of us.
    Thanks and Regards
    Happy Investing
    Reni George

    • Indeed Reni. For all the positives that BHEL has, the current price is still higher that what I’ll be happy to pay for it. Thanks anyways for sharing these nice inputs with us. These have added to the quality of discussion here. Regards.

    • Sanjeev Bhatia says:

      Very well put Reni, and nice info there. This is what makes the discussions so special, at times even more than the original post itself…. 😉

      We are at same wavelength Reni. Here, I also had some gut feel and initiated a small buy position despite MY intrinsic value calculated a month ago being slightly higher. I am still to see that level again….. 🙁

      BTW, I got a good post all devoted to me (and my never ending list of Biases ;( )by Vishal due to my discussions on BHEL in Saturday Jam. See what Reward I get …. 🙁

  6. Some data which I gathered on current estimated capital cost (there will be variance from project to project) of power projects basis type of fuel:
    Thermal Rs 7 Cr per MW
    Hydro Rs 10 Cr per MW
    Solar Thermal Rs 12 Cr per MW
    Solar PV Rs 9 Cr per MW
    Nuclear Rs 9 Cr per MW.

    The reason I tried to find out is that it tells us how competition is for power equipment suppliers basis type of fuel. For example if Nuclear was say Rs 20 Cr per MW, it would mean not very many plants can come up and no. of suppliers would therefore be limited, as was the case till last decade.
    If cost of setting up a plant is not very different basis fuel type , each fuel type manufacturer (thermal, hydro, nuclear etc) will have lot of lobbies and noise to promote their technology/ fuel type. No wonder there is so much noise about Nuclear and Hydro since they are also competing for the same capital (read money) which is scarce as well !

    • Thank you so much Sudhir for sharing these important data points! The point about nuclear+hydro versus thermal is also that the former are very location specific (near the shore, on mountains, etc.) while a thermal plant can be set up literally anywhere. So land availability is a major issue for the former as compared to the latter (though even the latter has been bearing the brunt on the land front).

      Second is the “ease” of availability of the fuel. Coal and gas are available in greater abundance than nuclear fuel and water. So that will also continue to keep the pendulum swinging in favour of thermal. Regards.

  7. How about sintex?? 🙂

  8. Hi Vishal, that was a very good analysis as you always did..:) and one has to definetely consider the points you raised in Risk Statement.!

  9. Hi Vishal

    When you calculate the debt to equity ratio why dont you consider total liabilities.

    Why do some charts have 2011 data while some have 2012 data?

    How is capital employed calculated?

    Capital Employed = Total Assets – Current liab
    = 674303 – 291554
    = 382.7 billion Rs

    while the cap employed chart shows 250 billion. Where am I going wrong?

    • Hi Krish, that graph shows the net working capital+fixed capital (or gross fixed assets) employed in the business. It’s not the debt+equity figure. Hope this clarifies. Regards.

      As for the first question, yes, while calculating debt to equity, i just take the long term debt figure and divide it by equity. As for some numbers being for 2011, those are largely cash flow numbers as BHEL’s FY12 annual report isn’t out as yet (the P&L and Balance Sheet were released with the FY12 results). Regards.

  10. Sunny Gupta says:

    Thanks Vishal

    I really like the two newly added sections 🙂

    Just one point, would not the growth rate assumption for next 10 years of 10% and 8% be too low, considering the past 25%+ growth rate and huge potential for power sector? I mean, i agree there’s risk of visibility, but BHEL enjoys some moat, and I tend to believe that even if there’s threat of chinese competition, PSU power companies like NTPC will still buy from BHEL or government will impose higher duties to favour domestic players, etc. Additionally, BHEL will win over quality, as such huge capex are not where NTPC and alike would like to take chance with chinese products, in longer run…

    I agree this might be my bias 🙂 but still I think we should adjust the growth rates a little higher, say 12% and 10%…

    • Thanks Sunny!

      Well, I just try to be as reasonable as possible while assuming growth rates. I generally don;t go beyond 10% growth for the first five year period, and especially given a heavy industry like BHEL’s that is likely to grow at the real GDP growth over the long term. Of course the past may indicate a higher number, but then taking cues from the past will generally lead you to unreasonable growth assumptions.

      The entire point is that, as a value investor, I won’t like to pay anything for growth (or pay very little), and that shows in my growth estimates. Also, the lower growth I take, I just add to my margin of safety.

      It’s just a personal assumption, and you are free to take a growth number that you are comfortable with in your model. Ultimately, it’s entirely based on the comfort level of an investor who’s doing the analysis. Regards.

  11. Vishal,

    What is the initial Cash flow value to be used in your excel for calculating intrinsic value using DCF? You have mentioned free cash flow in your value investing lessons. Please correct me as I want to try calculating for BHEL to see if I am getting the values correct 🙂

    • Hi Govind, I’ve taken the average of last 5 years’ FCF as the base for calculating the DCF value. Hope this helps.

      • Thanks Vishal. Currently I have to rely only on sites like Moneycontrol,Economictimes for financials of a company. In cashflows section of those sites for BHEL, I get 9630.15 for Mar 11. How did you get 8.5 as initial cashflow. Sorry to bug you, just want to try calculation on my own. Please suggest a site which I can refer for financial data for analysis.

        • If you look at this image, you need to look at the figures marked in the red (Net Cash From Operating Activities), and from these you need to minus “Purchase of Fixed Assets” that is not shown on Moneycontrol.

          For that you must pick up BHEL last 5 years’ annual reports, read the cash flow statements, and do the calculation. Then average the results for the last 5 years and you will get to the number I’m talking about (around Rs 1,575 crore). Hope this helps.

          • Thanks for your explanation. So now my understanding is, Net Cash From Operating Activities – Purchase of Fixed Assets and this value should be divided by total number of shares will give you free cash flow per share which comes to around 8.5. Am I correct?

            • No Govind! This number (the average of “Net Cash From Operating Activities – Purchase of Fixed Assets” for the past 5 years) must be taken as the base for calculating the DCF value of the stock.

          • Manish Sharma says:

            Thanks Vishal for explaining the calculation of FCF with so much detail.

            Can we use the addition in Gross Block as some approximate proxy for the calculation of purchase of fixed assets??

  12. Vishal,

    One more query in Altman Z score. You mentioned that BHEL moves its reserve to a general reserve. Is that not part of BHEL’s surplus and reserve. Why that should be excluded when we try to determine BHEL score?

  13. Sanjeev Bhatia says:

    Hi everybody. Great discussion here. Nice to see BHEL covered which I had recently discussed with Vishal.. 😀

    First Things First… Both the Risk Statement and Final Evaluation Checklist are lovely additions. These are the kind of things that give an edge to us as value investors. Vishal, you must be congratulated for coming up with new and new methods of fine tuning the evaluation process. Thanks.

    I have always been interested in BHEL for some reasons, mainly because it belongs to Heavy Engg Industry which has a considerable moat to begin with. Since the stakes are quite high, no body is willing to bet on any newcomer and the companies which have a long list of successful project executions like BHEL, L&T etc stand to gain tremendously. For this reason, I would not be worried about China having a dubious quality reputation. Moreover, since most of the power projects will be in public sector, BHEL stand to have an edge there too. This is a highly technical industry and any tom, dick or harry can’t enter. This creates a great entry barrier, plus the cost of initial equipment/land required. So despite having high margins or RoE/RoC, there is less threat of great deal of competition over here. Since I also manufacture Thermal Equipment, I have noticed (and suffered too… :() that people will like to pay much higher price to an established brand. So, all in all, things look pretty much ok for BHEL.

    Regrading Diversification (Di-worseification), unless they do something really stupid, I wouldnot be worried. They already have many electrical products, solar products in their product range. One interesting area is mini/micro turbines with capacities as low as 5MW. This has tremendous self power generating potential in Paper, Textile and chemical process industries where in any case boilers are required. So the process is , get micro turbine and boiler, use HP steam to run Turbine, Use the LP steam that is coming out from turbine in process. The Cost of power thus generated is much lesser and you can SELL the excess power to State Elec Boards. BHEL already is present in this segment but not much focussing on this since they have already huge orderbook for larger (and much more profitable) projects. If the scene for main projects dims somehow, there are other products which BHEL can supply, although in smaller projects it will face cost pressure from leaner, nimbler smaller players.

    This is one company which can very confidently pass on the increase in manufacturing expenses to the customers due to niche segment. It can, and will, face some competition from overseas companies but in a permanently power hungry country like India, plus the location advantages make BHEL a good company to buy and hold. Moreover, it has a long history of successful exports (40 years to more than 70 countries), that gives another edge.

    Very Nice Analysis. Great Coverage and interesting discussions. 😛

  14. Thanks for the explanation Vishal.

    One more question most websites calculate capital employed as Total Assets – Current liability while you are taking net working capital+fixed capital. Is there any specific reason for that?

    Govind check out this link.

    You will get free cash flow number there. Dont depend on money control. Moneycontrols’s EPS number does not match with Vishal’s EPS number.

  15. While evaluating BHEL, one thing important is BHEL is enjoying the preferred buyer status from NTPC and State Boards. However, entry of L&T-MHI, Alstom-Bhart Forge, BGR etc. created BIG competition in addition to Chinese. Being PSU, BHEL remains lack of aggression and competitive sprite (not required due to preferred buyer!!). Next power wave will be dominated by private players and will be difficult for BHEL to grow (it may sustain)
    Just a though.. Please compare BHEL in India is similar to Siemens in Germany, Alstom in France, GE in USA.. Growth of others vis-a-vis BHEL.. Even reports shows that BHEL out performed Index but check between L&T and BHEL.. My personal view is there are better alternatives in capital goods than BHEL, unless there are drastic measure from management..

  16. Hrishikesh Kale says:

    I completely disagree with your intrinsic value computation. I think BHEL deserves much more. I believe you have completely overlookeod the strong ROE that BHEL has churned out (more than 25% consistently) without employing any debt. Even if you assume a very conservative growth in EPS of 10% p.a. over the next 3 years my view of the intrinsic value comes to around Rs. 300. Employing a margin of safety of 20% I think Rs. 230 is a great buy.
    It is great to be pessimistic but I think like the market where BHEL is currently out of fashion I think this analysis just is following the course.

    • Thanks for disagreeing, Hrishikesh! 🙂 It’s good to see people who disagree rather than who simply act on what they read.

      I’ll repeat – the analysis you read above is based on “my” assumptions and in no way must be treated as a recommendation.

      If you like BHEL at the current price, you may as well buy it. I don’t like BHEL at the current price, so I will wait.

      In the long run, you may be proven right and I may be proven wrong, but then that’s fine till I stand true to my conviction. But rest assured, I won’t go with what’s popular/unpopular in the market. Regards.

      • Hrishikesh Kale says:


        Absolutely that is why the stock market exists. Let me put my point of view:
        There are two companies employing the same EPS say Rs. 10 while one is employing Rs. 100 of shareholders money while another is employing Rs. 200 then Rs. 100 capital should be returned back tothe shareholders; in effect what it means is that as a shareholder i will be willing to pay Rs. 100/no of shares lesser for it.
        Taking the opposite view if i have a expected return of say 20% and BHEL has been earning more than 25% then I am willing to pay a premium for it over and above its ‘Growth price’.
        Using a simple equity bond concept where EPS is akin to the ‘coupons’ assuming a 10% growth rate and discounting it with your expected rate of return and then putting in the premium as i have stated above BHEL commands a Rs. 300 IV in my view. Ofcourse that is my view. I have personally entered this stock at Rs. 220.

        • Agree Hrishikesh, but then I have a IV calculation method above that gives a number of Rs 554 for BHEL. But would I believe that one number alone? Not really, because I’m sure I’ll be wrong in going by just one IV number.

          That’s why I calculate IVs using 4-5 different ways and then arrive at a fair value range. Of course, even this would not bring out a correct assessment of IV, but then, in my belief, having a fair value range is always a better way to value stocks than just one way.

  17. Vishal… One more clarification…
    Does cost of capital varies from each sector/Company.How to identify it..


    • Karthik, it shouldn’t! One good and reasonable way is to keep the cost of capital (for DCF purposes) same for all companies and adjust the risk in FCF projections.

      What I do is use cost of capital between 10-15%. Safer the business, lower the number.

  18. Rajeev Juneja says:

    This is simply excellent. No more words. Thank you Sir.

  19. Varun Panaskar says:

    I liked the final evaluation checklist, its covers many things.
    By the way whats your take on NESCO Vishal? Would love to see it in stock talk.

  20. Hi Vishal,
    Thanks for the detailed analysis on BHEL.
    Some basic information if you can please let me know:
    – When did BHEL come out with IPO and what was the issue price
    – What are the various sources from which you gather the required information to do the detailed information(is the entire information present in the annual/financial report of a company)? I would like to do a similar analysis of other companies, so want to know how to get the required information for the same.

    • Hi Gurudev,

      BHEL was incorporated in 1964 and listed sometime after that. I don’t have the exact date. As for the second question, I read annual reports (also of competitors) and also read anything else that I can find on t he company on the Web. Regards.


    • Gurudev, I use for doing fundamental analysis just like Vishal.

      All the raw data is present in Annual Report but then you have to calculate everything on your own from the data.

  21. Dear Vishal,

    The below listed news came out in Business Line…. and being posted here for our fellow tribes info. (and not to scare)

    ‘BHEL facing alarming situation in absence of new orders’

    New Delhi, Oct 2: State-run BHEL is facing an “alarming situation” in the absence of new orders from the much-delayed power projects, despite an existing order book of Rs 1.30 lakh crore, according to a government official.

    The company conveyed its concerns recently to the Heavy Industry Ministry, the official said.

    The order flow has been hurt in recent times in the wake of multiple power sector problems. From 2011-12 onwards, issues of coal linkages, finances and delays in environment clearances are impacting the power sector.

    The official said no new orders are coming up while existing projects —— that have been finalised —— are going slow or put on hold in the wake of financial constraints. In the wake of these problems, BHEL is finding it difficult to proceed with many of the projects, he added.

    According to the official, BHEL informed the Ministry that “It is an alarming situation not only for BHEL because the company has expanded the capacity, taken number of people, but also for downstream industries of BHEL“.

    The company raked in a net profit of Rs 7,039 crore on a turnover of Rs 49,244 crore in the last financial year. During the same period, the entity’s net worth stood at Rs 25,373 crore.

  22. Shailesh Awasthi says:

    In one of the reports at money control, I am not able to understand how the change in working capital is calculated. Please refer to the Page 4. Thanks

  23. Ramesh Bhanu says:

    Hi Vishal,

    Excellent analysis.

    In my opinion, since there is slag in Infra sector the market is not seeing money making opportunities in short to mid term.
    Which is getting reflected in lowering PE from last couple of years.

    By the way, can you tell us how you calculated last 10 years average PE for BHEL?



  24. Hi,
    This is really wonderful stuff. But as you know Safal, it is quiet rightly said that God is in the details.
    This cannot be considered a detailed analysis in my opinion. BHEL operates in several sub-segments and faces competition from different competitors in each sub-segment.
    For instance, Switch gear segment – L&T, Super-critical thermal reactors – Thermax (recent JV with Babcok)…..etc
    Can L&T erode BHEL’s market share in the switch gear segment over the next 5 years? And if they do how will it impact BHEL’s top line?

  25. Surprisingly no one talked about Prafull Patel in the discussion. He is currently incharge of the ministry under which BHEL comes and is the real management (boss). So be sensitive to this fact and keep what has happened to the government airlines. Invest only when he is out.

  26. sanjeev singh says:

    Hi Vishal
    some of your research articles are done a year before. but the safe invest pricess are not updated as the company performs. probably you update your articles every year so that it will reflect accurate data . Thx
    Sanjeev singh

  27. Hi Vishal,
    It would be good and investor will be happy, if you compile all your company research for the present and your views on your research.
    I saw your version 2.0 on opto exclusively, instead, you can refresh all your views on your research. I understand it is hill task because it may eat up all your time. But we novice guys can benefit. Thanks in advance.


  28. I have a basic doubt about BHEL (and LT). Its EPS % is very poor. Its 5 year average diluted EPS is Rs.19; For CMP of 177 it is only around 10%. Do you think this is way too low… only 10% growth per annum !! At CMP LT is even worse only 5%. I feel, the company should grow by at least 15% on my purchase price. Please clarify this huge doubt for me.

    Thank you.

  29. parag panchal says:

    Bhel stock % fall/gain in profit proposnal current valuation of stock on 5august 2013 is currect ?Can u please guide how to estimate presence value.which r the keyfactor to understand bullish/berrish.parag

  30. Hi Vishal,

    I have calculated with your Excel sheet and i am getting different numbers on the Fair value part, Have you considered the Bonus and stock splits during your Calculation ?


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