BGR Energy Systems: BUY

BGR Energy Systems' (BGR Energy) timely execution of some of the largest Engineering Procurement and Construction (EPC) contracts for power projects such as the one in Mettur, Tamil Nadu and Kalisindh, Rajasthan, has powered its December quarter earnings. Sales expanded 97 per cent to Rs 1,251 crore over a year ago while net profits surged 109 per cent to Rs 88 crore.

The company has been doubling/trebling its net profits (on a Y-o-Y basis) in every one of the last four quarters; a clear sign of high-speed execution. Its strength in EPC, now backed by joint ventures with reputed players for power equipment, ample demonstration of timely financial closure and the ability to bid and win projects amidst stiff competition from large power equipment players, all buttress a case for investment in the stock of BGR Energy. At the current market price of Rs 509, the stock trades at 9.5 times its estimated per share earnings for FY-12, a significant discount to other focussed power equipment players such as BHEL and Thermax.

Stock decline

Despite execution worries being put to rest, the company's stock declined almost 30 per cent in the last three months as a result of poor order inflows. Delay in finalising/awarding a few key projects it has bid for, has been the reason for slow order flows.

This, in essence, implies that the issue is one of time-overrun in awarding projects and not inability to bid for projects.

With an order book of Rs 9,300 crore, which is three times FY-10 revenues, and strong pace of execution, the lag in order flows does not pose any threat to the company's revenues or earnings over the medium term. Investors can buy the stock with a two-year perspective; accumulating it on dips linked to broad markets.

Building on strength

Balance of Plant (BoP) works, typically involving electrical, mechanical work and the likes, has been BGR's forte. With over 50 per cent of the components needed being manufactured in-house, the company has for long enjoyed cost advantages. Its more recent entry into the EPC space ensured that it could bid for the entire spectrum of work in a power project — supplying equipment and building the plant. While the company has outbid bigger players such as BHEL in the past to secure large EPC orders in Tamil Nadu and Rajasthan, it had to source equipment from Chinese players for these projects as it did not have its own equipment venture then.

After last year's joint ventures inked with Hitachi for boilers and turbines separately, BGR will soon be equipped to provide fully-integrated services for power plants. Agreements for super-critical boilers with the same Japanese player is also likely to ensure that BGR keeps up with peers, at a time when even giants such as BHEL are still learning this technology.

No doubt, the Boiler Turbine Generator (BTG) segment has more players today, what with the entry of L&T, Thermax, JSW and Alstom, together with their respective joint-venture partners. However, we believe that BGR's key distinguishing factor could be its strength in BoP works. With larger projects, most power utilities prefer to award projects in bulk — equipment supply and the plant works. This being the case, BGR's experience in BoP could act as a strong reference point vis-à-vis most other competitors, which typically outsource the plant works. This is also evident in the recent orders that the company has bid for.

Temporary slowdown

BGR Energy is the second lowest bidder in two projects of 660 MW each from the Rajasthan SEB; there has been a delay in awarding the projects. The tender allows splitting of order between the two lowest bidders. The company is also in the fray in the bulk tenders from NTPC. This too has, however, been delayed as a result of plea by an aggrieved bidder.

Hence, while order inflows have dried up, we expect this to be a temporary phenomenon.

BGR may significantly gain on profit margins by producing equipment in-house. However, in the near-term, the rising price of metals such as steel and copper is likely to hurt, especially when there exists no escalation clause. While the cost of raw material, as a percentage of sales, has gone up by 2 percentage points in the December quarter over a year ago, the company managed to improve operating profit margins marginally to 11.4 per cent, thanks to lower employee costs. However, there could be some pressure to OPMs, going forward, as input cost hikes become more pronounced.

BGR may also be facing tight cash position in the medium-term, given the outlay (total outlay for the venture partners being Rs 4400 crore) involved in setting up the 4000 MW equipment manufacturing plant expected to be on-stream by 2012. However, given BGR's comfortable debt-equity ration of less than 1 and good credit rating record, financing for the debt component may not be difficult.

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