Emkay Note on BHEL – As per CNBC TV18, the government is considering a strategic sale in BHEL to reduce its stake from 63.17% currently to 26%. Additionally, four to five of its non-manufacturing units are marked for sale within this fiscal, as per the same news.

■ In our view, a strategic sale will be positive for the stock. Although it may not be quite easy to find a buyer, we think that there is a good value for the strategic buyout for global power and industrial equipment makers as well as domestic companies.

■ There will likely be investor concerns relating to demand for BHEL as a strategic buyout; however, we believe that being a PSU, BHEL has not been able to sufficiently and effectively diversify itself outside of power sector, despite its capability. A strategic buyout might enable that possibility and open up significant opportunities for BHEL both in the domestic and international markets.

■ Although the actual scenario might play out only over the next few months, this news flow is likely to support the stock price and adds to our Buy thesis.

Our Buy thesis on BHEL is based on the following key arguments –

■ We believe that the power sector is now poised for structural reforms, while end-consumer demand trends still remain healthy. Specifically for BHEL, an eventual upturn in the power capex cycle is a definite positive, in our view.

■ The new power ministry over the past few months has been working toward enforcing stricter contract and payments norms by discoms. Enforcing the Line of Credit-backed power supply and recent talks on linking central government assistance/PFC funding to privatization of distribution franchise in states are some of the measures that infuse confidence about a potential kick-start of the power capex cycle.

■ The current situation is comparable with FY04 when power deficit bottomed out before rising sharply over the subsequent years due to an economic boom, and in turn, driving power capex up.

■ Even otherwise, the company’s net cash position of ~Rs55bn as of Mar’19 and receivable book of Rs380bn provide valuation support given that its total market capitalization itself is Rs190bn (less than 0.5x receivables).

■ BHEL provides ~4%+ dividend yield (without assuming a further worsening [or a major improvement] in the cash conversion cycle), besides being an inexpensive play on the eventual power capex revival.

■ Valuation: Given the uncertainty looming over the actual capex revival, we value BHEL only for its net current assets (with receivables discounted by 30%) to arrive at our TP of Rs62/share. A continued slowdown in new orders/execution and write-offs on receivables are the key downside risks. We remain OW on the name in our sector EAP. #bhel

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