BHEL’s buyback: Is it throwing good money after bad?

In terms of share price performance, Bharat Heavy Electricals (BHEL) is currently trading at levels last seen about 14 years back. Among public sector undertakings (PSUs) it is one of the biggest wealth-destroyers. The management now seems to be considering a share-buyback. In an exchange filing, it recently sought a special resolution to insert Article 5A regarding buyback of shares.

The company is sitting on cash and cash equivalent of about Rs 11,200 crore, which is about 40 percent of its current market capitalisation of Rs 27,300 crore, indicating a good time for a buyback. Besides timing, it could be value accretive.

To put things in perspective, during FY20, the company is expected to make a profit of about Rs 3,000 crore, which provides an earning yield of close to 11 percent based on its current m-cap. This route is much better and tax efficient than capital being parked in a bank fixed deposit.

The confidence also stems from improving financial performance of the company in recent times. Its efforts to cut cost, greater push on value-added products and improving capacity utilisations has led to improvement in the margin and working capital cycle, which had been a major cause for worry.

Operating margin jumped to 6.9 percent in FY18 as against 3.7 percent in FY17. Its working capital cycle, which was at 317 days in FY16, has reduced sharply to 238 days in FY18. As a long-term strategic initiative, it is diversifying into different markets and products. Things like a development of propulsion system for electric vehicles, conversion of coal to methanol, collaboration with global technology leaders such as ISRO for li-ion cells and Kawasaki Heavy Industries for stainless steel metro coaches has been on its plate.

While the change is for the good, risks remain and its troubles are far from over as most financial indicators still remain very fragile, including a return on equity of a mere 2 percent in FY18.

Its fortune was shattered by poor external environment over the last decade and the fact that many of its peers survived and thrived underscore their strategic thinking and capabilities. In its report titled, 'Competitiveness of BHEL in emerging markets', the Comptroller and Auditor General of India (CAG) last year cited lack of timely diversification as a reason for the decline in its financial performance.

Moreover, the report said the company was operating on a static strategic planning for a 5 year period without any concern for yearly achievements. Due of this, it could not achieve any strategic plan targets like diversification and innovation, with the shortfall ranging between 23.33 percent and 113.91 percent against specific goals.

Its employee cost per MW is estimated to be about 5.6 times more than its closest peer Larsen & Toubro (L&T). “BHEL’s fixed expense is 3.8 times per MW versus L&T’s boiler, turbine and generator (BTG) plant. BHEL is the most inefficient player in this shrunken pie, making it harder for it to refuse business from state electricity boards that are delaying payments,” said Lavina Quadros who is tracking the company at Jefferies.

About its prospects, Quadros said, “Overcapacity in power, which reflects in low plant load factors, is curbing prospects of a sustained demand expansion. Additionally, the renewable energy focus of the government is also marring its potential. We believe BHEL’s business model remains flawed as high costs and industry overcapacity point to a sub-10 percent medium term RoE.”

It would be worth noting that the success of any buyback would only yield results with the commensurate turnaround in the fundamentals of the business. If that fails, it would throw good money after bad.

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