BGR Energy Systems: Buy

The Hindu Business Line

BGR Energy Systems, an engineering procurement and construction (EPC) player in the power sector, has bagged some of its biggest orders in the last two quarters, assuaging concerns about slowing order flow suggested by key macro indicators.

If order flow is not a problem, has the company been able to fund its projects given the massive size of the projects and the still tight liquidity scenario? It appears so, given BGR’s recent announcement that it has tied up credit lines for the Rs 3,100-crore Tamil Nadu State Electricity Board project, one of its bigger orders.

Healthy growth in revenue and earnings, strong order-book and execution track record differentiate BGR Energy from a good number of mid-cap companies that have succumbed to the pressure of testing macro-economic times. For a sector that caters to the perennially deficit power industry, BGR’s earnings potential too remains unaltered.

The sharp de-rating that the stock has undergone, along with some mid-cap companies, therefore, appears overdone.

We reiterate a buy on the stock of BGR Energy Systems. At the current market price of Rs 141 BGR trades at about eight times its expected earnings for FY10.

No dearth of orders

From Rs 3,200 crore in early June, BGR’s order-book has grown to Rs 10,590 crore now (seven times FY-08 sales). Besides the fact that BGR is in an industry that holds tremendous potential, the fact that most of its recent orders are from the Government could be the reason for its steady order intake.

The last two quarters were significant as they marked the beginning of the company’s stride into large power projects of over 500 MW, as a full fledged EPC player — supplying equipment and undertaking the balance-of-plant works.

It is noteworthy that the company competed with BHEL and won the last two large EPC power projects awarded by the Tamil Nadu and Rajasthan State electricity boards. There is little doubt, given the superior qualification of BHEL, that this project would have been won on the back of aggressive pricing.

However, BGR can have an edge over other EPC players for the following reasons: For one, the company’s strength and qualification in the BoP space provide it with a techno-commercial edge.

Two, BGR’s capability to manufacture over 50 per cent of components (required for a project) in-house also adds economies arising from backward integration. BGR has been scouting for technology transfers for Boiler Turbine and Generator (BTG) — the key equipment in a power plant — and has so far only tied up with Chinese players for the supply of equipment for the recently won projects. Given the close scrutiny that Chinese equipment are subject to in recent times, this could pose some risk until BGR successfully ventures into acquiring technology for BTG.

The company has made progress in technology transfer in another area; it has recently tied up with an Italian company for condensate polisher plants that help high pressure steam generators in thermal power stations improve efficiency of the unit.

Steady credit line

BGR’s massive projects have managed to receive funding at a time when bankers have been exercising caution in funding new projects. The company’s Rs 2,105 crore of fund and non-fund based requirement for its Tamil Nadu power project received good response from over five banks.

At an interest rate of 12.25 per cent, funding costs may soon decline with the recent cuts in prime lending rates of banks. The company has stated that the funding of the Rajasthan project too is likely to be completed in a month’s time.

While comfortably meeting its working-capital requirements at an average borrowing cost of 11 per cent, the company has been discreet in its spending on new facilities. It has been going slow on new facilities in Mundra SEZ as well as assemblies in China.

BGR has managed to maintain its operating profit margins in the 10 per cent range despite steep hike in raw material costs and a high proportion of fixed price contracts. Locking into input prices through bulk buying appears to have helped.

However, the benefit of the current decline in commodities is likely to be reflected only in projects executed the next year. This could aid some margin expansion.

Risk

The lock-in period for shares held by institutional investors (such as Citigroup) in BGR is over. Should these investors exit, this could trigger some selling pressure in the stock. However, given the strong prospects, investors can view this as a buying opportunity.