The Hindu Business Line : Electrifying times for equipment suppliers

The next five years may be the best of times for power equipment makers, with the power sector on a capex spree. A look at how they are placed to take on the challenges ahead.

The last two-three weeks saw yet another re-rating of power equipment stocks. Post-Budget, BHEL is up 12 per cent, at Rs 2,161, and Areva T&D shot up 52 per cent to Rs 762. Most top-notch stocks now trade at multiples of over 35 times the expected FY-06 earnings. And it appears that these valuations are here to stay.

The growth story is promising and, in the long run, we remain bullish on the power equipment sector. Shareholders may remain invested and consider accumulations on dips. Our top picks, from a five-year perspective, are BHEL, ABB, Siemens and Areva T&D. Newly-listed companies, such as Indo Tech Transformers, also hold potential.

The power sector is in the midst of a major capital expenditure splurge. The next five years may be the best of times for power equipment makers. A look at how they are placed to take on the challenges ahead.

Long-term growth story

The total capex plans announced so far could keep equipment makers' order-books bulging for the next few years. With order-book growth over the last three years touching the 40 per cent mark, there is a good chance that this will continue, given that a chunk of the planned investments in the generation and transmission sector is yet to materialise. In the generation sector, close to 34,000 MW (actual addition) will come on during the Tenth Plan and close to 61,000 MW are expected to be added in the Eleventh Plan (2007-12).

It is not just the size of investments planned but the Tenth Plan's impressive implementation schedule that inspires confidence in this story. Close to 82 per cent of the planned generation capacity for the Tenth Plan has either been implemented or is under implementation. This is a vast improvement over the implementation ratio of 50 per cent during the previous Plans. Even assuming a 70 per cent implementation ratio for the Eleventh Plan, close to 43,000 MW will be added — that is, a minimum of 25 per cent growth.

In the transmission sector, Power Grid Corporation is planning a capex of Rs 71,000 crore by 2010. The Government's initiative to reserve coal blocks for the power sector for captive mining and a substantial hike in this year's Budget towards rural electrification make the growth story more exciting.

The next two years may bring about a steady stream of orders for equipment manufacturers as major orders in both the generation and distribution segments will be placed over this time. In generation, five ultra mega power projects, totalling 20,000 MW are coming up in the next year. The transmission capacity is expected to be 23,000 MW in 2007, against 9,000 MW in 2005.

Capacity creation of this scale in such a short time-span would require upgradation to higher range equipment, faster capacity expansion, better project execution capabilities and the ability to shorten execution cycles. Competition, too, will pick up in the long run and may put pressure on margins.

The near term appears to present fewer concerns as most companies have expanded capacities and upgraded their technology. Easing of input costs and improved productivity may, in fact, improve operating margins for players such as Areva T&D and BHEL.

Moreover, the sheer quantum of capacity addition in the next couple of years may give players across the value chain more room to participate.

Strategies in place

As the nation shifts towards ultra mega power projects, there will be need for 600 MW or 800 MW (single-unit) generators or boilers. Addressing the need, BHEL is expanding its product range to 800 MW thermal sets and in other areas too. The company has tied up with Alstom for the super critical technology. Having made these moves, BHEL has a good chance of winning the bids for ultra mega power projects.

In the distribution sector, there will be demand for 765 kV transmission lines and high voltage products and substations. The opportunity is Rs 2,500 crore over the next three-five years. ABB and Siemens have a complete range of products across segments. Areva plans to manufacture high-range equipment in a phased manner.

Crompton Greaves has acquired an overseas company. This gives it access to higher range products, such as 500 kV transformers. Post its capacity expansion and acquisition of Pauwels, Crompton Greaves has the largest transformer manufacturing capacity.

MNCs on a stronger foot

Multinationals such as Areva T&D, ABB and Siemens are on a stronger foot due to their vast product range, project execution capability and the ability to rely on the parent company's expertise, portfolio and technology. These MNCs have reinforced their commitment to India and plan to invest more in expanding their product range. As this happens, competition could intensify in various segments.

Competitive scenario

Competition may not be a major challenge in the next couple of years. The sheer size of the capex could give space for players of various sizes to participate.

This is true for companies such as Emco and Bharat Bijlee, which operate at a capacity lower than Crompton Greaves or ABB. Moreover, in certain areas such as project execution, strict pre-qualification norms may limit competition. This could also maintain the margins for existing players in the near term.

But, in the longer run, competition may hot up and, hence, the pressure on margins could mount. Companies such as IVRCL, which have project execution experience in other sectors, are entering the power sector. This may force smaller players to forge alliances with bigger players for bidding or rely on subcontracts.

The big picture has never looked so good. The key happening to look forward to is the pace of implementation of the Eleventh Plan.

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