Accounting changes power BHEL growth

Strong results notwithstanding, the stock of BHEL took a beating, declining 6.7 per cent on close of Monday's trade. The 5 per cent disinvestment proposal recommended by the board appears to have triggered the decline. Previous divestment offers have seen the stocks battered in the run-up to the offer with the follow-on offer price turning out to be much lower than market price.

The published results of BHEL had very minor variances for the March 2011 quarter compared with the ‘flash' results announced on April 4. Net sales for the March quarter expanded 32 per cent to Rs 17,921 crore compared with a year ago. Net profits surged 46.5 per cent to Rs 2,798 crore over the same period.

The company's 26 per cent increase in net sales and 39 per cent increase in net profits for the full year ended March 2011 over a year ago was partly aided by changes in the company's accounting policies.

Accounting policy changes

For one, the annual turnover increased Rs 2,772 crore (6 per cent of sales) as a result of a change in accounting for provision made for warranties in respect of construction contracts. The company earlier followed a policy of creating a provision of 2.5 per cent of the contract value and deferred the warranty provision as well as the corresponding revenue until completion of trial operation. This has now been changed to providing warranty costs at 2.5 per cent of revenue progressively as and when the revenue is recognised. Accounting for this change, revenue as well as fresh provisions were higher. The sales growth eliminating this change was at a more sedate 19 per cent. However, given that this policy is going to be followed in future as well, the same has to be construed as a recurring event.

Similarly, the company has changed its policy on accounting for leave liability for employees to actuarial basis from accrual basis, and also changed its method of depreciation on cranes, based on their useful life. This has reduced the depreciation charged.

The above three changes together resulted in increasing the company's profit before tax for FY-11 by a good Rs 983 crore. Eliminating these, profits before tax grew by a still healthy 22 per cent. However, given that these are policy changes and not one-off adjustments, their impact would be recurring and hence have to be considered for future financial performance.

Net of the above impacts, raw materials consumed to sales declined by about 1.3 percentage points for FY-11 compared with a year ago. Despite cost controls, the competitive environment at present may not help the company keep up its operating profit margins at current levels of 20 per cent.

Sedate order intake

BHEL's order intake for the whole year, up by only 2.5 per cent, does cause concern. However, deferment of large orders such as the NTPC's bulk tender appears to be the key reason behind this. FY-12 can see some action on this front. Notwithstanding the slowdown, BHEL's order book at Rs 1,64,100 crore was a good 3.8 times FY-11 sales.

What comes as a cause for concern is the increased domestic competition. In this regard, the recent tie-up of Alstom with Shanghai Electric, wherein the joint venture would use Alstom's existing Indian unit can change the equation for BHEL on account of the following: one, BHEL has a technology tie-up with Alstom for super-critical boilers. If it does have a non-compete agreement, then the JV may come under dispute. If not, the venture may turn out to be a formidable competition for all domestic players for a couple of reasons: one, it would address the critical after-sales support that Chinese players were accused of not providing.

Two, it would also address technology issues, given that Alstom is known for superior technology. The formidable combine holds potential to erode BHEL's market share over the long term.

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