Report by JainMatrix Investments

BGR Energy Systems Ltd.

Date: December 2, 2011

CMP: Rs 269

Small Cap Market Cap 1952 crores

Advice: Invest at lower levels Target: 800 in 24 months

BGR Energy is a leader in the Power Plant EPC space. It has the execution capabilities, as well as the technology tie-ups/ production facilities for key components. However the industry headwinds have pulled down the business performance. Coal and Gas fuel linkage issues, poor financials among State Electricity Boards and high interest rates threaten investments in this sector. BGR shares have fallen sharply to current under priced levels, and may stay range bound at this level for 2 quarters. Thereafter the stock is expected to rise and recover lost ground. Warning Extreme volatility - this stock is not for the faint hearted.

BGR Energy Description and Profile

Water water everywhere, but not a drop to drink. For BGR, the line needs to be electricity shortages everywhere, but no orders for generation BGR Energy is primarily a Power Sector focused Engineering- Procurement- Construction (EPC) company. It builds Power plants for Utility companies and commissions and hands over the plant. Is Chennai based, with 2010-11 revenues of 4747 crores; market cap 1894 crores and 2200 employees. Power Plant work can be in a Turnkey EPC project mode, responsible for entire plant, or BoP (Balance of Plant) other than the BTG (Boiler Turbine Generator), or only BTG. BGR has domain capabilities in power, and the ability to plan, design, procure/ build, execute and commission projects. Thus experienced personnel are the main resource of this firm. Shareholding pattern is: Promoters Individual and Corporate: 81.1%, DII 5.1%; Bodies Corporate 1.9%; Individuals retail plus others 11.9%. Thus Promoters hold significant stake a good sign. By nature, the firm is paid in terms of milestones achieved in the project execution, so revenues tend to be lumpy. Also the Orders booked for this firm as a proportion of current revenues indicates the safety and visibility of the current business.

Strategies executed by BGR

BGR has extended its offerings to other verticals like Oil & Gas, Electrical projects (substations), environmental engineering projects and air fin coolers. In recent years, it has diversified into manufacture of BTG as well as key technology components with partners/ JVs, thus capturing a larger share of the Turnkey project budget. This also gives it an edge in terms of cost and timely execution of projects. It has set up a number of collaborations, subsidiaries and JVs to assemble the Plants and machinery:
o

With Hitachi, it has Turbine and Boiler JVs. These two firms are setting up manufacturing facilities in Tamil Nadu, near Chennai

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BGR Energy: Invest at lower levels

o

December 2, 2011

Group companies with GEA Energietechnik of Germany give access to Cooling systems technologies and specialized tube cleaning systems Other group companies Progen Systems - focuses on Design and manufacture capability for Process equipments. Also Cuddalore Powergen Corp Ltd is for setting up a Power Plant.

It can be seen that BGR is over time going to straddle the entire Power Plant lifecycle, from BoP to EPC to BTG/ key components manufacture, to the Plant Operator (Generation) and the Utility play.

Industry Note: Classification of Indian Industry players

o o

Power Industry is at a high level divided into Generation, Transmission and Distribution. The Public sector dominates the industry, owning 70-80% of current assets. However the government is opening up to the Private sector. In future, 50% of investments are expected to be from Private investments The key players in the Power Plant EPC market are NTPC, BHEL, L&T, and AIA Engineering. But it is a crowded market. The competition now includes Reliance and Tatas. Sub-segments are BoP and BTG manufacturers. Chinese manufacturers of BTG have a price advantage in India compared to locals. This anomaly should soon be corrected by the government.

The government has just come out with an order compelling open access, in line with the Electricity Act, 2003. This will allow all consumers of >1 MW freedom to choose the supplier, and only inform their current distributor. This will be a game changer for the Power industry if correctly implemented.

Stock valuation, performance and returns

BGR Energy had its IPO in Dec 2007. In a blockbuster offering, it was oversubscribed 119 times. Hoping to generate 438 crores, they attracted 52,000 crores. However, from its IPO price of 480, it has now fallen to 268 a fall of 14% per year. See Fig 1.
Investment and Dividends 600 500 400 300 200 100 2 0 -100 -200 -300 -300 -400 -500 -480 -500 2007 2008 2009 2010 2011 100 -100 3 7 500 10 300 900 700
Closing price for year

BGR Systems - Equity

CMP
Investment + Dividends

BGR Energy has given initial IPO investors a -14% return CAGR over the last 4 years

Fig 1 Investments and Returns

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BGR Energy: Invest at lower levels

December 2, 2011

Quarterly Sales and Net Profits

Sales - Crores 1800 1600 1400 1200 1000 800 600 400 200 40 0
Sales Turnover EBITDA Net Profit

EBIDTA and Net Profit - Crores 240 200 160 120 80

March quarter figures are highlighted

Fig 2 Quarterly Sales and Profits

As compared to share price, we can see that in the last 4 years, sales have grown at an average of 57% CAGR. See Fig 2 Quarterly Sales and Profits. Both EBITDA (53%) and Net Profits (69%) are growing rapidly.
EPS and Cash Flow
Cash Flow Crores 400 45 300 35 25 15 5 0 -5 -100 -15 -25 EPS Net Cash From Operating Activities EPS - TTM

200

100

Cash from operating activities is unpredictable and lumpy Annualised EPS is up 57% CAGR over the last 4 years

-200

Fig 3 EPS and Cash Flow We can see from EPS and Cash Flow Fig 3, the unevenness of the business model of BGR. Cash flow is unpredictable and lumpy. http://jainmatrix.com/

Report by JainMatrix Investments Ltd.

BGR Energy: Invest at lower levels

December 2, 2011

EPS however is growing fast at 57% CAGR. Again this is a good data, but from a low base.

Gross Debt - crores

2500 2000 1500 1000 500 0 Mar '10 Sepy '10 Mar '11 Sept '11

Fig 4 Gross Debt An important ratio for BGR analysis is the Orders booked to Revenues ratio (BTB). This has shown a cyclical nature, and by indications, is on an upswing now.
Orders Booked to Revenue ratio
Orders Booked Crores 14000
Revenues TTM

Bookings to Billings ratio 6.0

12000 10000 8000

Order Booked Position Booked to Bill ratio

5.0 4.0 3.0

6000 4000 2000 0 2.0 1.0 0.0

Fig 5 Orders Booked to Billings chart Debt is the big issue with BGR. It has increased significantly in the recent past. Gross Debt also stems from two sources Net working capital and Debtors. o Working capital increased from 103 days (end FY11) to 206 days (end 2QFY12). This could be due to execution delays across the ongoing projects. Debtors went up from 243 days (end FY11) to 341 days (end 2QFY12). This was due to a sharp rise in Retention Money, which was 1300 crores (end 2QFY12). Of this 900 crores is due to projects under execution and 400 crores against completed projects v/s 1100 crores (end FY11).

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BGR Energy: Invest at lower levels o

December 2, 2011

Retention Money is generally Bank deposits/guarantees for performance on projects. The completed project - Debtors is certainly payment issues faced from some customers, possibly State Electricity Boards that are themselves in financial stress. BGR expects debt to fall from 2300 crore (see Fig 4) to 2000 crores by the end of FY12 as the retention money is realized. And Debt equity is expected to increase from 1.4 (FY11) to 2 (FY12 end Estimated).

Financial Projections, with FY14 estimates

The financials and PE of BGR has been projected for the next 3 years. See Exhibit 6.
Mar '08 Sales Turnover - crores Growth % EBITDA - crores Growth % Net Profit - crores Growth % Earnings Per Share - Rs Growth % PE (at current Price) 127.5 115.4 11.7 36.3 80.7 84.4 36.3 15.9 74.7 1504.8 94.1 155.5 51.5 115.1 Mar '09 1922.1 27.7 235.6 Mar '10 3073.8 59.9 368.0 56.2 201.0 74.7 27.9 61.3 Mar '11 4747.0 54.9 559.0 51.9 324.0 61.2 44.9 -16.3 7.0 -1.6 271.0 -16.4 37.6 51.3 4.6 51.3 56.9 34.1 3.4 4.0 550.0 41.8 410.0 34.1 76.3 Mar 12 E 4950.0 Mar '13 E 6500.0 31.3 780.0 23.1 550.0 Mar 14 E 7900.0 21.5 960.0

Exhibit 6 - Key Financials and Projections

Market Price
1000

Price and PE chart

CMP PE

Price Earnings
40.0

900

35.0

800 30.0 700 25.0

600

500

20.0

400

15.0

300 10.0 200 5.0

100

0.0

Fig 7 Price and PE Trends Report by JainMatrix Investments Ltd. http://jainmatrix.com/

BGR Energy: Invest at lower levels

December 2, 2011

The current PE of BGR Energy is 6.7, below the industry average of 9.9. The average PE in the last 4 years has been 17.5. Certainly today BGR is at the lower end of the pricing range. The Price and PE chart Fig 7 - shows that the successful IPO gave big valuations, but this fell rapidly in the 2008-09 global financial crisis. The view of the EPS chart Fig 8 shows that EPS continued its rise thereafter, and the share price smartly recovered, only to fall again in this current situation. Certainly the fall in share price is very steep compared to EPS, so the share is today underpriced. The EPS of BGR is on a growth path, and is expected to stay in the defined Trend line range.
Price
900 850 800 750 700 650 600 550 500 450 400 350 300 250 200 150 100 50 3.00 8.00 18.00 13.00 23.00 28.00 33.00

Price and EPS Chart

CMP EPS

EPS
48.00 43.00 38.00

Fig 8 Price and EPS Trends

Risks:

Industry: 3-4 years ago the Electricity sector was the darling of Entrepreneurs and Investors. The yawning gap between demand and supply gave a demand assurance. Investors believed that they will be able to sell power at Merchant rates, and planned for large generation addition. Government too encouraged this with the Electricity Act, 2003 that threw open the sector to Private investors. o Today systemic flaws are appearing in the sector. There is financial stress among Utilities, particularly State Electricity Boards that are facing Tariff inflexibility and Collection issues. o Power Plants in India are facing an issue with fuel linkages and a shortage of Coal/ Natural Gas. This has affected the investment climate in this sector. The projects under execution by BGR may also be affected, and execution/commissioning may be delayed. Project execution delays due to government clearances like environmental, land acquisition, etc.

Interest rates increases in the Indian economy are certainly impacting the balance Sheet of BGR BGR: BGR is certainly facing a shortfall in Order Bookings due to this environment. However, as seen in Fig 5 this is reversing, and we expect recovery in the next 6-12 months. Vertical focus Risk, as revenues are essentially from the Power Gen. vertical. However, this is being addressed by BGR extending its EPC, manufacturing and technology strengths to other verticals. http://jainmatrix.com/

Report by JainMatrix Investments Ltd.

BGR Energy: Invest at lower levels

December 2, 2011

BGR share has fallen by 67% from 843 in Sept 2010 to todays 270. This is massive value destruction. It is partly because BGR has also been in the news for all the wrong reasons in the last 12 months:
o

In Nov10, BGR was in the news for a Finance bribery scam. The company clarified that it has no dealings with LICHF and Money Matters, and cooperated with the authorities. In Oct 2011, BGR received a notice from the Central Excise Department, for tax evasion of Rs 107 crore. The company is confident that it has not evaded taxes, and will clear these charges.

Opinion, Outlook and Recommendation

India has a surging growth in electricity demand, and there is a 9-13% power deficit today. This will widen in the next few years. As a leading EPC company, BGRs fortunes are closely linked to the improvements in the regulatory environment and overall industrial climate of the Indian power sector. In a stable environment, BGR should perform excellently based on current skill sets and manufacturing and execution capacities. The core undeniable strengths of BGR will take around 2 quarters to emerge in the form of business metrics like Orders booked, billings, profitability and EPS, as the government addresses industry systemic issues. BGR also needs to repair the Balance Sheet and manage the debt levels. A good sign is that Merchant power rates are now on the upswing in India. FY2011 was an excellent year, and BGR will not be able to show any significant improvements in FY12. However the demand gap will catch up, and FY13 will be a good year for BGR. BGR is a High Risk, High Gain stock. Share may even fall from current levels. Investors with a risk appetite and a 2-3 year time horizon can accumulate BGR at 220-270 levels over next 6 months. The 24-month projection (Sept 2013), for BGR is Rs 800, a 310% appreciation from CMP.

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Report by JainMatrix Investments Ltd.

http://jainmatrix.com/