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CEA’s new advisory positive for domestic equipment companies

The Central Electricity Authority (CEA) has issued a new advisory for central and state thermal power generating companies for sourcing supercritical units from indigenous manufacturers. Back in 2010, the CEA had advised gencos to incorporate a condition for setting up phased indigenous manufacturing facilities in the bids to be invited for boilers and turbine generators of supercritical projects. The period of advisory expired in October 2015. Giving a shot in the arm to domestic equipment manufacturers, the CEA has now extended the advisory period by another three years, that is, till October 2018. Along with the extension, certain guidelines have also been modified.

A look at the changes in the guidelines and the impact on the sector….

Guidelines

As per the CEA, a foreign company is eligible to bid for supercritical projects provided it has registered a subsidiary Indian joint venture (JV) company for manufacturing supercritical equipment in India. In that case, the bidder must maintain a minimum equity participation of 51 per cent in the subsidiary or a minimum 26 per cent in the JV company during the lock-in period of seven years.

Indian equipment manufacturing companies are eligible to bid if they have experience of 500 MW supercritical boilers or turbines and a valid ongoing collaboration and technology transfer agreement.

In the changes proposed, the CEA has removed the clause that requires bidders to furnish a deed of joint undertaking (DJU) in case certain criteria are met. (As per the DJU clause, all executing parties – the bidder, the technology provider, Indian manufacturers and the Indian promoter of JV – are jointly and severally liable to the procurer for successful performance of the contract.)

The criteria required to be met are that eight supercritical boilers (or turbine generators) manufactured and supplied in India by the bidder are already in commercial operation. Out of these eight, four boilers or turbine generators should be in commercial operation for at least one year. Further, performance guarantee tests should have been successfully completed in any two boilers or turbine generators.

Impact

Even though the advisory is applicable to only central and state utilities, and private sector firms are free to choose from BTG suppliers, the changes are expected to have a positive impact on equipment providers.

“At a time when most fresh equipment orders are expected to come from central and state generating companies, the extension of timelines is a major positive for BTG manufacturers,” India Ratings noted in a statement.

Further, the changes in the DJU clause are also expected to positively benefit the gross margins of equipment manufacturers, especially state-owned Bharat Heavy Electricals Limited (BHEL).

According to India Ratings, “Under the DJU clause, the domestic manufacturer has to furnish a guarantee from one of the collaborators, a large international technology company such as Siemens AG/Alstom. In order to provide guarantees, collaborators have been taking a higher share of the orders, thus impacting the gross margins of boiler, turbine and generator manufacturers.”

In recent years, BHEL’s gross margins have been under pressure because of increasing revenues from the engineering, procurement, contracting business and supercritical projects, both of which churn out lower profit margins. Further, a slowdown in the end-user industries has led to slow project execution and higher working capital, thus further dragging down profits.

BHEL’s order book now has supercritical set contracts with DJU clauses, thus the gross margin expansion in India Ratings’ opinion is some time away. The execution of the new projects without the DJU clause will begin to reflect in the gross margins only once BHEL wins new projects. Also, the overhang of the slow-moving order book, high employee costs, lower ordering activity given the subdued PLFs, limited participation from the private sector and stretched working capital cycle will continue to weigh on the overall financial profile of the company.

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