Bharat Electronics Ltd – Riding the defence wave

Bharat Electronics Ltd (BEL) is a government owned leading defence electronics company. Set up in 1954, BEL now produces state-of-art equipment in defence communication, radar, naval systems, electronic warfare, electro optics, and C4I systems. It also manufactures civilian products such as electronic voting machines. BEL has a strong manufacturing base with nine factories across India. 47% of its 9,700 employees are scientists/engineers and it invests 7-9% of its annual revenues on R&D.
BEL will be a major beneficiary of GoI’s higher focus on ‘Make in India’ and higher indigenous procurement. GoI plans to bring down import dependence to 30% from current 60%. With a planned capex of ~Rs.2300 crore between FY17-21, BEL is well placed to capitalize on the emerging defence sector. Further, under the new defence procurement policy, a new category called Buy Indian (Indigenously Designed, Developed and Manufactured – IDDM) was introduced, having the highest priority in procurement which will provide higher opportunities for domestic players and improve domestic R&D investments.
BEL has a strong balance sheet with no debt and cash balance of ~Rs.3800 crore with a strong order book of ~Rs. 40,000 crore which is 4.6x FY17 sales, providing strong revenue visibility for next 4 years. With moderate capex plans (Rs.2300 crore over five years which is lower than the current cash balance) and demand growth revival, capacity utilization levels are expected to improve leading to stable return ratios.
Over the past fifteen years, while BEL’s total employee base has reduced by 30%, the proportion of its technical employees (scientists and engineers) increased to 47% from 9% of its workforce. Typically, its employees have an average experience of >10 years, and this has enabled the Company to not only restrict loss of knowledge upon retrials, but also allowed it to adopt new technologies.
BEL has historically worked closely with India’s defence laboratories, especially on projects in radars, electronic warfare, and missile systems. In FY16, products co-developed by BEL and DRDO accounted for 47% of its revenues. This relationship helps BEL stay ahead of the curve on future products that the armed forces require.
BEL has a supply chain of more than 13,000 vendors. Such a deep vendor base is a competitive advantage against relatively new private sector players, who will require continuity in orders and over 5-10 years to develop such a supplier base.
In the Defence Budget in India the ratio is skewed towards upgrading existing products to manage technology obsolescence (60%) due to inadequate budgets for new products (30%) and state-of-art research (10%). It is typically the other way around in developed countries which spend more on new products & research. Due to BEL’s involvement in the 1st generation version of most radar, communication systems, and electronic warfare systems, it becomes a beneficiary of system upgrades, which typically account for 30-40% of its annual order inflow. This piece of the business is mainly free of competition.
BEL has outlined a capex of Rs.2300 cr over FY17-21 vs. Rs.1500 cr incurred over FY12-16. It has envisaged a major investment of Rs.500 cr for a defence-system integration facility in Andhra Pradesh, which will enable BEL to expand its missile system business. In addition, the Company will adopt a new state-of-the-art XR5 technology for image-intensifier tubes to be used in passive night-vision devices.
In Q4FY17 BEL reported revenues of Rs.4074.3 cr, up 22% YoY, EBITDA of Rs.979.6 cr, up 8.1% YoY. EBITDA margins came in at 24.0%. PAT came in at Rs.791.7 crore, up 6.3% YoY. Q4 is typically the best quarter for the Company as for all capital goods/engineering companies.
BEL bought back 1.66cr shares at Rs.1305/sh in October 2016 & accordingly share capital outstanding was reduced to that extent. Further there was a 10:1 stock split in January 2017.
BEL should be a good long term investment. I recommend a monthly SIP in BEL over the next 2 years. Continuous order inflows and BEL’s track record in execution give us confidence about the stable performance of the Company. We value the Company at 25x FY19E EPS of Rs.8.42 and recommend a BUY with a target price of Rs.211/sh.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named 'The Tortoise' 

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