Bharat Electronics: Defensive, yet attractive

Improving prospects augur well for the company; the scrip is available at reasonable valuations

Bharat Electronics (BEL) could benefit further from a re-rating, backed by expansion of margins and improving order outlook.

A new government at the Centre is easing worries regarding new orders. In FY14, BEL saw a 20 per cent decline in new order inflow at Rs 4,200 crore. “Order inflow will improve, based on strong pipeline of Rs 75,000 crore worth of orders to be placed by defence forces over the next three years. Hence, we raise our FY15 order inflow estimate to Rs 10,000 crore (Rs 6,100 crore earlier),” says Bhavin Vithlani of Axis Capital. BEL has signed an MoU for turnover with the government for Rs 6,850 crore in FY15 (up 12 per cent year-on-year), he adds.

“We anticipate improvement in the pace of orders from the armed forces, given the government's mandate to quicken piled-up defence deals. This, along with an improving outlook, places BEL in a sweet spot,” says Rahul Gajare of Edelweiss Securities. Even assuming there is minor delay, BEL’s order backlog is still healthy at Rs 23,200 crore, about 3.7 times its FY14 revenue. This  provides growth visibility of two to three years.

Operating profit margins, which improved to 14 per cent in FY14 (10 per cent in the previous two years) on account of lower employee cost and execution of the high-margin Akash Missile System (AMS) order, could also rise further, as BEL is to deliver six units of AMS in FY15. Gajare, thus, has raised his estimated earnings for BEL for FY15 and FY16 by four per cent and 11 per cent, respectively. He maintains a 'Buy' rating with a revised target of Rs 2,250 (earlier Rs 1,387), valuing the stock at 16 times the price to earnings ratio (11 times earlier).

There are other triggers. BEL generates free cash flow of Rs 1,000 crore annually, as the business does not require high capex (the past two years’ capex was Rs 120-130 crore each). While part of it is distributed as dividends, the rest keeps adding to the cash kitty. By end-FY16, BEL is estimated to have accumulated cash of Rs 6,000 crore, equivalent to 40 per cent of its market capitalisation or Rs 750 per share.

On the other hand, at the end of FY14, its net worth stood at Rs 7,000 crore. If one excludes the cash and its impact on other income, the core business is generating a return on equity (RoE) of 25 per cent, against the reported 14 per cent. In this backdrop, the valuations look attractive, despite the recent run-up. Hopefully, this surplus money, too, should either get deployed in high RoE core business or be paid to the shareholders.

Currently, the stock is trading at 13 times FY16 estimated earnings, reasonable, considering the quality of BEL’s business model.