Bharat Electronics' strong rally has more steam left

Clarification over missile orders and business from EVM sales to boost earnings

Bharat Electronics Ltd's revenues not being dependent on economic vagaries positions BEL as a unique infrastructure-cum-defence play. Over a third of the market share in defence orders has also helped the BEL stock beat the S&P BSE Sensex convincingly (gains of 73 per cent in the last two years). 

Despite the run-up, analysts expect more legs to the rally. Those at Edelweiss believe BEL is all set to surprise the Street as order execution picks up, given improved revenue visibility and better capability in systems integration. They also point out how BEL has transformed from a sub-system company to a systems integrator.

As a result, in an environment of earnings downgrade, BEL has enjoyed 16 per cent earnings upgrade in past two years, Edelweiss points out. "Our confidence is much higher, given upcoming large systems orders on top priority for BEL," the analysts add. The revenue growth of 17 per cent demonstrated in FY17, going by its provisional data, has added to the Street's confidence. While finer details are awaited, Credit Suisse believes this performance is ahead of its FY17 growth expectation of 15 per cent. Order book at about Rs 40,000 crore (up 25 per cent year-on-year) provides BEL earnings visibility of over four years. The order book has also seen a meaningful increase in technologically critical products such as long-range surface-to-air missile (LR-SAM) for navy and Akash Weapon Systems for air force. Order inflow for FY18 is estimated at Rs 16,000 crore and expected to include such technology-intensive orders. 

Recent clarification by BEL's management that orders for LR-SAM are secure and orders for Akash are likely to come through by July, increases earnings comfort. The government's decision to procure a new set of electronic voting machines (EVMs) from BEL and Electronics Corporation of India will also boost order inflows by Rs 6,000 in FY18-FY19, providing an incremental operating profit support of Rs 300 crore in these years. With order book no more being an issue and concerns on execution dispelled since FY16, investors can expect an improvement in operating efficiencies.

 

Focus on local manufacturing has helped BEL expand its operating profit margins. These have risen from 10 per cent in FY13 to 18-19 per cent in FY17. More importantly, the trend is sustainable, given the thrust on local production. The near debt-free nature of operations should also support return ratios. 

Going ahead, analysts at Antique Stock Broking expect 15-18 per cent earnings growth in next three to five years, 27 per cent return on capital employed and, 19 per cent return on equity during this period. Consequently, they say BEL is poised for further re-rating. 

But, there are potential downsides as well. The possible impact of increased foreign participation in India's defence sector requires monitoring. Analysts say it could take four to five years for foreign players to dent BEL's dominance. Other risks include expected order wins getting delayed, which for now looks unlikely.

Trading at 23 times FY18 earnings, investors wanting to capture India's defence theme may pick BEL stock.