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Bharat Electronics' (BEL's) stock price is down 25 per cent over the past three months due to contraction in earnings, coupled with the delay in order booking of a few projects. Yet, analysts have upgraded the stock citing BEL’s good prospects on account of the expected orders as well as earnings growth. India’s budget for defence equipment, for instance, has increased by 9 per cent for FY19. This will benefit platform developers and system integrators, undeniably BEL. Around half the project cost is electronics and software, and BEL's share is 45-50 per cent.
Strong order flow in FY19
BEL received orders worth Rs 100 billion, down 42 per cent, in 2017-18 and lower than the estimates of Rs 160 billion, taking its order book (orders pending execution) to Rs 403.50 billion at end of February. But, the timely execution has enabled BEL report revenue of Rs 100 billion in 2017-18 from Rs 88.25 billion in 2016-17. Of the revenues, about 85 per cent is from defence and balance 15 per cent is from civilian applications.
However, as the price negotiations for the Akash missiles order are complete, BEL should receive the final order shortly. Besides, orders for long-range surface-to-air missile (Rs 60-70 billion), EW Samyukta (Rs 10 billion), Commander Thermal Imagers, quick reaction surface-to-air missile (QR SAM) and Akash (Army; two regiments) are in pipeline. Analysts at Motilal Oswal Securities, thus, estimate new orders of Rs 180-190 billion for BEL in 2018-19.
The company is also venturing into the manufacturing of ammunition; this is a logical extension, given that it is already making fuses. It is also setting up two factories in Andhra Pradesh at a cost of Rs 25 billion.
M V Gowtama, BEL's Chairman and Managing Director expects 12-15 per cent annual growth in revenue to Rs 150 billion in the next three years.
Competitive landscape
On competition, while the Centre's Make In India initiative is yet to see traction in the defence sector from private players, analysts say BEL has good prospects.
“Currently, most of the large defence contracts are awarded to defence PSUs (BEL, HAL, etc) on nomination basis. And, opening up of the sector for private companies via strategic partnership model, Make In India programmes, among others, are unlikely to change this in the medium term,” say Edelweiss Securities’ analysts led by Amit Mahawar.
While the odds are still in favour of PSUs, BEL nevertheless has strengthened its capabilities by increasing research and development (R&D). It spends about 9 per cent of sales on R&D for developing new products, which accounts about 25 per cent of its turnover. With R&D spend likely to rise to 12 per cent of sales, new product development is likely to gain momentum. Around 87 per cent of turnover is currently from indigenously developed products/systems. Gowtama says the growth will be faster if the Centre's policy is more supportive of the Make In India programme. He wants removal of customs duty.
Some volatility in margins
BEL reported strong earnings before interest, tax, depreciation and amortisation (ebitda) margin of 20.5 per cent for FY17, mainly due to a reduction in material consumption because of commodity price correction and indigenisation initiatives. While FY18 may end with slightly lower margin of 19.7-19.8 per cent due to high salary bill in the fiscal year’s second half, these should rise to over 20 per cent thereafter, estimates Edelweiss.
However, BEL is transforming from a pure product-selling company to one that takes the contract as a system integrator. Though this has increased its revenue and order inflow outlook, margins may see some pressure as the profitability of purchased equipment is not as high as its own products. Yet, some analysts, however, say despite the execution of low-margin orders like electronic voting machines (BEL is one of the two suppliers) and LR SAM, higher margin orders like Akash missile systems will be supportive.
Exports, a potential area
Last year, BEL exported $30 million worth of products. To accelerate growth, Gowtama says BEL is targeting Indian Ocean regions and will set up new offices outside India (first one in Vietnam will be inaugurated in one-two months). BEL wants 5-10 per cent of its revenue from exports, compared to 3 per cent now.
Recently, BEL joined hands with L&T and Mahindra Defence to cater to domestic and export markets. BEL has an export order book of $93 million at end of February 2018, including offset order book of $19 million.
