Highlighting key pillars of growth

Transcription

1 BSE Sensex S&P CNX 33,360 10, November 2017 Update Sector: Capital Goods Bharat Electronics CMP: INR179 TP: INR210 (+19%) Buy Stock Info Bloomberg BHE IN Equity Shares (m) M.Cap. (INR b)/(usd b) 434.9/ Week Range (INR) 193/116 1, 6, 12 Rel. Per (%) 3/3/23 AvgVal. INR m 744 Free float (%) 32.1 Financial Snapshot (INR Billion) Y/E Mar E 2019E Net Sales EBITDA NP EPS (INR) EPS Gr. (%) BV/Sh (INR) RoE (%) RoCE (%) Valuations P/E (x) P/BV (x) EV/EBITDA (x) EV/ Sales (x) Shareholding pattern (%) As on Sep-17 Jun-17 Sep-16 Promoter DII FII Others FII includes depository receipts Stock Performance (1-year) Highlighting key pillars of growth Four key drivers crucial for sales and earnings growth Post a sedate 5% CAGR in sales growth over FY11-15, growth accelerated to 15% over FY In our view, there are four key pillars crucial to BHE s sales and earnings growth over the next few years. We highlight these in this update. Success in large systems programs: BHE diversified into missile systems when it collaborated with the DRDO to develop the indigenous Akash Missile System for the Air Force, starting Thereafter, it has won repeat orders from the Air Force/Navy, the latest being orders for the LR SAM-Barack 8 Missile for the Navy. It has also partnered with the DRDO on the QR SAM Missile System, for which orders are expected from FY19, apart from the order for the Akash (seven squadrons) for the Air Force. BHE is also in the fray for the Tactical Communication System (TCS) and Battle Management System (BMS). Expansion of customer base with strategic partnership (SP) model and addition of private sector players to existing kitty of customers: With the successful implementation of the SP model, we expect BHE s customer base to be more diversified until now, it was primarily a sub-vendor to DPSUs that were making large platforms. Increase in exports from 5% of sales in FY17 to 10%: Exports, primarily to neighboring countries, is a key focus area and could double from the existing 5% of sales. These would typically occur under G2G contracts and the SE Asian countries targeted are Vietnam, Sri Lanka, Indonesia, Nepal and Myanmar. Retention of 60-65% share in defense electronics: BHE has enjoyed 60-65% share in the Indian defense electronics market. With more orders being opened up for the private sector, it is critical that BHE maintains its share and also grows the same. A few areas where we expect competitive intensity to rise are radars, optronics and communication devices. These are relatively low tech compared to other products and the levels of investment required are also lower. However, BHE has key moats in the form of (a) a large R&D team, with R&D spends at 9-10% of sales, (b) ability to service and upgrade defense supplies for the next years, and (c) existing large programs with the DRDO, which provide visibility for the next 3-5 years. Maintain Buy play on faster decision making/accelerated indigenization in defense We expect BHE to report EPS of INR7.1 in FY18 and INR8 in FY19. Our target price is INR210 (25x December 2019E EPS). Key triggers are accelerated decision making towards large defense procurements and increased indigenization. Key risks include a) Budget cuts for defense spending, b) Sharp increase in competition from the private sector. Ankur Sharma Research Analyst (Ankur.VSharma@MotilalOswal.com); Amit Shah Research Analyst (Amit.Shah@MotilalOswal.com); Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 Success in large systems programs critical Eying missile systems and large TCS/BMS programs BHE diversified into missile systems when it collaborated with the DRDO to develop the indigenous Akash Missile System for the Air Force, starting Thereafter, it has won repeat orders from the Air Force/Navy, the latest being orders for the LR SAM-Barack 8 Missile for the Navy. It has also partnered with the DRDO on the QR SAM Missile System, for which orders are expected from FY19, apart from the order for the Akash (seven squadrons) for the Air Force. BHE is also in the fray for the Tactical Communication System (TCS) and Battle Management System (BMS), both of which are being developed under the government s Make criterion. Missile systems targeting at least one USD1b order in FY18 Missile systems accounted for 20% of BHE s sales in FY17. In 4QFY17, it won a USD1b order for LR SAM and is targeting at least one of (a) Akash Missile System (seven squadrons) from the Air Force, or (b) LR SAM (for seven ships) from the Navy in FY18. Each of these orders would be worth USD1b. It has also successfully test fired the QR SAM system, for which orders are expected from FY19. Exhibit 1: Missile systems timelines of awards Description Awarded Service Akash Missile Systems FY09 Air Force Akash Missile Systems FY11 Air Force Akash Missile Systems FY12 Army LR SAM - IAI/BEL Q417 Navy Akash - 7th Squadron Q218 Air Force QR SAM FY19 Army Source: Industry, Company BHE is setting up a defense systems integration complex at Ananthpur in Andhra Pradesh, covering 900 acres. This facility will enable BHE to expand its missile systems program. The facility is being built in 3-4 phases, as various projects mature, with an investment of INR5b over 3-4 years. Tactical Communication System (TCS) prototype orders likely in FY18 The Indian Army s requirement of a modern tactical communication system is actually over two decades old, and with each passing year, this need has grown exponentially. This is especially so, as the Amy is hard pushed to accommodate existing and future war-fighting concepts encompassing among others (a) mobility and rapid dispersion, (b) intelligence surveillance and reconnaissance (ISR), (c) battlefield transparency, (d) exchange of information, ( e) speedy target acquisition, and (f) speedy decision-making. The project (christened TCS 2000) was originally scheduled to commence in the year 2000, but did not see light of day then. Later, it was rechristened TCS 2010, and it really started moving forward only from the year The TCS has been conceived as a robust, snoop-proof, mobile, cellular network for the Indian Army s voice and data communications during battle, allowing integrated communication between the battlefield and command headquarters. The scope of the project includes everything from cellular telephones to equipment sensors. The present estimated cost of the TCS is about INR100b (approximately USD1.8b). 20 November

3 After the announcement of TCS for the Indian Army in 2009, expressions of interest (EOI) were sent out to a number of domestic IT businesses, seeking a consortium to develop an indigenous communications system. There were strong pressures to award the contract outright to BHE, but better sense eventually prevailed, and the Indian Army s sustained recommendations of a level playing field for the DRDO, PSUs and private sector players were honored. The documents were sent to five private sector companies and three PSUs. These five private players are Tata Power s Strategic Electronics Division (SED), HCL Infosystems, Wipro Technologies, Rolta India, and L&T. Sensing a threat from PSUs, three private sector companies that were given separate invitations to bid L&T, Tata Power (Strategic Electronics Division), and HCL joined forces. In accordance with the Defense Procurement Policy (DPP), the government would select and fund two vendors, each of whom would build a prototype of the high-tech TCS. The government would then select the winner, who would be awarded the contract to build seven TCS for seven corps of the Indian Army. The two developers selected by the Ministry of Defense are BHE and the consortium of L&T, Tata Power (SED) and HCL. The TCS will be a fully mobile communications grid, which can be moved anywhere during war, providing an army corps a backbone network on which to communicate and transfer large volumes of data. The exchanges and switches will be installed in high-mobility vehicles, large data applications like video streaming will be possible, and security and ECM measures will be incorporated. The developers have reportedly submitted a detailed project report (DPR) defining every system, sub-system, and capability of the TCS. Development cost of the prototype is likely to be around INR10b, of which the government will fund 80%. Battle Management System (BMS) two contenders in the fray BMS consists of a wireless network that links digital devices carried by combat soldiers, interlinking them, their commanders and a range of battlefield sensors. This provides a common battle picture to each individual. The system, customized to the specific army requirements, needs to be first integrated and tested in a controlled environment, for which a test bed laboratory will need to be established. Phase-I of Project BMS, comprising test bed laboratory and field trials at test bed location of one combat group and three infantry battalion groups by 2012 has been inordinately delayed. Initially, three years were lost due to indecision within the Army concerning delimitation between the BMS and the Futuristic Infantry Soldier As a System (F-INSAS), under development by the Infantry and concurrent fallout in re-ordering of the feasibility study. In February 2015, the EoI for BMS was finally issued to 14 domestic companies. However, only two consortiums (1) Tata Power (SED) L&T, and (2) BHE Rolta India qualified the bids. In February 2016, the Ministry of Defense (MoD) signaled these two consortiums to develop a BMS prototype for the Army, which could eventually generate INR400b-500b worth of procurement. MoD has instructed both consortiums to register special purpose companies for this project. Each of these development agencies will separately develop a working BMS. 20 November

4 Each BMS prototype is to have four variants: one, for the infantry battalion group; two, for combat group (armor); three, for combat group (mechanized infantry), and; four, for special forces. Technologies to be included in each prototype are a geographical information system, multi-sensor data fusion system, rugged computing devices, and a software-defined radio-based communication system for soldiers. Under Make in India, the government funds 80% of the prototype development cost and the development agencies cover the rest. Prototype development is estimated at about USD300m, according to an executive of a domestic company participating in one of the consortiums. The development agencies are free to choose overseas partners for technical assistance but the eventual tender will only be awarded to the domestic companies under the Make in India category. The BMS prototypes will be developed and tested in the next 40 months; a final order of 600 plus such systems will then be placed for more than USD5.8b. Once fully developed and proved, the BMS will be able to receive and transmit data, voice and images from multiple sources, including radars, cameras, laser rangefinders and ground sensors, allowing the soldier on the battlefield access to real time information simultaneously with the commanders up the chain. It will be a critical element of the Army s NCW capacity building as part of the Tac-C communication system. 20 November

5 Strategic partnerships to help expand customer base To add private players to existing kitty of defense PSUs With the successful implementation of the strategic partnership (SP) model and more private sector participation in large platforms, we expect BHE s customer base to become more diversified. Until now, BHE was primarily a sub-vendor to Defense Public Sector Undertakings (DPSUs Naval Yards, Hindustan Aeronautics Limited, Ordnance Factory Boards) that were making large platforms. Exhibit 2: Key segments to be initially awarded under the strategic partnership model Description Units Value (INR b) Single Engine fighter aircraft 200 1,500 Submarines (P75I) Helicopters (Naval Utility) Future Ready Combat Vehicles/Battle tanks Source: MOSL, Industry BHE a partner of choice for players seeking entry in India s defense segment The MoD has given approvals for the INR217b naval project for 111 armed light utility helicopters. 15 units would be imported on a fly away basis while the balance 95 units would be made in India. This paves the way for the issue of the RFP to foreign vendors who would thereafter need to collaborate with Indian vendors in setting up a factory for the manufacture of the 95 naval helicopters. On Future Ready Combat Vehicles (FRCVs), which would replace the Arjun/T-72 tanks, global RFIs have also been issued, recently. This is a clear signal from the Army that it would not be accepting the DRDO-developed Arjun tanks and would be looking at the SP model for the FRCV projects. We expect orders for other segments submarines (also on the priority list; EoI has also been issued) and fighter aircraft also to start. The RFI for the fighter aircraft is expected to be issued by the end of CY17, with global majors SAAB, Lockheed Martin being the major contenders. While the process could take 1-2 years before the final awards are made, this would open up a new customer base for BHE these large platform manufacturers would be the new customer set for BHE over the next 3-5 years. Steps in the selection of Indian vendor and foreign OEM under SP model Issue of expression of interest (EoI) to Indian private sector companies for selection of strategic partners in identified segments Submission of response to EoI by applicant companies, indicating inter alia choice for segments in which they wish to participate Evaluation of the companies based on minimum qualification criteria Segment-wise verification of segment-specific criteria Shortlisting of companies meeting minimum qualification criteria for issue of segment-wise RFP Issue of segment-wise RFPs with DAC approval to shortlisted companies based on their options of segment submitted in EoI response 20 November

6 Submission of techno-commercial offer in response to RFPs by companies, in collaboration with one of the short-listed OEMs or in exceptional cases, with two OEMs in segments with diverse platforms Opening and evaluation of technical offer of the companies Conduct of field evaluation trials (FET) and staff evaluation Opening of commercial offers of companies that are technically compliant with the RFP, segment wise Selection of SP having the lowest bid, segment-wise, with DAC approval Commencement of contractual negotiations Finalization and signing of contract. Defence opportunity pie at INR14t; primarily large platforms In our view, defense spending on major programs/platforms could total ~INR14t over the next decade, with the Army at INR6t, Navy at INR2.1t, and Air Force at INR5.2t. Exhibit 3: Overall Defense spending on major programs at INR14t over the next decade Description INR t Aircraft 5.2 Navy 2.1 Army 6.0 Integrated Security 0.3 Total (INR b) 14 Source: MOSL, Company Exhibit 4: Indian Army s acquisition plans at INR6.6t Description INR b Artillery 360 Missile systems 950 UAV 60 Combat Vehicles/Tanks 2100 Miscellaneous 1700 Small Arms 220 Helicopter 60 Communication systems 750 Security Systems 350 Total 6,610 Source: MOSL, Company Exhibit 5: Indian Navy s acquisition plans under major programs at INR2.1t Description INR b Landing Platform Docks 200 Corvette 175 Next Gen missile carrier 120 Indigenous Aircraft Carrier 900 P 75I Submarines 1210 Total 2,095 Source: MOSL, Company 20 November

7 Exhibit 6: Indian Air Force s procurement at INR5.3t under major programs Description No Value Single Engine fighter aircraft 200 1,500 Twin Engine fighter aircraft Deck based fighter aircraft for Navy UAV/Aerostats AN32/Avro aircraft Airborne Warning and control systems Medium range maritime aircraft Medium heavy helicopters Light utility helicopters Naval utility helicopters Total 5,267 Source: MOSL, Company 20 November

8 Attempting to double contribution of exports Targeting friendly neighboring countries Exports, primarily to friendly neighboring countries, are a key focus area for BHE, which is attempting to raise the share of exports from 5% of sales in FY17 to 10%. It is looking at exports to Vietnam, Sri Lanka, Myanmar, Malaysia, and Egypt. These exports would be made under the government-to-government (G2G) route. Exhibit 7: Exports at ~5% of sales in FY17 6,000 Exports(INRm) % of total sales 7.6% 4,500 3,000 1, % 1.5% 1.8% 2.0% 2.9% 3.3% 3.0% 4.1% 5.4% 4.9% 0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Source: Company, MOSL Exploring exports of Akash Missile System to Vietnam BHE is exploring the option of exporting the Akash Missile System to Vietnam ( Wary of China, India is in active discussions to sell its Akash Missile System as also the Brahmos Supersonic Cruise Missile and Varunastra Submarine Torpedo to Vietnam. India offered Vietnam a USD500m credit line in September to buy defense products. Offsets another possible area for growth Offsets are also another area for growth for BHE, though this has not been very successful till date. Under the offsets clause, 30% of the contract has to be sourced from India unfortunately, foreign OEMs selling into India have used Indian companies to do very low tech work, with wafer-thin margins. In turn, BHE has restricted itself from taking on too many offset-related contracts and has been very selective in the type of offset jobs it does. 20 November

9 Retaining 60-65% share in defense electronics crucial Focusing on staving-off competition from private sector players BHE has enjoyed 60-65% share in the Indian defense electronics market. With more orders being opened up for the private sector, it is critical that BHE maintains its share and also grows the same. A few areas where we expect competitive intensity to rise are radars, optronics and communication devices. These are relatively lowtech and the levels of investment required are also lower. Exhibit 8: Sales break-up Description % of sales Radar 20% Radio Communication 10% Optronics 10% Missile Systems 20% Communication Network Electronic Warfare Systems 15% Services 10% Non Defence - EVM, Solar 15% Source: MOSL Competition rising, especially in optronics and communication The MoD is keen to stimulate private sector competition. To achieve higher indigenization, it is trying to promote more private sector participation in defense. Private companies would take 3-4 years to develop products, absorb technology, tie up raw material vendors, and set up manufacturing facilities. BHE is not impacted materially by the private sector, as its focus is on platforms (submarines, aircraft, artillery guns, tanks, warships). The impact of private sector competition will be felt more in areas of night vision devices, communication radios and networking equipment, which are relatively low-tech and require lower investments. Tata Power (SED) is focusing on these areas. However, BHE enjoys deep moats BHE has key moats in the form of (a) a large R&D team, with R&D spends at 9-10% of sales, (b) ability to service and upgrade defense supplies for the next years, and (c) existing large programs with the DRDO, which provide visibility for the next 3-5 years. In our view, 70-80% of BHE s current order book is on nomination basis and has a pipeline of INR500b; so, we see little threat for the next 5-6 years. 20 November

10 Exhibit 9: Key operating metrics (INR m) INR M FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E Order book 249, , , , , , , ,402 Y-o-Y growth -3.1% -6.0% -7.8% 48.1% 25.7% 13.7% 7.5% 8.2% Order inflow 52,425 42,300 51, , , , , ,335 Y-o-Y growth -32.7% -19.3% 21.3% 233.2% -4.6% 0.0% -5.0% 10.0% Execution 59,905 61,223 66,755 71,737 82, , , ,814 Y-o-Y growth 6.0% 2.2% 9.0% 7.5% 15.6% 30.1% 11.7% 7.7% Book to bill ratio (x) Revenues 59,905 61,223 66,755 71,737 82, , , ,814 Defence 51,882 52,087 56,075 59,541 68,028 87,399 97, ,149 Non Defence 9,156 10,668 10,681 12,195 14,933 20,501 22,893 24,665 Revenues Indigeniously developed NA 41.0% 38.0% 39.0% In association with DRDO, etc NA 44.0% 42.0% 47.0% Total Indigenous 78.0% 85.0% 80.0% 86.0% ToT from Foreign OEM's 22.0% 15.0% 20.0% 14.0% Revenues Domestic 58,340 59,232 63,111 66,042 78, , , ,389 Exports 1,782 2,510 3,645 5,695 4,290 5,577 7,250 9,425 Exports, % of Total 3.0% 4.1% 5.5% 7.9% 5.2% 5.2% 6.0% 7.3% Cost structure (% of Revenues) Raw material cost Employee Cost Other Expenses Provisions/write off R&D Expenses (INR M) R&D Expenses % to Sales Net cash/( Debt) (INR M) 53,025 45,644 58,815 71,653 37,735 57,047 64,809 74,008 Core NWC (Days) Customer Advances Reported NWC (Days) November

11 Financials and valuations Income statement (INR Million) Y/E March E 2019E 2020E Net Sales 61,038 62,755 68,427 73,278 86, , , ,251 Change (%) Manufacturing Expenses 41,739 40,241 41,937 42,670 48,600 64,965 74,914 81,334 Staff Cost 11,108 10,304 12,635 12,573 15,483 18,713 20,161 21,711 Office & Site Establishment Exps 1,767 3,299 2,422 4,319 4,418 3,655 3,962 4,191 EBITDA 6,425 8,911 11,433 13,716 17,617 22,777 23,773 25,015 % of Net Sales Depreciation 1,307 1,421 1,540 1,722 1,915 2,166 2,491 2,816 Interest Other Income 6,100 4,285 4,780 5,371 4,710 3,000 5,100 6,000 PBT 11,210 11,741 14,659 17,320 20,294 23,561 26,331 28,148 Tax 2,248 2,431 2,994 4,248 4,818 6,126 6,583 7,037 Rate (%) Adjusted PAT 8,962 9,310 11,665 13,072 15,476 17,435 19,748 21,111 EO Income (Net of Expenses) Reported PAT 8,898 9,316 11,672 13,072 15,476 17,435 19,748 21,111 Change (%) Balance sheet (INR Million) Y/E March E 2019E 2020E Share Capital ,400 2,234 2,234 2,234 2,234 Reserves 62,429 69,498 78,141 87,484 72,937 95, , ,912 Net Worth 63,229 70,298 78,941 89,884 75,170 97, , ,145 Loans Deffered Tax Liability -2,716-2,995-3,378-4,608-5,323-3,000-3,000-3,000 Capital Employed 60,513 67,304 75,565 85,276 70,014 94, , ,145 Gross Fixed Assets 20,732 22,267 24,852 28,627 33,331 38,331 43,331 48,331 Less: Depreciation 14,978 15,757 17,140 18,862 20,778 22,944 25,436 28,252 Net Fixed Assets 5,755 6,509 7,712 9,764 12,553 15,387 17,895 20,079 Capital WIP 1,614 1,969 1,398 4,297 6,563 6,563 6,563 6,563 Investments ,191 4,597 4,597 4,597 4,597 Curr. Assets 134, , , , , , , ,676 Inventory 32,711 33,701 34,269 41,775 49,050 62,715 69,948 75,325 Debtors 33,347 41,508 38,180 37,119 43,549 55,681 62,102 66,877 Cash & Bank Balance 53,025 45,644 58,815 71,653 37,902 57,047 64,809 74,008 Loans & Advances 14,382 12,164 7, ,030 1,149 1,237 Other Current Assets ,976 11,219 14,344 15,999 17,229 Current Liab. & Prov. 81,233 74,974 73,056 91,357 96, , , ,770 Liabilities 74,071 68,979 65,289 82,185 83, , , ,802 Provisions 7,162 5,995 7,767 9,172 13,003 16,625 18,543 19,968 Net Current Assets 53,024 58,705 66,263 68,022 46,301 67,786 76,786 86,906 Misc. Expenses Application of Funds 60,513 67,303 75,565 85,274 70,014 94, , ,145 E: MOSL Estimates 20 November

12 Financials and valuations Ratios Y/E March E 2019E 2020E Adjusted EPS Growth (%) Cash EPS Book Value DPS Payout (incl. Div. Tax.) Valuation (x) P/E (standalone) Cash P/E EV/EBITDA EV/Sales Price/Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE RoIC Turnover Ratios Debtors (Days) Inventory (Days) Fixed Asset Turnover (x) Cash flow statement (INR Million) Y/E March E 2019E 2020E PBT before Extraordinary Items 11,209 11,740 14,659 17,320 20,294 23,561 26,331 28,149 Add : Depreciation 1,307 1,421 1,540 1,722 1,915 2,166 2,491 2,816 Interest Less : Direct Taxes Paid 2,248 2,431 2,994 4,248 4,818 6,126 6,583 7,037 (Inc)/Dec in WC -19,994-13,062 5,614 11,080-12,031-2,340-1, CF from Operations -9,717-2,298 18,831 25,919 5,479 17,312 21,051 23,057 Extra-ordinary Income CF from Operations after EOI -9,781-2,292 18,839 25,919 5,479 17,312 21,051 23,057 (Inc)/Dec in FA -2,439-2,530-2,171-6,674-6,970-5,000-5,000-5,000 Free Cash Flow -12,220-4,822 16,667 19,246-1,491 12,312 16,051 18,057 (Pur)/Sale of Investments ,001-1, CF from Investments -2,439-2,530-2,242-9,674-8,376-5,000-5,000-5,000 (Inc)/Dec in Networth ,551-24,448 14, (Inc)/Dec in Debt Less : Interest Paid Dividend Paid 2,083 2,181 2,728 4,911 6,457 7,274 8,239 8,808 CF from Fin. Activity -2,481-2,559-3,427-3,404-30,856 6,834-8,289-8,858 Inc/Dec of Cash -14,700-7,381 13,170 12,841-33,753 19,145 7,762 9,199 Add: Beginning Balance 67,725 53,025 45,644 58,815 71,653 37,902 57,047 64,809 Closing Balance 53,025 45,644 58,813 71,656 37,900 57,047 64,809 74,008 E: MOSL Estimates 20 November

13 N O T E S 20 November

14 Disclosures: The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (herein after referred to as the Regulations). Bharat Electronics Motilal Oswal Securities Ltd. (MOSL) is a SEBI Registered Research Analyst having registration no. INH MOSL, the Research Entity (RE) as defined in the Regulations, is engaged in the business of providing Stock broking services, Investment Advisory Services, Depository participant services & distribution of various financial products. MOSL is a subsidiary company of Motilal Oswal Financial Service Ltd. (MOFSL). MOFSL is a listed public company, the details in respect of which are available on MOSL is registered with the Securities & Exchange Board of India (SEBI) and is a registered Trading Member with National Stock Exchange of India Ltd. (NSE) and Bombay Stock Exchange Limited (BSE), Metropolitan Stock Exchange Of India Ltd. 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