Bharat Electronics Ltd Bloomberg Code: BHE IN

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1 Industrials - Aerospace & Defense - Aircraft & Parts Oct 13, 215 Bloomberg Code: BHE IN India Research - Stock Broking Mirroring India s Defence Ambitions Turnaround for BEL on the backdrop of Government s thrust towards reform in defence manufacturing sector: BEL will be beneficiary from the government s reform towards promoting self-reliance, indigenization, technology up-gradation and achieving economies of scale under Make-in-India initiative and developing capabilities for exports in the defence sector. Strong order book gives revenue visibility during the next couple of years: BEL s order book as on 1st April 215 stood at Rs mn which is more than 3x annual revenues, gives revenue visibility. With this huge order book size, BEL s management has set target to cross turnover of Rs.74 mn during FY16E. On the backdrop of strong order book, we expect the revenue to grow at a pace of 7.8% CAGR and EBITDA to register a CAGR of 14.2% during the FY14-17E. Thrust on exports to assist incremental revenue growth: BEL is also anticipating sizable export orders on account of the Offset policy in defence procurements. BEL has long term export plan which would contribute 1% of total sales from the current level of 5.5%. Strong R&D to meet the technology demand: BEL has well established R&D base with technology absorption and design capability to meet the technological demands through in-house R&D and strategic technical tie-ups with global players. Valuation and Outlook Policy footprints in defence manufacturing sector which emphasises in indigenisation efforts could provide great opportunity for BEL. Backdrop of healthy order book and orders in pipeline, thrust on exports and with 8% of its revenues from defence sector could provide incremental EPS at CAGR of 13.7% during FY14-FY17E. At CMP of Rs. 1187, we recommend a BUY with a target price of Rs.14, representing 24x FY17E EPS, representing an upside potential of 18%, in a time horizon of 9-12 months. Key Risks ydefence manufacturing sector may came out of strong hold of PSU and increased competition from private participation. BUY Recommendation (Rs.) CMP 1187 Target Price 14 Upside (%) 18 Stock Information Mkt Cap (Rs.mn/US$ mn) / wk High/Low (Rs.) 1387 / 66 3M Avg. daily volume (mn).5 Beta (x) 1.2 Sensex/Nifty / 8132 O/S Shares(mn) 24 Face Value (Rs.) 1. Shareholding Pattern (%) Promoters 75. FIIs 4. DIIs 14.7 Others 6.3 Stock Performance (%) 1M 3M 6M 12M Absolute Relative to Sensex Source: Bloomberg Relative Performance* Oct-12 Oct-13 Oct-14 Oct-15 BEL Sensex Source: Bloomberg; *Index 1 Exhibit 1: Valuation Summary (Rs. Mn) YE Mar (Rs. Mn) FY13 FY14 FY15 FY16E FY17E Net Sales EBITDA EBITDA Margin (%) Adj. Net Profit EPS (Rs.) RoE (%) PE (x) ; *Represents multiples for FY13, FY14 & FY15 are based on historic market price For private circulation only. For important information about Karvy s rating system and other disclosures refer to the end of this material. Karvy Stock Broking Research is also available on Bloomberg, KRVY<GO>, Thomson Publishers & Reuters Analyst Contact Joyjit Sinha joyjit.sinha@karvy.com 1

2 Company Financial Snapshot (Y/E Mar) Profit & Loss (Rs. Mn) FY15 FY16E FY17E Net sales Optg. Exp (Adj for OI) EBITDA Depreciation Interest Other Income PBT Tax Adj. PAT Profit & Loss Ratios EBITDA margin (%) Net margin (%) P/E (x) EV/EBITDA (x) Dividend yield (%) Balance sheet (Rs. Mn) FY15 FY16E FY17E Total Assets Net Fixed assets Current assets Other assets Total Liabilities Networth Debt Current Liabilities Other Liabilities Balance Sheet Ratios RoE (%) RoCE (%) Net Debt/Equity... Equity/Total Assets P/BV (x) Exhibit 2: Shareholding Pattern (%) Company Background (BEL) is a Navaratna central public sector enterprise engaged in the manufacturing of advanced electronic products for the Indian armed forces. BEL is the largest production partner of Defence Research and Development Organization (DRDO). It manufactures electronic communication equipment, night vision equipment such as image converter tubes, night vision binoculars, periscopes, gunsights and tank electronics. It also manufactures Electronic Voting Machines (EVMs), products for e-governance, homeland security, civilian radars, solar products, electronic components as well as telecom broadcast systems. BEL is also one among the 8 PSUs under the Ministry of Defence. BEL is the lead integrator of Akash, the Indian-made guided missile air defence weapon system. It has 9 manufacturing plants at Bangalore, Ghaziabad, Pune, Machilipatnam, Chennai, Panchkula, Kotdwara, Hyderabad and Navi Mumbai. BEL has a subsidiary BEL Optronic Devices Ltd (with 92.79% equity share) and has JVs with BEL Multitone Pvt Ltd (49% share) and GE BE Pvt. Ltd (26% share). Cash Flow (Rs. Mn) FY15 FY16E FY17E PBT Depreciation Interest (net) Tax (3556) (349) (418) Changes in WC (123) Others (329) (4214) (4681) CF from Operations Capex (2272) (537) (548) Investment (1) Others (6115) (4933) (4426) CF from Investing (8388) (547) (4974) Change in Debt 248 () Dividends (22) (282) (282) Interest and Other cost (141) (213) (22) CF from Financing (293) (333) (34) Change in Cash Exhibit 3: Geographical Revenue Segmentation (%) FIIs 4.% Promoters 75.% DIIs 14.7% Domestic 94.6% Others 6.3% Export 5.4% Source: BSE, Karvy Research 2

3 Government s thrust towards reform in defence manufacturing sector provides great opportunity to BEL to uphold its robust order book: Government s emphasis on Make-in-India initiative in defence sector provides great opportunity to BEL. Defence Production Policy (DPP) encourages indigenous manufacture of defence equipment. It prefers BUY (Indian) and BUY and MAKE (Indian) over BUY Global. Government s new campaign for Make in India which envisages increasing the manufacturing from 15% to 25% percent of GDP. For FY16E, defence budget comes in the backdrop of this optimistic macro-economic outlook wherein it is staged to see a decent growth in the key indicators of the Indian economy. There has been an increase in the defence budget from Rs.229 Bn to Rs.2467 Bn which is an increase of 7.7% compared to the previous budget. Being defence is BEL s main business and close to 8% of its revenues comes defence sector, Make in India initiative and indigenisation efforts would give them great opportunity to enhance their order book in the defence space. BEL has been signing Memorandum of Understanding (MoU) every year with the Government of India, Ministry of Defence. Strong order book gives a visibility on earnings for next couple of years: BEL s order book as on 1st April 215 stood at Rs mn which is more than 3x annual revenues, gives revenue visibility. With this huge order book size, BEL s management has set target to cross turnover of Rs.74 mn during FY16E. On the backdrop of strong order book, we expect the revenue to grow at a pace of 7.8% CAGR and EBITDA to register a CAGR of 14.2% during the FY14-17E. Its segments like Radar and Missile systems, Communication and Network Centric Systems, Tank Electronics, Gun upgrades & EO systems and Electronic Warfare & Avionics systems will continue to drive the company s growth in the coming 4 to 5 years. Capacity enhancements and creation of new test facilities help the company in achieving the targeted growth. Sensing growth opportunity in the civil segment, BEL is pursuing business in the field of Homeland Security, Smart cards and Smart City elements. Strategic collaboration /MOUs with foreign players could open opportunities for export: BEL is also anticipating sizable export orders on account of the Offset policy in Defence Procurements. BEL has long term export plan which would contribute 1% of total sales from the current level of 5.5 %. BEL has record export turnover of US$ 66.93mn during FY15 and registered significant growth of 37.7 % over FY14. BEL has an export order book which stood at US$2 mn as on 1st April 215 including offset order book of US$ 44 mn. In this regard, BEL has dedicated business unit and marketing group for exports. It has strategic alliances with global OEMs (Original Equipment Manufacturers) like Elbit, IAI, Thales and SAAB for joint development / co-production. It focuses on South East Asian countries for Communication, Sonars and Coastal Security solutions. Strong in-house R&D likely to boost product portfolio and sales: BEL has well established R&D base with technology absorption and design capability to meet the technological demands through in-house R&D and strategic technical tie-ups with global players. Its R&D spending is around 8% of turnover. Its 85% of the sales revenue is from indigenous developed products and around 8 new products introduced every year. BEL is the largest production partner of DRDO and its R&D centre is recognised by Department of Scientific and Industrial Research (DSIR). BEL might get tax incentive for its research programme. For the companies who engage in the manufacture of an in-house R&D centre, a weighted tax deduction of 2% towards both the revenue and capital expenditure under Section 35 (2AB) of the Income Tax Act, It might decrease the tax burden on the company deciding the effective tax rate on the profit. BEL s diversification and expansion plans could drive the revenue: BEL s non-defense business accounts for nearly 17% during the last 5 years and plans to increase its non-defense share in overall business during the coming years. It is likely to enter into new areas in defence and non-defense for further expansion. In defence domain, it is likely to enter into SAM systems, Electronic Ammunition Fuses, Satcom terminals, LTE, Gigabit Passive Optical Network, Routing & Switching products, etc. In the non-defense domain, BEL is exploring the opportunities related to Critical Infrastructure Protection, Air Traffic Management Radars, Intelligent Traffic Management Systems, Solar Power Plants, Smart City elements etc. 3

4 BEL is likely to set up 5 Mn Greenfield weapon systems facility in Andhra Pradesh. The new facility is expected to be commissioned in a 2 years of time and will deal with development and production of all kinds of weapon systems such as fire control, missile systems and other weapon upgrade program. Government s initiative for defence industry: yan increase in the defence budget from Rs.229 Bn to Rs.2467 Bn, representing 7.74% more compared to the previous budget. y Offset policy in Defence Procurements and various export incentives. yfdi limit has been extended to 49%. yunder Income Tax Act 1961, a weighted deduction is allowed to the donor specified scientific research organization. yvarious incentives such as subsidised land relaxation in stamp duty exemption on sale/lease of land, power tariff incentives, concessional rates of interest on loans, investment subsidies/tax incentives, backward areas subsidies, special incentive by the respective state Governments where the project situated. Robust balance sheet, zero debt and high interest income: BEL has maintained a commendable balance sheet with zero debt. We expect that BEL is expected to meet the fund requirement towards incremental working capital and additional investments on capital equipments out of internal resources. The cash and cash equivalent stood at Rs.6379mn in FY15 representing Rs.252/- cash per share. Improved Man Power Efficiency: Historically, the company has maintained a flattish revenue growth on a consistently declining human capital pointing towards a improved man power utilization. We expect a revenue growth at CAGR of 7.8 % during FY14 to FY17E and such rationalized human capital base could be maintained which could also be a tool for margin booster. Exhibit 4: Per Employee Sales Exhibit 5: No. of Employees % 6% % 7% % % 1% 5% % -3% -3% -3% % -3% % 973 % -1% -2% -3% -4% % FY1 FY11 FY12 FY13 FY14 FY15 Sales per employee (Rs. Mn) Growth (%) 1-5% FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 No of employees Variation from last year ( % ) 4

5 Exhibit 6: Business Assumptions Y/E Mar (Rs. Mn) FY14 FY15 FY16E FY17E Comments Consolidated Businesses Revenue Revenue Growth (%) EBITDA EBITDA Margins (%) We have assumed a order book growth at 1% during FY17E and the execution of at 3% of the total order book. BEL, being a PSU, is likely to benefit from the government s thrust on strengthening the armed forces and supporting the Indian defence equipment manufacturers. BEL has been signing a Memorandum of Understanding (MoU) every year with the Government of India, Ministry of Defence. Though the defence sector is being opened up for private sector participation as well which makes its future more challenging. We also assume that BEL will get sizeable export order on account of the Offset policy in Defence Procurements. We expect a decnt growth on revenue on y-o-y basis on the backdrop of decent increase in order book and execution at par could be maintained. Cost of production would go on the same proportion of revenue. It is assumed that the production could go high during the next couple of years on the back of backlog and the decent growth in the order book. Margins may hover at same numbers and could see an expansion during FY17E. PAT (Adjusted) There could be decent growth in PAT in FY17E on the back of increase in EBITDA and assuming that BEL being a cash Fully Diluted EPS (Rs.) rich company could earn a decent interest income. Capex- cash capex (3747) (2272) (537) (548) BEL has good cash reserve and is well placed to Net CFO (569) implement brown field as well as green field projects from its Net Debt (Long Term) internal reserves. BEL likely to set up Rs.5 Mn Greenfield Free Cash Flow (9438) weapon systems facility in Andhra Pradesh. The new facility is expected to be commissioned in a 2 years of time. We assumed that capex has been incurred during the preceded couple of years. Exhibit 7: Karvy vs Consensus Revenues (Rs. Mn) Karvy Consensus Divergence (%) Comments FY16E FY17E EBITDA (Rs. Mn) We have considered the consistent order book to sales. We have considered the consistent order book to sales with a incremental order book size of 1% y-o-y basis. FY16E We have assumed the production increase and closing stock would be there to decrease the FY17E (3.9) operating expenses. EPS (Rs.) FY16E Assumed other income increase by 1% y-o-y FY17E Source: Bloomberg, Karvy Research basis. 5

6 Exhibit 8: Operating Revenue and Growth % 9% 6% 6% 4% 3% FY11 FY12 FY13 FY 14 FY15 FY16E FY17E 1% 8% 5% 3% % Operating Revenue (Rs. Mn) Growth (%) We expect operating revenue to grow at a CAGR of 7.5% during FY15-17E while registering a growth of 6% and 9% in FY16E and FY17E, respectively. Exhibit 9: EBITDA and Margins FY11 FY12 FY13 FY 14 FY15 FY16E FY17E EBITDA (Rs. Mn) Margins (%) We expect EBITDA to grow at a CAGR of 14.2% on the strong order book and margins could see an expansion during FY17E in comparison of FY16E and likely to register a growth of 26%. Exhibit 1: Order Book Growth FY11 FY12 FY13 FY 14 FY15 FY16E FY17E Order Book as on 1st date of FY (Rs. Mn) BEL has maintained a consistent order book to sales ratio. We have assumed that it could able to maintain the same in the next couple of years and expect that the conversion rate could be marginally at higher side during the FY16E and FY17E. Exhibit 11: Production Growth % FY1 5.2% 5528 FY % 8.6% FY FY % FY % FY15 Value of Production (Rs. Mn) Growth (%) 1% 5% % -5% BEL witnesses a consistent growth production. During FY14, it de-grew by meagre 2.6% but again picked up during FY15. 6

7 Exhibit 12: Net Profit and Margins We expect net profit to register growth at CAGR of 14% on the back of high revenue growth. We expect the net profits to grow at 23% during FY17E on year on tear basis. FY11 FY12 FY13 FY 14 FY15 FY16E FY17E Net Profit (Rs. Mn) Margins (%) Exhibit 13: RoE and RoCE FY11 FY12 FY13 FY 14 FY15 FY16 FY17E RoE (%) RoCE (%) We expect there could be a marginal expansion during the FY17E on the back of better profit margins over FY16E. Exhibit 14: Current Ratio BEL s average current ratio during the last five financial years is 1.7x. During the next two financial years, we are expecting average current ratio of 2x showing an improvement in working capital management. 1. FY11 FY12 FY13 FY 14 FY15 FY16E FY17E Current Ratio (x) Exhibit 15: Dividend Payout and Yield FY11 FY12 FY13 FY 14 FY15 FY16 FY17E Dividend Payout (%) Dividend Yield (%) The company has a good dividend track record and has consistently declared dividends for the last 5 years. We believe that the company is likely to continue its high dividend payout policy. 7

8 Exhibit 16: Company Snapshot (Ratings) Low High Quality of Earnings 33 Domestic Sales 33 Exports 33 Net Debt/Equity 33 Working Capital Requirement 33 Quality of Management 33 Depth of Management 33 Promoter 33 Corporate Governance 33 ythe company s revenue earnings are not diversified. 8% of the revenue is from defence sector. Revenues and Earnings are not insulated from any slow down in capex plan, delay in execution or cash flow could be affected in the case of delay in release of payment from the Government. ybel is a debt-free and thus has no interest cost. The cash rich position helps the company to execute growth plans without affecting the financial performance of the company. yexports contribute 5.5% of total sales. Any domestic slow down in the capex cycle could hit its revenue and profit adversely. y It a cash rich company whose working capital could able to meet from its internal resources. It enjoys a historical (last 5 years) average current ratio of 1.6:1. 8

9 Valuation & Outlook BEL is well placed to tap government s initiatives of indigenization in the defence manufacturing sector where 6% of requirements met by imports. Further, it has strong R&D with further export orders on account of the Offset policy in Defence Procurements could boost its revenue and profit. Historically, the stock traded within wide 1 year forward PE x band of 6x and 28x. At CMP of Rs.1187, the stock is trading at 2.4x FY17E EPS and we recommend a BUY with a target price of Rs.14 representing 24x FY17E EPS, with an upside potential of 18%. Exhibit 17: 1yr Forward PE Multiple Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 6x 12x 2x 28x PE (RHS) Source: BSE, Karvy Research Currently, BEL is trading at 2.9x of FY17E BV. Historically, the stock has traded between wide range of.9x to 3.7x 1-year forward BV. We have assigned a 3.5x FY17E BV of Rs.45.9per share for a target of Rs.14 representing an upside potential of 18%. Exhibit 18: 1yr Forward PB Multiple Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Source: BSE, Karvy Research 1x 2x 3x 4x P/B (RHS) Key Risks yincrease in competition from private players: FDI limit in defence sector has increased to 49% which can lead to huge investment in the sector by the foreign players along with Indian private players and bid for the defence projects. Defence manufacturing sector increasingly opened up for private sector participation which pushed BEL towards higher competitiveness. yrapid changes in technology: Upgradation and absorption of the technology would be key for the success of BEL. Any failure under-performance Government for imports or towards the introduction of foreign players. ydelay in orders: BEL is a PSU company and 8% of its revenue is coming from defence sector. Any delay in capex plan Government could hit the order book adversely which could hit the revenue and margins. 9

10 Financials Exhibit 19: Income Statement YE Mar (Rs. Mn) FY13 FY14 FY15 FY16E FY17E Revenues Growth (%) Operating Expenses EBITDA Growth (%) (7.2) 25.9 Depreciation & Amortization Other Income EBIT Interest Expenses PBT Tax Adjusted PAT Growth (%) (4.7) 22.6 Exhibit 2: Balance Sheet YE Mar (Rs. Mn) FY13 FY14 FY15 FY16E FY17E Cash & Cash Equivalents Sundry Debtors Inventory Loans & Advances Investments Gross Block Net Block CWIP Miscellaneous Total Assets Current Liabilities & Provisions Debt Other Liabilities Total Liabilities Shareholders Equity Reserves & Surplus Total Networth Minority Interest Total Networth & Liabilities

11 Exhibit 21: Cash Flow Statement YE Mar (Rs. Mn) FY13 FY14 FY15 FY16E FY17E PBT Depreciation Interest Tax Paid (2449) (255) (3556) (349) (418) Inc/dec in Net WC (2143) (12371) (123) Other Income (565) (425) (4316) (567) (5574) Other non cash items 856 (612) Cash flow from operating activities (15394) (569) Inc/dec in capital expenditure (3885) (3747) (2272) (537) (548) Inc/dec in investments (1) (1) Others (6115) (4933) (4426) Cash flow from investing activities (8388) (547) (4974) Inc/dec in borrowings (2) (1) 248 () Dividend paid (1566) (291) (22) (282) (282) Interest paid (8) (41) (29) (13) (1) Others (2) (112) (2) (21) Cash flow from financing activities (1578) (2133) (293) (333) (34) Net change in cash 56 (23) Exhibit 22: Key Ratios YE Mar FY13 FY14 FY15 FY16E FY17E EBITDA Margin (%) EBIT Margin (%) Net Profit Margin (%) Dividend Payout ratio Net Debt/Equity..... RoE (%) RoCE (%) Exhibit 23: Valuation Parameters YE Mar FY13 FY14 FY15 FY16E FY17E EPS (Rs.) DPS (Rs.) BV (Rs.) PE (x) P/BV (x) EV/EBITDA (x) EV/Sales (x) ; *Represents multiples for FY13, FY14 & FY15 are based on historic market price 11

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