Bharat Electronics BUY

13 June 2018 India Industrials Company Update Bharat Electronics BUY Inflated concerns on delayed order inflows Bharat Electronics 4QFY18 results missed expectations as net sales fell 10% YoY (11% below JMFe), while EBITDA was down 19% YoY as margins were better than estimates at 22.1% (JMFe: 21.6%). A delay in the award of 2 large orders - Akash Missile (INR 55bn) and LRSAM for P17-A frigates (INR 85bn) drove a slump in FY18 order inflows (-38% YoY). The stock is down 35% YTD and provides an attractive entry price as its 1-year forward PE multiple stands at 18x, closer to its 10-year median of 16x. However, we would like to highlight a few points from FY18 results: a) Despite a delay in inflows (not unusual in Defence), its book-to-bill ratio is above 1.0x and order book/sales is 4.0x. b) Margins were sturdy at 19.4% (-110bps YoY), despite a 100bps increase in R&D expenses, higher civilian sales and a 60% slump in exports. c) Improved cash utilisation through buybacks resulted in an improved RoE profile. d) There are new business opportunities in satellite integration, space, UAVs and cyber security. We cut our FY19-20 EPS estimates by 4-10% to factor in slower inflow growth and lower margins in integration orders (IACCS, Akash and LRSAM). We maintain BUY with a revised TP of INR 145, based on 20x FY20E EPS as we forecast 12% earnings CAGR over FY18-20. Slow execution leads to revenue decline: Net sales were down 9.5% YoY (11% below JMFe) to INR 34.2bn led by delayed execution for existing orders. Order book was flat YoY to INR 401.1bn (4.0x TTM sales) and inflows declined 70% YoY as large orders for Akash missile, LRSAM for P17A should materialise only by 2QFY19. In FY18, inflows were down 38% YoY to INR 100bn, but the export order book stood 9% higher at USD 92mn. Operating margins inch lower but better than estimates: Operating margins fell to 22.1% (-250bps YoY), largely led by an adverse project mix and a decline in sales, which led to a 220bps increase in other expenses. Employee costs were 32% lower YoY. Overall, EBITDA fell 18.7% YoY, 8% below JMFe. Despite a higher share of revenue from the civilian segment (15% vs. 12%), higher R&D expenses at 9.8% of revenues (+100bps) and a slump in exports (-60% YoY), margins shrunk only by 100bps to 19.4% in FY18. Other income reported a sharp drop of 70% YoY as dividend/interest income tends to be lumpy. The company has completed the buyback of 20.4mn shares at a price of INR 182.5/share, translating to an outflow of INR 3.7bn. Also, the Board has declared a total dividend of INR 2.0 per share in FY18. Net profit was down 29% YoY to INR 5.6bn, lower than JMFe by 10%; PAT was down 9.6% to INR 13.9bn. Sandeep Tulsiyan sandeep.tulsiyan@jmfl.com Tel: (91 22) 66303085 Recommendation and Price Target Current Reco. BUY Previous Reco. BUY Current Price Target (12M) 145 Upside/(Downside) 19.4% Previous Price Target 200 Change -27.5% Key Data BHE IN Current Market Price Market cap (bn) INR121 INR295.8/US$4.4 Free Float 33% Shares in issue (mn) 2,436.6 Diluted share (mn) 2,436.6 3-mon avg daily val (mn) INR650.6/US$9.6 52-week range 193/110 Sensex/Nifty 35,693/10,843 INR/US$ 67.5 Price Performance % 1M 6M 12M Absolute -5.0-33.1-19.4 Relative* -5.5-37.7-29.7 * To the BSE Sensex Maintain BUY with revised TP of INR 145: We cut our EPS estimates by 4-10% to factor in slower inflow growth and lower margins in system integration orders (IACCS, Akash and LRSAM). Yet, we believe the recent stock price correction of 35% YTD offers an attractive entry price as its book-to-bill is above 1.0x, order book/sales is strong at 4.0x TTM sales and operating margins are expected to sustain at 19%. Improved cash utilisation (towards buybacks) should improve RoEs and new business opportunities in satellite integration, space, UAVs and cyber security could improve growth prospects. We maintain BUY with a revised TP of INR 145 (20x FY20E EPS) as we forecast 12% earnings CAGR over FY18-20. Financial Summary Net Sales 73,279 86,119 1,03,223 1,12,126 1,27,432 Sales Growth (%) 7.1 17.5 19.9 8.6 13.7 EBITDA 13,718 17,617 19,997 21,563 24,266 EBITDA Margin (%) 18.7 20.5 19.4 19.2 19.0 Adjusted Net Profit 13,074 15,476 13,993 15,333 17,660 Diluted EPS (INR) 5.0 6.3 5.7 6.3 7.2 Diluted EPS Growth (%) 12.1 27.2-8.8 9.6 15.2 ROIC (%) 47.9 49.7 32.8 30.4 31.6 ROE (%) 15.4 18.8 18.3 18.5 19.0 P/E (x) 24.4 19.2 21.1 19.2 16.7 P/B (x) 3.6 4.0 3.8 3.4 3.0 EV/EBITDA (x) 16.3 14.6 13.2 12.0 10.4 Dividend Yield (%) 0.8 2.1 1.7 1.6 1.8 Source: Company data, JM Financial. Note: Valuations as of 12/Jun/2018 JM Financial Research is also available on: Bloomberg - JMFR <GO>, Thomson Publisher & Reuters S&P Capital IQ and FactSet Please see Appendix I at the end of this report for Important Disclosures and Disclaimers and Research Analyst Certification. JM Financial Institutional Securities Limited

Exhibit 1. Change in estimates Actual Revised Estimates Previous Estimates % chg YoY % FY18A FY19E FY20E FY19E FY20E FY19E FY20E FY19E FY20E Net Sales 1,03,223 1,12,126 1,27,432 1,18,286 1,31,381-5.2-3.0 8.6 13.7 EBITDA 19,997 21,563 24,266 22,254 26,703-3.1-9.1 7.8 12.5 EBITDA Margin (%) 19.4% 19.2% 19.0% 18.8% 20.3% 40bps -130bps -10bps -20bps Adj PAT 13,993 15,333 17,660 16,014 19,646-4.3-10.1 9.6 15.2 Adj EPS (INR) 5.7 6.3 7.2 6.6 8.1-4.3-10.1 9.6 15.2 RoCE (%) 18.2 18.5 19.0 18.0 19.5 RoE (%) 18.3 18.6 19.0 18.0 19.5 Exhibit 2. Quarterly Performance Y/E March 4QFY17 4QFY18 YoY (%) 4QFY18E YoYE (%) FY17 FY18 YoY (%) Net Sales 39,877 36,085-9.5 40,538 1.7 86,043 1,03,223 20.0 Expenditure 30,081 28,123-6.5 31,785 5.7 68,502 83,226 21.5 EBITDA 9,796 7,962-18.7 8,753-10.7 17,541 19,997 14.0 EBITDA (%) 24.6 22.1-250bps 21.6-300bps 20.4 19.4-100bps Other income 909 279-69.3 630-30.6 4,786 2,004-58.1 Depreciation 571 766 34.1 618 8.2 1,915 2,510 31.1 EBIT 10,134 7,475-26.2 8,765-13.5 20,412 19,491-4.5 Interest 9 10 9.0 0 118 13-89.2 PBT before EoI 10,125 7,465-26.3 8,765-13.4 20,294 19,478-4.0 EoI 0 0 0 0 0 PBT 10,125 7,465-26.3 8,765-13.4 20,294 19,478-4.0 Tax 2,208 1,878-14.9 2,372 7.4 4,818 5,486 13.9 Tax rate (%) 21.8 25.2 27.1 23.7 28.2 PAT 7,917 5,587-29.4 6,393-19.2 15,476 13,993-9.6 EPS (INR) 3.2 2.3-28.8 2.6-19.2 6.3 5.7-8.8 Adj PAT 7,917 5,587-29.4 6,393-19.2 15,476 13,993-9.6 Adj EPS (INR) 3.2 2.3-28.8 2.6-19.2 6.3 5.7-8.8 Exhibit 3. Cost break-up 4QFY17 4QFY18 YoY (%) 4QFY18E YoYE (%) FY17 FY18 YoY (%) COGS 20,603 20,010-2.9 21,080 2.3 44,131 55,152 25.0 as a % of sales 51.7 55.5 380bps 52.0 30bps 51.3 53.4 210bps Staff Cost 5,611 3,819-31.9 6,533 16.4 15,483 17,723 14.5 as a % of sales 14.1 10.6-350bps 16.1 200bps 18.0 17.2-80bps Other Expenditure 3,866 4,294 11.1 4,172 7.9 8,888 10,351 16.5 as a % of sales 9.7 11.9 220bps 10.3 60bps 10.3 10.0-30bps Source: Bloomberg, Company, JM Financial JM Financial Institutional Securities Limited Page 2

Exhibit 4. PER Chart 35x 30x 25x 20x 15x 10x 5x 1 yr fwd PER Median (10-yr avg) +1 Standard deviation -1 Standard deviation Order inflow 2,00,000 1,80,000 1,60,000 1,40,000 1,20,000 1,00,000 80,000 60,000 40,000 20,000 0x 0 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18 JM Financial Institutional Securities Limited Page 3

Financial Tables (Standalone) Income Statement Net Sales 73,279 86,119 1,03,223 1,12,126 1,27,432 Sales Growth 7.1% 17.5% 19.9% 8.6% 13.7% Other Operating Income 0 0 0 0 0 Total Revenue 73,279 86,119 1,03,223 1,12,126 1,27,432 Cost of Goods Sold/Op. Exp 37,973 43,802 55,152 60,548 70,087 Personnel Cost 12,573 15,483 17,723 18,803 20,335 Other Expenses 9,015 9,217 10,351 11,213 12,743 EBITDA 13,718 17,617 19,997 21,563 24,266 EBITDA Margin 18.7% 20.5% 19.4% 19.2% 19.0% EBITDA Growth 20.0% 28.4% 13.5% 7.8% 12.5% Depn. & Amort. 1,722 1,915 2,510 2,772 3,120 EBIT 11,996 15,702 17,487 18,791 21,146 Other Income 5,371 4,710 2,004 2,505 3,381 Finance Cost 45 118 13 0 0 PBT before Excep. & Forex 17,321 20,294 19,478 21,296 24,528 Excep. & Forex Inc./Loss(-) 0 0 0 0 0 PBT 17,321 20,294 19,478 21,296 24,528 Taxes 4,248 4,818 5,486 5,963 6,868 Extraordinary Inc./Loss(-) 0 0 0 0 0 Assoc. Profit/Min. Int.(-) 0 0 0 0 0 Reported Net Profit 13,074 15,476 13,993 15,333 17,660 Adjusted Net Profit 13,074 15,476 13,993 15,333 17,660 Net Margin 17.8% 18.0% 13.6% 13.7% 13.9% Diluted Share Cap. (mn) 2,640.0 2,457.0 2,436.6 2,436.6 2,436.6 Diluted EPS (INR) 5.0 6.3 5.7 6.3 7.2 Diluted EPS Growth 12.1% 27.2% -8.8% 9.6% 15.2% Total Dividend + Tax 2,956 7,415 5,895 5,536 6,376 Dividend Per Share (INR) 0.9 2.5 2.0 1.9 2.2 Cash Flow Statement Profit before Tax 17,321 20,294 19,478 21,296 24,528 Depn. & Amort. 1,703 1,914 2,510 2,772 3,120 Net Interest Exp. / Inc. (-) 0 0 0 0 0 Inc (-) / Dec in WCap. 13,254-12,364-5,909 817-1,887 Others 0 0 0 0 0 Taxes Paid -4,979-5,533-4,474-5,963-6,868 Operating Cash Flow 27,299 4,311 11,605 18,922 18,893 Capex -6,504-6,967-7,793-6,000-6,000 Free Cash Flow 20,795-2,656 3,813 12,922 12,893 Inc (-) / Dec in Investments -3,000-1,406 0 0 0 Others 0 0 0 0 0 Investing Cash Flow -9,504-8,373-7,793-6,000-6,000 Inc / Dec (-) in Capital 1,600-21,878-3,520 0 0 Dividend + Tax thereon -2,956-7,415-5,895-5,536-6,376 Inc / Dec (-) in Loans 0 500-500 0 0 Others -2,005-897 -1,800-338 0 Financing Cash Flow -3,361-29,690-11,715-5,874-6,376 Inc / Dec (-) in Cash 14,434-33,751-7,902 7,047 6,516 Opening Cash Balance 57,219 71,653 37,902 30,000 37,047 Closing Cash Balance 71,653 37,902 30,000 37,047 43,563 Balance Sheet Shareholders Fund 89,884 75,170 77,949 87,407 98,690 Share Capital 2,400 2,234 2,437 2,437 2,437 Reserves & Surplus 87,484 72,936 75,512 84,970 96,253 Preference Share Capital 0 0 0 0 0 Minority Interest 0 0 0 0 0 Total Loans 0 500 0 0 0 Def. Tax Liab. / Assets (-) -4,608-5,323-4,312-4,312-4,312 Total - Equity & Liab. 85,276 70,347 73,637 83,095 94,378 Net Fixed Assets 14,063 19,116 24,399 27,627 30,507 Gross Fixed Assets 11,469 16,170 22,198 28,198 34,198 Intangible Assets 0 0 0 0 0 Less: Depn. & Amort. 1,703 3,617 6,127 8,899 12,018 Capital WIP 4,297 6,563 8,328 8,328 8,328 Investments 3,191 4,597 4,597 4,597 4,597 Current Assets 1,58,711 1,42,525 1,51,601 1,67,604 1,91,942 Inventories 41,775 49,050 47,755 61,439 69,826 Sundry Debtors 37,119 43,549 55,000 55,295 62,843 Cash & Bank Balances 71,653 37,902 30,000 37,047 43,563 Loans & Advances 855 806 1,381 10,752 12,219 Other Current Assets 7,309 11,219 17,465 3,072 3,491 Current Liab. & Prov. 90,689 95,891 1,06,961 1,16,733 1,32,668 Current Liabilities 11,620 13,466 22,469 23,039 26,185 Provisions & Others 79,069 82,425 84,492 93,694 1,06,484 Net Current Assets 68,022 46,634 44,641 50,871 59,274 Total Assets 85,276 70,347 73,637 83,095 94,378 Dupont Analysis Net Margin 17.8% 18.0% 13.6% 13.7% 13.9% Asset Turnover (x) 0.9 1.0 1.3 1.4 1.4 Leverage Factor (x) 1.0 1.0 1.0 1.0 1.0 RoE 15.4% 18.8% 18.3% 18.5% 19.0% Key Ratios BV/Share (INR) 34.0 30.6 32.0 35.9 40.5 ROIC 47.9% 49.7% 32.8% 30.4% 31.6% ROE 15.4% 18.8% 18.3% 18.5% 19.0% Net Debt/Equity (x) -0.8-0.5-0.4-0.4-0.4 P/E (x) 24.4 19.2 21.1 19.2 16.7 P/B (x) 3.6 4.0 3.8 3.4 3.0 EV/EBITDA (x) 16.3 14.6 13.2 12.0 10.4 EV/Sales (x) 3.0 3.0 2.6 2.3 2.0 Debtor days 185 185 194 180 180 Inventory days 208 208 169 200 200 Creditor days 71 72 99 93 93 JM Financial Institutional Securities Limited Page 4

History of Earnings Estimate and Target Price Date Recommendation Target Price % Chg. Recommendation History 21-Sep-17 Buy 220 31-Jan-18 Buy 200-9.1 JM Financial Institutional Securities Limited Page 5

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