Best defence bet! October 8, 212 Kunal Sheth kunalsheth@plindia.com +91-22-66322257 Riddhi Kothari riddhikothari@plindia.com +91-22-66322238 Rating BUY Price Rs1,224 Target Price Rs1,457 Implied Upside 19.% Sensex 18,938 Nifty 5,747 (Prices as on October 5, 212) Trading data Market Cap. (Rs bn) 97.9 Shares o/s (m) 8. 3M Avg. Daily value (Rs m) 59.6 Major shareholders Promoters 75.86% Foreign 3.79% Domestic Inst. 15.56% Public & Other 4.79% Stock Performance (%) 1M 6M 12M Absolute.3 (19.) (18.5) Relative (9.) (27.3) (38.4) How we differ from Consensus EPS (Rs) PL Cons. % Diff. 213 113.1 19. 3.7 214 132.5 122.7 8. Price Performance (RIC: BAJE.BO, BB: BHE IN) (Rs) 1,9 1,7 1,5 1,3 1,1 9 7 5 3 1 Oct-11 Dec-11 Source: Bloomberg Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Bharat Electronics (BEL) is a pure play on growing expenditure by the Indian government on defence. It is a market leader, with ~6% market share in defence electronics in India. The company has an order book of Rs25bn (executable over four years). Though private competition has opened up in the sector, BEL believes that it is a threat only in the long term (4-5 years). We expect the stock to deliver 13% CAGR in earnings and 1% CAGR in order flow over FY12-14E. While the opportunity for BEL is large, given the increase in defence spend, both for capital equipments and modernization, we expect volatility in annual earnings (due to change in product mix) and order flow to impact sales. The stock is trading at 9.2x FY14E earnings. We believe BEL offers good investment opportunity to the investor who wants to invest in the Indian defence sector with a long-term view. We assign a BUY, with a target price of Rs1,457. Margins to trend back to 12-14% levels: Margins in FY12 came down to 9% in FY12 mainly on account of a delay in booking sales worth Rs1bn on account of 1) change in specification by MoD in few projects like Shakti 2) delay in supply by vendors like L&T for launchers and missiles and from Bharat Dynamics (BDL) for the Akash Missile project and 3) delay in approval by customers (bulk procurement certificate etc). Also, higher proportion of non-defence sale is at 27% due to non-regular orders like tablet PC, national population register and socio-economic caste census. BEL expects margins to improve in FY13 from 9% to ~12% if MOU target for sales of Rs63bn for FY13 is achieved. It believes the product mix is better in FY13 and slower growth in employee cost (wage agreement signed till 216) can help margins to improve. Going forward, BEL believes that the margins can be maintained in the band of 12-14%. Contd 2 Key financials (Y/e March) 211 212 213E 214E Revenues (Rs m) 54,718 56,5 62,5 7,116 Growth (%) 5.6 3.3 9.8 13. EBITDA (Rs m) 8,783 5,7 6,999 9,62 PAT (Rs m) 8,615 8,299 9,44 1,599 EPS (Rs) 17.7 13.7 113.1 132.5 Growth (%) 19.5 (3.7) 9. 17.2 Net DPS (Rs) 21.6 2.8 22.6 26.5 Profitability & Valuation 211 212 213E 214E EBITDA margin (%) 16.1 8.9 11.3 12.9 RoE (%) 18.4 15.6 15.1 15.5 RoCE (%) 18.5 15.7 15.1 15.5 EV / sales (x).6.5.5.4 EV / EBITDA (x) 3.7 6. 4.5 2.9 PE (x) 11.4 11.8 1.8 9.2 P / BV (x) 2. 1.7 1.5 1.3 Net dividend yield (%) 1.8 1.7 1.8 2.2 Source: Company Data; PL Research Company Update PrabhudasLilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Healthy order book provides strong visibility greater opportunity ahead: The current order book stands at ~Rs25bn which is to be executed over the next four years providing strong visibility. The company maintains that the order flow in the current year will be ~Rs1bn. However, channel checks suggest the order flow could be in the range of Rs6bn for FY13. The long term potential, on the other hand, is huge with cumulative market size of Rs3,2bn by 22 (mainly back-ended in FY18/19/2). We expect the order flow to grow at a CAGR of 1% over FY12-14E. Outlook and Valuation: The stock is trading at 9.2x FY14E earnings. We expect the stock to deliver at 13% CAGR in earnings and 1% CAGR in order flow over FY12-14E. BEL remains the best play on increasing defence spend. We assign BUY, with a target price of Rs1,457. Exhibit 1: One year forward PE Band 3, 2,5 2, 1,5 1, 5 2x 15x 1x 5x Apr-3 Oct-3 Apr-4 Oct-4 Apr-5 Oct-5 Apr-6 Oct-6 Apr-7 Oct-7 Apr-8 Oct-8 Apr-9 Oct-9 Apr-1 Oct-1 Apr-11 Oct-11 Apr-12 Source: Company Data, Bloomberg, PL Research October 8, 212 2
FY12 was an unpredictable year where sales worth Rs1bn could not be booked due to various reasons Higher proportion of non defence sale is at 27% due to non regular orders like tablet PC, national population register and socioeconomic caste census which lead to adverse product mix and impacted margins Margins in band of 12 14% can be maintained. What went wrong in FY12: BEL s margin declined from 16% in FY11 to 9% in FY12. The top-line growth also came in at 3% despite a huge order book of Rs25bn. The management highlighted that FY12 was an unpredictable year where sales worth Rs1bn could not be booked due to various reasons. Rs2bn sales of Shakti networking system could not be booked due to change in specification from the customer (needed software to be Grade 3 encrypted instead of Grade 2), Rs3bn Akash missile systems could not be delivered (BEL is a system integrator) due to delay in supply by vendors like BDL (for missile) and L&T(for launchers), respectively. Other issues like delay in getting bulk clearance certificate for few products also impacted sales. Also, higher proportion of non-defence sale is at 27% due to nonregular orders like tablet PC, national population register and socio-economic caste census (low margin products) lead to adverse product mix and impacted margins. It expects the margin to improve in FY13 from 9% to ~12% if MOU target for sales of Rs6.3bn for FY13 is achieved. It believes the product mix would be better in FY13 and slower growth in employee cost (wage agreement signed till 216) can help margins to improve. Going forward, it believes margin can be maintained in the band of 12-14%. Q1FY13 also had similar issues of booking sales and unfavourable product mix. Structurally margin has come down due to change in defence procurement procedures It highlighted that structurally margins have come down from the 25% range 5-6 years back to ~12-14% range at present due to the fact that procurement procedures were very different and level of negotiations were very low from the customer s side. After the new defence procurement, procedures have made negotiation compulsory; a bench mark price has to be arrived at by the procurement committee making them more aware and proactive. Exhibit 2: Trend in Revenue growth (Rs bn) 8 7 6 5 4 3 2 1 Revenues YoY gr. (RHS) FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E 14.% 12.% 1.% 8.% 6.% 4.% 2.%.% October 8, 212 3
Exhibit 3: Trend in EBITDA margins and RM cost 7. 6. 5. 4. 3. 2. 1. EBITDA Margin Rm % sales. FY6 FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E The current order book stands at ~Rs25bn to be executed over the next four years Our channel checks suggest the order flow could be in the range of Rs6bn for FY13 The long term potential is huge with cumulative market size of Rs3,2bn by 22 Healthy order book provides strong visibility greater opportunity ahead: The current order book stands at ~Rs25bn to be executed over the next four years. The order book comprises of 1) 33% Radar orders, 2) 43% weapon/networking systems orders, 3) 5% Communication orders, 4) 7% Electronics order, 5) 4% Electro optics order, 6) 2% Electric wartime orders and 7) 6% other orders. Out of the current order book, ~Rs55bn is to be delivered each year till FY15. The company maintains that the order flow in the current year will be at ~Rs1bn. However, channel checks suggest the order flow could be in the range of Rs6bn for FY13. The long term potential, on the other hand, is huge with cumulative market size of Rs3,2bn by 22 (mainly back-ended in FY18/19/2). Two orders for Akash Missile system are among the larger orders in the order book. The first Akash Missile system order is from Air Force (Rs36bn order for six squadrons), where BEL is the system integrator. The project deliveries are upto FY16, with major deliveries of BEL product (~6% of the project value) in FY14/15. The second order (Rs31bn) for Akash Missile system is from the Army. In this project, BDL is the system integrator and BEL is the supplier of major equipments like Radar and allied accessories. The delivery timelines for this project is also up to FY16E. We expect order flow to grow at a CAGR of 1% over FY12-14E.. October 8, 212 4
We expect order flow to grow at a CAGR of 1% over FY12 14E Exhibit 4: Trend in Order book Order Backlog Order Backlog / Sales (RHS) 35 3 25 (Rs bn) 2 15 1 5 FY7 FY8 FY9 FY1 FY11 FY12E FY13E FY14E 5. 4. 3. 2. 1.. Exhibit 5: Break up of order book Exhibit 6: Delivery timelines of order book Electronics Cummunica 7% tion 5% Electro Optics 4% Others 8% Systems 43% FY16 18 FY17 8 beyond 7 FY13 23 Radars 33% FY15 22 FY14 22 Exhibit 7: Major order win in FY11 Particulars Rs (bn) Akash weapon systems 36 Battlefield surveillance system 25 Advanced gunfire control 17 3D tactical control radar 14 Passive night vision devices 1 Command information & decision support system 9 Schilka upgrade 7 Exhibit 8: Major order win in FY12 Particulars Rs (bn) Akash weapon systems 31 Coastal surveillance system 6 Socio economic and caste surveillance 5 Others 37 October 8, 212 5
India s defence spending in the 11th Plan period (27 12) has grown at a CAGR of 13% Industry outlook remains healthy: India s defence spending in the 11th Plan period (27-12) has grown at a CAGR of 13%. Imports in defence equipment procurement have averaged at 3% of total procurement in the last three years. As per the 13th Finance Commission Report, the Defence Capital Budget is set to grow at a CAGR of 1% per annum during 21-215. Presuming the same rate of growth for the balance plan period, the total Defence Capital budget allocation during the 12th Plan is likely to be at Rs4,455bn. The capital acquisition budget ranges between 75-85% of the total capital expenditure and is likely to be around Rs3,564bn. The capital acquisition budget ranges between 75 85% of the total capital expenditure and is likely to be around Rs3,564bn in 12th Plan. Exhibit 9: Trend in defence spend Defence Spend (Capex) YoY Growth (%) 12 1 8 6 4 2 3% 25% 2% 15% 1% 5% FY9 FY1 FY11 FY12 FY13E FY14E FY15E FY16E FY17E % Source: Ministry of Defence, PL Research According to the report by working group on defence equipment, the Defence Electronics sector is likely to see a high growth during the 12th Plan period. While the Navy and IAF are likely to contribute about 15% each, the bulk of demand (about 7%) is expected to come from the Army. Network Centric Systems, Radars, Communication Systems, Electronic Warfare and Electro Optic equipment will be in demand. The working paper estimates a cumulative size of Rs958bn by FY13 17, a CAGR of 24% The major products and systems planned for induction by Indian MoD during 12th plan are - Battlefield Management Systems, Future Infantry Soldier as a System, Long Range Surveillance Radars, Weapon Locating Radars, Mountain Radars, Tactical Communication Systems, Software Defined Radios, EW Systems for different terrains, Unmanned Aerial Vehicles and Aerostats, Electronic Warfare Suites for Fighter Aircrafts, Long Range Electro Optical Surveillance Systems, Thermal Imager based Sights for Tanks & Weapons, Image Intensifier based Passive Night Vision Devices and Weapon & Missile Systems. October 8, 212 6
Our channel check suggests a cumulative market size of Rs3.2trn by 22 The working paper estimates a cumulative size of Rs958bn by FY13-17, a CAGR of 24%. Assuming the same growth for FY18/19/2, the cumulative market size could be ~Rs2.1trn. Our channel check suggests a cumulative market size of Rs3.2trn by 22 (likely to be back-ended i.e. FY18/19/2). Many huge projects like Battle management systems (Rs6bn project), Tactical communication system (Rs3bn project etc. will drive the growth in order inflows apart from increasing requirement for products like Radars and Missiles. Exhibit 1: Trend in growth of defence electronic Defense Electronics Production (Rs bn) 166 2 23 257 17 FY13 FY14 FY15 FY16 FY17 Source: Ministry of Defence, PL Research BEL has entered into a JV with French defence major Thales. This JV will focus on design, development, marketing, supply and support of civilian and select defence radars for Indian and global markets Update on JV with Thales: BEL has entered into a JV with French defence major Thales. This JV will focus on design, development, marketing, supply and support of civilian and select defence radars for Indian and global markets. Thales owns a 26% stake in the combined entity and BEL owns 74%. The board approval for the same has been received and approval from the Ministry of Defence is expected in FY13. The board approval for the JV has been received and approval from the Ministry of Defence is expected in FY13 Thales has a significant presence in India and is a major supplier to Dassault's Rafale, which has been shortlisted for the Indian Air Force's US$11bn Medium Multi-Role Combat Aircraft (MMRCA) competition, which is currently in its final stages. Separately, the French defence major is also involved in the Indian Air Force's US$2bn Mirage-2 fighter upgrade programme. If the MMRCA deal goes through with Rafales, it could throw up ~Rs3bn worth of offset opportunity for BEL as it has a long-standing relation with Thales. Thales is a supplier for Radar to Rafales for the MMRCA deal and it is expected that Thales will source some sun system for Radar from BEL under offset clause (not part of the JV). Cash end of Q1FY13 stood at ~Rs53bn. Cash: In FY12, cash on book stood at Rs68bn and at the end of Q1FY13, it was at ~Rs53bn. Free cash ex of advance and capex requirement in the books is ~ Rs 25bn. The high cash balances make the company an ideal candidate for buy-back or special dividend. October 8, 212 7
Exhibit 11: Cash on books growing steadily Cash on books (Rs bn) Cash / share (RHS) 8 7 6 5 4 3 2 1 FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E 1 8 6 4 2 Key Risks: Government has shown increased intent of involving private players in the defence procurement process and to develop an active private sector supply to the armed forces Delay in execution of contracts: Defence procurement procedures are complex and GOI/Ministry of defence being the sole customer, the decision-making can be slower-than-expected, both in finalizing of new orders and product approvals, leading to volatility in earnings. Competition from private players: The government has shown increased intent of involving private players in the defence procurement process and to develop an active private sector supply to the armed forces. Particularly offset contracts could make a negative impact on BEL s margins. October 8, 212 8
Income Statement (Rs m) Y/e March 211 212 213E 214E Net Revenue 54,718 56,5 62,5 7,116 Raw Material Expenses 31,446 35,791 38,471 43,121 Gross Profit 23,271 2,79 23,579 26,995 Employee Cost 1,418 1,812 11,461 12,149 Other Expenses 4,7 4,89 5,119 5,785 EBITDA 8,783 5,7 6,999 9,62 Depr. & Amortization 1,219 1,28 1,461 1,559 Net Interest 46 43 25 28 Other Income 4,93 6,993 6,78 6,848 Profit before Tax 11,612 1,749 12,222 14,323 Total Tax 2,997 2,45 3,178 3,724 Profit after Tax 8,615 8,299 9,44 1,599 Ex-Od items / Min. Int. Adj. PAT 8,615 8,299 9,44 1,599 Avg. Shares O/S (m) 8. 8. 8. 8. EPS (Rs.) 17.7 13.7 113.1 132.5 Cash Flow Abstract (Rs m) Y/e March 211 212 213E 214E C/F from Operations 32,929 6,548 2,63 7,612 C/F from Investing (1,431) (2,18) (1,551) (2,) C/F from Financing (1,849) (1,977) (2,616) (95) Inc. / Dec. in Cash 29,649 2,553 (1,565) 4,662 Opening Cash 35,784 65,433 67,986 66,421 Closing Cash 65,433 67,986 66,421 71,83 FCFF 32,263 5,858 63 5,612 FCFE 32,259 5,854 62 5,612 Key Financial Metrics Y/e March 211 212 213E 214E Growth Revenue (%) 5.6 3.3 9.8 13. EBITDA (%) 7. (43.) 39.8 29.5 PAT (%) 19.5 (3.7) 9. 17.2 EPS (%) 19.5 (3.7) 9. 17.2 Profitability EBITDA Margin (%) 16.1 8.9 11.3 12.9 PAT Margin (%) 15.7 14.7 14.6 15.1 RoCE (%) 18.5 15.7 15.1 15.5 RoE (%) 18.4 15.6 15.1 15.5 Balance Sheet Net Debt : Equity (1.3) (1.2) (1.) (1.) Net Wrkng Cap. (days) (362) (38) (27) (223) Valuation PER (x) 11.4 11.8 1.8 9.2 P / B (x) 2. 1.7 1.5 1.3 EV / EBITDA (x) 3.7 6. 4.5 2.9 EV / Sales (x).6.5.5.4 Earnings Quality Eff. Tax Rate 25.8 22.8 26. 26. Other Inc / PBT 34.1 65.2 54.9 47.8 Eff. Depr. Rate (%) 6.8 6.4 7. 6.8 FCFE / PAT 374.4 7.5 6.7 52.9. Balance Sheet Abstract (Rs m) Y/e March 211 212 213E 214E Shareholder's Funds 5,26 56,369 63,297 73,896 Total Debt 4 Other Liabilities (1,86) (2,282) (2,282) (2,282) Total Liabilities 48,223 54,88 61,16 71,615 Net Fixed Assets 5,427 6,237 6,328 6,769 Goodwill Investments 12 12 62 62 Net Current Assets 42,676 47,73 54,68 64,226 Cash & Equivalents 65,193 67,725 66,161 71,773 Other Current Assets 6,26 72,219 78,199 88,365 Current Liabilities 82,724 92,214 9,293 95,913 Other Assets Total Assets 48,222 54,87 61,16 71,615 Quarterly Financials (Rs m) Y/e March Q2FY12 Q3FY12 Q4FY12 Q1FY13 Net Revenue 1,61 14,316 22,972 7,969 EBITDA 46 1,131 3,222 (1,63) % of revenue 3.8 7.9 14. (13.3) Depr. & Amortization 294 293 3 36 Net Interest (1,625) (1,576) (1,471) (1,629) Other Income 1,626 1,576 1,472 1,632 Profit before Tax 1,737 2,414 4,393 26 Total Tax 487 668 1,54 67 Profit after Tax 1,25 1,746 3,339 193 Adj. PAT 1,25 1,746 3,339 193. October 8, 212 9
Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 57, P. B. Marg, Worli, Mumbai-4 18, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 229 Rating Distribution of Research Coverage % of Total Coverage 6% 5% 4% 3% 2% 1% % 54.7% 22.3% 22.3%.7% BUY Accumulate Reduce Sell PL s Recommendation Nomenclature BUY : Over 15% Outperformance to Sensex over 12-months Accumulate : Outperformance to Sensex over 12-months Reduce : Underperformance to Sensex over 12-months Sell : Over 15% underperformance to Sensex over 12-months Trading Buy : Over 1% absolute upside in 1-month Trading Sell : Over 1% absolute decline in 1-month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly This document has been prepared by the Research Division of Prabhudas Lilladher Pvt. Ltd. Mumbai, India (PL) and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accept any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either PL or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. We may from time to time solicit or perform investment banking or other services for any company mentioned in this document. October 8, 212 1