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Bharat Electronics – Stock of the Month (April 2014)

25 March, 2014

Price: Rs. 352.18

Bharat Electronics Limited (“BEL” or the “Company”) is a Government of India undertaking (75.86 % holding with the Central Government) engaged in the manufacture and supply of strategic electronic products primarily for defence services.  The Company operates under the Ministry of Defence of the Government of India and is engaged in the designing and developing of specialised weapons and advanced electronic products for the Indian armed forces. The Company also makes surveillance systems, X-ray baggage inspection systems, home and street lighting systems and traffic management systems for civil users.

This Stock Analysis report presents a long term outlook and the future prospects of Bharat Electronics Limited.

INVESTMENT RATIONALE

Fundamentally sound and continuously profit making

The Company’s net revenue from operations over the 5 year period (i.e. 2008-09 to 2012-13) grew at an impressive CAGR of 17.88 %. For FY 2013, income from operations has increased by 6.05 % to Rs. 6,273.02 Cr. from Rs. 5,915.25 Cr. and Net Profit has increased by 7.49 % to Rs. 910.78 Cr. from Rs. 847.33 Cr. BEL has reserves in excess of Rs. 5,821.95 Cr and operates with negligible debt on its books. In addition, the company is sitting on a robust order book of Rs. 24,502 Cr. as on 1st January 2014 which is ~ 5 times its annual revenue. We believe that this should translate into strong revenue visibility over the next 2-3 years.

At CMP of Rs. 1,056.55 (25th March, 2014), the stock is trading at a P/E of 9.81x.

We believe that the opportunity for BEL is huge. Post the General Election of 2014, we believe that there will be a push in defence spending. 

BEL Financial Position

Increasing defence budget allocation

BEL Stock AnalysisIn the Union Budget 2013-14, there was an increase of 5.3 % in the defence allocation to Rs. 2,03,672.10 Cr. (US$ 37.4 billion). There has been an increase in percentage share of the capital expenditure from 41.15 % (2012 – 13) to 42.59 % (2013 – 14) in the defence budget.  This increase in capital expenditure would lead to higher acquisition of weapon systems and equipments by the armed forces. BEL being one of the major providers of defence equipment is likely to benefit from this increased allocation. In FY2013, defence supply contributed 85 % to the total turnover of the Company as against 73% in FY 2012.

Amongst the three defence services capital expenditure on Air Force equipment has increased more compared to other services. BEL supplies various air and ground control equipments to the Indian Air Force and will benefit from this increase.

Dominant supplier of defence electronics 

Bharat Electronics is a market leader in in defence electronics in India with ~60% market share. The Company manufactures products with applications in communication, radar, naval systems, electronic warfare systems, weapon systems and tank electronics in addition to electronic voting machines, TV set-top boxes and solar cells and lighting systems.

The customer profile of BEL can be classified into defence and non-defence customers.

Bharat Electronics

Growing Defence and Security needs

Given the cross border tension on India’s north eastern and western borders the country’s capital expenditure on defence is likely to grow over the next few years. Further, increasing crimes have increased the demand for security systems in the non-defence segment. Historical evidence suggests that the rate of crime increases with an increase in population.

Sensing growth opportunity in the non-defence segment, the Company is taking steps to expand its business in the field of homeland security, smart cards and telecom. The Company has developed some products like x – ray baggage inspection system, under-carriage vehicle inspection system and video analytic software and is further working to tap the opportunity in this space.

We believe that the non-defence segment which currently contributes ~20 % to the total revenue could become a major growth driver for the Company. 

INVESTMENT CONCERNS

Increasing competition from Indian private industry

The Defence Sector is increasingly being opened up for private sector participation. Government has allowed private sector participation up to 100 % in the defence industry sector with foreign direct investment (FDI) permissible up to 26 %. Earlier, Bharat Electronics was the only vendor chosen by the Government of India to build radars, communication and electronic warfare systems for the Indian military. Now, companies such as the Tata Motors, Rolta India Ltd, Alpha Design Technologies Pvt. Ltd, Data Patterns (India) Pvt. Ltd and Astra Microwave Products Ltd have won orders competing against BEL. The growing competition from private sector players has resulted in margin pressures and has impacted the overall profitability of the Company.

Rapid changes in technology

Defence and security equipment space is constantly evolving and witnessing rapid technological advancements. The Company faces a challenge of keeping pace with the latest technological advancements in its business areas. The technologies required to manufacture various products in the segment in which BEL operates, are being upgraded continuously.

This process of technology upgradation involves huge capital investment which the Company needs to incur continuously in order to maintain its competitive position in the market which may put pressure on the operating margins of the Company.