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Buy Bharat Electronics  Ltd For Target Rs.208

Q1 miss doesn’t alter medium/long term prospects

Bharat Electronics’ (BEL) reported lower than expected Q1FY22, with an EBITDA of Rs629mn (down 57% YoY). Revenues were down 4.5% YoY, with execution expected in Q1FY22 from Akash (3 squadrons) and LRSAM expected in Q1FY22. The decline in gross margins negatively surprised – partly contributed by escalating costs on account of chip shortage and partly by changing nature/scope of contracts. We are confident that BEL will be able to improve on its Gross/EBITDA margins over the course of the year and stand true on management guidance of 20-22% EBITDA margins. Order inflow of Rs26bn is also expected to pick up progressively. We maintain BUY with a revised target of Rs208/share (Rs177/share earlier).

* Q1FY22 order inflow at Rs26bn; BEL has guided for order visibility of > Rs600bn over next 4-5 years. QRSAM is under user evaluation at present. Management expects user trials of QRSAM to complete by March 2022 and orders are expected by FY23. Also BEL expects to receive follow on order for electronics for Akash order by army where BDL would be the lead integrator. Missiles order – including Akash, MRSAM, LRSAM and QRSAM offers an order opportunity of Rs250-300bn in the next 5 years. Management also expects Rs120-150bn of order inflows from EW segment over the course of next 5 years. Further, BEL expects Rs120-150bn of orders from the Indian navy comprising of fire control radars, Navigation system, and combat management system. Homeland security, smart city projects, communication control system for expanding metro networks provides an additional opportunity of Rs50bn. Combined, BEL has the order visibility on ~Rs600bn accruing steadily over next 4-5 years.

* Recent management commentary. Management continues to guide for double digit topline growth, EBITDA margins at 20-22%, continued diversification of the revenue stream with an objective to create 25% of the revenue stream from non defence /civilian products and services. Management expects Rs150-170bn of order inflow for FY22E. RnD (revenue) spend will increase from 7% at present to 10% of topline to incentivise talent, while employee cost as a proportion of revenue will come down from 16% to 12% due to incremental outsourcing of non-core work – BEL made it clear that the number of technical graduates will increase. BEL continues to take great strides in improving working capital dynamics – achieved best ever recovery of Rs160bn in the history of the company in FY21, inventory days have been controlled at 180 days (derived for standalone) and management sees further scope of improving working capital.

* Maintain BUY. We value BEL at 20x FY23E earnings (vs 17x FY22E earlier). We expect BEL to continue to witness strong order inflow and execution over next 2-3 years. Given the return profile, government ownership (51.1% implying little scope of further divestment given strategic nature of operations) and growth prospects, we see no reason for BEL to rerate further.

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