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Strong execution despite COVID disruption

* Revenue surpasses FY20 levels: In a communication to the stock exchanges, Bharat Electronics (BHE) announced that it had ended FY21 with a turnover of over INR135b (+7% YoY, ex-other operating income). BHE grew the business despite the challenges posed by the COVID-19 outbreak and rising competitive intensity in the business. For 4QFY21, implied execution is likely at INR64.4b (+11% YoY), marginally better than our expectation (+8% YoY). The management would continue to focus on indigenization and increasing supply to the domestic markets, with an eye on reducing import dependency across the sector.

* Execution of large ticket size orders leads to revenue beat: Key projects executed in FY21 include: ICU ventilators, missile systems (Akash & LRSAM), gun upgrades, various radars, various sonars, command & control systems, electro-optic systems, communication & encryption products, EW systems, coastal surveillance system, electronic fuses, homeland security & smart city projects, Kerala Fibre Optic Network (KFON), and Avionics Package for LCA.

* Order inflows at INR150b: The total order inflows for FY21 stood at INR150b (up 14% YoY). Key new orders include ICU ventilators; software-defined radios & communication equipment; various types of radars, sonars, torpedo decoy systems, electronic warfare systems, and networking & encryption products; smart cities, etc.

* Order book remains robust at INR530b: The FY21 order book stood at INR530b (flat YoY). This translates to an OB/rev ratio of 3.9x, providing strong revenue visibility over the next three years. BHE has demonstrated a strong execution capability, despite the COVID-19 disruption, and is well-placed for capitalization over FY22/FY23E.

* Working capital remains key monitorable: While we remain confident of BHE’s execution capability and believe it is the best play in the Indian Defense sector, we believe the company’s re-rating depends on its working capital management. While the working capital cycle has shown signs of improvement over the past year, it is still higher than historical levels. With the government’s fiscal deficit likely to come under pressure due to economic downturn and COVID-19-related spending, this could pose some risk to the working capital in the near term.

* Focus on diversification to non-defense areas: BHE is keen to leverage its strong R&D expertise and technical capability by tapping into new growth areas and entering new businesses. The company has already forayed into potential business segments such as Healthcare Solutions, Network & Cyber Security, Space Electronics, Energy Storage Systems, Software, etc.; it is confident of making significant headway in these segments over the next few years.

* Valuation and view: We forecast a revenue/EBITDA/PAT CAGR of 14%/14%/16% over FY21–23E. We have built in a sufficient margin cushion as we assume an EBITDA margin of 19.2%/19.1% for FY22E/FY23E (v/s 21.1% in FY20). At CMP, the stock trades at FY22E/FY23E P/E of just 15x/14x – despite having RoE/RoCE of ~17%/18%, dividend yield of ~3%, and FCF yield of 3.5–6%. Maintain Buy, with unchanged TP of INR150 (on 16x FY23E EPS).

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