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Soft numbers in Q3, expect decent numbers going forward

BEL reported earnings of Rs.5.98 bn, against a yoy profit of Rs.5.83 bn while sequentially it was down by 2% on a high base of Q2. Revenues grew by just 4.7% qoq and 11.8% yoy at ?41.3 bn. EBITDA de-grew by 0.3% qoq while growing by 3.8% yoy at Rs.8.53 bn. On the margins front, EBITDA margins came in at 20.7% which were 100 bps down qoq and 160 bps down yoy. The order book now stands ~Rs.501 bn providing strong visibility of ~4.4x of TTM revenues. BEL added ~Rs.36 bn of orders in 9M of FY23 and targets to add ~Rs.170 bn in Q4 alone on the back of huge order pipeline.

Strong defence order pipeline gives us confidence for long term visibility

BEL boasts of a healthy order book of Rs.501 bn, which provides revenue visibility of more than three years. The company gained only Rs.36 bn worth orders in 9M, while seems very confident to add ~Rs.170 bn of orders in the last quarter of the current fiscal, out of which management maintains to add at least Rs.50 bn of orders in Q4 through big projects like LRSAM, Akash, Akash Prime, Avionics for air fighters, Sonar ships, Air Defence Fire Control Radar-ATULYA, mountain radars and electronic warfare systems in the near term. About 75-80% of its revenue comes from government orders. BEL rightly targets 15% topline growth in FY 23 and 15-20% target for next two years. The company plans to spend Rs.6 bn towards various expansion initiatives, while ~Rs.10 bn would be spent on R&D (BEL currently has 2,700 engineers and scientists) from FY23 onwards every year. Currently, ~82-85% of revenue comes from indigenous technologies developed either by BEL or Defence Research and Development Organisation (DRDO).

Non-defence segment also to provide significant opportunities

To reduce dependence on defence, BEL has been focusing on diversifying into new and allied business verticals such as Medical Electronics, EVMs, Homeland Security, Metros, Energy Storage, Unmanned system, Space electronics and systems, Software Service (SAASopportunity Rs.50bn), Ammunition (Rs.5bn/year opportunity), etc. Along with this, BEL is working on new businesses fetched in Q2 in the form of Civil orders like the Chennai Metro for door screening, Triton deal secured, ATMS (Air Traffic Management System), E-mobility LOI worth Rs.80 bn for railways, UP100 smart city, EV charger installation at highways, EV battery packs etc. Non-defence segment contributed 10% of total revenue in Q3 FY23. This segment shall reduce BEL’s dependence on defence segment. It expects 20% revenue contribution to come from non-defence in FY24-25 from current 10%. It expects exports to continue to contribute 10% of total revenues as it is expanding presence in international markets and has participated in many tenders.

Margin Outlook remains good

BEL has a strong indigenous portfolio of products (82-85%), which has reduced dependence on imports and other commodity prices. Also, BEL intends to add nearly 1,000 employees for new competencies. It intends to reduce employee cost without compromising on R&D (7% of topline). Furthermore, now that the chip shortage issue is behind them, we can expect strong surge in order delivery leading to higher capacity utilisation thus providing operating leverage. In Q2, the GOI has announced to localise 411 defence related goods. This step shall surely lead to higher indigenization leading to higher margin performance of the defence sector in totality. Also reducing dependence on nominated programs through higher contribution from services, non-defence and exports orders shall augur well for the margins. Additionally, BEL has a seasonally lumpy Q4, where financials witness an unusual jump, during which maximum orders are executed and topline as well as margin performance is elevated. Therefore, we believe that margins in FY23E should be in the 20-21% range. For FY24E and FY25E as well we expect margins to be better on improved product mix and stable input costs.

Outlook and Valuation

 BEL reported subdued Q3 FY23 numbers. It is leveraging its past R&D investments and change in defence ministry’s stance on import ban and increasing its levels of indigenization. Its impetus on outsourcing low-value-addition functions is further helping in improving and derisking its cost structure. Further, the company plans to set up a semi-conductor fabrication plant in consortium with Hindustan Aeronautics Limited (HAL) and other companies, which would further reduce dependency on imports in the long term. BEL is expected to utilize the above cost savings to increase its spending on R&D (7% of topline) and capex (Rs.6bn per annum over the next 3-4 years) and enter new markets.

BEL has been able to negate the overhang of lower margin in nomination-based contracts by increasing the quantum of exports and non-defence. It is also focusing on up-skilling its workforce and adding to employee count (100 per year taking up to 2600 employees currently with 40% engineers) in new areas with good growth prospects. Its strong order book, welldefined and distinct order pipeline gives us a very strong visibility over mid to long term despite 9M FY23 being a period of lower order offtake. BEL’s new initiative in non-defense streams and emphasis on exports is expected to gain momentum soon and contribute meaningfully to the topline. On the back of decent topline and margin performance, huge cash surplus, comfortable WC cycle and rich return ratios, we maintain our BUY rating on the stock with a TP of Rs.119 (22x rolled over FY25E earnings).

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