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Diversifying into multiple revenue streams

Strategy to diversify revenue streams away from a constrained domestic defence budget – was a key takeaway from Bharat Electronics’ (BEL) analyst meet. BEL does not mind additional capex to achieve the same (10-15% YoY capex growth p.a. from the likely Rs5.5bn in FY21). The idea, if properly executed, can allow BEL to maintain double-digit revenue growth in the foreseeable future; it also underlines the limited headroom the base business offers for continuation of growth, given scale. Maintain HOLD with a revised target price of Rs102.

* Onus is on execution. BEL targets: i) civilian segment (including medical equipments) to move from 7% of topline to 15% in the next 2-3 years; ii) to increase the current 10% revenue contribution from service sector (including AMCs); iii) capture the revenue expenditure budget of the Armed Forces via entry into electronic fuses, RF seekers (new complex in Machilipatnam to be commissioned next year); and iv) gain share in the base business, i.e. integration of missile complex (Palasamudram; another separate SBU for QRSAM in Bengaluru), entry into ammunitions, etc.

* Key operational guidance. BEL hopes to manage double-digit topline growth in the foreseeable future. Order inflow for FY21 will certainly exceed FY20 inflow of Rs130bn (mentioned Rs150bn of possible inflow). Management hopes to maintain EBITDA margins of 20+/-1%even without any favourable policy review of cost-plus margins in nominated orders. Capex guidance for FY21 remains Rs5.5bn with a strong outlook to capture multiple opportunities. R&D spend has been finalised at 8-10% of profit, with an eye for return as tax benefits are no longer available.

* Near-term order opportunities. BEL has already accounted for execution of avionics related to LCA Mk 2, as HAL has received LoI for the same. Key elements of the avionics package for LCA Mk 2 include Fly by Wire Digital Flight Control Computer (DFCC). Future opportunities include Jammer for LCA. Also, LUH and LCH (helicopters) may allow BEL sensors (MAWS and counter-measure dispensers along with HMDS) and weapons to significantly augment BEL’s avionics revenue. Yet, order inflow for FY21 seems dependent on the electronics orders from Akash squadrons that have accrued to BDL.

* Despite LRSAM execution and increasing % of nominated orders under revised margins, management expects to maintain ~20% EBITDA margin in FY21. LRSAM execution will begin in FY21 and the first four systems have limited (~40%) work share for BEL. Company has been able to indigenise majority of the work orders, thereby helping margin profile. To offset the possible weakness because of LRSAM execution, BEL will try to deliver the first Akash squadron in FY21. BEL will also be executing IACCS over next two years, the project has matured thereby yielding enhanced margins.

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