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Growth levers intact

Despite the reduced majority, we expect that the upcoming government’s policy focus on investment-led growth, capex, infrastructure, manufacturing, and defense will continue. Particularly for the defense sector, the government initiated several initiatives in last 3-4 years, such as indigenization, higher private sector participation, and increasing defense exports, and we expect a similar focus to continue going forward too. Accordingly, we continue to like Bharat Electronics (BHE) in the defense space, given its presence across highly specialized defense electronics segment. The company’s order inflows for FY24 were far ahead of its guidance, thereby hedging it against any slowdown in order inflows in FY25. With a strong order book, stable gross margin and efficient control over working capital, we expect BHE to continue to benefit from defense spending. We thus maintain our estimates and BUY rating on BHE with an unchanged TP of INR310, based on 35x two-year forward earnings.

Defense will continue to be a key focus area for the government

Government had initiated several reforms and initiatives during last 2-3 years for defence indigenization, higher private participation and increasing defence exports. We expect similar focus to remain on the defence sector from the government even post the electoral outcome. Given that the sector is closely linked to national security, we do not see possibility of any re-orientation in defense policy. While a slight tinkering might not be ruled out, we do not foresee any major policy shift that can potentially lead us to revisit our thesis, which remains unchanged.

BEL ideally positioned to benefit from continued defence spending

We expect BEL to remain a key beneficiary of continued government spending on defence. Company has re-rated in last two years on 1) Improving share of BEL in overall defence capex and possibility of company improving this from current 12.6% levels going forward as against historical share of 8-9% during FY11-18, 2)Stable gross margins at current levels of 47.6% versus 37-46% seen during FY11-18, 3) Long term CAGR of 16% in revenues and 17% in EBITDA over next decade (driven by sectoral tailwinds too) versus 10%/12% seen over FY11- 21, 4) Control over working capital which is at 22 days over FY25-27 versus average NWC cycle of 80-110 days seen during FY19-21, 5) Improving return ratios. RoE/RoCE moving towards 24%/26% by FY26 on improved profitability, control over working capital versus mid-teens RoE/RoCE during FY11-21, 6) Positive tailwinds on order inflows from import embargo, large sized surface to air missiles, radars, avionics etc.

Strong order inflow during FY24 to sustain healthy growth in revenues

In FY24, BHE successfully secured orders worth around INR350b, including electronic fuses, EW systems, communication systems for naval warships, fire control systems, Akash prime weapon/system, radars, sonars, software defined radios, night vision devices, tactical communication systems, and other projects in the non-defense sector. The order for electronic fuses is of a 10-year period, while the duration of other contracts is 2-5 years. This resulted in a strong order book of INR760b for BHE to be executed over the next 2-3 years. We expect that a moderation in order inflows in FY25 due to any delay in decision-making on large projects will not impact revenue growth for the company thanks to its strong existing order book. The company had already guided for delays in the finalization of large projects like QRSAM, and hence, its guidance of INR500b of order inflows for the next two years excludes QRSAM inflow. Execution over the next two years would come from projects like Akash, LRSAM, Himshakti, Arudra radar, air defense control, etc.

Continuously building capabilities across new areas

BHE is continuously investing in capex for:

1) advanced night vision factory at Neemaluru (already ready) on 50 acres of land for INR3b; 2) EW system at Ibrahimpatnam for INR2b, to be ready in a year; 3) weapon system and integration at Palasamudram for all missile system integration, to be ready in two years; 4) fuse complex and explosives in Nagpur, to be ready in 2-3 years; 5) airborne equipment and EW system at Davangiri; and 6) working in UP defense corridor for setting up an MRO facility for missile systems. All put together, BHE will continue to invest INR6- 7b in capex every year.

Financial outlook

We maintain our estimates for the company and expect a CAGR of 19%/20%/22% in sales/EBITDA/PAT over FY24-26E. We expect OCF/FCF to remain strong over FY24- 26 on control over working capital. Further, the company had a cash surplus of INR110b (as of FY24), providing scope for further capacity expansion.

Key risks and concerns

A slowdown in order inflows from the defense and non-defense segments, increased competition, further delays in finalization of large tenders, a sharp rise in commodity prices and delays in payments from MoD can adversely impact our estimates on revenues, margins and cash flows.

Valuation and view

BHE is currently trading at 41x/34x on FY25E/FY26E EPS. We expect the company to remain a beneficiary of improved market share, technology tie-ups, MoUs, and an improving share of exports and non-defense in total revenues. We maintain our TP of INR310, based on 35x P/E on two-year forward earnings, which bakes in a 19% CAGR in revenue over the next decade vs. 11% CAGR over the last decade.

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