Bharat Electronics

Public sector Defence equipment maker, Bharat Electronics (BEL), clocked better revenue and profit growth in the fourth quarter of FY-09, a trend observed in earlier years as well. An order book of Rs 10,000 crore that captures revenues for the next couple of years, tie-ups to capitalise on the Defence offset provisions and the traditionally high proportion of the union budget spent on Defence augur well for BEL’s earnings growth.

The stock of BEL has, however, run up 30 per cent from January this year. Besides, given the sharp rise in the Sensex over a relatively short time-frame, any profit booking could well drag the market in the near term. Investors can, therefore, employ such opportunities to buy the stock of BEL on declines.

A two-three-year investment perspective may be required to benefit from any upside arising from the company’s tie-ups with overseas and local players. At the current market price of Rs 991, the stock trades at 8.3 times its expected per share earnings for FY-10.
Steady financials

After three quarters of lacklustre growth in earnings, Bharat Electronics recorded a 14 per cent increase in net profits while revenue grew by 19 per cent for the quarter ended March 2009, as against a year ago numbers. The company has traditionally recorded lumpiness in revenues and in FY-09 too profits from the fourth quarter ended March alone accounted for 70 per cent of the full year’s profits. The fourth quarter performance is an indicator that execution has not altogether slowed in FY-09.

For the full year, while revenues grew by 12 per cent, profits remained flat, on the back of higher raw material costs as well as hike in employee expenses as a result of provisions made under the wage bill.

The company, however, managed to secure its operating profit margin at 25 per cent, suggesting that profitability was not badly hit by hike in costs.

While BEL’s growth rates on a year-on-year basis have not run at a scorching pace, the company has recorded a 26 per cent compounded annual growth in net profits over the last five years. The averages have not been skewed by a single year’s performance and have instead seen a steady growth rate.

Cash-rich companies such as BEL also provide better comfort during downturns. The company has had a consistent dividend payout ratio of over 20 per cent with dividends of over 100-200 per cent (on face value of Rs 10) declared in each of the last five years. Return on equity too has remained over 25 per cent during this period.
Dominant position

Bharat Electronics continues its dominant position as the largest Defence play in the listed space.

The company, with an estimated market share of 25 per cent of the domestic industry, had 86 per cent of its revenues coming directly from the Defence space, while the rest came from sectors such as broadcasting and communications for the year-ended March 2009.

The company has been consistently adding new products every year; it has in recent times attempted to diversify into areas such as solar photovoltaic business, microwave components and electronic warfare programmes through tie-ups with other corporates. Revenue flows from these tie-ups may, however, be visible only after a couple of years.
Offset arrangements

With Defence spending in India increasing by at least 15-25 per cent every year and about 15 per cent of the total interim budget spending announced in February 2009 being allocated for Defence, business opportunities in the sector have been steady and non-cyclical.

While this business pie remains, the next driving force for Defence equipment orders could be in the form of offset provisions.

To encourage transfer of technology and protect the domestic industry at the same time, offset provisions call for foreign suppliers who are awarded contracts in India, to source 30 per cent of the contract value from India.

This could be in the form of the foreign player sourcing equipment from local players or facilitating the export of domestic production or investing in R&D facilities in India. Currently, bulk of India’s Defence supplies is from foreign suppliers.

This essentially means that the offset provision would emerge as a significant source of order flow for domestic companies. BEL has quickly made good this opportunity with at least six tie-ups with foreign players for off-set arrangements.

However, the Defence offset provision also means that foreign players are free to tie-up with private players. Companies such as Larsen & Toubro have already made headway in this area. This, in turn, suggests that BEL will no longer be devoid of competition.

Nevertheless, high upfront costs, tight licensing norms and Government policies in Defence are likely to slow the growth of private sector for at least a couple of years. Slowdown in execution, as a result of Government policies, nevertheless remains a perennial threat for BEL’s revenue growth.