Bharat Electronics: Poised to reap indigenization benefits

25 May 2023 , 10:04 AM

Recommendation: Buy

Target Price: Rs. 138

Conservative accounting practices have built sufficient cushion in provisions, which should be reversed on project completion, based on past trends. BHE’s capabilities on system integration of large platforms and various electronic systems for airborne and naval platforms provide long-term growth visibility from new domestic defence procurement and upgrade of existing fleet. Its industry-leading R&D spend underscores the culture of localization of new technology platforms for Indian Defence services. Healthy FCF, returns profile and proven execution track record make risk-reward extremely attractive versus peers at 18x FY25 estimated EPS.

Conservatively guides for at least Rs. 200 billion inflows

FY23 order inflows grew 8% YoY at Rs. 206 billion, while OB was +5% YoY at Rs. 606 billion (3.5x sales). BHE is expected to do at least flat inflows of Rs. 200 billion in FY24 (of which Akash missiles, Fuzes, Naval systems contribute ~Rs. 150 billion) and excludes large ordering for QR SAM (completed trails successfully) due to potential risk of slippage. Analysts at IIFL Capital Services are forecasting 22% growth in inflows in FY24 at Rs. 250 billion, ahead of BHE guidance. Inflow mix for FY23 and FY24 has significant local content and hence, should carry healthy margins.

Earnings poised for 20% CAGR in FY24-26

BHE outpaced its targeted EBITDA margins in FY23 at 23%, +130 bps YoY, despite sharp jump in provision for LDs (Rs. 3.6 billion, 2% of sales) owing to supply chain-led delay in deliveries. Reversal in provisions for LDs is customary on project closures in similar cases (past precedence), thereby cushioning OPMs in FY24-25. Analysts at IIFL Capital Services expect revenue/EBITDA CAGR of 16% / 18%, respectively, in FY24-26.

Continues to invest in R&D and new capabilities

BHE continues to step up its R&D spend (from 6.3% FY23 to 7% levels in FY24) for next-gen technologies, ensuring strong localization support to GoI’s drive for domestic procurement. Capex for FY24 is targeted at Rs. 7 billion.