Bharat Electronics: Buy

Attractive valuations, hefty order book, and agreements with international players make this stock promising.

High cash on books, negligible debt and a non-cyclical business make a good case for investing in the stock of Bharat Electronics (BEL) in the current market scenario. Investors with a two-year perspective can consider taking exposure to the stock. At the current market price of Rs 1,642, the stock trades at 12 times its expected per share earnings for FY-13. The valuations appear attractive on the back of the company's hefty order book, amounting to over four times the FY-11 revenues. Its ability to ink agreements with a good number of international players which forge ties to fulfil their Defence offset clause also suggests that Bharat Electronics is not threatened by the increasing presence of local players.

BEL is one of the largest public sector companies making Defence equipment with revenues of Rs 5,530 crore and net profits of Rs 108 crore in FY-11. Solar photo voltaic cells, electronic voting machines and a number of other electronic components are some of its non-Defence products that make up 20 per cent of revenues.

Defence spending

Amid the order-deferment scenario faced by many industries, the Defence space does not suffer from similar uncertainties. Defence spending by the Indian government has grown by about 15 per cent per annum over the past decade with technology upgradation benefitting players such as BEL. This is reflected in BEL's order book of Rs 23,800 crore, up 100 per cent over a year ago. Various research and development initiatives and the resultant new products have all helped increase order flows at a time when a number of local players, including Larsen & Toubro, have evinced keen interest in the Defence space.

While expanding its non-Defence revenue to tackle risks from increased competition in the Defence space, BEL has also been astute in forging ties with global Defence equipment manufacturers setting foot in India. The latter have to comply with the offset clause regulations that require at least 30 per cent of the contract (above Rs 300 crore) to be subcontracted locally. BEL has entered into an MoU with Sagem of France for land navigation and artillery-pointing applications even as it tied up with German and US companies in the medium multi-role combat aircraft (MMRCA) segment. The MoUs dispel concerns over BEL losing out to private players entirely. Over 60 per cent of its export order book (as of June 2011) of $66 million is from the offset clause. However, it remains to be seen how profit margins will pan out from these subcontracted orders.

Margins and product mix

As is the trend, BEL had a sluggish June quarter with revenue expanding 1.2 per cent over a year ago. Net profits, surged 50 per cent entirely on account of other income (predominantly treasury income). EBITDA margins, while expected to be poor in the first quarter of every fiscal, saw a dip of over 4 percentage points in the latest ended quarter; suggesting that the product mix may be in favour of low-margin orders. EBITDA margins for the fiscal could therefore see a dip compared with the 18-22 per cent norm historically. BEL's cash in hand, as of March 2011, doubled to Rs 6,520 crore, partly on account of advances received. Its cash per share at Rs 815 is 50 per cent of current market price.

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