Bharat Electronics: Buy

Bharat Electronics (BEL) stock is a good option for investors looking for defensive bets in the capital goods sector. At Rs 1,578, the stock trades at 13 times its expected per share earnings for FY-13.

A debt-free balance sheet, an order book that assures revenues for over four years, and a generous dividend policy, aided by ample cash coffers, augur well for an investment in the stock of Bharat Electronics.

A two-three-year perspective in the stock may be needed to allow the current order-book to generate revenues.

BEL, one of the country's largest Defence equipment makers, has been insulated from the slowing business cycle and stretched working-capital requirements witnessed by most other capital goods players.

It has, instead, benefitted from the rising government expenditure on modernisation of the Defence forces. More recent policies that favour a higher proportion of local equipment are also likely to help BEL.

Sound order-book

Bharat Electronics has seen steady order inflows every quarter. At Rs 26,700 crore, as of December 2011, the order backlog is 64 per cent higher than a year ago. It is also close to five times FY-11 sales. Sales for FY-11 was Rs 5,530 crore, while profits stood at Rs 860 crore.

The order backlog might suggest that the order to revenue conversion time is slow. But it is noteworthy that BEL's product mix has also undergone a change.

From mere product orders, it has in recent times moved to catering to orders on an integrated systems basis, the Akash Missile system being an example. These orders tend to have a longer lead time but are more margin-accretive.

This said, integrated system orders can also result in slower conversion of revenues because of delays from other players involved in the project. For instance, in the Akash Missile squadrons, there has been delay in receiving the missiles from Bharat Dynamics as well as launchers from Larsen & Toubro. The company may, therefore, end FY-12 on a sedate note, with revenue bunching up in the next fiscal.

BEL's EBITDA margins, that are normally 16-18 per cent, slipped to 9 per cent in the December quarter as a result of certain low-margin products.

BEL's order-book typically has a 20-25 per cent proportion of civil orders, which are less lucrative compared with Defence orders and tend to pull down margins in quarters when they are booked as revenue. These orders, such as the tablet personal computer for the Rural Development Ministry and work done for National Population Register project, fetched lower margins in the recent quarter. Higher cost of imports due to the depreciating rupee also pulled down margins.

Cash-rich

BEL has been a debt-free company and enjoys high cash reserves. Its large cash coffer though, is not always favourably viewed by the markets, except during economic slowdowns.

Robust cash holding can be partly attributed to high advance received from clients besides low capital expenditure.

For instance, well over a third of the cash balance of Rs 5,500 crore in the December quarter came from advances. Besides, BEL has limited capital expenditure, given that its primary investment is only in the form of research and development (6-7 per cent of sales). These factors tend to boost its cash position.

But BEL has been rewarding investors twice a year with interim and annual dividends. It recently paid a 100 per cent interim dividend for FY-12.

Defence spend

BEL is mainly dependent on its sole customer, the Defence Ministry, for orders. Any lower spending may hurt prospects.

However, Defence capital spending has been growing by 15 per cent annually in the last five years and is expected to be $19 billion by 2015, according to a CII-Deloitte report. That would mean about 10 per cent a year growth between 2012 and 2015.

Spending too has been on track, 66 per cent of the Defence modernisation fund allocation for the current fiscal being spent up to December 2011.

The offset clause in the country's Defence policy has also ensured that foreign players contract at least 30 per cent of the orders they bag in India (for orders over Rs 300 crore), to local players. This too has helped players like BEL.

Over the long term, though, the competitive scenario may intensify for BEL with many private players beginning to show interest in the sector.

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