Bharat Electronics (BEL) is a PSU and a leader in the domestic defense electronics space,
with major proportion of its revenue coming in from the Indian Navy and Army.
Defense spending at an inflexion point: After years of lull, government announced
15.4% yoy increase in Defense Capital Budget to Rs94,588cr. In our view, we are
at an inflexion point where Indian Defense capex cycle, led by government
spending is entering new era of growth. Our view strengthens on account of
following developments, (1) Defense sector getting high priority in government’s
‘Make in India’ campaign, with increased emphasis on the indigenization aspect,
(2) increase in FDI limits in defense from 26% to 49%, and (3) $47bn worth of
projects cleared by Defense Acquisition Council (DAC) in last 19 months,
indicating faster clearances in place. Also high expectations are being built from
soon to be released Defense Procurement Procedures (DPP). Current bid pipeline,
which could lead to strong award activity for next few years, along with abovementioned
factors indicate that good times are ahead for Defense sector.
BEL to emerge as key beneficiary: At the backdrop of higher allocation made
towards defense capex with ~$47bn worth of projects cleared by DAC, we expect
good times ahead for defense players, including BEL. BEL in FY2015 had market
share of 37% in domestic defense electronics. On considering (1) bid-pipeline
dominated by Indian Airforce and Navy’s platform projects, which have high
Defense Electronics components requirement, (2) BEL’s in-house R&D capabilities,
(3) tie-up with Thales, France for product development, and (4) zero debt status with
potential for further improvement in working capital cycle, all point out that BEL should
maintain its strong market positioning in Defense Electronics space. On a whole, we
expect BEL to emerge as key beneficiary of the revival in Defense capex cycle.
Outlook & Valuation: At the current market price of Rs1,206/share, BEL is trading
at FY2016E and FY2017E P/E multiple of 22.3x and 19.6x, respectively. In the
last 5 years, BEL’s stock has traded at 1-year forward P/E multiple of 14.0x. We
expect BEL to report a 12.4% top-line and 13.7% bottom-line CAGR during
FY2015-18E; a similar growth rate is expected to be maintained beyond FY2017E
as well. We expect BEL to trade at a premium to its historical valuations on
account of the uptick in investment cycle, which indicates strong long-term growth
prospects. The current low competitive intensity and the contention of it justifiably
commanding a scarcity premium, being the largest listed defense player, make
the stock all the more attractive. Considering the long-term growth prospects,
which should stretch beyond FY2017E, we assign a 1-year forward P/E multiple of
23.0x to arrive at price target of Rs1,414/share. Given the 17% upside from the
current levels, we initiate coverage on the stock with a BUY rating.
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