Bharat Electronics Ltd – Leading India into modern warfare


Company Name – Bharat Electronics Ltd (BEL)


Current Share Price – INR 235 (June 17, 2022)


Market Cap – INR 57,187 cr


 

1. What is interesting about the stock?

We are seeing controversy around Agniveers in our country. What is Agniveer?


The Government of India (GOI) approved a recruitment scheme for Indian youth to serve in the three services of the armed forces called Agnipath for a limited period, on June 14, 2022, and the youth selected under this scheme will be known as Agniveers. What is the logic of this scheme?


Modern warfare puts a greater emphasis on superiority in areas such as the air, space, and cyberspace – reducing the importance of the ground force. So, it doesn’t make sense to continue with similar strength of the army especially when a nuclear arsenal is a deterrent for large man-to-man combat. Branches such as the navy, air force, and missile units can now play a bigger role in the event of conflict by fighting enemy forces beyond borders. Electronics have become of paramount importance in modern warfare.


With the supply chains disrupted due to Covid-19 and the possibility of geopolitical pressures due to India’s external affairs policies, the aim is to decrease import dependence. The Government of India has formulated the Defense Production and Export Promotion Policy (DPEPP), 2020, which provides thrust to India’s defense production capabilities and exports with a measurable target for defense manufacturing. This Policy aims toward an annual turnover of INR 1,75,000 cr in local defense manufacturing by 2025, which implies a 15% CAGR over FY20-FY25. The policy is looking to double the domestic procurement to INR 140,000 cr by FY25, from INR 70,000 cr in FY20.


GOI is also pushing to develop the domestic defense eco-system through initiatives such as ‘Make in India’ and ‘Atamanirbhar Bharat’ programs presenting opportunities for domestic suppliers. Government has put a ban on the import of ~300 defense equipment and items to boost indigenization.


Bharat Electronics Ltd, a Navratna defense public sector undertaking (DPSU), was established in 1954 under the Ministry of Defense, to cater to the electronic equipment requirements of the defense sector. The Company has ~55% market share in the defense electronics sector. GOI remains BEL's largest shareholder with a current shareholding of 51%. BEL has been conferred the Navratna PSU status in June 2007.


BEL is the dominant supplier of radar, communication, and electronic warfare equipment to the Indian armed forces. The company has nine manufacturing units across India and two research units. The Bangalore and the Ghaziabad units are BEL's two major units, with the former contributing the largest share to the company’s total revenue and profits.


The Company caters to all the three arms of defense i.e. Army, Air Force, and Navy. BEL’s product portfolio covers defense and non-defense segments:

  • Defense Products - Defense Communications Products, Land-based Radars, Naval Systems, Electronic Warfare Systems, Avionics, Electro-Optics, Tanks & Armoured Fighting Vehicle Electronic Systems, Weapon Systems, C4I Systems, Shelters & Masts, Simulators, Batteries, and Components. Revenue from defense products was 88% of total revenue in FY22

  • Non-defense product portfolio includes e-Governance Systems, Homeland Security, Civilian Radars, Turnkey Projects, and Telecom Broadcast Systems. Its range of products also includes electronic voting machines (EVMs), communication equipment, radar warning receiver, and casings

Major orders executed in FY22 were:

Future Prospects


BEL has a strong order pipeline with an order book of INR 57,570 cr (including ~ USD 270 million export) as of March 31, 2022 (~3.75x of FY22 revenue) providing adequate revenue visibility in the medium term. Company also increased spending on R&D to ~ INR 1,050 cr vs INR 873 cr in FY21. Management expects:

  • Order inflow to be INR 20,000 cr in FY23, and R&D investment should be around INR 1,000 cr

  • Revenue growth of ~15-17% in the next couple of years and EBITDA margins of ~20-22%

Why invest in Bharat Electronics Ltd?

  • Tailwind in the industry – modern warfare needs more electronics; focus on the increase in localization of defense manufacturing

  • Established player in India’s defense electronics sector with ~55% market share

  • Robust order book providing revenue visibility and improved cash position of Indian government leading to better payment cycle (lower cash conversion days or working capital)

  • R&D spend of ~7% of revenue in FY22

2. Key Historical Financials

  • Revenue growth has been muted from FY20 onwards ranging between 7-9% - showing that Company faces execution challenges despite having a high order book

  • EBITDA margin has been stable between 21-24% during FY19-22

  • Cash conversion days are coming down leading to strong cash flow convertibility (CFO/EBITDA) in FY21 and FY22

  • BEL is debt-free

  • I expect the CFO/EBITDA to be ~80-85% in the next few years implying a CFO of at least INR 3,000 cr which would be enough to support the current dividend level (~INR 1,000 cr) and capex of ~INR 500-600 cr

  • Robust return (ROCE/ROE) ratios at 27%/21% in FY22

3. What is my view on company valuation?


BEL share price has increased ~55% in the last 1 year vs negative return in most of the indices.


Company trades at an EV/EBITDA multiple of 16x and P/E (TTM) of 24x vs a five-year P/E (TTM) multiple of 15x. Given that the Company has faced execution challenges and is a PSU but has strong tailwinds, I would be comfortable at a PEG ratio of 1.25x with EPS growth to be ~15% for the next few years implying a P/E ratio of 18-19x.


So, BEL is expensive at the current levels, and investors can evaluate entering at lower levels.


4. What are the risks to the investment analysis?


Risks to the analysis are:

  • Exposure to government procurement policies and payment cycles

  • BEL being majority-owned by the Government of India, may not always take decisions that are in favor of minority shareholders

  • Increasing competitive pressure from the private sector

 

About the Author


I have over 15 years of experience in venture capital, private equity and investment banking in India and Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in Middle East, to look after investments, M&A and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB) and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.


I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).


I am an Insignificant Investor in the public market and co-founder of SocInvest.


Disclosure


I have no stock, option or similar derivative position in any of the companies mentioned since last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.


I am not a SEBI registered advisor. This article is purely for educational purpose and not to be construed as an investment advice. Please consult your financial advisor before acting on it.


I have used publicly available information while writing this article.




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