Bharat Electronics stock attractive after stake sale by Norges Bank

PSU Bharat Electronics (BEL) has seen a sharp decline in its share value in the past few sessions. While lower than estimated profitability in the October-December quarter of the 2022-23 financial year (Q3FY23) may have disappointed investors, the key trigger was the decision by Norway’s sovereign fund, Norges Bank, to divest holdings in BEL on geopolitical grounds.

BEL’s decision to sell a remote-controlled weapons station to the Myanmar government in 2021 was unacceptable to the Norwegian government since Myanmar uses weapons “in ways that constitute serious and systematic violations of international humanitarian law” according to the fund’s statement.

BEL derives well over 80 per cent of its revenue from defence- related products including radar, missile systems, electronic warfare & avionics, anti-submarine warfare, electro-optics, homeland security, and so on. 

For the company. revenue increased 11.8 per cent year-on-year or YoY (up 4.7 per cent quarter-on-quarter or QoQ) to Rs 4,131 crore in Q3FY23. But higher raw material costs led to earnings before interest, tax, depreciation and amortisation (Ebitda) margin contraction by 160 basis points (bps) YoY (a negative 103 bps QoQ) to 20.7 per cent. However, profit after tax (PAT) increased 2.6 per cent YoY to Rs 598.8 crore.

The order book was Rs 50,116 crore as of December, 2022 end (which is roughly 3 times its annual revenues). The order book grew Rs 1,452 crore during Q3, and by Rs 3,736 crore in the first nine months of FY23. Interest costs were higher at Rs 9.7crore versus Rs 0.2 crore in Q3FY22. 

The strong order book, and the likelihood of better margins -- as the supply chain untangles and raw material costs decline -- are good reasons to back BEL in the long term. In addition, the industrial policy of Atmanirbhar and the effort to indigenise defence production is positive. 

The company is also looking to raise the revenue share of its civilian products segment, as well as its exports focus, and to shore up its services division. Ebitda is likely to grow at roughly 20 per cent over the next two or three financial years with the margin recovering to around 22-23 per cent.

The company’s ability to maintain a decent pace of order-execution and its zero debt balance sheet and high dividend payouts are also attractive. Value-investors would note that the ROCE (return on capital employed) is around 43 per cent. 

Key assumptions include the government of India maintaining budgeted defence capex growth while focussing on reduction in defence imports. A slowdown in new orders, or execution delays, or continuing supply chain constraints (since semiconductors are crucial components) and the government’s own liquidity remain potential risks. Due to the inherent nature of the business, revenues can also be lumpy since these are dependent on orders/deliveries of defence equipment, which tend to come in bursts. 

Analyst consensus is “buy” given all the positives. However, there could be revenue volatility and the Norges sell-off have clearly impacted the share price. Total FPI (foreign portfolio investor) holdings before the sell-off amounted to 17.35 per cent, which means there could be a significant impact if other FPIs also sell. 

The stock closed at Rs 89 on Monday, down from Rs 101 a week ago. Adjusted for a 2:1 bonus in September 2022, this is down about 25 per cent from the 52-week high. Analysts have valuations in the range between Rs 120-130, which implies a 34 per cent upside.