Strategic tie-ups, new product development, good track record and cash hoard augur well for Bharat Electronics.
India’s recent test of two missiles, including the land-attack version of the BrahMos supersonic cruise missile, is part of its ongoing investments in strengthening its defence capabilities. The growing concerns over cross border tensions and the increasing terrorist activities in the country indicate that the need for higher defence expenditure and focus on enhancing capabilities is at its zenith. The statement of India’s defence minister at a recent seminar on Defence industry only confirms the rising importance of defence. “As the security scenario is undergoing unprecedented changes, the defence industry has come to occupy the centre-stage like never before – not only in our country, but the world over.”
Defensive business model
One of the key beneficiaries of India's focus on strengthening its defence capabilities will be Bharat Electronics, which was formed with the aim of serving different mechanical and electrical requirements of the Indian defence sector. As the defence sector is considered to be strategic, it is not surprising that government of India holds 75.86 per cent stake in the company.
| CONSISTENT PERFORMER | |||
| in Rs crore | FY08 | FY09E | FY10E |
| Net sales | 4059 | 4627 | 5320 |
| EBITDA (%) | 24.7 | 23.2 | 23.5 |
| PAT | 826 | 879 | 1011 |
| EPS (Rs) | 103 | 110 | 126 |
| PE (x) | 7.9 | 7.4 | 6.5 |
| E: Estimates | |||
This has also resulted in most of the defence requirements being met through Bharat Electronics (BEL). While 70 per cent of the equipment requirements are sourced from overseas markets, BEL enjoys over 57 per cent market share of the 30 per cent sourced locally. The company supplies strategic electronics such as range of military communication systems, radars, naval systems, telecom & broadcast systems, electronic warfare systems, tank electronics and many more to all the defence establishments including Army, Navy, Air Force and Paramilitary Forces. As a result of this, 83 per cent of the company's revenue accrue from the defence sector, while 17 per cent is accounted by civil equipment like telecommunication, broadcasting products like DTH and electronic voting machines (EVM). The company was recently awarded an Rs 100 crore order for EVM by the election commission.
Consistent growth
Historically, the growth in the defence expenditure has been in the range of 6-8 per cent, which is expected to continue on the back of similar growth in the GDP. Though the growth may not look very strong, but given the consistency in the defence spending, the company has been able grow on sustainable basis. BEL's revenue and net profit have never declined in any of the last ten years. Its revenue and net profit have consistently grown annually at 14.6 per cent and 35 per cent, respectively during FY99-FY08 respectively. Moreover, the company's current order book of Rs 10,000 crore is 2.5 times BEL’s FY08 revenue and provides good revenue visibility.
Going forward, considering the political scenario and cross border tension in the country it is unlikely that India's capex on defence will be curtailed. Also, the emphasis is now given on newer and indigenous technologies with an aim to reduce dependence on imports.
Inventing to grow fast
The need for indigenous technologies and increasing overall production, the government has allowed 100 per cent private participation in the defence equipment sector. Companies like L&T are eying these opportunities in the big way. Although competition will increase, the opportunities continue to be huge given that India imports almost 70 per cent of its defence equipment. Bharat Electronics, too, has appointed global consultancy firm, KPMG, to help identify opportunities to expand in existing as well as new business segments. The company is consolidating its businesses so as to achieve its targeted revenue of Rs 10,000 crore by FY12 (from Rs 4,100 crore in FY08) implying an growth rate of 26 per cent per annum.
Plan of action
To achieve this, the company has planned a total capital expenditure of Rs 570 crore for the next two years (FY09 and FY10). This will be towards modernising its manufacturing facilities. Also, the focus will be strategic tie-ups with its partners to enhance business capabilities. The company already has partnerships with aerospace majors like Lockheed Martin and Boeing and global defence companies like EADS, Northrop Grumman, Raytheon and Honeywell.
"BEL is looking for new growth opportunities through organic or inorganic growth in existing and new areas. In this direction, BEL is discussing with reputed foreign and Indian players for forming joint venture companies in India, in the areas of defence electronics, namely electro optics, airborne electronic warfare, missile electronics and guidance systems, microwave super components, etc. Some of these proposals are in the advanced stage of discussions," says N K Sharma, Director (Marketing), BEL. The company has also been aggressively investing in developing new products in-house—in FY08, it introduced about 20 new products. The company now intends to increase its R&D expenditure, which was about 5 per cent in FY08, to 8-10 per cent of its turnover, which should help sustain its efforts in this direction.
Investment rationale
The company’s strategy to increase spend on R&D and new capacities, acquire new technologies and identify key growth areas augurs well and should help in achieving its ambitious long-term growth plans. BEL is a debt-free company and is sitting on a cash and cash equivalent worth Rs 2,400 crore, which also indicates that the company has enough muscle to fund its future plans.
In turbulent times, this stock proves to be a safer investment available at attractive valuations (PE multiple of 6.4 times its FY10 estimated earnings). Since the company has maintained a dividend payout in excess of 20 per cent, one can expect additional returns in terms of healthy dividends (yield of 3.2 per cent based on FY10 profits) in future as well. The company's cash (yields interest income of about Rs 200 crore or earnings of Rs 23 per share) is valued at about Rs 300 per share or 38 per cent of its current market price. At Rs 800, the stock is capable of delivering healthy returns in the long-run.
