Bharat Electronics (BEL)

Considering the growth potential, expertise and recession-proof nature of its order book, Bharat Electronics can be expected to record profit growth of 25-30% p.a. over the next few years. Investors with a time frame of 2-3 years can consider taking exposure in the stock

BHARAT Electronics (BEL) is a public sector enterprise with 76% government ownership. The Bangalore-based company is country’s premier manufacturer of electronics products and components for the defence sector. Even though the stock has nearly doubled in last six months, it is still trading at an attractive valuation. Considering the growth potential, its expertise and recession proof nature of its order book, the company can be reasonably expected to record profit growth of 25-30% over the next few years. Investors with a time frame of 2-3 years can consider taking exposure in the stock.

COMPANY’S BUSINESS:

As the name suggests, BEL is an electronics manufacturer and mainly caters to the defence needs of the country. It makes communication devices like radars & sonars. Besides that it makes telecommunication and broadcast equipment, electronic voting machines and e-governance network, among others. While most of its revenues come from meeting the needs of defence sector, in recent years the company has been creating a market potential for its various product and systems in non-defence sectors, such as, for civil aviation, oil & gas and railways, among others. The share of non-defence continues to remain low at 15% of the sales, which the company targets to take up to about 30%. Its civilian product portfolio includes items, such as, high frequency communication sets, transceivers, radio relays, fire control systems, communication systems for various ships and yards, air traffic control surveillance, 3D surveillance radar, night vision binoculars, satellite based mobile communication system and electronic voting machines. It is also into solar products, where it is serving the needs of individual and private organisation also.

The company’s market is relatively protected from foreign and domestic competition owing to the sensitive nature of the products, and the threat for orders drying up is low. This business offers a high potential, with increasing importance of renewable source of energy, and the developing stage of technology for the product. The entry into non-defence market is significant as the company has a high degree of technical and manufacturing expertise, which it can leverage to become a leading supplier of high-end electronic systems to the civilian sector. Unlike many of its competitor, the company is an integrated manufacturer of most of the electronic components that go into the final product. This lowers its cost and significantly improves its profitability.

While the company’s product line continues to remain protected, the defence sector is progressively being opened to private players and foreign competitors. Still, the downside of this to BEL is limited and it has actually helped the company improve its operations through various efforts related to quality, cost control and so on. The company has also focussed on improving the product development and delivery cycle time, to match the international standards.

Among other growth initiatives, BEL is now focussing on focus on exports, indigenisation of imported systems and exploring new segments in the domestic market. The company is also actively exploring various JV especially with foreign players for domestics as well as foreign market. Further, newer high-growth areas such as solar energy and egovernance provide good upside potential and they share complementarities with its exiting businesses. It has also identified areas for further exploration such as homeland security and nuclear power Instrumentation, where there is significant scope for the company, more so because of its public sector status.

FINANCIALS:

The company net profit grew at a compounded annual rate (CAGR) of 22% during three years ending March 2008, much faster than 10% CAGR growth in its net sales. While it managed to grow sales by nearly 13% in FY09, profitability took a knock leading to 9.6% decline in net profit. This was mainly due to 47% increase in raw material cost, impacted due to depreciation in rupee, as 70-80% of its raw material is imported.

However, it has managed a turnaround in H1’FY10 recording sales of Rs 2219 core, an impressive increase of 88% year-on-year. With relatively lower growth of 62% in raw material cost, the company managed to improve its operating margin by as much as 10 percentage point. With a marginal growth of 1% in total other costs; company managed to register profit of Rs 310 core, an impressive growth of 146%.

VALUATIONS:

While the profit growth of 150% in H1’10 is not sustainable, but it has enough capability to sustain growth rate of 25%, at least over the next few years. Since, the defence continues to remain a priority for successive government, its core business area remains unaffected by the economic ups and downs. Further, the diversification into non-defence market will help it shore up the volume further, even though the margins may not be as good as in the defence market. The stock is trading at an attractive priceearnings ratio of 15 times its trailing earnings and is an attractive proposition for investors with a medium term outlook.