>BHARAT ELECTRONICS LIMITED: A Solid Play on Indian Defense Modernization

Initiate coverage with Overweight rating, Sept-12 PT of Rs2000 based on 16x Sep13E P/E. BHE, a leading Indian manufacturer of defense electronics, is a play on rising government expenditure on modernization of Indian defense forces. This is supported by a favorable policy framework that seeks a higher share of domestically-produced equipment. With its strong R&D capability, solid execution track record, and long-standing relationship with the Indian defense establishment, we think BHE is well positioned to benefit. It currently has an order book of Rs270B providing revenue visibility for 4-5 years. Valuations have de-rated over the past few quarters on account of margin pressure owing to oneoff lower-margin non-defense orders. We expect a rebound in margins to drive 18% EPS CAGR over FY12-FY14E, which should drive valuations higher. We estimate BHE has Rs55B of cash (Rs685 per share, 45% of market cap) as at 3Q FY12; with the govt. looking at sources of cash to fund its fiscal deficit, we see a case for higher/special dividend payout (the govt. has a 75.9% stake in Bharat).


■ Well positioned to benefit from rising defense expenditure. Indian govt. spending on defense equipment is expected to rise at a 10% CAGR to USD19B by 2015 (source CII-Deloitte). While most defense equipment procurement is from foreign vendors, govt. wants to increase domestic share. Defense Procurement Policy mandates minimum 30% offset against any foreign capital acquisition over Rs3B. BEL is well positioned to benefit, given its strong R&D capabilities and longstanding relationships with Indian defense establishment. Its current order book of Rs270B is largely skewed towards defense related orders (80%+) providing steady revenue visibility over next 4-5 years.


■ Margins set to recover, solid cash profile. We forecast EPS CAGR of 18% over FY12-FY14E, driven by 8% revenue CAGR and margin recovery. We estimate BHE has cash balance of Rs55B (Rs685 per share) on its books, which will increase to Rs63.6B (Rs795 per share) by FY14E.


■ Price target, valuations and key risks. Our Sep-12 PT of Rs2000 is based on 16x Sep13E P/E, towards the middle of BHE's historical trading range. BHE is trading at 13xFY13E P/E, which we believe is attractive given its order-book, earnings growth and cash profile. We expect margin recovery to drive stock rerating. Key risks to our thesis are increasing competition, delay in execution, changes to payment terms and slowdown in defense expenditure.


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