Bharat Electronics rating: Buy — A robust performance in the final quarter

BEL, despite a high base in Q4FY19, posted 50% sales jump led by execution of LRSAM/IACC, reflecting poor gross margin, but better absorption of fixed costs and overheads.

Despite a tall ask of recouping margin lost in 9mFY20 and forex loss, Bharat Electronics’ (BEL) Q4FY20 Ebitda surpassed estimate by 25% (margin at 25.5%). This implies greater operating leverage and y-o-y dip in contractual labour/warranties, in our view. Q4 numbers materially address two major concerns—operating margin and cash flow; both came better, vindicating stronger competitive MOAT around superior systems integration capabilities and under-appreciated internal efficiencies and reflects a much higher seriousness towards critical defence procurement.

We now expect a much better revenue growth in FY21/22 given high visibility for ventilators in H1, execution of three-four large projects in order book and healthy payment cycle reflecting in strong FY20 cash flow. Factoring in impact of sharp OPM improvement and better near-term revenue visibility, we revise up FY21/22e EPS 14%/9%. Maintain Buy with revised TP of Rs 110 (Rs 90 earlier) given growth/return visibility.

Simultaneous large projects execution, lower overhead drive margin: BEL, despite a high base in Q4FY19, posted 50% sales jump led by execution of LRSAM/IACC, reflecting poor gross margin, but better absorption of fixed costs and overheads. This aided 7% revenue growth and 5% Ebitda dip in FY20, better than Street’s expectation. While top-line growth was lower than guidance (10%), margin came higher versus general guidance range of 17-19%. Lower contract cost/warranties in FY20 apart from operating leverage benefits contributed to better operating margin.

What’s in store for 12-24 months? We expect the healthy revenue growth to sustain, reflected in strong order book of Rs 520 bn (4x FY20 sales) and a run rate of Rs 130-150 bn for new orders annually. With better systems integration capabilities, BEL is capable of delivering a much larger turnover, yielding better cash flows/returns over two-three years.

Outlook: Fortifying its niche
Near-term concerns on growth, profitability and cash flows stand largely addressed; however, the bigger picture lies in BEL’s improved capability to handle multiple large value systems integration, which could yield much better returns/cash flow in its core areas of platform-based weapon systems & maintenance, etc. We maintain ‘BUY/SO’.