Bharat Electronics: Prepped for rising defense expenditure

Bharat Electronics

Initiating Coverage | Sector: Capital Goods

Bharat Electronics

BSE Sensex

27,265

S&P CNX

8,153

CMP: INR2,062

TP: INR2,600

Buy

Battle ready

Prepped for rising defense expenditure

Stock Info

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1, 6, 12 Rel. Per (%)

M.Cap. (INR b)

M.Cap. (USD b)



BHE IN

80.0

2,320/895

7/85/34

165.0

2.7



The leader in Defense Electronics in India, Bharat Electronics (BHE) would be a

key beneficiary of the rising defense expenditure in the country.

The Indian Air Force would be finalizing large ticket acquisitions of USD20b-22b,

and as the proportion of Electronics is higher in Air Force orders, these deals

would be important from BHE’s perspective.

We expect BHE to report revenue CAGR of 14% and earnings CAGR of 18% over

FY15-17. Buy; our target price of INR2,600 implies 26% upside.

Financial Snapshot (INR Million)

2015E 2016E 2017E

Y/E Mar

Net Revenue 70,485 80,896 92,070

EBITDA

Adj PAT

EPS (INR)

Growth (%)

BV/Sh (INR)

RoE (%)

RoCE (%)

P/E (x)

P/BV (x)

9,754 12,600 15,027

9,637 11,485 13,436

120.5 143.6 167.9

12.5

8.4

17.2

2.2

13.4

10.1

14.4

2.0

14.1

11.0

12.3

1.8

965 1,069 1,190

Defense Electronics at inflexion point:

Large ticket acquisitions of USD20b-22b

to be finalized by the Indian Air Force –(1) MMCRA of ~USD20b from Dassault

(with 50% offset), and (2) Chinook/Apache Helicopters of ~USD2.5b from Boeing

– would be the key near-term drivers for Defense Electronics. Given that the

proportion of Electronics is higher in Air Force orders, the finalization of these

deals would be important from the perspective of Bharat Electronics (BHE).

Large Electronic Warfare Systems such as Tactical Communication Systems (TCS),

Battle Field Management Systems (BFMS), and Future Infantry Soldier System

(FISS), among others, would be medium-term drivers. In the past, BHE has stated

that the potential pipeline from TCS/BFMS stands at INR400b-500b.

Bharat Electronics to be key beneficiary:

BHE is the leader in Defense Electronics

in India, with a share of 55%+. BHE is well positioned to benefit from the rising

defense expenditure, supported by (1) strong manufacturing base (capacity

utilization of ~65%) and execution track record, (2) relationships with defense

and government agencies, (3) strategic collaboration with foreign technology

partners for new product development, and (4) in-house R&D capabilities (R&D

spend at 7.6% of revenues). Increased exports to friendly countries and higher

‘offset’ contribution opens up additional interesting growth opportunities.

Expect 14% revenue CAGR, 18% earnings CAGR over FY15-17:

We expect BHE to

report 14% revenue CAGR over FY15-17, largely supported by execution of the

Akash Missile project. During FY11/12, BHE received orders of ~INR65b for Akash

Missiles, and execution has been delayed. Improved execution will support

EBITDA margin (expect 210bp expansion during FY14-17), aided by lower staff

cost (expect 200bp decline), and lower provisions (expect 180bp decline),

offsetting the expected 165bp reduction in gross margin during this period. Net

working capital (NWC) is likely to deteriorate – being the lead integrator, BHE

had received advances on the Akash Missile project in FY11/FY12, leading to a

surge in cash balance and negative reported NWC.

Buy; price target of INR2,600 implies 26% upside:

We expect BHE to report EPS

of INR121 in FY15 (up 3%), INR144 in FY16 (up 19%), and INR168 in FY17 (up

17%). We initiate coverage with a

Buy

rating; our target price is INR2,600 (18x

FY16E EPS).

Key risks:

Delayed decision making for defense procurements and

increased competition from the private sector.

Shareholding Pattern (%)

As on

Promoter

DII

FII

Others

Jun-14 Mar-14 Jun-13

75.0

17.7

2.3

5.0

75.0

16.9

3.7

4.3

75.9

15.1

4.3

4.7

Notes:

FII incl. depository receipts

Stock Performance (1-year)

10 September 2014

Bharat Electronics

Defense Electronics at inflexion point

The Defense / Strategic Electronics sector, which contributes 6-7% of India’s overall

Electronics market, is at an inflexion point. We expect the production of Strategic

Electronics, which was INR90b in FY13, to grow at a CAGR of 16-18% over FY14-20.



Near-term drivers:

Large ticket acquisitions of USD20b-22b to be finalized by

the Indian Air Force – (1) MMCRA of ~USD20b from Dassault (with 50% offset),

and (2) Chinook / Apache Helicopters of ~USD2.5b from Boeing – would be the

key near-term drivers for Defense Electronics. Given that the proportion of

Electronics is higher in Air Force orders, the finalization of these deals would be

important from the perspective of Bharat Electronics (BHE).

Medium-term drivers:

Large Electronic Warfare Systems such as Tactical

Communication Systems (TCS), Battle Field Management Systems (BFMS), and

Future Infantry Soldier System (FISS), among others, would be medium-term

drivers. In the past, BHE has stated that the potential pipeline from TCS / BFMS

stands at INR400b-500b.

Big-ticket projects in the pipeline: Key drivers for Defence Electronics

Tactical Communication Systems

Battle Field Management Systems

Command Information Decision Support System

Future Infantry Soldier System

High data Rate Multi-band Software Defined Radio

Unmanned Arial Vehicles and Aerostats

Source: Industry

Dominant share in Strategic Defense Electronics (INR b)

Defense / Strategic Electronics at inflexion point (INR B)

Source: Dept of Electronics and Information Technology, Company,

MOSL (FY14 industry growth assumed at 5%)

Source: Dept of Electronics and Information Technology, Company,

MOSL (FY14 industry growth assumed at 5%)

Capital Expenditure budget constitutes ~40% of the Defense budget

Source: Company, MOSL

10 September 2014

Bharat Electronics

Indian Defense sector has a large procurement pipeline

India’s defense sector has been long plagued by delayed decision making. The slow

procurement over the decades and the collapse of a string of defense deals during

the recent past has left the military short of key equipments. Hence there is an

urgent need to accelerate the process. We highlight the key procurement plans of

Indian Air Force, Army and Navy.

Indian Air Force Procurement Plan

Fighter Aircraft

Status

Induction into service

MMRCA



Specifications, contractual setup and work



If a contract is signed this year, then

share has been finalized with HAL by

the first batch of aircraft would be

Dassault Aviation. Initial 18 to be procured

delivered by 2017.

as fly-away and remaining 108 to be

licensed-produced by HAL in Bengaluru

PMF (FGFA) 5th Generation Fighter



PMF preliminary design phase (PDP)



To take place in 2022-2025 time frame.

completed in June 2013. Series production

HAL to commence flight testing of IAF

expected to commence in 2022. Su-30 MKI

variant in 2018

would have ended by then. 250 FGFA to

be procured

Sukhoi Su-30 MKI



Total of 272 ordered till date. HAL will



More than 150 Su-30 MKI are in IAF

complete delivery of 222 aircraft it has on

service

order by 2019-2020

Mirage 2000 Upgrade



Two aircraft being upgraded at present in



Upgrade of all aircraft scheduled to be

France. Remaining 47 aircraft to be

completed by 2021.

upgraded by HAL in Bengaluru

MiG 29 Upgrade



First of upgraded aircraft to enter service



Upgrade of 60 plus aircraft will be

this year

completed by middle of 13th plan

Jaguar Upgrade



Contract signed with HAL



Upgrade of all aircraft will be

completed by end of 13th plan

LCA ‘Tejas’ Mk1



FOC to be obtained by end of 2014



Two squadrons to be inducted by end

of 12th plan

Trainers

Status

Entry into service

Pilatus PC-7 Mk II



RFI for additional 106 trainers to be



Already in service with 37 trainers

acquired through ‘buy & make (Indian)’

delivered as of May this year

Basic Trainer

has been released

HJT 36 Sitara Intermediate Jet



IOC yet to be obtained



Entry into service likely to be delayed

Trainer (IJT)

by a few years

Hawk Mk-132 Advanced Jet Trainer



Orders for 20 more Hawks for Surya Kiran



All 66 from first order have been

(AJT)

display likely to be placed by next year

delivered. Deliveries underway as part

of additional contract for 40

Helicopters

Status

Entry into service

Light Utility Helicopter (LUH)



First prototype likely to be ready this year



Induction into service end of 12th plan

Reconnaissance & Surveillance



Winner yet to be declared



Helicopter

Advanced Light Helicopter



Dhruv Mk4 deliveries currently underway



All Dhruv helicopter deliveries to

completed by end of 12th plan

Light Combat Helicopter (LCH)



65 on order for IAF



IOC likely to be obtained by 2015

Medium Lift Helicopter



All 71 Mi-17V-5 helicopters to be delivered



80 helicopters from previous order are

by next year

already in service

Heavy Lift Helicopter



Boeing Ch-47 D Chinook declared winner



Order for 15 helicopters has been

delayed

Attack Helicopter



Boeing AH-64 D Apache block 3 selected



Order for 22 helicopters has been

delayed

VVIP Helicopters



Order for 12 VVIP AW 101 helicopters



Three helicopters delivered to the IAF

terminated in January this year

before the order was terminated

Source: Force Magazine

10 September 2014

Bharat Electronics

India Navy Procurement Plan

Indigenous Warships

Project 15A 'Kolkata' class

Destroyer

Project 15B Destroyer

Entry into service



First of class INS Kolkata, to be delivered to

Navy this year. Sister ships INS Kochi and INS

are likely to be in service by 2016



Follow on class to project 15A. Contract for



Delivery schedule for four ships projected to

four P-15B ships has been signed in January

be July 2018, July 2020, July 2022 and July

2011

2024



will consist of 7 Frigates



First of class expected to be delivered to

Indian Navy post 2018



Total of four in class, Keel of the third ASW



INS Kamorta to be delivered to Indian Navy

corvette 'Kiltan' was laid in August 2010.

in FY15

Fourth and last of class named Kavaratti

Status

Entry into service

Status



All three 6,800 tonne destroyers are

significantly behind schedules

Project 17 A Frigate

Project 28 'Kamorta' Class

ASW corvette

Aircraft Carrier

Indigenous Aircraft Carrier 1



Now named INS Vikrant. Phase I completed



Trials to begin in 2016 with induction into

(IAC-1)

Navy being planned for 2018

Submarines

Status

Entry into service

Project 75 'Scorpene'

Total of six on order, has experienced

substantial delays, but project is now said

to be back on track



Upgrades planned to refit newer INS Shalki

and Shankul with Harpoon missiles



First in class named INS Arihant. Total of

three submarines to be built

Status



First Scorpene submarine will join the Indian

Navy only in 2016. Deliveries of remaining 5

submarines will be completed by 2021

Sishumar-class HDW type

209/1500

Nuclear submarine

(indigenous)

Naval Air Arm

Boeing P-8 Long range

Maritime Reconnaissance

(LRMR)

Medium Range Maritime

Reconnaissance (MRMR)

MiG-29K



Sea trials are expected to commence this

year

Entry into service

Fourth P-81 delivered on schedule last

month. Two additional aircraft to be

delivered this year.

First MIG 29K Squadron was commissioned

last year at INS Hansa

Request for Information has been sent out



for Eight aircraft

Boeing Ch-47 D Chinook declared winner



Light Combat Aircraft (LCA)

Navy MK1



All 16 Fighters from initial order have been



delivered. Additional orders for 29 more

placed in 2010 and deliveries are now

underway

Behind schedule. Target date for initial



operational clearance (IOC) by 2014 will

not be met.

IOC likely to be achieved by 2016-17 with

entry into service towards 2020

Source: Force Magazine

10 September 2014

Bharat Electronics

India Army Procurement Plan

Rockets and Artillery

Status

Induction into service

Brahmos supersonic cruise



Army has placed orders for three regiments of



Two regiments with Brahmos are already

missile

Brahmos. Sanction for 4th regiment awaited.

operational. Third Regiment of Brahmos

Upgraded block III Brahmos has undergone

to be deployed in Arunachal Pradesh

successful series of trials

M777 ultra light



MOD delay has pushed back purchase of 145



If an order is placed by 2015-16, then

howitzers

M777 155mm/39 calibre ultra light howitzer's

first guns would be delivered by 2017-

pending since 2010. Cost has now increased from

2018, with deliveries being completed by

USD 647 mn to USD 885mn

2020 for 5 regiments

Ordinance factory Board



Ordinance Factory board displayed 155/45mm



If an order is placed by 2015-16, then

155/45mm calibre

calibre Dhanush based on original bofors

first guns would be delivered by 2017-

Dhanush artillery gun

drawings at Defexpo 2014. OFB has received

2018, with deliveries being completed by

indent for 114 units of 155mmx45 calibre

2020 for 5 regiments

artillery gun

Towed gun systems (TGS)



Has been declared a Make and Buy for 1800



2016-2018

and Mounted Gun system

systems. Winner yet to be declared

Armour

Status

Induction into service

T-90 S Bhisma Main battle



tank (MBT)

59 armoured regiments to be equipped with



around 1600 tanks (1000 to be manufactured in

India). DAC has cleared manufacture of 235 T-90

tanks at HVF Avadi

The fleet of T-72 tanks is being upgraded with



thermal imager stand alone system, improved

engines and auto land navigation system for

command and control tanks

All 124 tanks have been delivered to the Indian



Army

Already in operation. Substantial

numbers of T-90's to be upgraded with

improved shifting, navigation and fire

control system

Upgraded t-72 tanks are entering service

and with life extension to remain

operational beyond 2025

T-721 M1 Ajeya MBT



Arjun MBT MK-1

Arjun MBT MK-2

Future infantry combat

vehicle (FICV)

BMP-2/2K Sarath

Small Arms, Anti Tank

& Air Defence

Indian small arms system

(INSAS) Rifle replacement

The 43rd armoured regiment at

jaisalmer and 75th armoured regiment

are fully operational with 45 tanks each



Orders for 118 Arjun MK-2 likely to be obtained



If orders placed next year, deliveries will

next year. Trials expected to be completed this

begin in 2018. Production rate of 30

year

tanks annually being targeted



Make India project has requirement for 2600



An indigenous FICV will require at least 3

FICV's. Project approved in 2009. contenders are

years to enter production. The large

Mahindra, L&T, Tata motors and OFB

numbers mean that obsolete BMP2/2K

will be replaced only by 2030



Indian Army looking to upgrade BMP-2/2K to



Large numbers and delays in the upgrade

BMP-2M standard without replacement of

mean that the entire fleet upgrade for

existing turret

approximately 1400 BMP's would be

complete only by 2025

Status

Entry into Service



To be replaced through global route. Request for



proposal issued in November 2011 for 60000

assault rifles. Field trials underway

Requirements for 43000 carbines



Induction likely to begin 2016 onwards.

Transfer of technology will see Indian

ordinance factories manufacture 140000

rifles

Close Quarter battle

carbines

3rd generation Anti tank

guided missile (ATGM)

Very short range air

defence system

(VSHORADS)



Israel Rafael spike and Raytheon/Lockheed



Martin Javelin in contention for order of up to

2000 launchers with 24,000 missiles

Tender underway since 2010. Competitors are



MBDA Mistral, Saab RBS 70 NG and KBM Igla S

for an order of close to 1,000 launchers with

6000 missiles initially. Raytheon's stinger also an

offer

Source: Force Magazine

10 September 2014

Bharat Electronics

Bharat Electronics: Strengthening its Moat

Bharat Electronics (BHE) is the leader in Defense Electronics in India, with a share of

55%+. The company is well positioned to benefit from the rising defense

expenditure, supported by (1) strong manufacturing base (capacity utilization of

~65%) and execution track record, (2) relationships with defense and government

agencies, (3) strategic collaboration with foreign technology partners for new

product development, and (4) in-house R&D capabilities (R&D spend at 7.6% of

revenues). Increased exports to friendly countries and higher ‘offset’ contribution

open up additional interesting growth opportunities.

BHE: Customer profile

Segments

Defense Communication

Naval Systems, Electro Optics, Electronic

Warfare, Avionics, Tank Electronics,

Weapon Systems, Command and Control

Systems

Radars & Sonars

Telecommunication

Broadcasting Equipments and Studio

Systems

Electronic Voting Machine

Solar Products & Systems

Turnkey Systems, E-Governance

Networks

Components

Customers

Indian Defense Services, Para-military forces

Indian Defense Services, Civil Aviation, Meteorological

Department, Space Department.

Department of Telecommunication, Para-military forces,

Railways, DRDO

All India Radio, Doordarshan, (National Radio & TV

Broadcasters), ISRO

Election Commission of India.

Police, Individuals, Private and Government organizations.

Police, State governments, Public sector undertakings,

ISRO

All India Radio and Doordarshan the National Radio & TV

Broadcasters, Instrumentation Industry, Switching

Industry, Entertainment Industry, Telephone Industry,

Individuals

Source: MOSL, Company

BHE’s Key Product portfolio

Defense Products

Non Defense Products

Services



Army Communication Products &

Systems

Land-based Radars

Naval Systems

Electronic Warfare Systems

Avionics

Electro Optics

Tank & Armoured Fighting Vehicle

Weapon Systems

C4I Systems

Shelters & Masts

Simulators

Batteries



E-governance

Systems

Homeland

Civilian Radars

Solar products

Electronic

Telecom,



PCB assembly (SMT, Through Hole, BGA) and testing

Precision Machining and Fabrication

Opto electronics components and assemblies

Microwave Integrated Circuit Assemblies

Super Components Modules

Cable assemblies and wiring harnesses

Design and manufacturing of professional grade

Antennae manufacturing

Source: MOSL, Company

10 September 2014

Bharat Electronics

R&D spend at 7.6% of revenues

To improve indigenization, adapt upcoming technologies, and maintain its

leadership position in the fast evolving Defense Electronics market, BHE has laid

strong emphasis on R&D (FY14 spend at 7.6% of net sales). Its focused approach has

led to 85% of its revenues coming from indigenously developed products. Products

developed in-house account for 41% of its revenues, while products developed in

association with DRDO and other national laboratories account for 44%.

BHE has enhanced R&D spending (% of revenues) / R&D

manpower meaningfully since FY09

R&D (% Revenues)

R&D Employees

BHE’s revenue composition: Higher proportion of revenues

from indigenously developed products

Indigenous

ToT

40%

15%

27% 19% 17% 25% 25% 22% 19% 22%

60%

85%

73% 81% 83% 75% 75% 78% 81% 78%

Source: Company, MOSL

BHE has filed for 9 patents

during FY14 in the area of x-

ray baggage scan images,

radar scan converter,

gradient estimate for

adaptive analog beam,

accurate target bearing

using digital compass, etc

BHE: New products developed / introduced

FY11

Akash Weapon System

New Generation Humsa Sonar

Mobile Communication Terminal

Combat Management Systems for Ships

Coastal Surveillance System

Tablet PC

Integrated anti submarine warfare complex

Advanced torpedo defence system

Digital radio trunking system

Upgraded indigenous forward observer simulator

Electro optic fire control systems

Integrated radio line modem

Remotely operated vehicle

Thermal imaging camera for fly catcher radar

National Command Control Communication and Intelligence Network (NC3I)

Mobile Cellular Communication System

Passive Night Vision Devices with XD4 technology

ESM system for small ship

Point to Multi Point Radio and mast for LORROS

3D Tactical Control Radar

Low Level Light Weight Surveillance Radar (Bharani)

Missile Approach Warning System

Printing attachment to EVM to facilitate comparison of votes in event of disputes

EVM with new specifications incl digital certification and tamper proof mechanism

Hull Mounted Sonar

Source: MOSL, Company

FY12

FY13

FY14

10 September 2014

Bharat Electronics

Technology collaborations / MoUs with several foreign players for product

development / offset opportunities

BHE has forged technology collaborations with global players like (1) Thales, France

(radars for select defense and civilian applications), and the JV has been approved

by the FIPB / Central Government, and (2) Elbit Systems Intelligence and Electro-

Optics (licensed collaborated manufacturing and D-level maintenance of Compact

Multi-Purpose Advanced Stabilized System for the Advanced Light Helicopter

Program), among others. These collaborations should enable BHE to enhance its

capabilities to cater to various domestic projects.

Also, given the strong “Offset” pipeline in Defense Procurement, BHE is interacting

with several foreign companies like Elbit Systems, Boeing, Lockheed Martin,

Raytheon, Northrop Grumman, BAE Systems, SAAB, Thales, and Israel Aerospace

Industries for possible business arising out of various RFPs issued by the Ministry of

Defense. It has already signed several MoUs, which should enable BHE to be a part

of the global supply chain.

During FY14, BHE has received record high export order inflow of US$142m and

export order book stands at US$194m. Of the total order book, offset order book

stands at US$28m, growth of 119% YoY basis. We believe that recent 49% FDI

approval in defence from central government augurs well for BHE’s offset portfolio

as every order above INR3bn will have an 30% offset clause built in.

Technology tie-ups / MoUs signed by BHE

Company

Oerlikon Contraves, Switzerland

Norcontrol, Norway

Northrop Grumman, USA

ELTA, Israel

INROS, Russia

Matra Defence Equipments & Systems,

Sextant, France

ELBIT, Israel

Ericsson, Sweden

Elopotro, South Africa

Signaal, The Netherlands

Thompson Tube Electronic, France

Optelian International Corp

Thales, France

Elbit Systems Intelligence and Electro-

TCOM, USA

Textron Systems

Sagem, France

Israel Aerospace Industries

Elbit Systems Intelligence and Electro-

Optics

Products

Naval FC Systems

Radar Scan Convertor

Airport Radars

Battle Field Surveillance Radar

Sonobouys

Electric Drive system for Tanks

LCD display unit

Stand alone communication unit

Radio Relay System

Laser Range Finder

Fire Control Radar

TWT

Manufacture & Design of optical networking systems in India

Radars for select defense and civilian applications

Compact Multi Purpose Advance Stabilization System

Aerostat Surveillance and Communication System

Unattended Ground Sensor (UGS) system

Navigational Sensors like periscope, Inertial Navigational

Long range Surface to Air Missile ship-defense systems

Licensed collaborated manufacturing and D-Level

Maintenance of Compact Multi-Purpose Advanced Stabilized

Source: MOSL, Company

10 September 2014

Bharat Electronics

Increased exports to friendly countries

Increased exports of defense equipment and armaments to friendly countries could

also be a key driver. Going by recent media articles, BHE could make a beginning by

exporting BrahMos missiles to South East Asian and South American countries.

Vietnam, Indonesia, and Venezuela have expressed willingness to procure the

BrahMos supersonic missiles. India could also export indigenously developed Light

Combat Aircraft (Tejas; expect clearance in 2014), Air Defense Systems (Akash and

Prahar class of missiles), etc, to friendly countries.

BHE’s export order book increased meaningfully in FY14 to USD194m (v/s USD94m

in FY13). It exported sonar systems for the first time in FY14. Other major products it

has exported include Automatic Identification Systems, Radar Warning Systems,

Radar Finger Printing Systems, Casings, Stators, Electromechanical Parts, etc. Also,

BHE has successfully established itself as a supply chain partner of global players like

Boeing and Hamilton Sunstrand. In FY14, it successfully commenced manufacturing

of Aircraft Cable Looms for Pilatus of Switzerland.

The management targets to increase its export sales to total sales ratio from the

current 4% in FY14 to 7% by FY19.

BHE: Increased contribution of exports (INR B)

Exports (INR B)

% of Revenues

Source: MOSL, Company

Infrastructure in place to target INR100b revenue

BHE has created a strong manufacturing base of nine factories, which currently

operate at ~61% capacity utilization. The management believes these assets can

support revenues of up to INR100b; the business has meaningful operating leverage.

Steady infrastructure Creation over the Years

FA turnover ratio to improve as execution picks up (x)

Source: MOSL, Company

10 September 2014

Source: MOSL, Company

Bharat Electronics

BHE: Key manufacturing facilities

Military communication equipment, network centric systems, military radars,

navel systems, electronic warfare(airforce), avionics, weapon system, telecom and

broadcast system, components, coastal surveillance system, electronic voting

machines, solar products, traffic signals, security systems, microwave super

components.

Network centric systems, radars, antennae, satcom (defense), microwave

components

Military communication equipment, encryption products

Telecommunication systems, military communication systems

X-ray tubes, batteries and laser products

Shelters and masts

Electronic warfare systems

Electro optics ( nights vision devices)

Tank electronics, gun upgrades

Source: MOSL, Company

Bangalore

Ghaziabad

Panchkula

Kotdwara

Pune

Navi Mumbai

Hyderabad

Machilipatnam

Chennai

10 September 2014

Bharat Electronics

Expect 14% revenue CAGR, 18% earnings CAGR over FY15-17

We expect BHE to report 14% revenue CAGR over FY15-17, largely supported by

execution of the Akash Missile project. During FY11/12, BHE received orders of

~INR65b for Akash Missiles and execution is delayed. With successful test firing for

the Indian Air Force in FY13 / Indian Army in FY14, execution should pick up in FY15-

16. Improved execution will support EBITDA margin (expect 210bp expansion during

FY14-17), aided by lower staff cost (expect 200bp decline), and lower provisions

(expect 180bp decline), offsetting the expected 165bp reduction in gross margin

during this period. We expect net profit to grow at a CAGR of 18% over FY15-17.

Net working capital (NWC) is likely to deteriorate – being the lead integrator, BHE

had received advances on the Akash Missile project in FY11/FY12, leading to a surge

in cash balance and negative reported NWC.

Expect revenue CAGR of 14%, led by Akash Missile execution

Expect revenue CAGR over FY14-17 to improve to 14%

Revenues (INR B)

% YoY

Expect

acceleration

Constrained

execution

Execution of Akash Missile to normalize BTB

Order Book (INR B)

Akash Missile order in

FY11/12 of INR65b

BTB (x)

Source: Company, MOSL

Gross margin to decline but EBITDA to increase, given lower staff costs

Expect gross margin to decline further, but EBITDA margin

should expand

Gross Margins (%) LHS

60%

50%

40%

30%

20%

10%

EBIDTA (%)

30%

25%

20%

15%

10%

26.0%

22.0%

18.0%

14.0%

10.0%

Employee strength cut by ~45% from peak levels in FY01; to

support margins

Staff Costs (% of Revenues)

Employees (Nos)

16000

14000

12000

10000

8000

Source: Company, MOSL

10 September 2014

Bharat Electronics

Reported NWC to deteriorate, largely due to execution of Akash Missile project

Customer advances to decline sharply as % of revenues, but

to be stable as % of order book, impacting NWC

% of Order Book

40%

30%

20%

10%

% of Revenues

160%

120%

80%

40%

400

300

200

100

-100

-200

Volatility in FY11/12 in NWC / cash was due to advances on

Akash Missile project

NWC (Days)

Net Cash (INR B)

-20

-40

Source: Company, MOSL

Core NWC to improve; however reported NWC to deteriorate as customer advances decline (Days)

FY10

Inventories

Debtors

Loans and Advances

Other Current Assets

Total Current Assets

Creditors

Other Current Liabilities

Provisions

Total current Liabilities

Core NWC

Customer Advances

Reported NWC

168

149

347

283

241

FY11

161

189

386

311

421

-110

FY12

177

170

106

457

365

454

-89

FY13

196

199

486

396

353

FY14

196

241

512

418

307

111

FY15E

190

225

499

406

265

141

FY16E

180

210

479

388

225

163

FY17E

175

200

469

382

210

172

Source: MOSL, Company

CFO to turn positive led by improvement in core NWC

Cash balance (% of CE) to decline

Source: MOSL, Company

10 September 2014

Bharat Electronics

BHE: Key orders acquired and executed in FY14

Key orders acquired

Advanced composite communication

Electronic support measures system

Missile warning system

Stabilized optronic pedestal for CRN 91

Passive night vision devices

Modular Combat Management System

Ship borne EQ System

Electronic Voting Machines

Key orders executed

Akash Missile system

Passive night vision devices

Central Acquisition Radar

National Population Register

Electronic support measure system for small ships

Missile warning system

Low level light weight Radar (Bharani)

Low intensity conflict EW system

National Command Control Communication and

Fire Control System

Hull Mounted Sonar

Electronic Voting Machine

Source: MOSL, Company

10 September 2014

Bharat Electronics

Buy; price target of INR2,600 implies 26% upside

We believe that BHE is well positioned to benefit from the rising defense

expenditure, supported by (1) strong manufacturing base (capacity utilization of

~60%) and execution track record, (2) relationships with defense and government

agencies, (3) strategic collaboration with foreign technology partners for new

product development, and (4) in-house R&D capabilities (R&D spend at 7.6% of

revenues)We expect BHE to report EPS of INR121 in FY15 (up 3%), INR144 in FY16

(up 19%), and INR168 in FY17 (up 17%). We initiate coverage with a

Buy

rating; our

target price is INR2,600 (18x FY16E EPS).

Key risks:

Delayed decision making for

defense procurements and increased competition from the private sector.

Net profit growth of 18% CAGR over FY15-17E as

P/E band

Source: Company, MOSL

Return Ratios to improve

P/B band

Source: Company, MOSL

Global Peer Group valuation Matrix (USD m)

CY13

Company

Thales SA

Rockwell Collins Inc

L-3 communications Holdings

ITT Corp

CAE Inc

Heico Corp

Mcap

11,688

10,388

9,741

4,510

3,285

2,965

Sales

18,854

4,610

12,629

2,497

2,033

1,009

Op Margin PAT Margin

RoE

CY14E

6.2

10.9

9.4

9.8

10.0

13.5

EV/EBIDTA

CY15E

5.9

10.1

9.1

8.8

8.9

12.1

CY16E

5.8

9.3

8.7

8.1

8.2

11.0

CY14E

12.2

17.1

14.1

20.2

20.0

28.4

P/E (x)

CY15E

11.4

15.5

12.9

17.9

17.4

25.3

CY16E

10.6

13.9

11.6

16.1

15.2

22.1

Source: MOSL, Company

10 September 2014

Bharat Electronics

Operating Matrix

INR m

Order book

Y-o-Y growth

Order inflow

Y-o-Y growth

Execution

Y-o-Y growth

Book to bill ratio (x)

Net Sales

Defence

Non Defence

Net Sales

Indigenously developed

In association with DRDO, etc

Total Indigenous

ToT from Foreign OEM's

Net Sales

Domestic

Exports

Exports, % of Total

Cost structure (% of Revenue)

Raw material cost

Employee Cost

Other Expenses

Provisions/write off

R&D Expenses (INR m)

R&D Expenses % to Sales

Net cash/( Debt) (INR m)

Core NWC (Days)

Customer Advances

Reported NWC (Days)

FY10

113,500

9.3%

61,444

14.1%

51,804

13.0%

2.2

51,804

44,330

8,798

FY11

236,000

107.9%

177,217

188.4%

54,717

5.6%

4.3

54,717

44,696

11,174

FY12

257,480

9.1%

77,897

-56.0%

56,500

3.3%

4.6

56,500

42,104

15,573

FY13

249,490

-3.1%

52,425

-32.7%

59,905

6.0%

4.2

59,905

51,882

9,156

FY14

234,520

-6.0%

42,300

-19.3%

61,223

2.2%

3.8

61,223

52,087

10,668

FY15E

220,634

-5.9%

54,990

30.0%

68,876

12.5%

3.2

68,876

57,856

11,020

FY16E

212,914

-3.5%

71,487

30.0%

79,207

15.0%

2.7

79,207

65,742

13,465

FY17E

215,551

1.2%

92,933

30.0%

90,296

14.0%

2.4

90,296

74,043

16,253

57.0%

18.0%

75.0%

25.0%

57.0%

21.0%

78.0%

22.0%

54.0%

27.0%

81.0%

19.0%

78.0%

22.0%

41.0%

44.0%

85.0%

15.0%

51,131

1,067

2.1%

53,680

1,617

3.0%

55,157

1,879

3.3%

58,340

1,782

3.0%

59,232

2,510

4.1%

65,613

3,263

4.7%

74,965

4,242

5.4%

8,782

5,514

6.1%

56.4

19.0

4.8

2.0

3159

5.9

35,777

283

241

56.3

18.6

5.0

2.4

3882

6.9

65,192

311

421

-110

62.1

18.7

5.7

2.9

4682

8.1

67,725

365

454

-89

62.4

18.2

6.0

2.9

5099

8.4

53,025

396

353

57.9

16.4

6.3

5.4

4670

7.4

45,644

418

307

111

59.0

16.7

6.3

4.3

59.3

15.1

6.3

3.8

59.5

14.4

6.3

3.5

46,040

406

265

141

47,366

51,540

388

382

225

210

163

172

Source: MOSL, Company

10 September 2014

Bharat Electronics

Risks and concerns

Increase in competition from private players

In order to thrust indigenization in the defence sector, Government has increased

the FDI Limit in July 2014 in defence sector to 49%. Increased FDI limit can lead to

huge investments in defence sector by global defence giants by forging partnership

with Indian private companies and bid for the upcoming projects. This will

significantly increase the competition in the defence Sector and might hurt the

financials of the private sector.

Delay in Finalization of defence orders

Over the last five years, BHE as well as defence sector has witnessed sluggish order

finalization on account of the policy logjam at the Centre. If the constrained ordering

environment continues in future than it might significantly impact the financials of

the company.

Inability to indigenize Technology

Technology tie up and absorption of the technology for indigenization remains key

for financial success of BHE. Any failure to successfully tie with foreign vendor or in

absorption of technology will impact the financials of the company.

De-licensing of the BHE’s product list

Currently BHE’s product continue to be in the licensed category and thus any new

player entering the BHE’s product category has to procure license from Government

for the manufacturing of the same. If going ahead government de-licenses BHE’s

products since electronics are not standalone weapons systems then it can intensify

the competition and impact the financials of the company.

10 September 2014

Bharat Electronics

Company background

Bharat Electronics Limited (BHE) was established at Bangalore, India, by the

Government of India under the Ministry of Defence in 1954 to meet the specialized

electronic needs of the Indian defence services. Over the years, it has grown into a

multi-product, multi-technology, multi-unit company servicing the needs of

customers in diverse fields in India and abroad.

Key Milestones

Year

1956

1961

1962

1964

1967

1970

1972

1973

1979

1985

1989

Products Introduced

Communication Equipment

Receiving Valves

Germanium Semi-conductors

Radio Transmitters for AIR

Transmitting Tubes, Silicon Devices and Integrated circuits

Black and white TV picture Tube, X-ray tube and microwave tubes

TV transmitters for Doordarshan

Frigate Radars for Navy

Image Converter and Image intensifier tubes

Low power TV transmitters and TVRO for expansion of Doordarshan's Coverage

Telecom switching and transmission systems

Electronic Voting Machine

Source: MOSL, Company

Year

1966

1968

1974

1980

1981

1982

1983

1985

1986

Manufacturing Facility Set up

Sets up radar manufacturing Facility for Army

Sets up in-house R&D Facility

Sets up PCB manufacturing Facility

Sets up Manufacturing facility for Radars and Tropo communication Equipment for Indian Air

force

Sets up first overseas office in Newyork for procurement of components and materials

Sets up manufacturing Facility for Magnesium Manganese Dioxide batteries at Pune

Sets up Space Electronic division at Bangalore

Takes over Andhra Scientific Company

Sets up manufacturing facility for supply of Tank Electronics

Sets up manufacturing facility for military communication equipment

Sets up manufacturing facility for switching Equipment

Sets up manufacturing facility for TV glass Shell

Sets up Manufacturing Facility for Electronic warfare Equipment

Sets up separate Naval Equipment division

Sets up first central Research Laboratory to focus on R&D

First JV with M/s Delft of Holland

Sets up second Research Laboratory

Sets up JV with M/s GE USA

Sets up second overseas at Singapore to source components from South East Asia

Mini Ratna Status

Navratna Status

Source: MOSL, Company

1987

1990

1992

1997

1998

2002

2007

10 September 2014

Bharat Electronics

Financials and valuations

Income statement

Y/E Mar

Net Revenue

Change (%)

EBITDA

EBITDA Margin (%)

Depreciation

EBIT

Interest

Other Income

Extraordinary items

PBT

Tax

Tax Rate (%)

Reported PAT

Adjusted PAT

Change (%)

Min. Int. & Assoc. Share

Adjusted PAT

2012

57,676

6,146

10.7

1,208

4,938

5,855

-39

10,748

2,450

22.8

8,338

8,299

-1

8,299

2013

61,038

6,425

10.5

1,307

5,118

6,100

-64

11,146

2,248

20.2

8,962

8,898

2014

62,755

8,911

14.2

1,421

7,490

4,285

11,747

2,431

20.7

9,310

9,316

2015E

70,485

9,754

13.8

1,525

8,229

4,000

12,199

2,562

21.0

9,637

(INR Million)

2016E

80,896

12,600

15.6

1,632

10,969

3,600

14,539

3,053

21.0

11,485

2017E

92,070

15,027

16.3

1,740

13,287

3,750

17,007

3,571

21.0

13,436

Balance sheet

Y/E Mar

Share Capital

Reserves

Net Worth

Debt

Deferred Tax

Total Capital Employed

Gross Fixed Assets

Less: Acc Depreciation

Net Fixed Assets

Capital WIP

Investments

Current Assets

Inventory

Debtors

Cash & Bank

Loans & Adv, Others

Curr Liabs & Provns

Curr. Liabilities

Provisions

Net Current Assets

Total Assets

2012

800

55,570

56,370

-2,282

54,088

19,016

13,914

5,102

1,136

120

139,941

27,918

26,869

67,725

17,429

92,210

86,323

5,887

47,731

54,088

2013

800

62,429

63,229

-2,716

60,513

20,732

14,978

5,755

1,614

120

134,257

32,711

33,347

53,025

15,174

81,233

74,071

7,162

53,024

60,513

2014

800

69,498

70,298

-2,995

67,304

22,267

15,757

6,509

1,969

120

133,680

33,701

41,508

45,644

12,826

74,974

68,979

5,995

58,705

67,304

2015E

800

76,434

77,234

-3,000

74,234

23,467

17,283

6,184

2,000

120

142,401

36,691

43,449

46,040

16,221

76,471

69,133

7,338

65,930

74,234

(INR Million)

2016E

2017E

800

84,700

94,369

85,500

95,169

-3,000

82,500

92,169

24,667

25,867

18,914

20,655

5,752

5,212

2,000

120

153,529 169,844

39,894

44,143

46,543

50,449

47,366

51,540

19,725

23,711

78,902

85,007

70,036

74,917

8,865

10,090

74,628

84,837

82,500

92,169

E: MOSL Estimates

10 September 2014

Bharat Electronics

Financials and valuations

Ratios

Y/E Mar

Basic (INR)

EPS

Cash EPS

Book Value

DPS

Payout (incl. Div. Tax.)

Valuation(x)

P/E

Cash P/E

Price / Book Value

EV/Sales

EV/EBITDA

Dividend Yield (%)

Profitability Ratios (%)

RoE

RoCE

Turnover Ratios (%)

Asset Turnover (x)

Debtors (No. of Days)

Inventory (No. of Days)

Creditors (No. of Days)

Leverage Ratios (%)

Net Debt/Equity (x)

2012

104.2

118.8

704.6

20.8

23.3

2013

112.0

127.6

790.4

22.3

23.4

2014

116.4

134.2

878.7

23.3

23.4

17.8

15.4

1.3

0.8

5.2

1.1

14.7

6.8

3.0

170.0

176.7

68.4

0.0

14.1

6.5

2.9

199.4

195.6

67.4

0.0

13.3

8.4

2.7

241.4

196.0

69.6

0.0

2015E

120.5

139.5

965.4

28.9

24.0

17.2

14.8

2.2

1.8

12.4

1.4

12.5

8.4

2.9

225.0

190.0

69.0

0.0

2016E

143.6

164.0

1068.7

34.5

24.0

14.4

12.6

2.0

1.5

9.5

1.7

13.4

10.1

3.2

210.0

180.0

68.0

0.0

2017E

167.9

189.7

1189.6

40.3

24.0

12.3

10.9

1.8

1.3

7.7

1.9

14.1

11.0

3.5

200.0

175.0

65.0

0.0

Cash flow statement

Y/E Mar

OP/(Loss) before Tax

Depreciation

Others

Interest

Direct Taxes Paid

(Inc)/Dec in Wkg Cap

CF from Op. Activity

(Inc)/Dec in FA & CWIP

(Pur)/Sale of Invt

Others

CF from Inv. Activity

Inc/(Dec) in Net Worth

Inc / (Dec) in Debt

Interest Paid

Divd Paid (incl Tax)

CF from Fin. Activity

Inc/(Dec) in Cash

Add: Opening Balance

Closing Balance

2012

10,787

1,208

2,450

-2,534

6,979

-2,010

-496

-1

-6

-1,934

-2,437

2,531

65,194

67,725

2013

11,210

1,307

2,248

-19,994

-9,780

-2,439

-390

-8

-2,083

-2,481

-14,700

67,725

53,025

2014

11,741

1,421

2,431

-13,062

-2,291

-2,530

-345

-34

-2,181

-2,560

-7,381

53,025

45,644

2015E

12,199

1,525

2,562

-6,828

4,364

-1,231

-1,232

-5

-30

-2,701

-2,736

396

45,644

46,039

(INR Million)

2016E

2017E

14,539

17,007

1,632

1,740

3,053

3,571

-7,371

-6,036

5,776

9,170

-1,200

-30

-3,220

-3,766

-3,250

-3,796

1,327

4,174

46,040

47,366

51,540

E: MOSL Estimates

10 September 2014

Bharat Electronics

NOTES

10 September 2014

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

Analyst ownership of the stock

BHARAT ELECTRONICS

Disclosures

Bharat Electronics

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10 September 2014

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