Initiating Coverage | 10 September 2014 Bharat...

Battle ready

Bharat Electronics

Initiating Coverage | 10 September 2014Sector: Capital Goods

Satyam Agarwal ([email protected]); +91 22 3982 5410

Amit Shah ([email protected]); Nirav Vasa ([email protected])

Bharat Electronics

10 September 2014 2

Bharat Electronics: Battle ready

Page No.

Summary .............................................................................................................. 3

Defense Electronics at inflexion point ........................................................... 4-7

Bharat Electronics: Strengthening its Moat ............................................... 8-12

Expect 14% revenue CAGR, 18% earnings CAGR over FY15-17 ................ 13-15

Buy; price target of INR2,600 implies 26% upside .................................... 16-17

Risks and concerns ............................................................................................ 18

Company background ....................................................................................... 19

Financials and valuations ........................................................................... 20-21

Investors are advised to refer through disclosures made at the end of the Research Report.

Bharat Electronics

10 September 2014 3

Battle ready Prepped for rising defense expenditure

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.

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.

Initiating Coverage | Sector: Capital Goods

Bharat Electronics CMP: INR2,062 TP: INR2,600 Buy

BSE Sensex S&P CNX

27,265 8,153

Stock Info

Bloomberg BHE IN

Equity Shares (m) 80.0

52-Week Range (INR) 2,320/895

1, 6, 12 Rel. Per (%) 7/85/34

M.Cap. (INR b) 165.0

M.Cap. (USD b) 2.7

Financial Snapshot (INR Million)

Y/E Mar 2015E 2016E 2017E Net Revenue 70,485 80,896 92,070

EBITDA 9,754 12,600 15,027

Adj PAT 9,637 11,485 13,436

EPS (INR) 120.5 143.6 167.9

Growth (%) 3 19 17

BV/Sh (INR) 965 1,069 1,190

RoE (%) 12.5 13.4 14.1

RoCE (%) 8.4 10.1 11.0

P/E (x) 17.2 14.4 12.3

P/BV (x) 2.2 2.0 1.8

Shareholding Pattern (%)

As on Jun-14 Mar-14 Jun-13

Promoter 75.0 75.0 75.9

DII 17.7 16.9 15.1

FII 2.3 3.7 4.3 Others 5.0 4.3 4.7

Notes: FII incl. depository receipts

Stock Performance (1-year)

Bharat Electronics

10 September 2014 4

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)

Source: Dept of Electronics and Information Technology, Company,

MOSL (FY14 industry growth assumed at 5%)

Defense / Strategic Electronics at inflexion point (INR B)

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

Bharat Electronics

10 September 2014 5

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

share has been finalized with HAL by Dassault Aviation. Initial 18 to be procured as fly-away and remaining 108 to be licensed-produced by HAL in Bengaluru

If a contract is signed this year, then the first batch of aircraft would be delivered by 2017.

PMF (FGFA) 5th Generation Fighter PMF preliminary design phase (PDP) completed in June 2013. Series production expected to commence in 2022. Su-30 MKI would have ended by then. 250 FGFA to be procured

To take place in 2022-2025 time frame. HAL to commence flight testing of IAF variant in 2018

Sukhoi Su-30 MKI Total of 272 ordered till date. HAL will complete delivery of 222 aircraft it has on order by 2019-2020

More than 150 Su-30 MKI are in IAF service

Mirage 2000 Upgrade Two aircraft being upgraded at present in France. Remaining 47 aircraft to be upgraded by HAL in Bengaluru

Upgrade of all aircraft scheduled to be completed by 2021.

MiG 29 Upgrade First of upgraded aircraft to enter service this year

Upgrade of 60 plus aircraft will be 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

acquired through ‘buy & make (Indian)’ has been released

Already in service with 37 trainers delivered as of May this year Basic Trainer

HJT 36 Sitara Intermediate Jet Trainer (IJT)

IOC yet to be obtained Entry into service likely to be delayed by a few years

Hawk Mk-132 Advanced Jet Trainer (AJT)

Orders for 20 more Hawks for Surya Kiran display likely to be placed by next year

All 66 from first order have been 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 Helicopter

Winner yet to be declared NA

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

by next year 80 helicopters from previous order are

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

terminated in January this year Three helicopters delivered to the IAF

before the order was terminated

Source: Force Magazine

Bharat Electronics

10 September 2014 6

India Navy Procurement Plan

Indigenous Warships Status Entry into service Project 15A 'Kolkata' class Destroyer

All three 6,800 tonne destroyers are significantly behind schedules

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

Project 15B Destroyer Follow on class to project 15A. Contract for four P-15B ships has been signed in January 2011

Delivery schedule for four ships projected to be July 2018, July 2020, July 2022 and July 2024

Project 17 A Frigate will consist of 7 Frigates First of class expected to be delivered to Indian Navy post 2018

Project 28 'Kamorta' Class ASW corvette

Total of four in class, Keel of the third ASW corvette 'Kiltan' was laid in August 2010. Fourth and last of class named Kavaratti

INS Kamorta to be delivered to Indian Navy in FY15

Aircraft Carrier Status Entry into service

Indigenous Aircraft Carrier 1 (IAC-1)

Now named INS Vikrant. Phase I completed Trials to begin in 2016 with induction into 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

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

Upgrades planned to refit newer INS Shalki and Shankul with Harpoon missiles

NA

Nuclear submarine (indigenous)

First in class named INS Arihant. Total of three submarines to be built

Sea trials are expected to commence this year

Naval Air Arm Status Entry into service

Boeing P-8 Long range Maritime Reconnaissance (LRMR)

Request for Information has been sent out for Eight aircraft

Fourth P-81 delivered on schedule last month. Two additional aircraft to be delivered this year.

Medium Range Maritime Reconnaissance (MRMR)

Boeing Ch-47 D Chinook declared winner NA

MiG-29K All 16 Fighters from initial order have been delivered. Additional orders for 29 more placed in 2010 and deliveries are now underway

First MIG 29K Squadron was commissioned last year at INS Hansa

Light Combat Aircraft (LCA) Navy MK1

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


Bharat Electronics

10 September 2014 7

India Army Procurement Plan

Rockets and Artillery Status Induction into service Brahmos supersonic cruise missile

Army has placed orders for three regiments of Brahmos. Sanction for 4th regiment awaited. Upgraded block III Brahmos has undergone successful series of trials

Two regiments with Brahmos are already operational. Third Regiment of Brahmos to be deployed in Arunachal Pradesh

M777 ultra light howitzers

MOD delay has pushed back purchase of 145 M777 155mm/39 calibre ultra light howitzer's pending since 2010. Cost has now increased from USD 647 mn to USD 885mn

If an order is placed by 2015-16, then first guns would be delivered by 2017-2018, with deliveries being completed by 2020 for 5 regiments

Ordinance factory Board 155/45mm calibre Dhanush artillery gun

Ordinance Factory board displayed 155/45mm calibre Dhanush based on original bofors drawings at Defexpo 2014. OFB has received indent for 114 units of 155mmx45 calibre artillery gun

If an order is placed by 2015-16, then first guns would be delivered by 2017-2018, with deliveries being completed by 2020 for 5 regiments

Towed gun systems (TGS) and Mounted Gun system

Has been declared a Make and Buy for 1800 systems. Winner yet to be declared

2016-2018

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

Already in operation. Substantial numbers of T-90's to be upgraded with improved shifting, navigation and fire control system

T-721 M1 Ajeya MBT 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

Upgraded t-72 tanks are entering service and with life extension to remain operational beyond 2025

Arjun MBT MK-1 All 124 tanks have been delivered to the Indian Army

The 43rd armoured regiment at jaisalmer and 75th armoured regiment are fully operational with 45 tanks each

Arjun MBT MK-2 Orders for 118 Arjun MK-2 likely to be obtained next year. Trials expected to be completed this year

If orders placed next year, deliveries will begin in 2018. Production rate of 30 tanks annually being targeted

Future infantry combat vehicle (FICV)

Make India project has requirement for 2600 FICV's. Project approved in 2009. contenders are Mahindra, L&T, Tata motors and OFB

An indigenous FICV will require at least 3 years to enter production. The large numbers mean that obsolete BMP2/2K will be replaced only by 2030

BMP-2/2K Sarath Indian Army looking to upgrade BMP-2/2K to BMP-2M standard without replacement of existing turret

Large numbers and delays in the upgrade mean that the entire fleet upgrade for approximately 1400 BMP's would be complete only by 2025

Small Arms, Anti Tank & Air Defence

Status Entry into Service

Indian small arms system (INSAS) Rifle replacement

To be replaced through global route. Request for proposal issued in November 2011 for 60000 assault rifles. Field trials underway

Induction likely to begin 2016 onwards. Transfer of technology will see Indian ordinance factories manufacture 140000 rifles

Close Quarter battle carbines

Requirements for 43000 carbines NA

3rd generation Anti tank guided missile (ATGM)

Israel Rafael spike and Raytheon/Lockheed Martin Javelin in contention for order of up to 2000 launchers with 24,000 missiles

NA

Very short range air defence system (VSHORADS)

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

NA


Bharat Electronics

10 September 2014 8

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 Customers

Defense Communication Indian Defense Services, Para-military forces Naval Systems, Electro Optics, Electronic Warfare, Avionics, Tank Electronics, Weapon Systems, Command and Control Systems

Indian Defense Services, Para-military forces

Radars & Sonars Indian Defense Services, Civil Aviation, Meteorological Department, Space Department.

Telecommunication Department of Telecommunication, Para-military forces, Railways, DRDO

Broadcasting Equipments and Studio Systems

All India Radio, Doordarshan, (National Radio & TV Broadcasters), ISRO

Electronic Voting Machine Election Commission of India.

Solar Products & Systems Police, Individuals, Private and Government organizations. Turnkey Systems, E-Governance Networks

Police, State governments, Public sector undertakings, ISRO

Components

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

E-governance Systems

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

Land-based Radars Homeland

Precision Machining and Fabrication Naval Systems Civilian Radars Opto electronics components and assemblies Electronic Warfare Systems Solar products Microwave Integrated Circuit Assemblies Avionics Electronic

Super Components Modules

Electro Optics Telecom,

Cable assemblies and wiring harnesses Tank & Armoured Fighting Vehicle

Design and manufacturing of professional grade

Weapon Systems Antennae manufacturing C4I Systems Shelters & Masts Simulators Batteries


Bharat Electronics

10 September 2014 9

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

4.8%

4.8%

4.7%

4.1%

4.0%

4.3%

4.0%

3.7%

3.5%

5.1%

5.3%

6.1%

7.0%

8.2%

8.5%

7.6%

2393

2553

2558 27

90 3025

3177 34

20 3670

3696 3869

3991

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

R&D (% Revenues) R&D Employees


BHE’s revenue composition: Higher proportion of revenues from indigenously developed products

60%73% 81% 83% 75% 75% 78% 81% 78% 85%

40%27% 19% 17% 25% 25% 22% 19% 22% 15%

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Indigenous ToT


BHE: New products developed / introduced

FY11 Akash Weapon System

New Generation Humsa Sonar

Mobile Communication Terminal

Combat Management Systems for Ships

FY12 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

FY13 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

FY14 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


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

#1

Bharat Electronics

10 September 2014 10

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 Products Oerlikon Contraves, Switzerland Naval FC Systems Norcontrol, Norway Radar Scan Convertor Northrop Grumman, USA Airport Radars ELTA, Israel Battle Field Surveillance Radar INROS, Russia Sonobouys Matra Defence Equipments & Systems,

Electric Drive system for Tanks

Sextant, France LCD display unit ELBIT, Israel Stand alone communication unit Ericsson, Sweden Radio Relay System Elopotro, South Africa Laser Range Finder Signaal, The Netherlands Fire Control Radar Thompson Tube Electronic, France TWT Optelian International Corp Manufacture & Design of optical networking systems in India Thales, France Radars for select defense and civilian applications Elbit Systems Intelligence and Electro-

Compact Multi Purpose Advance Stabilization System

TCOM, USA Aerostat Surveillance and Communication System Textron Systems Unattended Ground Sensor (UGS) system Sagem, France Navigational Sensors like periscope, Inertial Navigational

Israel Aerospace Industries Long range Surface to Air Missile ship-defense systems

Elbit Systems Intelligence and Electro-Optics

Licensed collaborated manufacturing and D-Level Maintenance of Compact Multi-Purpose Advanced Stabilized


#2

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)

462

610

824

1,06

7

1,61

7

1,87

9

1,78

2

2,51

0

3,26

3

4,24

2

5,51

4

1% 1% 2% 2%3% 3% 3%

4%5%

5%6%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

FY17

E

Exports (INR B) % of Revenues


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)


#3

#4

Bharat Electronics


BHE: Key manufacturing facilities

Bangalore

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.

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

Panchkula Military communication equipment, encryption products Kotdwara Telecommunication systems, military communication systems

Pune X-ray tubes, batteries and laser products

Navi Mumbai Shelters and masts Hyderabad Electronic warfare systems Machilipatnam Electro optics ( nights vision devices)

Chennai Tank electronics, gun upgrades


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%

11.9

14.8

17.0

19.2

24.4

27.4

31.8

35.0

38.9

40.6

45.8

51.8

54.7

56.5

59.9

61.2

68.9

79.2

90.3

24%

15%

13%

27%

12% 16

%10

%11

%4%

13%

13%

6% 3% 6%2%

13% 15

%14

%

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

EFY

16E

FY17

E

Revenues (INR B) % YoY


Execution of Akash Missile to normalize BTB 19

.6

27.1

30.0

41.3

69.4

66.5

61.1

66.3

91.3

95.9

103.

9

113.

5

236.

0

257.

5

249.

5

234.

5

220.

6

212.

9

215.

6

1.7 1.8

1.8 2.

2 2.9

2.4

1.9

1.9 2.

3

2.4

2.3

2.2

4.3 4.6

4.2

3.8

3.2

2.7

2.4

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

FY17

E

Order Book (INR B) BTB (x)


Gross margin to decline but EBITDA to increase, given lower staff costs Expect gross margin to decline further, but EBITDA margin should expand

0%5%10%15%20%25%30%

0%10%20%30%40%50%60%

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

E

FY17

E

Gross Margins (%) LHS EBIDTA (%)


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

8000

10000

12000

14000

16000

10.0%

14.0%

18.0%

22.0%

26.0%

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

E

FY17

E

Staff Costs (% of Revenues) Employees (Nos)


Constrained execution

Expect acceleration

Akash Missile order in FY11/12 of INR65b

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

0%

40%

80%

120%

160%

0%

10%

20%

30%

40%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

EFY

16E

FY17

E

% of Order Book % of Revenues


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

-40

-20

0

20

40

60

80

-200

-100

0

100

200

300

400

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

EFY

16E

FY17

E

NWC (Days) Net Cash (INR B)


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

FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Inventories 168 161 177 196 196 190 180 175 Debtors 149 189 170 199 241 225 210 200 Loans and Advances 30 35 106 86 71 80 85 90 Other Current Assets 0 1 4 5 4 4 4 4 Total Current Assets 347 386 457 486 512 499 479 469 Creditors 55 55 68 67 70 69 68 65 Other Current Liabilities 8 20 24 23 25 24 23 22 Provisions 37 37 37 43 35 38 40 40 Total current Liabilities 64 75 92 90 95 93 91 87 Core NWC 283 311 365 396 418 406 388 382 Customer Advances 241 421 454 353 307 265 225 210 Reported NWC 43 -110 -89 43 111 141 163 172


CFO to turn positive led by improvement in core NWC


Cash balance (% of CE) to decline


Bharat Electronics


BHE: Key orders acquired and executed in FY14

Key orders acquired Key orders executed

Advanced composite communication

Akash Missile system Electronic support measures system Passive night vision devices Missile warning system Central Acquisition Radar Stabilized optronic pedestal for CRN 91 National Population Register Passive night vision devices Electronic support measure system for small ships Modular Combat Management System Missile warning system Ship borne EQ System Low level light weight Radar (Bharani) Electronic Voting Machines Low intensity conflict EW system

National Command Control Communication and

Fire Control System

Hull Mounted Sonar

Electronic Voting Machine


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


Return Ratios to improve


P/B band


Global Peer Group valuation Matrix (USD m)

CY13 EV/EBIDTA P/E (x)

Company Mcap Sales Op Margin PAT Margin RoE CY14E CY15E CY16E CY14E CY15E CY16E

Thales SA 11,688 18,854 10 4 15 6.2 5.9 5.8 12.2 11.4 10.6

Rockwell Collins Inc 10,388 4,610 23 14 44 10.9 10.1 9.3 17.1 15.5 13.9

L-3 communications Holdings 9,741 12,629 12 6 14 9.4 9.1 8.7 14.1 12.9 11.6

ITT Corp 4,510 2,497 11 20 51 9.8 8.8 8.1 20.2 17.9 16.1

CAE Inc 3,285 2,033 21 7 13 10.0 8.9 8.2 20.0 17.4 15.2

Heico Corp 2,965 1,009 22 10 17 13.5 12.1 11.0 28.4 25.3 22.1


Bharat Electronics


Operating Matrix INR m FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E Order book 113,500 236,000 257,480 249,490 234,520 220,634 212,914 215,551 Y-o-Y growth 9.3% 107.9% 9.1% -3.1% -6.0% -5.9% -3.5% 1.2% Order inflow 61,444 177,217 77,897 52,425 42,300 54,990 71,487 92,933 Y-o-Y growth 14.1% 188.4% -56.0% -32.7% -19.3% 30.0% 30.0% 30.0% Execution 51,804 54,717 56,500 59,905 61,223 68,876 79,207 90,296 Y-o-Y growth 13.0% 5.6% 3.3% 6.0% 2.2% 12.5% 15.0% 14.0% Book to bill ratio (x) 2.2 4.3 4.6 4.2 3.8 3.2 2.7 2.4 Net Sales 51,804 54,717 56,500 59,905 61,223 68,876 79,207 90,296

Defence 44,330 44,696 42,104 51,882 52,087 57,856 65,742 74,043 Non Defence 8,798 11,174 15,573 9,156 10,668 11,020 13,465 16,253

Net Sales Indigenously developed 57.0% 57.0% 54.0% NA 41.0% In association with DRDO, etc 18.0% 21.0% 27.0% NA 44.0% Total Indigenous 75.0% 78.0% 81.0% 78.0% 85.0% ToT from Foreign OEM's 25.0% 22.0% 19.0% 22.0% 15.0% Net Sales Domestic 51,131 53,680 55,157 58,340 59,232 65,613 74,965 8,782 Exports 1,067 1,617 1,879 1,782 2,510 3,263 4,242 5,514 Exports, % of Total 2.1% 3.0% 3.3% 3.0% 4.1% 4.7% 5.4% 6.1% Cost structure (% of Revenue) Raw material cost 56.4 56.3 62.1 62.4 57.9 59.0 59.3 59.5 Employee Cost 19.0 18.6 18.7 18.2 16.4 16.7 15.1 14.4 Other Expenses 4.8 5.0 5.7 6.0 6.3 6.3 6.3 6.3 Provisions/write off 2.0 2.4 2.9 2.9 5.4 4.3 3.8 3.5 R&D Expenses (INR m) 3159 3882 4682 5099 4670 R&D Expenses % to Sales 5.9 6.9 8.1 8.4 7.4 Net cash/( Debt) (INR m) 35,777 65,192 67,725 53,025 45,644 46,040 47,366 51,540 Core NWC (Days) 283 311 365 396 418 406 388 382 Customer Advances 241 421 454 353 307 265 225 210 Reported NWC (Days) 43 -110 -89 43 111 141 163 172


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.

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 Products Introduced

1956 Communication Equipment 1961 Receiving Valves 1962 Germanium Semi-conductors 1964 Radio Transmitters for AIR 1967 Transmitting Tubes, Silicon Devices and Integrated circuits 1970 Black and white TV picture Tube, X-ray tube and microwave tubes 1972 TV transmitters for Doordarshan 1973 Frigate Radars for Navy 1979 Image Converter and Image intensifier tubes 1985 Low power TV transmitters and TVRO for expansion of Doordarshan's Coverage 1989 Telecom switching and transmission systems Electronic Voting Machine


Year Manufacturing Facility Set up

1966 Sets up radar manufacturing Facility for Army

Sets up in-house R&D Facility

1968 Sets up PCB manufacturing Facility

1974 Sets up Manufacturing facility for Radars and Tropo communication Equipment for Indian Air force

1980 Sets up first overseas office in Newyork for procurement of components and materials 1981 Sets up manufacturing Facility for Magnesium Manganese Dioxide batteries at Pune 1982 Sets up Space Electronic division at Bangalore 1983 Takes over Andhra Scientific Company 1985 Sets up manufacturing facility for supply of Tank Electronics

Sets up manufacturing facility for military communication equipment

1986 Sets up manufacturing facility for switching Equipment

Sets up manufacturing facility for TV glass Shell

Sets up Manufacturing Facility for Electronic warfare Equipment

1987 Sets up separate Naval Equipment division

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

1990 First JV with M/s Delft of Holland 1992 Sets up second Research Laboratory 1997 Sets up JV with M/s GE USA 1998 Sets up second overseas at Singapore to source components from South East Asia 2002 Mini Ratna Status 2007 Navratna Status


Bharat Electronics


Financials and valuations Income statement (INR Million) Y/E Mar 2012 2013 2014 2015E 2016E 2017E Net Revenue 57,676 61,038 62,755 70,485 80,896 92,070 Change (%) 3 6 3 12 15 14 EBITDA 6,146 6,425 8,911 9,754 12,600 15,027 EBITDA Margin (%) 10.7 10.5 14.2 13.8 15.6 16.3 Depreciation 1,208 1,307 1,421 1,525 1,632 1,740 EBIT 4,938 5,118 7,490 8,229 10,969 13,287 Interest 6 8 34 30 30 30 Other Income 5,855 6,100 4,285 4,000 3,600 3,750 Extraordinary items -39 -64 6 0 0 0 PBT 10,748 11,146 11,747 12,199 14,539 17,007 Tax 2,450 2,248 2,431 2,562 3,053 3,571 Tax Rate (%) 22.8 20.2 20.7 21.0 21.0 21.0 Reported PAT 8,338 8,962 9,310 9,637 11,485 13,436 Adjusted PAT 8,299 8,898 9,316 9,637 11,485 13,436 Change (%) -1 7 4 4 19 17 Min. Int. & Assoc. Share 0 0 0 0 0 0 Adjusted PAT 8,299 8,898 9,316 9,637 11,485 13,436

Balance sheet (INR Million) Y/E Mar 2012 2013 2014 2015E 2016E 2017E Share Capital 800 800 800 800 800 800 Reserves 55,570 62,429 69,498 76,434 84,700 94,369 Net Worth 56,370 63,229 70,298 77,234 85,500 95,169 Debt 0 0 0 0 0 0 Deferred Tax -2,282 -2,716 -2,995 -3,000 -3,000 -3,000 Total Capital Employed 54,088 60,513 67,304 74,234 82,500 92,169 Gross Fixed Assets 19,016 20,732 22,267 23,467 24,667 25,867 Less: Acc Depreciation 13,914 14,978 15,757 17,283 18,914 20,655 Net Fixed Assets 5,102 5,755 6,509 6,184 5,752 5,212 Capital WIP 1,136 1,614 1,969 2,000 2,000 2,000 Investments 120 120 120 120 120 120 Current Assets 139,941 134,257 133,680 142,401 153,529 169,844 Inventory 27,918 32,711 33,701 36,691 39,894 44,143 Debtors 26,869 33,347 41,508 43,449 46,543 50,449 Cash & Bank 67,725 53,025 45,644 46,040 47,366 51,540 Loans & Adv, Others 17,429 15,174 12,826 16,221 19,725 23,711 Curr Liabs & Provns 92,210 81,233 74,974 76,471 78,902 85,007 Curr. Liabilities 86,323 74,071 68,979 69,133 70,036 74,917 Provisions 5,887 7,162 5,995 7,338 8,865 10,090 Net Current Assets 47,731 53,024 58,705 65,930 74,628 84,837 Total Assets 54,088 60,513 67,304 74,234 82,500 92,169

E: MOSL Estimates

Bharat Electronics


Financials and valuations Ratios Y/E Mar 2012 2013 2014 2015E 2016E 2017E Basic (INR) EPS 104.2 112.0 116.4 120.5 143.6 167.9 Cash EPS 118.8 127.6 134.2 139.5 164.0 189.7 Book Value 704.6 790.4 878.7 965.4 1068.7 1189.6 DPS 20.8 22.3 23.3 28.9 34.5 40.3 Payout (incl. Div. Tax.) 23.3 23.4 23.4 24.0 24.0 24.0 Valuation(x) P/E

17.8 17.2 14.4 12.3

Cash P/E

15.4 14.8 12.6 10.9 Price / Book Value

1.3 2.2 2.0 1.8

EV/Sales

0.8 1.8 1.5 1.3 EV/EBITDA

5.2 12.4 9.5 7.7

Dividend Yield (%)

1.1 1.4 1.7 1.9 Profitability Ratios (%) RoE 14.7 14.1 13.3 12.5 13.4 14.1 RoCE 6.8 6.5 8.4 8.4 10.1 11.0 Turnover Ratios (%) Asset Turnover (x) 3.0 2.9 2.7 2.9 3.2 3.5 Debtors (No. of Days) 170.0 199.4 241.4 225.0 210.0 200.0 Inventory (No. of Days) 176.7 195.6 196.0 190.0 180.0 175.0 Creditors (No. of Days) 68.4 67.4 69.6 69.0 68.0 65.0 Leverage Ratios (%) Net Debt/Equity (x) 0.0 0.0 0.0 0.0 0.0 0.0

Cash flow statement (INR Million) Y/E Mar 2012 2013 2014 2015E 2016E 2017E OP/(Loss) before Tax 10,787 11,210 11,741 12,199 14,539 17,007 Depreciation 1,208 1,307 1,421 1,525 1,632 1,740 Others 0 0 0 0 0 0 Interest 6 8 34 30 30 30 Direct Taxes Paid 2,450 2,248 2,431 2,562 3,053 3,571 (Inc)/Dec in Wkg Cap -2,534 -19,994 -13,062 -6,828 -7,371 -6,036 CF from Op. Activity 6,979 -9,780 -2,291 4,364 5,776 9,170 (Inc)/Dec in FA & CWIP -2,010 -2,439 -2,530 -1,231 -1,200 -1,200 (Pur)/Sale of Invt 0 0 0 0 0 0 Others 0 0 0 0 0 0 CF from Inv. Activity -2,010 -2,439 -2,530 -1,232 -1,200 -1,200 Inc/(Dec) in Net Worth -496 -390 -345 -5 0 0 Inc / (Dec) in Debt -1 0 0 0 0 0 Interest Paid -6 -8 -34 -30 -30 -30 Divd Paid (incl Tax) -1,934 -2,083 -2,181 -2,701 -3,220 -3,766 CF from Fin. Activity -2,437 -2,481 -2,560 -2,736 -3,250 -3,796 Inc/(Dec) in Cash 2,531 -14,700 -7,381 396 1,327 4,174 Add: Opening Balance 65,194 67,725 53,025 45,644 46,040 47,366 Closing Balance 67,725 53,025 45,644 46,039 47,366 51,540

E: MOSL Estimates

Bharat Electronics


N O T E S

Bharat Electronics


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Disclosure of Interest Statement BHARAT ELECTRONICS Analyst ownership of the stock No

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Bharat Electronics


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