RESULT UPDATE

BHARAT ELECTRONICS Weak order momentum; margin improvement on cards

India Equity Research| Engineering and Capital Goods

EDELWEISS 4D RATINGS Bharat Electronics (BEL) surprised the Street with above estimate revenue Absolute Rating BUY and margin for Q4FY13, though it belied our estimates on both fronts. The company missed (by 3%) its FY13 revenue and order intake guidance Rating Relative to Sector Outperformer (by 25% miss to INR52.5bn) led by approval delays and cancellation of a Risk Rating Relative to Sector High Sector Relative to Market Underweight few projects. It has inked FY14 MoU for INR67.5bn sales (up 10%) and INR60bn (up 14%) for order intake. While we cut our FY14E and FY15E earnings 7% each building in lower turnover in line with the MoU, we MARKET DATA (R: BAJE.BO, B: BHE IN) believe BELs profitability is set to improve over FY14-15 on back of higher CMP : INR 1,267 proportion of high-value addition sales (radars, weapon systems etc). Target Price : INR 1,617 Maintain ‘BUY‘ with revised TP of INR 1,633 (earlier INR1,610), rolling 52-week range (INR) : 1,399 / 1,105 forward to FY15E. Share in issue (mn) : 80.0 M cap (INR bn/USD mn) : 101/ 1,804 Avg. Daily Vol.BSE/NSE(‘000) : 32.8 FY14 MoU guidance in double digits; margins to improve

BEL signed FY14 revenue and order intake MoU at INR67.5bn and INR60.0bn, SHARE HOLDING PATTER N (%) respectively. The company expects order inflows for weapon locating radars, missile Current Q3FY13 Q2FY13 warning systems, mobile communication systems and passive night vision devices. Promoters * 75.9 75.9 75.9 FY14E revenue to primarily include deliveries for Akash missile systems (6 squadrons), MF's, FI's & BK’s 15.2 15.6 15.4 2 regiment of Army, missile warning systems etc. We expect the company to report FII's 3.7 3.4 3.4 superior margins in FY14 and FY15 led by higher volumes from Akash Missile Systems Others 5.2 5.1 5.3 with higher value addition by BEL. * Promoters pledged shares : NIL (% of share in issue)

FY13-15E earnings CAGR at 10%; upside potential from JVs PRIC E PERFORMANCE (%) We expect BELs earnings to post 10% CAGR over FY13-15E led by strong order book of EW Capital INR249bn (book to bill at 4.1XFY13 sales) and higher proportion of defence turnover Stock Nifty Goods Index (which implies better margin). Also, we have not factored in any upside in order intake and earnings from potential JV order inflows from Thales etc. 1 month 7.8 3.3 6.0 3 months 12.4 7.6 (1.6)

12 months 0.9 23.7 (3.9) Outlook and valuations: Positive; maintain ‘BUY’

We continue to remain positive on BEL given stable earnings outlook and strong positioning in domestic defence capex. While policy changes favouring the private sector remain a key long-term risk, we do not expect BEL’s growth rate to get impacted over two-three years atleast. We maintain our ‘BUY/SO’ with a revised TP of INR1,633 at which the stock discounts its FY14E and FY15E earnings 10.4x and 9.7x, respectively. Amit Mahawar Financials (INR mn) +91 22 4040 7451 [email protected] Year to March Q4FY13 Q4FY12 % change Q3FY13 % change FY13 FY14E FY15E Rahul Gajare Net rev. 27,781 22,972 20.9 14,652 89.6 61,038 66,985 74,179 +91 22 4063 5561 EBITDA 5,929 3,221 84.0 1,597 NM 6,361 8,239 9,272 [email protected] Net profit 5,927 3,540 67.4 1,977 199.8 8,899 9,771 10,521 Swarnim Maheshwari Dilu. EPS (INR) 74.1 44.3 67.4 24.7 199.8 111.2 122.1 131.5 +91 22 4040 7418 Dilu.P/E (x) 11.4 10.4 9.7 [email protected]

EV/EBITDA (x) 7.6 5.7 4.8 ROAE (%) 14.9 14.5 13.9 May 30, 2013 Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

Engineering and Capital Goods

Chart 1: Revenue growth came back strongly though missed the FY13 sales guidance 28,321 159.0

23,932 119.8

19,543 80.6 (%) 15,153 41.4 (INR mn) (INR

10,764 2.2

6,375 (37.0) Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Revenue Revenue growth (%)

Chart 2: EBITDA margins improved on account of strong execution and OPLEV. 6,978 31.0

5,327 21.4

3,676 11.8 (%) 2,026 2.2 (INR mn) (INR

375 (7.4)

(1,276) (17.0) Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 EBITDA EBITDA margins

Chart 3: Order book to stabilize at ~INR240bn 300 208.0

240 153.0

180 98.0 (%)

(INR bn) (INR 120 43.0

60 (12.0)

0 (67.0) FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E Order book Order intake growth

Source: Company, Edelweiss research

2 Edelweiss Securities Limited Bharat Electronics

Chart 4: BEL trades at a 30 % discount to historical PE of 13.8x 25.0

20.0

15.0 (x) 10.0

5.0

0.0 06 07 07 08 08 09 09 10 10 11 11 12 12 13 ------Jun Jun Jun Jun Jun Jun Dec Dec Dec Dec Dec Dec Nov May BEL 1 year forward P/E

Source: Company, Edelweiss research

3 Edelweiss Securities Limited Engineering and Capital Goods

Financial snapshot (INR mn) Year to March Q4FY13 Q4FY12 % change Q3FY13 % change FY13 FY14E FY15E Net revenues 27,781 22,972 20.9 14,652 89.6 61,038 66,985 74,179 Staff costs 3,120 2,410 29.4 2,406 29.7 11,108 12,526 13,871 Direct costs 16,408 15,184 8.1 9,457 73.5 38,069 40,191 44,359 Other expenses 2,325 2,157 7.8 1,192 95.1 5,500 6,029 6,676 Total expenditure 21,852 19,751 10.6 13,055 67.4 54,677 58,746 64,906 EBITDA 5,929 3,221 84.0 1,597 271.2 6,361 8,239 9,272 Depreciation 374 300 24.8 318 17.4 1,307 1,385 1,502 Other income 1,728 1,472 17.4 1,295 33.4 6,100 6,002 6,071 Interest 4 - - 8 - - Profit before tax 7,279 4,394 65.7 2,574 182.8 11,146 12,856 13,841 Tax 1,352 853 58.4 597 126.5 2,248 3,086 3,322 Core profit 5,927 3,540 67.4 1,977 199.8 8,899 9,771 10,519 Net profit 5,927 3,540 67.4 1,977 199.8 8,899 9,771 10,519 Equity capital 800 800 800 800 800 800 No. of shares (mn) 80 80 80 80 80 80 Diluted EPS (INR) 74.1 44.3 67.4 24.7 199.8 111.2 122.1 131.5

As % of net revenues Direct costs 59.1 66.1 64.5 62.4 60.0 59.8 Employee cost 11.2 10.5 16.4 18.2 18.7 18.7 Other expenses 8.4 9.4 8.1 9.0 9.0 9.0 EBITDA 21.3 14.0 10.9 10.4 12.3 12.5 Reported net profit 21.3 15.4 13.5 14.6 14.6 14.2

Change in estimates FY14E FY15E New Old % change New Old % change Comments Net Revenue 66,985 75,118 (10.8) 74,179 82,651 (10.3) Building in lower turnover in line with the MoU signed with the GOI. EBITDA 8,239 9,240 (10.8) 9,272 10,166 (8.8) EBITDA Margin 12.3 12.3 12.5 12.3 Core profit 9,771 10,448 (6.5) 10,519 11,249 (6.5) Due to lowered revenues. PAT Margin 14.6 13.9 14.2 13.6 Capex 1,400 1,460 (4.1) 1,400 1,460 (4.1)

4 Edelweiss Securities Limited Bharat Electronics

Company Description Established by GoI under the Ministry of Defence in 1954 to meet the specialised electronic needs of the Indian defence services, Bharat Electronics Limited (BEL) has grown into a multi-product, multi-technology and multi-unit company, serving the needs of customers in diverse fields in India and abroad. BEL offers products and services in a wide spectrum of technology like radars, military communications, naval systems, electronic warfare systems, telecommunications, sound and vision broadcasting, opto-electronics, tank electronics, solar photovoltaic systems, embedded software and electronic components. The company also provides turnkey systems solutions like command control communication & computer intelligence (C4I), covering the requirements of all three forces.

Investment Theme BEL, one of India’s largest defence public sector undertakings (PSU), specialises in manufacturing defence electronics. It is emerging as a key beneficiary of increase in defence capital expenditure. Further, domestic companies, including BEL, are likely to benefit from key changes in government policies, notably the offset clause (30% of an order must be sub- contracted domestically). Despite the entry of private players, we believe BEL as a defence PSU is poised to benefit from increased defence capital expenditure and the offset policy.

BEL has a strong order book, equivalent to nearly four years of revenues. Its order book is slated to grow over the next few years because of steady demand for its existing product range; potential orders from high value projects (e.g., tactical communication systems) and growth opportunities in the non defence/ export segments.

Key Risks Delay/lumpiness in execution of defence contracts The defence market is monopsonistic in nature with GoI being the sole buyer of defence equipment, which puts suppliers such as BEL at a disadvantage. Further, defence procurement procedures are complex and past experience suggests that they have tended to move at an extraordinarily slow pace. This has a dual impact: the equipment flow may not occur and it leads to a high degree of lumpiness in the order book.

Increased competition from private players

The government has shown increased intent of involving private players in the defence procurement process and to develop an active private sector supply to the armed forces. We believe DPSUs have strong competitive advantages over the private sector in the near– to-medium term. However, incremental competition, particularly for offset contracts, could make a negative impact on BEL’s margins.

5 Edelweiss Securities Limited Engineering and Capital Goods

Financial Statements

Key Assumptions Income statement (INR mn) Year to March FY12 FY13 FY14E FY15E Year to March FY12 FY13 FY14E FY15E Macro Income from operations 57,676 61,038 66,985 74,179 GDP(Y -o-Y %) 6.5 5.5 6.5 7.0 Materials costs 35,791 38,069 40,191 44,359 Inflation (Avg) 8.8 7.8 6.0 6.0 Employee costs 10,812 11,108 12,526 13,871 Repo rate (exit rate) 8.5 7.5 6.8 6.0 Other Expenses 4,966 5,500 6,029 6,676 USD/INR (Avg) 47.9 54.5 55.0 53.0 Total operating expenses 51,569 54,677 58,746 64,906 Company EBITDA 6,108 6,361 8,239 9,272 Defence CAPEX in Country (INR bn) 692 695 867 997 Depreciation and amortisation 1,208 1,307 1,385 1,502 Order intake (INR bn) 80 50 60 72 EBIT 4,900 5,054 6,854 7,770 Burning rate (%) 18.1 19.8 22.0 24.0 Other income 5,855 6,100 6,002 6,071 Depreciation 6.5 6.5 6.5 6.5 Interest expenses 6 8 - - Yield (%) 8.5 11.3 11.0 10.6 Profit before tax 10,749 11,146 12,856 13,841 Tax rate (%) 22.8 20.2 24.0 24.0 Provision for tax 2,450 2,248 3,086 3,322 Excise duty as a % of sales 1.0 1.0 1.0 1.0 Net profit 8,299 8,899 9,771 10,519 Capex (INR mn) 1,663 2,466 1,600 1,500 Profit After Tax 8,299 8,899 9,771 10,520 Debtor days 177 180 193 198 Shares outstanding (mn) 80 80 80 80 Inventory days 178 196 200 187 Diluted EPS (INR) 103.7 111.2 122.1 131.5 Payable days 68 74 73 72 Dividend payout (%) 23.3 21.8 19.8 18.4

Common size metrics Year to March FY12 FY13 FY14E FY15E Operating expenses 89.4 89.6 87.7 87.5 EBITDA margins 10.6 10.4 12.3 12.5 Net profit margins 14.4 14.6 14.6 14.2

Growth ratios (%) Year to March FY12 FY13 FY14E FY15E Revenues 3.3 5.8 9.7 10.7 EBITDA (38.2) 4.2 29.5 12.5 EPS (1.4) 7.2 9.8 7.7

6 Edelweiss Securities Limited Bharat Electronics

Balance sheet (INR mn) Cash flow metrics As on 31st March FY12 FY13 FY14E FY15E Year to March FY12 FY13E FY14E FY15E Equity capital 800 800 800 800 Operating cash flow 1,213 2,922 4,776 6,062 Reserves & surplus 55,570 62,429 70,364 78,946 Investing cash flow 9,266 2,446 1,400 1,400 Shareholders funds 56,370 63,229 71,164 79,746 Financing cash flow (2,389) (2,474) (1,836) (1,938) Sources of funds 54,088 60,513 68,448 77,030 Net cash flow 8,089 2,894 4,340 5,524 Tangible assets 5,063 5,693 5,592 5,402 Capex (2,011) (2,446) (1,400) (1,400) Intangible assets 38 60 77 88 Dividends paid (2,380) (1,938) (1,938) (1,938) CWIP (incl. intangible) 1,134 1,615 1,715 1,815

Total net fixed assets 6,236 7,369 7,384 7,305 Profitability & efficiency ratios Non current investments 120 120 120 120 Year to March FY12 FY13E FY14E FY15E Cash and equivalents 67,723 53,023 54,563 57,269 ROAE (%) 15.6 14.9 14.5 13.9 Inventories 26,738 31,913 32,483 34,029 ROACE (%) 9.6 8.8 10.6 10.7 Sundry debtors 26,869 33,347 37,622 42,678 Inventory day 178 196 200 187 Loans and advances 16,815 14,382 14,383 15,233 Debtors days 177 180 193 198 Other current assets 1,797 1,590 1,829 1,829 Payable days 68 74 73 72 Total current assets (ex cash) 72,219 81,232 86,317 93,769 Cash conversion cycle (days) (219) (160) (69) (40) Sundry creditors and others 86,326 74,071 74,915 76,171 Current ratio 0.8 1.0 1.1 1.2 Provisions 5,887 7,162 5,023 5,259

Total current liabilities & 92,213 81,233 79,938 81,430 Operating ratios Net current assets (ex cash) (19,994) (1) 6,379 12,339 Year to March FY12 FY13E FY14E FY15E Net Deferred tax (2,282) (2,716) (2,716) (2,716) Total asset turnover 1.1 1.1 1.0 1.0 Uses of funds 54,088 60,513 68,448 77,030 Fixed asset turnover 9.9 9.0 9.1 10.1 Book value per share (INR) 704.6 790.4 889.5 996.8 Equity turnover 1.1 1.0 1.0 1.0

Free cash flow (INR mn) Valuation parameters Year to March FY12 FY13E FY14E FY15E Year to March FY12 FY13E FY14E FY15E Net profit 8,299 8,899 9,771 10,520 Diluted EPS (INR) 103.7 111.2 122.1 131.5 Depreciation 1,208 1,307 1,385 1,502 Y-o-Y growth (%) (1.4) 7.2 9.8 7.7 Others (6,041) - - - CEPS (INR) 118.8 127.6 139.4 150.3 Gross cash flow 3,466 10,206 11,156 12,021 Diluted PE (x) 12.2 11.4 10.4 9. 7 Less: Changes in WC 2,254 7,284 6,380 5,959 Price/BV (x) 1.8 1.6 1.4 1.3 Operating cash flow 1,213 2,922 4,776 6,062 EV/Sales (x) 0.6 0.8 0.7 0.6 Less: Capex 2,011 2,446 1,400 1,400 EV/EBITDA (x) 5.5 7.6 5.7 4.8

Free cash flow (799) 476 3,376 4,662

Peer comparision valuation PE (x) P/BV (x) ROE (%) Market cap Name of the companies CMP 2014E 2015E 2014E 2015E 2014E 2015E (USD mn) BEL 1,271 1,816 10.4 9.7 1.4 1.3 14.5 13.9 Thales SA (Euro) 37.8 5,948 10.7 10.1 1.3 1.2 11.6 11.7 Dassault systemes (Euro) 95.2 9,289 23.7 20.7 3.9 3.6 16.8 16.7 Meggit PLC (GBP) 534 6,157 12.9 12.2 1.7 1.5 13.5 13.2

Source: Bloomberg, Edelweiss research

7 Edelweiss Securities Limited Engineering and Capital Goods

Additional Data

Directors Data Anil Kumar Managing Director M S Ramachandran Part Time Independent Director N Sitaram Part Time Independent Director R Venkata Rao Part Time Independent Director V K Bhalla Part Time Independent Director SN Dash Part Time Independent Director Anil Razdan Part Time Independent Director Anurag Kumar Part Time Independent Director SP Kochhar Part Time Government Director Satyajeet Rajan Part Time Government Director M L Shanmukh Whole Time Director Sunil Kumar Sharma Whole Time Director Amol Newaskar Whole Time Director H N Ramakrishna Whole Time Director - Marketing Ajit T Kalghatgi Director

Auditors - RGN Price & Co *as per last annual report

Holding – Top10 Perc. Holding Perc. Holding Government of india 75.86 Life insurance corp 8.32 Hdfc asset managemen 2.78 Uti asset management 1.17 Templeton asset mgmt 0.49 Vanguard group inc 0.45 Capital group compan 0.28 Bnp paribas inv part 0.25 Sbi funds management 0.22 Bank of new york mel 0.18

*in last one year

Bulk Deals Data Acquired / Seller B/S Qty Traded Price

No Data Available

*in last one year

Insider Trades Reporting Data Acquired / Seller B/S Qty Traded

*in last one year

8 Edelweiss Securities Limited RATING & INTERPRETATION

Company Absolute Relative Relative Company Absolute Relative Relative reco reco risk reco reco Risk ABB India REDUCE SU L Bajaj Electricals HOLD SP M BGR Energy REDUCE SU M Bharat Electronics BUY SO H Bharat Heavy Electricals HOLD SP L Crompton Greaves HOLD SP M Cummins India BUY SO L Havells India BUY SO M Jyoti Structures HOLD SP M Kalpataru Power HOLD SP M KEC International BUY SO M Larsen & Toubro BUY SO M Siemens HOLD SP L Sterlite Technologies HOLD SP H Techno Electric & Engineering HOLD SP M Thermax REDUCE SP L Voltamp Transformers REDUCE SU M Voltas HOLD SP L

ABSOLUTE RATING

Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe within the sector

RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING

Ratings Criteria Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

9 Edelweiss Securities Limited Engineering and Capital Goods

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098. Board: (91-22) 4009 4400 , Email : [email protected] Vikas Khemani Head Institutional Equities vikas.khemani@edel weissfin .com +91 22 2286 4206

Nischal Maheshwari Co-Head Institutional Equities & Head Research [email protected] +91 22 4063 5476

Nirav Sheth Head Sales [email protected] +91 22 4040 7499

Coverage group(s) of stocks by primary analyst(s): Engineering and Capital Goods ABB India, BGR Energy, Bharat Electronics, Bharat Heavy Electricals, Bajaj Electricals, Crompton Greaves, Havells India, Jyoti Structures, KEC International, Cummins India, Kalpataru Power, Larsen & Toubro, Siemens, Sterlite Technologies, Techno Electric & Engineering, Thermax, Voltamp Transformers, Voltas

Recent Research

Date Company Title Price (INR) Recos

28 -May -13 Havells India Burning bright; 720 Buy Result Update 27 -May -13 Bajaj E&P cost over runs wound 169 Hold Electricals profitability, yet again; Result Update 24 -May -13 Crompton Lower domestic margin add to 96 Hold Greaves the woes; Result Update

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe Rating Interpretation

Buy Hold Reduce Total Rating Expected to

Rating Distribution* 120 49 17 186 Buy appreciate more than 15% over a 12-month period * - stocks under review Hold appreciate up to 15% over a 12-month period > 50bn Between 10bn and 50 bn < 10bn

Reduce depreciate more than 5% over a 12 -month period Market Cap (INR) 118 56 12

10 Edelweiss Securities Limited Bharat Electronics

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11 Edelweiss Securities Limited Engineering and Capital Goods

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