Bharat Electronics Limited (BEL)’s Q3’09 revenue moved up a meager 1.8% y-o-y to Rs6.84 billion, compared with a 10.1% y-o-y growth in the last quarter.
However, the operating profit shot up 29.2% y-o-y to Rs1.34 billion on the back of a significant 687-bps y-o-y fall in SG&A expenses (as a percentage of sales).
We believe revenue will grow at a CAGR of 9-9.5% during FY08-FY11, though marginally lower that the last 15 years’ CAGR of 10.3%.
BEL is the prime defence electronics company for the Government of India and enjoys near-monopoly status with regard to the supply of high-tech defence products.
Servicing a priority sector gives the company a bullish outlook; the current weak economic scenario may impact the order inflow growth but to a minimal extent.
The company is expected to incur a capital expenditure of Rs5.7 billion in the next two years to modernize its manufacturing plants, which in turn would increase realization.
Armed with a robust R&D base and proven manufacturing skills, BEL has decided to increase its R&D expenditure from the current 5% to 8–10% of sales in the coming years in order to increase self-reliance through indigenisation.
This is likely to put pressure on near-term margins but should help BEL in the long run.
Given the slow execution rate in 9M’09, we have reduced our revenue target for FY09 from 8.4% to 6.8%.
However, we have upwardly revised our revenue target post FY10, as we believe the current concerns relating to the domestic security should significantly increase the demand for defence and security equipments.
Consequently, we have increased our target price from Rs816 in our last report to Rs994, based on the DCF valuation and assuming a 16.2% WACC and a 5% terminal growth rate.
The target price provides a 12.1% upside over the current market price of Rs887. We have downgraded our rating from Buy to HOLD.