Bharat Electronics: Huge opportunity, but execution is key

Buzz about the defence sector has driven up the Bharat Electronics Ltd stock 34% in the last one year


Graphic: Subrata Jana/Mint
Graphic: Subrata Jana/Mint

The government has chosen an opportune time to sell shares in Bharat Electronics Ltd (BEL). The stock hit new 52-week highs last month and the defence sector is seeing increased investor interest. The momentum will help the government find enough buyers for the 5% stake it is selling.

Retail investors, who are allowed to bid on Thursday, are being offered a discount on the cut-off price, potentially creating an arbitrage opportunity. But for long-term investors, gains can be back-ended.

Buzz about the defence sector has driven up the stock 34% in the last one year. Valuations at 21 times one-year forward earnings are no longer cheap. So, even though the company delivered a strong performance for the December quarter, several analysts remain cautious about the stock. “Given the sharp run-up in price over the last few quarters and consequent re-rating of BEL, we believe returns from here on are likely to be gradual,” ICICI Securities Ltd said in a note.

Of course, BEL is seen as a direct beneficiary of the government’s localization push. At the beginning of this calendar year, it had an order backlog of Rs33,806 crore, which is 4.4 times the revenues of the previous fiscal year. Based on the management’s guidance, ICICI Securities estimates the order backlog to rise to Rs35,500 crore by the end of the current fiscal year.

Further, according to Jefferies India Pvt. Ltd, BEL is well placed to receive large orders in the next few years. “BEL’s competitive advantage of working with Defence Research Development Organisation on new technology for more than 3 decades will see it flush with orders for at least 3-5 years,” Jefferies said in a note.

The order backlog and pipeline provides good revenue visibility. The problem is the execution timeline. Systems integration, which is a large business for BEL, now involves high customer involvement and tends to see delays. With billing done towards the end of the projects, the long execution period can stretch the order book to revenue conversion cycle.

M.V. Gowtama, chairman and managing director of BEL, told CNBC-TV18 as much in January when the business news channel prodded him about the current quarter’s revenue growth guidance. “We can’t predict. Defence is one business where customer has to walk along with us,” he said.

Perhaps that is one reason why the company forecast a subdued 8-10% average annual growth rate for the next five years in last year’s analysts meeting, despite the strong order pipeline. This is not much higher than the 7.8% average annual growth it registered in the last three fiscal years. While this indicates uncertain execution cycles, several analysts expect the execution pace to pick up, pushing the annual revenue growth to more than 10%.

The conviction, one analyst points out, is based on the government’s push to boost the defence forces, which will ensure revenue realization even if it is delayed by six months or so. The BEL stock is reflecting the optimism. For it to continue do well, it is crucial the company delivers on execution and revenue growth expectations.

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