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  • Policy change at Bharat Electronics: Should stock investors worry?

    Publish Date: October 09, 2018

    The shares of defence public sector undertaking (PSU) Bharat Electronics Ltd. (BEL) have become more than 50% cheaper since hitting a 52-week high of Rs 192. That should be enough for bottom-fishers to take a good look at this company, which is the lead integrator of Akash Missile systems.

    Are green shoots of value emerging in BEL stock? After all, the company boasts of a strong balance sheet and a good moat, given its defence work capabilities. Recently, the Indian government announced a new pricing policy, which has investors worried about the risk in policy changes. The recent government policy on the pricing of defence equipment has come as a negative. But we note BEL’s high order book which shows strong revenue visibility and healthy finances.

    Policy change explained

    According to the new pricing policy for nomination projects (which form 35% of BEL's order book), the Ministry of Defence (MoD) has allowed a 7.5% profit before tax (PBT) margin. This is lower than the earlier 10–12% margin. So, such projects would impact margins on a like-to-like basis.

    Company view

    In our recent interaction with BEL, the management has remained positive on the business outlook. The recent policy suggests an impact on the margin profile in the long term. However the policy also has some positives. Importantly, it allows a pass-through of some costs and risks in the project, which was not the case earlier. This is certainly an mitigating factor which should reduce the adverse impact on margins.

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    Strong order book

    The new policy does not affect the existing Rs 50,000 crore order book of BEL. This means there will be almost no impact on BEL for the next two to three years. It must be mentioned that the company management anticipates a 70–200 bps downside on margins for nomination orders starting FY22.


    In the current fiscal, the company is expecting orders for Akash Missile systems. An order for Long-Range Surface-to-Air Missile (LRSAM) has already been placed with the company. BEL is now geared up for projects such as Quick Response Surface-to-Air Missile (QRSAM) for the Army, Medium-Range Surface-to-Air Missile (MRSAM) for the Air Force, and Long-Range Surface-to-Air Missile (LRSAM) for the Navy.

    Revenue growth outlook

    The BEL management expects revenue growth of 15% in FY19. On EBITDA margins, the management expects margins to remain at around 18–19%. This is more or less in the same range as in FY18. BEL has been shortlisted by India’s space agency (ISRO) to assemble satellites. There is demand for assembling 45 large satellites from India. Globally, there is an estimated requirement of 5,000 small and micro satellites. This could be a growth area for BEL.

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    Stock correction reflects excessive pessimism

    The BEL stock has been de-rated in recent months. We think this could be due to the listing of Bharat Dynamics and HAL at attractive valuations. Those listings appear to have weighed on the valuation of BEL. Until the new listing of the two defence PSUs, BEL was the only sizeable defence player available for investors.

    We have revised our target price on the company. More importantly, we have priced in the risk of the change in government regulations and policies. We now value the stock at a 25% discount against our earlier target multiple of 20 times the FY20 estimates. Our price target is Rs 96, an upside of about 17% from current levels of Rs 75-76.

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