BEL has broken out from the sub 10% y-o-y revenue growth range in FY17. We have raised our FY17e-19e EPS by 8-9% factoring this. Defence indigenisation drive, order flow, execution ramp-up drove the last 2-years re-rating and upside. Limited surprise potential henceforth, muted FY18e EPS growth (pay revision) and defence company’s IPOs impacting scarcity premium should cap upside. Downgrade to Hold — revised TP of `190.
`800 billion TCS order — tough competition if single vendor
BEL has a visible `110-130 bn annual order flow pipeline for the next 3 years, which is in our estimates. Tactical Communication Systems (TCS) and Battlefield Management Systems (BMS) are 2 sizeable orders of `800 bn and `500 bn — BEL and L&T driven 2 consortiums are shortlisted. Our industry interactions suggest that TCS could be finalised by end FY18e and BMS could be pushed out by 2-3 years. TCS potentially is expected to be given to only one of the two consortiums. We believe this order win may not add upside to BEL from current levels, as the project will be executed over 5-10 years, with material revenues commencing post FY20e only. However, given the tough private sector consortium of L&T-Tata Power-HCL Infosystems opposing, loss of this order would lead to fears of the private sector taking share from the public sector.
Pay hike to impact FY18e margins
Given strong 17% y-o-y revenue growth in FY17e v/s expected 15% y-o-y, we have revised our margins upwards for FY17e-19e by 210-230 bps taking into account some operating leverage benefit. Seventh Pay Commission revision will lead to muted EPS growth of 6% y-o-y for BEL in FY18e. Management at its half yearly meet highlighted that 17-18% NPM (19% in FY16) should be sustainable. Our estimates factor in 18-19.5% for FY17e-19e.
Cochin Shipyard, HAL — upcoming Defence IPOs
BEL has enjoyed a scarcity premium, being the only sizeable and pure play listed company in defence with no perceived corporate governance issues. In next 12 months, Cochin Shipyard and HAL are potential listings, with discussed valuations suggesting lower multiples than BEL currently trades at. We believe this will further weigh on BEL.
We downgrade the stock to Hold given limited upside. Our TP of `190 (v/s `175), values BEL at 24x PE FY18e, a 8% premium to previous peak levels. Upside Risk: Sustainable margin improvement. Downside Risk: Indigenisation push slows down.
`110-130 billion annual order pipeline known
Ongoing government projects suggest BEL should have at least a three-year pipeline of `400 bn, excluding larger Tactical Communication Systems (TCS) and Battlefield Management System (BMS) projects. These have been factored in estimates and any potential loss of TCS/BMS orders will lead to a downside risk on perception/valuation.
Double-digit revenue growth expectations met
Management at its September 2016 analyst meet exhibited confidence in revenue growth ramp-up from 10-12% y-o-y to 12-15% y-o-y. BEL has reported 17% y-o-y revenue growth in FY17, moving out from the sub-10% y-o-y growth performance of FY11-16. Given BEL’s 4.4x order book to revenue coverage, we believe FY17-19e will remain in the 15-18% y-o-y range. However, the readiness of army-navy-air force to take deliveries and BEL’s conservative policy of not accounting for revenues until bills are accepted are key constraints.
Margin trajectory stable to downward trend
We have raised our FY17e-19e margins by 210-230 bps considering operating leverage from better revenue growth and also 9MFY17 503 bps y-o-y margin improvement. In FY18e we anticipate a dip from seventh pay commission linked employee wage hike.