We initiate coverage on Bharat Electronics (BEL) with a ‘buy’ rating and price target of Rs 3,700 per share valuing the stock at at 22x P/E FY17e, close to its peak of historical multiples. Defence procurement and upgrade have been long pending, with nine naval accidents given outdated equipment in FY14 and resignation of the chief of naval staff, emphasising the urgency.
BEL is a market leader in domestic defence electronics, with 75% of its defence revenues coming from Navy and Army. With zero debt and improving working capital, it is well-placed to benefit from the defence opportunity. It has tied up with Thales, France, one of the global majors in defence electronics, for product development. In next 12-18 months, strong order flow growth, coupled with 14% earnings CAGR during FY14-17e, ROE improvement to 15% from 13-14% levels and brighter prospects beyond FY17e should see the stock’s re-rating. We expect 22% CAGR in FY14-20e for the domestic defence industry.
India’s capital defence spending was $13 billion in FY14 — a mere 4% of the US and 12% of China. We believe India’s capital defence spend will rise at 16% CAGR in FY14-20e versus 10% in FY05-14.
India imports 70% of its defence requirements and is focused on reversing this ratio in the coming decade. A closer analysis of numbers allayed our initial scepticism on achieving this target.