BHARAT ELECTRONICS :Disappointing quarter; Edelweiss

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􀂄 Disappointing results; net revenue disappoint
Bharat Electronics (BEL) reported Q2FY11 adjusted profit of INR 1.04 bn, a 56%
Y-o-Y decline. While staff cost rose sequentially, the main disappointment was on
account of a sharp decline in revenue (down 25% Y-o-Y).
􀂄 Operating leverage impacts margins; revenues may rebound in H2
The revenue decline of 25% Y-o-Y is particularly disappointing in view of the
company’s strong order book. However, we note that the management recently
reiterated its revenue guidance of INR 5.7 bn (i.e., up 10% Y-o-Y) for FY11. This
seems to imply strong revenue growth (>20%) in H2FY11. The current quarter
possibly indicates lumpiness due to the company’s revenue recognition policy.
While wage expenses (not reflected in Q2FY10 but in full year FY10) were higher
as expected, EBITDA margins (down 1400bps Y-o-Y) were more affected by the
negative operating leverage. Notably, raw material cost to sales declined 50bps Yo-
Y and 300bps sequentially, indicating that the gross contribution remains
positive.
􀂄 Strong order book provides comfort
We estimate BEL’s order book at ~INR 120 bn which implies over two years of
sales. In addition, media reports indicate new potential orders for the company
including one for the upgrade in the electronic systems for Indian navy aircrafts.
For FY11, management has a sales revenue target of INR 57 bn (implying 10%
growth). Over a three year period management expects revenue in excess of INR
100 bn.
􀂄 Outlook and valuations: Better times ahead; maintain ‘BUY’
While Q2FY11 results were disappointing, we expect H2FY11 to be stronger on
account of: (a) management guidance suggests revenues may be back ended and
should be robust going forward; and (b) gross margins have improved. Hence, we
expect EBITDA margin to revive as operating leverage benefits flow through.
Fundamentally, we believe with a confirmed order book (in excess of two years
sales), a steady recession proof business and potential growth opportunity from
the offset clause, the company’s business remains strong. Current valuations of
~14x FY11E and ~12x FY12E are inexpensive. New order announcements could
be near-term triggers. We maintain ‘BUY’ recommendation on the stock.