Bharat Electronics-Disappointing results;REDUCE.:: Kotak Sec

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Bharat Electronics (BHE)
Industrials
Disappointing results; reiterate REDUCE. BEL reported disappointing revenues of
Rs9.8 bn, 30% below estimates and down 25% yoy. EBITDA margin at 11% (versus
estimate of 19%) was about 15 percentage points lower than 2QFY10 margins
primarily led by negative operating leverage and higher employee costs. Highlight
potential risk to meeting our full-year estimates implying strong 30% revenue growth
and double EBITDA in 2HFY11 (versus 2HFY10).





Disappointing revenues; negative operating leverage further magnified by higher employee cost
􀁠 Revenues disappoint: Revenues at Rs9.8 bn was about 30% below our estimate of Rs14 bn,
recording a 25% de-growth on a yoy basis. We had expected the company to report a
moderate growth of about 6.5-7% in this quarter. (see Exhibit 1)
􀁠 Sharp EBITDA margin decline on negative operating leverage and higher employee cost:
BEL reported EBITDA margin of 11%, significantly lower than our estimate of 19% and about
15 percentage points lower than 2QFY10 margins of 25%. Contribution margins have however
not declined and EBITDA margin decline is essentially a result of negative operating leverage.
Employee costs have increased to Rs2.7 bn in 2QFY11 from Rs1.9 bn in 2QFY10. For 1HFY11
employee costs have increased by 40% to Rs5 bn versus Rs3.6 bn in 1HFY10.
􀁠 1H performance - similar trend of revenue decline and margin contraction: 1HFY11
turnover has declined by 14% and PAT has declined by 40% on a yoy basis. EBITDA margin has
declined by 850 bps during 1H but largely led by employee costs (up 40% yoy) and negative
operating leverage. Absolute EBITDA has declined by 53% yoy during 1HFY11 while
contribution margin has expanded to 43.6% from 40% during 1HFY2011 on a yoy basis.

Significant risk to full-year FY2011E estimates - EBITDA needs to double on a yoy basis
Our full-year estimates require the company to report revenues of Rs38 bn during 2HFY11E versus
Rs30 bn last year (yoy growth of about 30%) against a decline of about 15% in 1HFY2011.
EBITDA required would be Rs8 bn versus Rs4 bn reported in 2HFY10. Our full year employee cost
at Rs9.8 bn may have a bit of downside as 1H employee cost has been Rs5 bn. (see Exhibit 2)

Retain estimates; reiterate REDUCE rating with a target price of Rs1,800/share
We retain our estimates of Rs105.9 and Rs120.3 for FY2011E and FY2012E. Reiterate REDUCE
(TPL Rs1,800) based on (1) potential long-term increase in competition, (2) lack of publicly
available data points, (3) potential margin dilution based on shift to system integration orders and
(4) infrequent investor communication.