Bharat Electronics: Downgrade on weak operating performance, competition : Kotak Securities PDF link

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http://www.kotaksecurities.com/pdf/indiadaily/indiadaily04042012.pdf

Downgrade on weak operating performance, competition. Weak operating
performance in 4QFY12 (marginal decline in sales, EBITDA likely halved) led to a sharp
38% decline in PAT (Rs2.8 bn). Private-sector competition, dilution of offset opportunity
and lack of confidence in execution constrain our view even though the company
trades at 13-14X average free cash gen. adj. for spare cash (Rs400/share) and other
income. Downgrade to REDUCE from ADD (target price cut to Rs1,500 from Rs1,650).
Flash results: 4QFY12 sales decline; EBITDA margins likely halve, leading to sharp PAT contraction
BEL reported FY2012 provisional sales of Rs57 bn, implying marginal decline in 4Q sales to Rs22.9
bn against our estimate of Rs28 bn. EBITDA margin likely halved to 11.7% in 4QFY12 with
contribution margin declining by1,200 bps. The margin fall was likely to have been led by
execution of low-margin orders (tablet PCs, caste census) contributing significantly to FY2012
turnover. Sharp margin contraction and flat sales led to a 38% decline in 4QFY12 PAT (Rs2.8 bn
assuming 29% tax rate). We note strong other income in FY2012 (about Rs6.4 bn, up 70% yoy)
limiting decline in PAT (Rs7 bn, down 13% yoy) versus  EBITDA (Rs4.5 bn, down 47% yoy).
“Buy and Make” provision catalyzing private sector competition
We highlight the “Buy & Make” provision in the Defense Procurement Policy (DPP), enabling
Indian companies to bid for defense projects (with the option of tie-ups with technology
providers). We note key projects being bid by private players including (1) the Futuristic Infantry
Combat Vehicle project (Ashok Leyland L&T consortium), (2) Tactical Communication System (L&T,
HCL and Tata bidding together) and (3) 155 mm self-propelled Howitzer project (L&T announced
JV with Samsung).
Private industry gears up for defense business, offset business may be weak
Key takeaways from the interaction with industry specialists at Defense Expo include: (1) the
private sector is gearing up for defense business and the Government seems more serious about
awarding orders to the private sector, (2) weak prospects for offset business (dilution in policy as
well as foreign players lacking confidence in Indian capabilities.
Revise estimates on lower execution and margin expectations; downgrade to REDUCE
We revise estimates to Rs87 and Rs114 from Rs114 and Rs131 for FY2012 E and FY2013E
respectively, to account for (1) lower execution (7-8% revision) and (2) lower margin (125-150 bps
revision), partly on operating leverage. We downgrade to REDUCE on (1) weak performance,
(2) concerns about incremental business (private-sector participation, weak offset prospects,
technology-transfer issues with foreign vendors and DRDO) and (3) cash chest supporting bottomline in absence of operational earnings. Revise TP to Rs1,500 (Rs1,650 earlier) based on 13X
FY13E.