Bharat Electronics, established in 1954 under the Ministry of Defence, is a Navratna PSU that predominantly manufactures advanced electronic products for the aerospace and defence sector. The Group employs over 9,700 people. The company’s offerings can be classified into defence equipment, such as radar and fire control systems, communication systems, electronic warfare systems, and network and cybersecurity equipment, contributing 81% of FY24 revenue; and non-defence applications including homeland security, smart city solutions, software solutions and medical electronics, 19% of the revenue mix.

Conducive Indian government policy a tailwind

In the past 10 years, the Indian government has consciously supported the home-grown defence manufacturing industry by mandating increased procurement from domestic suppliers. The total share of domestic procurement shot up to 75% in 2024 from 54% in 2019 and is expected to increase further in the coming years. Furthermore, the government’s recent INR1.45tn defence order mandates 99% fulfilment from domestic suppliers.

The Indian government is also focused on growing its defence exports to INR500bn annually by FY29 from INR211bn in FY24. Bharat Electronics is well poised to leverage this opportunity and capture market share given its international partnerships and experience in servicing foreign markets. The company’s export revenue grew 92.4% YoY to USD93mn in FY24.

Additionally, electronic and communication capabilities are steadily gaining importance in warfare, in the form of surveillance, targeting and guiding, and electronic warfare systems. In this scenario, Bharat Electronics, aided by its technical leadership and a long and solid record in designing and manufacturing electronics and communication systems, is likely to gain the most.

Non-cyclical business and robust financials

The defence sector is largely non-cyclical, as it predominantly caters to governments and defence investments are generally immune to business and economic cycles. This is reflected in Bharat Electronics’s historical performance, with revenue growing every year over the period FY15-24, and reporting a revenue CAGR of 12.6% to reach INR203bn. Also, the operating margin continually expanded over the period, increasing over 863 basis points (bps) to touch 23.2% in FY24, showcasing the company’s ability to continuously improve operating efficiencies. The company’s cash generation profile has also strengthened in recent years, with Bharat Electronics generating positive free cash flows from FY19 onwards. In comparison, the company’s peer, Hindustan Aeronautics, witnessed a lower revenue CAGR of 7.7% over the FY15-24 period to reach INR304bn. However, operating margin performance fared better, increasing by over 18.6% to 24.2% in FY24.

Bharat Electronics continued with its positive performance trajectory in 2QFY25, demonstrating a 14.8% YoY rise in operating revenue to INR46bn. Gross margins increased by over 431 bps to 55% owing to a favourable product mix. Net profit outpaced revenue growth, surging 38.4% YoY to INR10.9bn. The Group reported a rise in inventories to INR93.6bn as of Sep-24, from INR74.5bn as of Mar-24, driven by plans to achieve the turnover target of around INR145bn in the second half of the fiscal. However, during the same time, the cash reserves of the company increased by INR8bn to INR20bn as of Sep-24, driven by robust cash inflow from investments.

Bharat Electronics has returned cash to shareholders regularly in the form of annual and one or more interim dividends over the period FY15-24. While the cash outflow for dividends has increased progressively since 2019, the yield has decreased owing to an increase in shares outstanding following the issuance of two bonus shares for each share held in FY23. Consensus estimates suggest yield would continue to move northwards in line with profit growth, reaching around 1.5% in FY27.

Robust order book secures clear revenue path

The company has maintained a robust order book position of INR746bn as of October 1, 2024, with the first half of FY25 witnessing order inflows of INR75bn. The highlight of the first half was the execution of LRSAM order worth around INR16bn. The management remains steadfast in achieving its FY25 order inflow guidance of INR250bn, with major orders anticipated in the second half from Ashwini Radar at around INR25bn, Electronic Warfare Suite for MI-17 at around INR20bn, ATULYA order at around INR20bn, and Shakti Phase IV at another INR20bn.

Premium valuations justified by fundamentals

The stock is trading at a P/E ratio of 41.6x, based on the estimated FY25 EPS of INR6.5, trading slightly higher than the global peer average of 38.6x, and at a notable premium compared to the historical 10-year average of 21.2x. Bharat Electronics is also trading at a premium valuation, compared to local peer, Hindustan Aeronautics, which is trading at a P/E of 35.6x. Consensus estimates are pencilling in a 16.1% CAGR in revenue and a 68 bps EBIT margin expansion over FY25-27. The stock has performed well in the last one year and delivered solid returns of 46%, tracking positive fundamental cues.

In conclusion, the increasing use of electronics both in defence equipment and civilian applications, indicates a large and growing target market for the company. The company is well positioned to capitalise on the Indian government’s policies of promoting the domestic defence industry and increasing defence exports, which should drive new orders in the coming years. However, key risks for the stock include a slowdown in defence and non-defence orders, revised government procurement policies, heightened competition and delays in tender finalisation and payments. However, the consensus outlook and the stock’s valuation suggest that investors are willing to shell out a premium amount for holding the stock in their portfolio.