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Bharat Electronics' Q2FY18 results (Outperformer) - Strong pick up in execution; outlook robust

Q2FY18 result highlights

• PAT at Rs4.12bn (+19% yoy): led by a strong pick up in execution and margin expansion.
• Revenues jump sharply (+45% yoy): to Rs24.8bn led by pick up in execution of some key orders such as Integrated Air command & control system (IACCS), Hand held thermal imaging (HHTL), Weapon Locating Radar (WLR), etc.
• Positive operating leverage drives margin expansion: by 410bps to 24%: We note that margins improved despite impact of 7^th pay commission, which led to employee costs +44% yoy to Rs4.7bn. Hence EBITDA increased sharply by 76% yoy to Rs5.95bn
• Order intake momentum to sustain: at Rs31.7bn (-23% yoy) impacted by a high base with YTD intake at Rs56bn (+9% yoy). Intake pipeline remains healthy with likely order wins of Rs150bn in FY18E from projects such as LRSAM, Akash, Electro-optics, etc. Accordingly, order backlog increased 20% yoy to Rs417.5bn (4x FY18E revenues).
• Other income fell sharply: by 70% yoy on lower surplus cash due to share buyback program of Rs21bn undertaken in 3Q17 (7% capital reduction) as also lower yields.

Key positives: Strong order execution, margin expansion

Key negatives: Lower other income

Impact on financials: FY18/19 EPS upgraded by 3%/3.5% to Rs7.7/9

Valuations & view

BEL is well-positioned to capture the growing defence spend led by its strong manufacturing capabilities and R&D focus. Accordingly, we expect the order intake momentum to sustain at Rs150bn on an annual basis over the next few years, providing strong visibility of revenues with a current order backlog of Rs418bn (4x FY18E revenues). As execution picks up (22% revenue CAGR over FY17-19E), we expect margins to remain stable led by positive operating leverage. However, earnings growth is being impacted by lower other income (12% CAGR; 18% growth in FY19E). The stock trades at 23x FY19E earnings, which we believe is attractive given the sustained order inflows, long-term earnings potential and improvement in return ratios. Maintain Outperformer.