MOSL: BHARAT ELECTRONICS | ANNUAL REPORT UPDATE (Buy)-New pricing policy has limited impact on profitability

Bharat Electronics | Annual Report UPDATE: New pricing policy has limited impact on profitability; Strategies planned to drive sustained growth

(BHE IN, Mkt Cap USD3.1b, CMP INR91, TP INR120, 31% Upside, Buy)

In this report, we attempt to understand the implications of the Ministry of Defense’s (MoD) new pricing policy for Bharat Electronics (BHE). We also delve into BHE’s FY18 annual report to get insights into the company’s performance and strategy. Key highlights:

 Implication of the new pricing policy

 Limited impact on BHE's medium-term profitability

• The MoD has proposed a new pricing mechanism for defense PSUs with intent of making PSUs more efficient on the operational front. According to the new guidelines, margins (at PBT level) have been lowered from 12.5% to 7.5% for projects given to all defense PSUs on a nomination basis. The new pricing mechanism will be applicable for future orders (not applicable to the recently concluded long-range surface-to-air missile order of INR92b) and will not impact the company's existing order book of INR500b. Management believes that the new pricing policy is more detailed/scientific in nature and covers all costs associated with orders. The revised guidelines also allow pass-through of royalty, R&D, program management and prototype costs, which were not covered in the earlier version. The new policy will not have a material adverse impact on BHE's business, according to management.