MOSL: BHARAT ELECTRONICS (Buy)-Limited impact of new pricing policy

Bharat Electronics: Limited impact of new pricing policy; Capex planned at INR25b over next 3-4 years

(BHE IN, Mkt Cap USD2.6b, CMP INR84, TP INR100, 19% Upside, Buy)

We highlight key takeaways from the Bharat Electronics analyst meet:

•  Limited impact of change in pricing policy: As per the new pricing policy for nomination projects finalized by the Ministry of Defense (MoD) in May 2018, a 7.5% PBT margin would be allowed v/s the earlier 10-12% margin; however, this allows pass-through of all costs and risks in the project, which was not the case earlier. Note that the new policy does not affect existing INR500b order book and therefore no impact is expected for the next 2-3 years. However, management expects a 50-200 bps impact on margins for nomination orders starting FY22 from this policy change – currently 35% of the order book is from nominated orders and assuming a similar share of order book in FY21, the impact on FY22 margin is limited to 0.2-0.7%. As per management, legacy orders (24% of order book) would not be covered under this policy since these are repeat orders. In a worst case scenario, if we assume that legacy orders are also primarily on a nomination basis where the new pricing policy is applicable, then the overall impact rises to 0.3-1.2% of margins. On the positive side, the new policy is expected to shorten the ordering timelines, which is the Government’s intention.
• Targeting new growth areas over next few years: These include a) satellite integration, b) engaging with strategic partners for aircraft, tank and submarines—MOU’s signed with Mahindra, L&T, Defence Shipyards, c) setting up a dedicated business vertical for cyber security, d) setting up offices across south-east Asia for exports, and e) setting up factories for IR/RF seekers, ammunition, and fuses. Capex has been planned at INR25b to set up manufacturing facilities for RF and IR seekers, ammunition fuses, missile system testing and satellite integration.