At its peak, the company had traded at 25-32 times its forward earnings as against the current valuation of 11 times.
PSUs are generally considered boring stocks as they seldom reward investors with rapid spikes in share prices. But sometimes, PSU stocks could prove to be good bets as they not only provide long-term capital appreciation but also protecting capital. Bharat Electronics is one such stock, which got hammered in the recent market correction.
While the slowdown in the order delivers to the defence sector was already factored in, the government policy to cap the margins of companies in the defence space accentuated its fall.
Take a moment
First and foremost, these developments are already factored in the price considering that the stock is trading at about 11 times its next year’s earnings and currently offering a dividend yield of close to 3 percent based on current year dividend.
Current valuations are significantly lower than the historical averages. Over the last 10 years, the stock has traded at an average price to earnings valuation of about 16 times.
What is in the price?
Our reverse calculations suggest, assuming an exit PE of 15 times (assumed current price Rs 85 per share) in FY21, earnings for FY21 works out to Rs 5.6 per share. Considering that in FY18 the company reported an EPS of Rs 5.7 per share, this implies that the market is expecting a negative earnings growth, which in our view has very remote probability.
Penny wise pound foolish
Coming back to margins, government’s cap of 7% margins for the nominated projects would not have a significant net impact, considering that this is going to be applicable (not applicable on current order book) for the new order that will be probably get booked from the year 2021.
Secondly, by the end of 2021, the share of projects won based on the nomination would decline to about 35%. Rest will be projects that are won through competitive bidding because of the declining legacy orders and execution on one large project pertaining to LRSAM (long range surface to air missile programme).
Considering these facts, the management has guided to a net impact of about 50-150 basis points that too from the fiscal year 2021. Margins will still be healthy at 17%-19% range as against the operating margins of about 19.4% and 20.5% witnessed during the last two fiscal years.
The defence pipeline is very strong and BEL has a strong market share with proven capabilities without any threat of significant competition, considering there is huge entry barrier in terms of approval and time taken to build capacity and capability.
Nevertheless, apart from the strong economic moat, the revenue visibility is good and predictable considering that the company is sitting on an order book of close to Rs 50,000 crore, which is about 5 times its sales.
To sum up, one is buying a company which does not have a balance sheet (debt free) and promoter risk, business is protected because of the entry barrier and has a decent amount of certainty and predictability of growth because of the strong order book. Once near-term worries are behind, BEL should certainly command higher valuations. At its peak, the company had traded at 25-32 times its forward earnings as against the current valuation of 11 times.Moneycontrol Research Page.