Sedate execution in the defence segment (up ~10% y-o-y versus our forecast of 30%) led to an overall miss for Bharat Electronics (BHE). Key highlights: (i) Defence revenue grew 10% y-o-y, adjusting for Rs. 12.6-bn EVM/VVPAT execution in the base quarter and civil revenue in Q2FY20; (ii) Rs. 71-bn order inflow was aided by the Akash contract; there are no major orders in the pipeline now; (iii) Ebitda margin dipped about 530bps dragged by higher raw material cost; decline would have been sharper adjusting for the lower other expenses.
In May 2019, we had downgraded the stock on the premise that the FY19 peak performance was behind, and Ebitda margin and order inflow are likely to slide, leaving limited room for upside. Factoring in the weak Q2, we are trimming EPS for FY20e and FY21e by 4% each. Maintain Hold with an unchanged TP of Rs. 125 as we roll over the valuation to March 2021.
Muted defence execution; adjusted margin springs negative surprise: Overall revenue fell 19% y-o-y, but adjusting for EVM/VVAPT and civil execution, defence revenue grew merely 10% y-o-y. Execution pick-up (~30% y-o-y growth ask in H2) is key to meeting the lower end of revenue guidance of 12–15%. Adjusting for performance warranty reversal, margin would have been 16.9% (~350bps below estimate).
Outlook: Limited near-term triggers —While we believe BHE, being a major integrator, will sustain its competitive edge, the structural deterioration in its margins and RoE implies limited upside potential given unrelenting uncertainty around OPMs on negotiated contracts. Watch out for working capital and new order pipeline. Maintain ‘HOLD/SP’. The stock is trading at 15.8/14.5x FY20/21e EPS.