Investor's Eye: Update - Bharat Electronics; Viewpoint - DCM

 

Investor's Eye [December 19, 2014]  Sharekhan www.sharekhan.com

Summary of Contents STOCK UPDATE     Bharat Electronics Recommendation: Buy Price target: Rs3,500 Current market price: Rs2,789   Long-term defensive play; with a brighter outlook than ever      Key points  Make in India initiative will be a boost for India's defence sector incumbents, BEL being the largest beneficiary: India is one of the biggest markets for defence which has grown substantially in the recent years. Recently, the Department of Industrial Policy & Promotion (DIPP) has granted industrial licences to several defence companies, in line with the new government focus on 'Make in India' push, the DIPP has cleared most of the 34 industrial licence proposals stuck since 2012. The government has recently cleared defence projects worth Rs1.55 trillion which includes purchase of submarines, anti-tank guided missiles and surveillance aircraft. Out of which, Bharat Electronics Ltd (BEL) is executing order worth Rs7,120 crore pertaining to the integrated air command and control systems (IACCS). The company being a government-owned company is the largest domestic player in defence with advance technology and strong know-hows. Hence, we see BEL as the biggest beneficiary of the increase in defence spends and Make in India initiatives.  Reiterate Buy with a revised price target of Rs3,500: A niche public sector unit player like BEL has got significantly re-rated (being a market leader) in the last one year and we expect a further re-rating on the stock to follow with ease in the foreign direct investment norms for the sector. There are chances of BEL being chosen a preferred joint venture partner for the foreign players given the vast expertise of BEL. Further, an initial public offering of another government defence company, Hindustan Aeronautics Ltd (HAL), by early next year and successful listing will improve the overall valuation for the sector and BEL being a sector leader, we expect the company to re-rate further. Looking at the better order inflow in the coming years and acceleration in order execution, we have revised our earnings estimate upwards and roll-over our valuation multiple to FY2017, and arrived at the price target of Rs3,500. We reiterate our Buy rating on the stock. Order books and execution set to improve significantly in the coming years: Given the increasing thrust of the new government in ramping up the defence spend coupled with the Make in India initiative, we expect strong order flows over the next two to three years and expect BEL to get an incremental pie of the government spends on defence. The management expects Rs5,000 crore order inflows in FY2015, while the company already has a backlog of Rs1,800 crore in H1FY15. Further, it expects around Rs7,000-Rs7,500 crore of order intakes in FY2016E. Also, over the next four to five years, the management expects an addressable market of almost Rs40,000-Rs50,000 crore in the areas of tactical communication system (TCS), battlefield management systems (BMS) and multirole medium combat aircraft, among others.       VIEWPOINT       DCM Current market price: Rs99 View: Positive      On the road to recovery, set for a re-rating    Key points A hidden auto ancillary story set to unfold: DCM Engineering, a 75% subsidiary of DCM Ltd (DCM; a listed entity), is one of the major suppliers of castings across all segments in the automotive market, which includes car, multi-utility vehicle, tractor, light commercial vehicle, heavy commercial vehicle and earth moving equipments. The top automotive players likes Maruti Suzuki India, Hyundai Motor Company, Mahindra & Mahindra, Ashok Leyland, Volvo Eicher Commercial Vehicles, Tata Cummins, Suzuki Powertrain India and Force Motors are some of its clients. The company has plants in North and South India with a capacity of ~72,000MT.  Earnings set for a turnaround in FY2016E, mirroring revival of auto sector: In the last two years, DCM Engineering (auto ancillary subsidiary) incurred losses owing to a lackluster growth in the auto sector and capacity utilisation remains stagnant at around 72%, while the revenues growth remained muted at Rs447 crore. In H1FY2015, the company has recorded a loss of Rs10.4 crore at the EBIT level. However, given the revival in the auto sector in the next two years in both passenger cars and commercial vehicle segments, we expect DCM Engineering to turn profitable with an increase in capacity utilisation. The management has also indicated at getting profitable in the auto segment by FY2016E and expects an overall turnaround in the other businesses as well. In FY2011, the operating margins in the auto business were at around 8%, which we believe is quite achievable as the operating leverage will start kicking in over the next two years.  Amalgamation of auto ancillary subsidiary will create 40 lakh treasury shares, the management sees intrinsic value of Rs150 per share for DCM Engineering: Recently, the board of directors has approved the scheme of amalgamation of DCM Engineering with DCM, with a swap ratio wherein every 77 shares of DCM Engineering will get 20 shares of DCM. At the end of FY2014, DCM holds ~1.5 crore shares of DCM Engineering, after the scheme of amalgamation DCM will get around ~40 lakh treasury shares of the company on its books, which the company can use for funding its future growth. Further, looking at the comparable peers valuation base on FY2014, Hinduja Foundries (with revenues-Rs996 crore, OPM-8%, net loss-Rs251 crore, market cap-Rs287 crore and market cap/sales-0.31), and Nelcast (with revenues-Rs515 crore, OPM-9%, net profit-Rs22.5 crore, market cap-Rs296 crore and market cap/sales-0.6), the embedded value of DCM Engineering (with revenues-Rs447 crore, OPM-3% and net loss-Rs5.43 crore), will be much higher than the current valuation and also the management sees the intrinsic value of DCM Engineering at around Rs150 per share.  Valuation: At the current level, DCM trades at around Rs99 (with a market cap of Rs171 crore), while the total debt of the company stands at Rs238 crore (down Rs57 crore YoY). With revival in the auto sector, DCM's auto subsidiary earnings performance is expected to improve materially over the next two years and will trigger a re-rating in the stock. Further, improvement in other business segments like textiles (43% of revenues), IT services (7% of revenues, already profitable) and real estate (co-developing own land parcels in Delhi) will offer further value to the stock. We expect a gradual re-rating of the stock with overall improvements in earnings led by auto segments. We have a positive view on DCM and expect a 20-25% upside from the current level. Click here to read report: Investor's Eye        Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Regards,  The Sharekhan Research Team

 

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