The brokerage expects five-year EPS (FY18-23) of the company to decline to 9 per cent compounded annually from 12 per cent

NEW DELHI: Shares of this listed missile maker halted its sharp down slide on Monday, but was still down for the 10th consecutive session in a row. 

This, despite the company having bagged a whopping Rs 9,200 crore order for supply of seven long range surface-to-air missile (LRSAM) systems earlier this week.

The fresh order made Bharat Electronics’ total order book bulge above Rs 50,000 crore, the first time in any financial year. The new order bolstered the bill-to-book ratio of the firm to 5 times FY 2018 revenue.

The company is also expected to bag big orders for electronic voting machines (EVM) from the Election Commission of India ahead of state and general elections next year. 

Despite such earnings visibility, the stock is down in the dumps. The defence ministry’s recent guidelines to cap margins of state-run defence manufacturers have taken the sheen off this stock, which has fallen 22 per cent in 10 sessions till Friday and another half a per cent on Monday. 

Bharat Electronics generates 80-85 per cent of its revenues from the defence segment. It is estimated to take a 200-300 basis points hit on margins/RoCE in the wake of the latest guideline. 

What has come as relief for the company is the fact that guidelines do not impact the mega contract bagged this week. 

The New Guidelines

The Ministry of Defence (MOD) has slashed the benchmark margin on prospective contracts awarded on a nomination basis to 7.5 per cent for both value-added and bought-out components compared with 12.5 per cent permitted for value-added earlier. 

Brokerage Edelweiss Securities noted that nomination contacts form 50-60 per cent of the company’s overall order intake. 

“It is a structural negative for defence PSUs and puts a question mark over sustainability of their future margins. This warrants a P/E de-rating. We, thus, cut the target PE from 23 times to 15 times, which is the last 12 years’ average P/E and at a 10 per cent discount to global peers. We also cut EPS estimates by 2 per cent and 5 per cent for FY19 and FY20, respectively,” the brokerage said. 

It has slashed the price target for Bharat Electronics stock to Rs 110 from Rs 175 earlier. 

PhillipCapital, which has downgraded the stock to neutral, said that the upcoming large orders such as Coastal Surveillance radars and Samyukta EW will be awarded under the old terms. 

Brokerage firm Sharekhan said even though the cap would be applicable to new projects, it will surely impact earnings estimates beyond 2021, as reduction of around 400-500 BPS at PBT level for projects to be received under nomination is significant.

“Earnings growth could be impacted severely owing to increasing competitive intensity in the defence industry with foreign participants forging alliances with private business houses and the latest notification from Defence Ministry. Given the structural issues of policy headwinds, we are reducing our target multiple to 14 times and arriving at a revised target of Rs 96,” Sharekhan said. The brokerage has downgraded its rating on the stock to ‘Hold’ from ‘Buy’.

JM Financial has maintained its ‘buy’ rating on the stock, but said the PBT margins would fall by 250-350 bps over next 5 years, as share of new orders rises.

The brokerage expects five-year EPS (FY18-23) of the company to decline to 9 per cent compounded annually from 12 per cent. At prevailing price, 10-year sales CAGR stands merely at 8.8 per cent.

Sanjiv Bhasin of IIFL called the guidelines ‘draconian’. “If I had to keep putting his money in defence, it would be Bharat Forge and L&T, where there would be huge upside in the coming years,” he said.