Defense And Space Spending Will Drive Long Term Upside Potential

Catalysts

About Centum Electronics

Centum Electronics designs and manufactures advanced electronics systems and modules for defense, space and high reliability industrial applications.

What are the underlying business or industry changes driving this perspective?

• Acceleration in domestic defense and space spending, including large programs such as space based surveillance constellations and electronic warfare payloads, is set to convert the current INR 650 crores BTS order book and INR 2,000 crores targeted bookings over three years into a sustained revenue growth runway and higher earnings visibility.
• Rising localization requirements in defense and naval platforms, supported by partnerships such as the GRSE navigation systems MoU and BEL tie up for electronic warfare and radar, position Centum as a preferred indigenous supplier, which should support premium pricing and structurally stronger net margins.
• Scale up of EMS operations with new customer additions already ramping into production, combined with robust forecast backed inventory, is likely to deliver high double digit growth in the stand alone EMS business and drive operating leverage benefits into EBITDA margins and earnings.
• Strategic exit or restructuring of loss making Canada operations and a potential strategic reset in Europe, targeted to materially reduce subsidiary losses from FY27, should narrow the gap between strong stand alone profitability and consolidated results, lifting consolidated net margins and PAT.
• Recent capacity expansion, NABL accreditation and energy efficient operations recognition enhance execution capability and qualification for larger, more complex programs, which should support higher value add mix, improving EBITDA margins and return on capital over the medium term.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Centum Electronics's revenue will grow by 20.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.3% today to 9.5% in 3 years time.
• Analysts expect earnings to reach ₹2.0 billion (and earnings per share of ₹97.74) by about December 2028, up from ₹153.2 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 28.5x on those 2028 earnings, down from 208.0x today. This future PE is lower than the current PE for the IN Electronic industry at 40.1x.
• Analysts expect the number of shares outstanding to decline by 5.26% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 16.2%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prolonged macroeconomic weakness and intense competition in the European ER&D market, where Centum is already facing subdued demand and pricing pressure, could keep the subsidiary structurally subscale and margin dilutive. This could prevent consolidated EBITDA margins from converging toward the healthier stand-alone level and limit earnings growth.
• If the planned divestment of the Canada business and the strategic reset in Europe are delayed, achieve weak terms, or fail to fully stem overseas losses, the drag from international operations could persist just as domestic capex and execution ramp up. This could constrain consolidated PAT expansion and depress the valuation multiple.
• The long sales and execution cycles in domestic defense, space and naval programs, combined with dependence on large contracts such as space-based surveillance constellations and navigation systems for warships, mean any delays in approvals, budget allocations or production schedules could slow order conversion and revenue recognition. This could pressure top-line growth and operating leverage.
• The strategy of building substantial inventory against firm orders and customer forecasts supports near term growth. However, if forecasted demand is revised down, or if program timelines slip, working capital could remain elevated for longer, squeezing cash flows and increasing reliance on borrowings, which would weigh on net margins and earnings quality.
• While management is targeting around 30% stand-alone revenue growth with 13% to 15% EBITDA margins, the need to continually invest in capacity, talent and technology for high reliability defense and space solutions, alongside potential wage and component cost inflation, could offset operating leverage and lead to lower than expected sustainable EBITDA margins and earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of ₹3000.0 for Centum Electronics based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be ₹21.1 billion, earnings will come to ₹2.0 billion, and it would be trading on a PE ratio of 28.5x, assuming you use a discount rate of 16.2%.
  
• Given the current share price of ₹2161.7, the analyst price target of ₹3000.0 is 27.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.