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INSTITUTIONAL EQUITY RESEARCH

Page | 1 | PHILLIPCAPITAL INDIA RESEARCH

India Defence Sector

Here come the champions

INDIA | Sector Initiation

27 March 2018

In this report we highlight four government owned defence companies that are national champions in their respective domains. We expect these companies to thrive irrespective of upcoming risk from the private sector. Their domain expertise, investments in R&D and a robust pipeline of projects will help them stave off competition. We reiterate our BUY rating on Bharat Electronics (BEL) and initiate coverage on Hindustan Aeronautics (HAL), Cochin Shipyard (CSL) with BUY ratings and on Bharat Dynamics (BDL) with a Neutral. Profile of our coverage list BEL is India’s leading defence electronics company with presence in Radars, Surface to Air Missiles, Avionics, Strategic communication and Electro optics. HAL is India’s sole fighter aircraft and helicopter manufacturer with experience in both Western and Russian origin platforms. BDL is India’s only Anti Tank Guided missile and Surface to Air missile manufacturer. CSL is the most efficient government shipyard, which is building India’s first indigenous aircraft carrier and is India’s largest public shipyard by capacity and has a largest market share in domestic ship repairs. $ 80bn of opportunities within touching distance The top down thesis of India’s need to grow defence spending and resort to import substitution is well documented and we will not be dwelling on that in this report. Instead we forecast a bottom up derived opportunity pipeline of US$ 80bn spread over a five to ten year period for our coverage against their cumulative FY18E revenues of just $ 5.5bn. Projects in the pipeline are for products already developed or transfer of technology from foreign OEM’s, hence the tangibility of these orders is high. HAL accounts for bulk of the opportunities at $ 43bn, followed by BEL ($ 26bn), BDL ($ 8bn) and CSL ($ 3bn). Risk of competition is low We believe that the level of system maturity required to stabilize complex defence products such as aircrafts, radars and missiles is still nascent in the private sector and will take time to ramp up. Hence we see limited threat of competition from the private sector on our coverage companies. We believe HAL, BEL and BDL are most immune from competitive pressures while CSL would face high competition to secure its project pipeline. Would margins pay the price for long term revenue visibility? We think not While we acknowledge that EBITDA margins of all the four companies under coverage are at cyclical highs and in the near term could see downside risks on account of adverse sales mix or higher employee cost. However, we clearly do not see a challenge in retaining their organic margins on their core products due to efficiencies developed over years. From FY20 we expect margins to expand for BEL and HAL and from FY22 for BDL. In case of CSL higher share of cost plus revenues on the IAC may suppress the positives of growing high margins ship repair business until FY22. Attractive valuations + robust order pipeline + cash generation = ripe for re-rating After the recent stock price correction in BEL (-23% in 3M) and CSL (-12%) valuations now price in the near term headwinds of adverse sales mix and its impact on margins. However, they do not reflect emerging positives of strong order inflows (for BEL and CSL) and margin recovery (in BEL). At its IPO price HAL trades at 18x PE FY20E, inline with global peers, for a higher earnings growth (17% CAGR in FY18-22) and a robust order pipeline. BDL trades 13x PE FY20E which adequately captures the near term risk of earnings decline (FY18-21) and back ended order inflow. The key rerating catalysts for all companies would be realization of order inflows and margin recovery and strong growth capital generation.

Companies Bharat Electronics Rating BUY CMP, Rs 143 Target Price, Rs 190 Hindustan Aeronautics Rating BUY CMP, Rs 1,240 Target Price, Rs 1,470 Cochin Shipyard Rating BUY CMP, Rs 483 Target Price, Rs 595 Bharat Dynamics Ltd Rating NEUTRAL CMP, Rs 397 Target Price, Rs 445 Jonas Bhutta (+ 9122 6246 4119) [email protected] Vikram Rawat (+ 9122 6246 4120) [email protected]


DEFENCE SECTOR UPDATE & INIITATING

Focus Charts

We forecast a US$ 80bn opportunity for HAL, BEL, BDL and CSL realizable over next five to ten years

While current consolidated revenue base of the coverage list is $5.5bn

Source: Company, PhillipCapital India Research Estimates

Typical EBITDA margin profile over the lifecycle of a defence equipment

Near term downside risk to margins are not structural in nature


Consolidated earnings of coverage companies

ROE’s in mid to high teens


43

80

26

8 3

0

20

40

60

80

HAL BEL BDL CSL Total order oppourtunity

(US$ bn)

5.5 5.9

6.3 6.5

7.9

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

FY18E FY19E FY20E FY21E FY22E

(US$ bn) Revenues (US$ bn)

0%

5%

10%

15%

20%

25%

30%

Yr-1

Yr-4

Yr-7

Yr-1

0

Yr-1

3

Yr-1

6

Yr-1

9

Yr-2

2

Yr-2

5

Yr-2

8

Yr-3

1

Yr-3

4

Yr-3

7

Yr-4

0

Spares & services phase (20 years)

Manufacturing phase

(10 years)

Development phase

(8-10 years)

10%

12%

14%

16%

18%

20%

22%


EBITDA margins (%)

HAL BEL BDL CSL

648 681

805 816

992

-

200

400

600

800

1,000


(US$ mn) Recurring PAT (US$ mn)

10%

15%

20%

25%

30%


RoE (%)

HAL BEL BDL CSL



Valuation comparison

Sales (Rs bn) EBITDA (Rs bn) EBITDA margin (%) PAT (Rs bn)

Company name FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E

Bharat Electronics 106.2 119.0 133.0 20.8 22.0 25.3 19.6 18.5 19.0 15.2 16.1 18.9

Hindustan Aeronautics 178.7 182.2 202.8 24.6 25.7 32.5 13.8 14.1 16.0 16.8 16.8 23.4

Cochin Shipyard 24.0 32.4 39.5 4.6 5.7 6.2 19.0 17.5 15.8 3.9 4.9 5.1

Bharat Dynamics 44.6 47.5 29.5 8.1 8.3 4.3 18.2 17.6 14.5 6.1 6.4 4.7

Average

17.6 16.9 16.3

Price Shares Mkt cap PE (x) EV/EBITDA (x) RoE (%)

Company name (Rs) O/s (mn) (USD mn) FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E

Bharat Electronics 143 2,457 5,428 23.2 21.9 18.6 15.2 13.7 11.1 19.1 18.3 19.3

Hindustan Aeronautics 1,240 334 6,408 24.7 24.7 17.7 13.3 9.6 7.2 13.5 13.1 16.9

Cochin Shipyard 483 136 1,016 16.8 13.5 12.8 8.3 5.2 6.0 14.8 14.1 13.6

Bharat Dynamics 397 183 1,124 11.9 11.4 15.6 7.3 4.7 4.1 27.9 27.2 17.2

Average

19.1 17.9 16.2 11.0 8.3 7.1 18.8 18.2 16.7

Source: Bloomberg, PhillipCapital India Research



Table of Contents

Companies Section Bharat Electronics ····································································································· 5 Hindustan Aeronautics ······························································································ 8 Cochin Shipyard ········································································································· 41 Bharat Dynamics Ltd ································································································· 66



Bharat Electronics (BHE IN)

Thesis intact; will help ride through short-term dissonance

INDIA | CAPITAL GOODS | Company Update

27 March 2018

Order inflows to pick up after a lacklustre FY18 We expect BEL’s order inflows to pick up in the next 12 months, as much-delayed projects are awarded after a poor show in FY18 (-30% yoy). We now expect BEL to win Rs 210bn of orders in FY19 against our earlier estimate Rs 170bn. Based on our interactions with the company, Akash (seven squadrons) and LRSAM (seven ships) orders should be awarded in 1HFY19. In addition, relatively smaller projects, such as electronic warfare suites, commander sights, and night vision devices, should also flow through in FY19. Long-term order opportunity continues to build Our list of long-term order opportunities for BEL (over the next 10 years) has now swelled to US$ 26bn vs. US$ 24bn at the start of FY18. Large projects such as DFCC for LCA Mark 1A and CIWS for IAF have led to a majority of the increase. Order book will continue to accrue until FY22 Based on our estimates of yearly phasing of the opportunities listed above, we believe BEL’s order book should easily continue to accrue until FY22. We expect BEL’s order book to increase by 75% from Rs 409bn in FY18 to Rs 710bn in FY22, still providing a robust 4.8x book-to-bill even in FY22. Pace of execution to help sustain 12% CAGR in revenues We expect BEL’s current order book to support a 12% CAGR in FY18-20 revenues. We additionally derive confidence on our revenue estimates through a bottom-up project-wise revenue estimation for large projects in BEL’s order book. Near-term margins could be lower due to fast-paced execution of EVM order Over the next three quarters, we expect BEL’s margins to have downside risk due to the fast-tracked execution of EVM/VVPAT orders (Rs 30bn). These are fixed-price contracts to be executed by 2QFY19 and BEL should ideally derive operating leverage benefits. However, upfront investment in testing lines due to increased size of the project coupled with unfavourable payment terms should impact profitability. This in turn would drag company-wide margins, particularly in 1HFY19, as this order should account for 35-40% of 1H revenues. However, margins should revert to 19% in FY20 After the completion of the EVM order in 1HFY19, we expect the sales mix to improve. Though share of revenues from integration projects such as IACCS and LRSAM will be higher in overall revenues vs. FY17, their impact on margins has already been built into our estimates. Our FY20 EBITDA margin estimate (19%) implies a 300bps contraction compared to the FY17 cyclical high margins but should be higher than FY19 margin of 18.5%. Recent price correction factors in lower FY19 margins and loss of scarcity premium BEL’s stock price has corrected by 26% in 3 months, and we believe that it now adequately prices-in the impact of the EVM order on FY19 margins and loss of scarcity premium that BEL used to enjoy (being the only pure-play listed defence company). Though we argue that listing of other defence PSUs (HAL and BDL) should not impact BEL’s standing, since it provides a linear visibility in order inflows and revenues, which is not the case for both HAL and BDL, and should generate Rs 22bn of growth capital over FY18-20 with 19% ROE. Maintain BUY with revised target price of Rs 190 We maintain our Buy rating with a revised target of Rs 190 (earlier Rs 200). We base our target price on 25x FY20 PE. BEL is our top pick within our coverage. We have cut our FY19/20 estimates by 8%/5% respectively to factor in lower margins.

Buy (Maintain) CMP RS 143 TARGET RS 190 (+33%)

COMPANY DATA

O/S SHARES (MN) : 2457

MARKET CAP (RSBN) : 351

MARKET CAP (USDBN) : 5.4

52 - WK HI/LO (RS) : 193 / 138

LIQUIDITY 3M (USDMN) : 14.4

PAR VALUE (RS) : 1

SHARE HOLDING PATTERN, %

Dec 17 Sep 17 Jun 17

PROMOTERS : 66.7 67.9 68.2

FII / NRI : 8.7 8.1 6.7

FI / MF : 16.5 16.1 17.7

NON PRO : 0.8 0.6 0.7

PUBLIC & OTHERS : 7.4 7.3 6.7

PRICE PERFORMANCE, %

1MTH 3MTH 1YR

ABS -9.1 -24.3 -0.2

REL TO BSE -3.7 -20.1 -10.9

PRICE VS. SENSEX

KEY FINANCIALS

Rs mn FY17 FY18E FY19E

Net Sales 86,119 1,06,249 1,18,994 EBIDTA 18,987 20,789 22,002 Net Profit 16,123 15,156 16,068 EPS, Rs 6.6 6.2 6.5 PER, x 21.8 23.2 21.9 EV/EBIDTA, x 16.5 15.2 13.7 P/BV, x 3.6 3.0 2.5 ROE, % 19.6 19.1 18.3

Source: PhillipCapital India Research Est. Jonas Bhutta (+ 9122 6246 4119) [email protected] Vikram Rawat (+ 9122 6246 4120) [email protected]

50

70

90

110

130

150

170

190

Apr-16 Oct-16 Apr-17 Oct-17

BEL BSE Sensex

mailto:[email protected]

mailto:[email protected]


BHARAT ELECTRONICS COMPANY UPDATE

We see US$ 26bn order opportunities over next 10 years

Pace of execution to increase: 12% CAGR in FY18-20


Margins should be resilient after a decline in FY19 despite higher share of integration sales

BEL should generate growth capital of Rs 22bn over FY18-20 vs. Rs 16bn in FY15-17


BEL’s PE is highly correlated to order inflows

BEL: Two-year forward EV/order book – average 0.4x


817

1,689 722

150

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Next 3 years 3-5 years 5-10 years Total Oppotunity

(Rs bn)

57

.7

61

.0

62

.8

68

.4

73

.3

86

.1

10

6.2

11

9.0

13

3.0

0%

5%

10%

15%

20%

25%

10

30

50

70

90

110

130

150

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

FY1

8E

FY1

9E

FY2

0E

Revenues (Rs bn) % yoy (rhs)

12% CAGR

8.3% CAGR

6.1

6.4

8.9

11

.4

13

.7

19

.0

20

.8

22

.0

25

.3

10.7% 10.5%

14.2%

16.7%

18.7%

22.0%

19.6% 18.5% 19.0%

5%

8%

11%

14%

17%

20%

23%

0

5

10

15

20

25

30

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

FY1

8E

FY1

9E

FY2

0E

EBITDA (Rs bn) EBITDA margin (%)

0

2

4

6

8

10

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

FY1

8E

FY1

9E

FY2

0E

(Rs bn) Operational cash flow

-

50

100

150

200

250

0

5

10

15

20

25

30

35

Ap

r-0

6

Ap

r-0

7

Ap

r-0

8

Ap

r-0

9

Ap

r-1

0

Ap

r-1

1

Ap

r-1

2

Ap

r-1

3

Ap

r-1

4

Ap

r-1

5

Ap

r-1

6

Ap

r-1

7

(Rs bn) (x) BEL 1yr fwd PE (x) 1yr fwd inflows

Correl 0.8x

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Ap

r-0

7

No

v-0

7

Jun

-08

Jan

-09

Au

g-0

9

Mar

-10

Oct

-10

May

-11

Dec

-11

Jul-

12

Feb

-13

Sep

-13

Ap

r-1

4

No

v-1

4

Jun

-15

Jan

-16

Au

g-1

6

Mar

-17

Oct

-17

2yr fwd EV/OB Average

+1SD 0.7x

Avg 0.4x

-1SD 0.1x


BHARAT ELECTRONICS COMPANY UPDATE

Financials

Income Statement Y/E Mar, Rs mn FY17 FY18e FY19e FY20e

Net sales 86,119 1,06,249 1,18,994 1,32,974

Growth, % 18 23 12 12

Total income 86,119 1,06,249 1,18,994 1,32,974

Raw material expenses -44,131 -57,906 -66,934 -75,795

Employee expenses -14,113 -17,369 -18,293 -19,262

Other Operating expenses -8,888 -10,186 -11,765 -12,615

EBITDA (Core) 18,987 20,789 22,002 25,302

Growth, % 38.4 9.5 5.8 15.0

Margin, % 22.0 19.6 18.5 19.0

Depreciation -1,915 -2,351 -2,700 -3,027

EBIT 17,072 18,437 19,302 22,275

Growth, % 42.3 8.0 4.7 15.4

Margin, % 19.8 17.4 16.2 16.8

Interest paid -118 -50 -50 -50

Other Non-Operating Income 4,070 2,374 2,759 3,681

Non-recurring Items -647 -888 0 0

Pre-tax profit 20,377 19,874 22,011 25,906

Tax provided -4,901 -5,606 -5,943 -6,995

Profit after tax 15,476 14,268 16,068 18,911

Net Profit 15,476 14,268 16,068 18,911

Growth, % 27.0 (6.0) 6.0 17.7

Net Profit (adjusted) 16,123 15,156 16,068 18,911

Unadj. shares (m) 2,457 2,457 2,457 2,457

Wtd avg shares (m) 2,457 2,457 2,457 2,457

Balance Sheet Y/E Mar, Rs mn FY17 FY18e FY19e FY20e

Cash & bank 37,902 35,091 50,726 70,874

Debtors 43,549 52,397 57,052 61,933

Inventory 49,050 62,681 68,563 72,258

Loans & advances 0 0 0 0

Other current assets 12,025 14,001 15,445 17,053

Total current assets 1,42,525 1,64,171 1,91,786 2,22,118

Investments 4,597 4,597 4,597 4,597

Gross fixed assets 16,170 21,451 28,787 33,299

Less: Depreciation -3,617 -5,968 -8,668 -11,695

Add: Capital WIP 6,563 5,282 2,445 1,934

Net fixed assets 19,116 20,765 22,564 23,538

Total assets 1,71,561 1,94,855 2,24,270 2,55,575

Current liabilities 82,888 94,952 1,14,183 1,33,159

Provisions 13,003 16,511 17,493 18,643

Total current liabilities 95,891 1,11,463 1,31,676 1,51,802

Total liabilities 96,391 1,11,463 1,31,676 1,51,802

Paid-up capital 2,234 2,457 2,457 2,457

Reserves & surplus 72,937 80,935 90,137 1,01,317

Shareholders’ equity 75,170 83,392 92,594 1,03,774

Total equity & liabilities 1,71,561 1,94,856 2,24,271 2,55,576


Cash Flow Y/E Mar, Rs mn FY17 FY18e FY19e FY20e

Pre-tax profit 20,377 19,874 22,011 25,906

Depreciation 1,915 2,351 2,700 3,027

Chg in working capital -12,364 -8,884 8,232 9,942

Total tax paid -5,616 -5,606 -5,943 -6,995

Cash flow from operating activities -1,085 6,299 24,291 28,249

Capital expenditure -6,968 -4,000 -4,500 -4,000

Cash flow from investing activities 31,478 -2,514 -1,741 -319

Free cash flow 30,393 3,785 22,551 27,930

Equity raised/(repaid) -166 223 0 0

Dividend (incl. tax) -6,046 -6,866 -7,732 -9,100

Other financing activities -22,522 547 816 1,318

Cash flow from financing activities -28,234 -6,596 -6,916 -7,782

Net chg in cash 2,159 -2,810 15,635 20,148

Valuation Ratios

FY17 FY18e FY19e FY20e

Per Share data EPS (INR) 6.6 6.2 6.5 7.7

Growth, % 36.5 (6.0) 6.0 17.7

Book NAV/share (INR) 30.6 33.9 37.7 42.2

FDEPS (INR) 6.6 6.2 6.5 7.7

CEPS (INR) 7.6 7.5 7.6 8.9

CFPS (INR) 0.1 2.2 9.9 11.5

DPS (INR) 2.0 2.3 2.6 3.1

Return ratios Return on assets (%) 8.8 7.8 7.7 7.9

Return on equity (%) 19.6 19.1 18.3 19.3

Return on capital employed (%) 20.8 20.5 19.5 20.4

Turnover ratios Asset turnover (x) 2.8 2.2 2.3 2.9

Sales/Total assets (x) 0.5 0.6 0.6 0.6

Sales/Net FA (x) 5.2 5.3 5.5 5.8

Working capital/Sales (x) 0.3 0.3 0.2 0.1

Receivable days 184.6 180.0 175.0 170.0

Inventory days 207.9 215.3 210.3 198.3

Payable days 73.2 77.9 79.4 83.1

Working capital days 92.1 117.2 82.4 49.6

Liquidity ratios

Current ratio (x) 1.7 1.7 1.7 1.7

Quick ratio (x) 1.1 1.1 1.1 1.1

Interest cover (x) 144.9 368.7 386.0 445.5

Net debt/Equity (%) (49.8) (42.1) (54.8) (68.3)

Valuation

PER (x) 21.8 23.2 21.9 18.6

PEG (x) - y-o-y growth 0.6 (3.9) 3.6 1.0

Price/Book (x) 4.7 4.2 3.8 3.4

Yield (%) 1.4 1.6 1.8 2.2

EV/Net sales (x) 3.6 3.0 2.5 2.1

EV/EBITDA (x) 16.5 15.2 13.7 11.1



Hindustan Aeronautics (HNAL IN)

No risk of a ‘dog fight’ – open skies ahead. BUY INDIA | DEFENCE | INITIATING COVERAGE

27 March 2018

We initiate coverage on Hindustan Aeronautics (HAL), a government-owned enterprise engaged in the manufacturing and overhauling of fighter aircrafts, helicopters, and avionics, with a BUY rating and a target price of Rs 1,470. HAL is currently India's only fighter-aircraft manufacturer. As of December 2017, it had an order book of Rs 685bn, implying a book-to-bill of 3.9x FY17 revenues. Over FY18-22, we expect HAL to report a strong 17% CAGR in earnings, and generate Rs 64bn of growth capital. Lastly, HAL is backed by a robust order inflow opportunity of US$ 43bn over the next ten years. About Hindustan Aeronautics Ltd (HAL) Incorporated in 1963, HAL is a government-owned defence company with 'Navratna' status. It designs, develops, and manufactures aircrafts, helicopters, aero-engines, avionics, accessories, and aerospace structures. It is also provides upgrading, maintenance, and repair and overhaul (ROH) services.

Key investment arguments Over time, HAL has developed strong moats in terms of design and development capabilities (R&D expenditure at 7% of revenues), deep knowledge of both Russian- and Western-origin fighter-aircraft platforms, and an ability to provide low-cost life-cycle support. These strengths would deter competition from the private sector in the long term. In addition, a US$ 43bn opportunity pipeline for products that it has already developed, provides sustainable visibility of order inflows and revenues. After a decline in FY18, operating profitability should improve led by benefits from cost savings on raw materials for the light-combat aircraft (LCA) program, coupled with increasing share of ROH revenues – to 39% in FY21 from 30% of sales in FY17. Lastly, over FY18-22, we expect HAL to generate Rs 64bn of growth capital (residual cash flow after capex and dividend, but excluding working capital). Key risks Paucity of government funds could delay awards of large projects such as the Rs 600bn LCA Mark1A project. In addition, long gestation timelines increase risk of liquidated damages. Higher than expected provisioning for liquidated damages could negate our margin expansion thesis. Initiate coverage with a BUY rating and target price of Rs 1,470 We believe that the following factors should lead to a rerating – (1) visibility on HAL’s ability to grow earnings despite low revenue growth, (2) catalysts such as actual placement of the Rs 600bn LCA Mark 1A order, (3) visibility on follow on orders for LCA, and (4) higher-than-expected EBITDA margin expansion.

We advise investors to take a five-year view on HAL, mainly because: (1) it is an aircraft manufacturer whose order-award timelines and execution are spread over 10-15 years, and (2) the true return profile of these projects will be seen over a five-year block, which is the usual time taken to stabilise production of an aircraft and reap size benefits. Therefore, in all our financial analysis, we have based our comments on the time horizon FY18-22, over which period HAL’s earnings CAGR should be 17% and it should generate Rs 64bn of growth capital. Our confidence on HAL’s ability to deliver long-term steady growth in operating earnings stems past track record - its revenue and EBITDA have grown at 12% CAGR over FY96-17.

At the higher end of its IPO price band of Rs 1,240, HAL trades at an FY20 PE of 18x. We value HAL at 21x FY20 PE to arrive at our target price of Rs 1,470. Our target PE is at a 20% premium to global peers, given HAL’s strong order visibility over the next ten years, coupled with earnings growth. Due to the long gestation cycles in the aerospace industry, we also support our valuation with a DCF-based target price.

BUY IPO PRICE / CMP RS 1240

TARGET RS 1470 (+19%) COMPANY DATA EQUITY SHARES 334.4mn

IPO PRICE BAND Rs 1215 – 1240

MKT CAP Rs 406.3-414.6bn

KEY FINANCIALS


Net Sales 174.14 178.73 182.16

EBIDTA 27.24 24.60 25.73

Net Profit 22.39 16.79 16.75

EPS, Rs 67.0 50.2 50.1

PER, x 18.5 24.7 24.7

EV/EBIDTA, x 11.5 13.3 9.6

P/BV, x 3.3 3.4 3.1

ROE, % 19.0 13.5 13.1



HINDUSTAN AERONAUTICS LTD INITIATING COVERAGE

Focus charts and tables

Going back to its roots of design, development, and assembly

A US$ 43bn opportunity pipeline for HAL, with no competition Products Units Value (Rs bn)

Aircrafts Tejas - LCA Mk1A (RFP received) 83 600

Tejas - LCA Mk1A 121 681

Total 204 1,281

Helicopters ALH Dhruv & Rudra 500 863

Kamov 226T 100 40

LUH 600 276

LCH (RFP received) 15 45

LCH 125 277

Total 1,340 1,501

Total Opportunity 1,544 2,781

Total Opportunity (US$ bn)

43

Source: RHP, PhillipCapital India Research

Focus on R&D to limit the threat of competition

Expect 10% CAGR in revenues over FY18-22 led by a pickup in production of indigenous products, along with ROH


Gross margins to vary between 47-51% due to sales mix; EBITDA margins to expand on operating leverage

17% CAGR in recurring PAT with improved quality of earnings on lower other income contribution


19.5 10.8 10.4 11.9 12.8 5.1

12.9%

7.2% 6.7%

7.1% 7.4%

9.9%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

0

5

10

15

20

25

FY13 FY14 FY15 FY16 FY17 1HFY18

(Rs bn) R&D expenses (Rs bn) % of net sales

0%

5%

10%

15%

20%

25%

30%

35%

0

50

100

150

200

250

300 F

Y16

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e

(Rs bn) Revenues (Rs bn) % yoy

47.2% 47.9% 48.9% 49.4% 50.6% 47.4%

15.6% 13.8% 14.1%

16.0% 16.4% 17.0%

0%

20%

40%

60%

FY17 FY18e FY19e FY20e FY21e FY22e

Gross margins EBITDA margins

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0

10

20

30

40

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e

(Rs bn) Recurring PAT (Rs bn) % yoy

17% CAGR



RoEs should improve after a dip in FY18...

...and generate growth capital of Rs 64bn over FY18-22 vs. Rs 55bn in FY13-17


About the IPO Rs 41-42bn issue of 34.1mn shares at a price band of Rs 1,215-1,240 per share

Issue includes offer for sale by promoter "Government of India (GoI)"

Market capitalisation: Rs 406-415bn

Post-issue, GoI's shareholding will reduce to 89.8% from 100%

Hindustan Aeronautics - Issue details ISSUE OPENS 16th March 2018

ISSUE CLOSES 20th March 2018

PRE- ISSUE EQUITY SHARES 334.4mn

- LOWER BAND Rs 1215

- UPPER BAND Rs 1240

PRICE BAND Rs 1215 - 1240

- FRESH ISSUE 0.0mn

- OFS 34.1mn

NO OF SHARES OFFERED FOR SALE 34.1mn

RETAIL AND EMPLOYEE SHARE (%) 36.3%

RETAIL DISCOUNT (RS) Rs 25

ISSUE SIZE Rs 41.1-42.0bn

POST- ISSUE EQUITY SHARES 334.39mn

MKT CAP Rs 406.3-414.6bn

Shareholding pattern post-issue


Allocation of shares offered in the IPO

Shares (mn) % of net issue

Retail 11.70 35.0%

Non-institutional 5.02 15.0%

- Mutual fund 0.84 2.5%

- Other QIBs 15.88 47.5%

QIBs 16.72 50.0%

Net Issue 33.44 98.0%

Employees 0.67 2.0%

Total Issue 34.11 100.0%


19.0%

13.5% 13.1%

16.9% 15.6%

18.3%

0%

3%

6%

9%

12%

15%

18%

21%


RoE (%)

0

5

10

15

20

25

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e


GOI 89.8%

Others 10.2%



About the company Hindustan Aeronautics Ltd (HAL), incorporated in August 16, 1963, is a government-owned defence company with 'Navratna' status. It is engaged in the design, development, and manufacture of aircrafts, helicopters, aero-engines, avionics, accessories and aerospace structures along with upgrade, maintenance, repair & overhaul (ROH) services to aircrafts, helicopters and engines. HAL derives majority of its revenues from the Indian Defence Forces (IDF), which contributed 93% of its revenues in FY17. Finished products (54% of sales): During FY17, domestic sales of finished products contributed 54% of its revenues, which included 56 aircrafts (Su-30 MKI, Hawk Mk 132, LCA Tejas, and Dornier Do-228) and helicopters (ALH Dhruv, ALH-WSI Rudra and Cheetal), in addition to production of engines and accessories. Repair and Overhaul (31% of sales): ROH services contributed 31% of its FY17 revenues. It has overhauled 197 aircrafts and helicopters and 473 engines.

At more than 90%, HAL derives a majority of its revenues from the Indian Defence Forces

Domestic products sales and ROH services contributed 85% of its FY17 revenues


HAL manufactures aircrafts, helicopters, engines, various avionic equipment, both indigenously designed as well as under licences from OEMs or under transfer of technology (ToT) agreement with third parties.


92.6% 94.2% 93.3% 91.4%

0%

20%

40%

60%

80%

100%

FY15 FY16 FY17 1HFY18

Revenue from Indian defence services (%)

Exports 3%

Finished products

54%

ROH 31%

Spares 9%

Development & others 4%

Domestic sales 97%

Su-30 MKI

MiG-21 variants

MiG-27

Hawk Mk 132

Dornier 228

Jaguar

Mirage 2000

upgrade

Cheetah

Chetak

Cheetal

Lancer

AL-31FP

Adour Mk 871-07

Adour Mk

804E/811

Shakti 1H1

Garrett TPE-331-5

Artouste IIIB

LM-2500

Hindustan Aeronautics

LCA Tejas

Jaguar Darin-III

upgrade

HTT-40

Mini UAV - 8tn

ALH Dhruv

ALH Mk IV (Rudra)

LCH

LUH

Su-30 MKI

MiG

Hawk Mk 132

Dornier 228

Jaguar

Mirage 2000

AN-32

Cheetah

Chetak

AL-31FP

Adour Mk 871-07

Adour Mk

804E/811

Shakti 1H1

Garrett TPE-331-5

Artouste IIIB

LM-2500

RD-33

R-11/R-25

R-29B

TM333-2B2

Gnome1400

Industrial Avon

Industrial 501K

Aircrafts Helicopters Engines Aircrafts Helicopters Aircrafts HelicoptersEngines - HAL

ManufacturedEngines - Others

Manufactured under TOT/Licences Indigenously developed Repair & Overhaul (ROH)



Major avionic equipment, other accessories, and aerospace structures manufactured by HAL Avionic equipment

Advanced Communication System (ACS-235)

VHF Omni Range and Instrument Landing System (VOR/ILS)

Tactical Air Navigation (TACAN)

Identification of Friend or Foe (IFF)

Radio Altimeter (RAM)

Mission Computer and Display Processor

Precision Approach Radar (PAR)

Passive Phased Array Radar

Solid State Digital Video Recording System (SSDVRS)

Inertial Navigation and Global Positioning System (INGPS)

Weapon Control System

Multi-Functional Display (MFD)

Head Up Display System

Solid State Flight Data Recorder (SSFDR)

Opto-Electric Sighting and Navigation Complex

Accessories for aircraft, helicopters & aero-engines

Hydraulic Systems and Power Control

Environment Control Systems

Engine Fuel Systems

Instruments

Electrical Power Generation and Control Systems

Landing Gear Systems

Aerospace Structures

Large aluminum alloy riveted structures & welded tanks for PSLV, GSLV, IRS & INSAT

Heat shield assembly, nose cone assembly, tank and shrouds for satellites


Manufacturing facilities HAL's operations are organised into five complexes –Bangalore, MiG, helicopter, accessories, and design – which together include 20 production divisions and 11 R&D centres located across India. Aircrafts manufacturing: HAL has four aircraft manufacturing facilities: (1) Aircraft division, Bangalore complex, which is currently used for the production support to LCA due to completion of Hawk Mk 132, (2) LCA (Tejas) division, which can produce eight LCAs annually; trying to expand to 16 LCAs annually, (3) aircraft manufacturing, MiG complex, currently producing 12-13 SU-30 MKI aircrafts annually, and (4) transport aircraft division, Kanpur, with a capacity to manufacture 12 Dornier Do-228. Helicopters manufacturing: HAL manufactures helicopters from its helicopter division, Bangalore, that has capacity to manufacture 30 helicopters. Currently, the plant is being used to manufacture ALH MK III (Dhurv), ALH MK IV Rudra, and Cheetal helicopters. HAL is setting up a new helicopter manufacturing facility at Tumkur, with a capex of Rs 63bn. The facility will be used for the production of the 3-tonne class Light Utility Helicopter (LUH). It is also establishing an assembly facility for a second line of ALH in order to ramp-up the production capacity.



HAL's aircraft, helicopter, and engine-manufacturing plants

Plant Complex Capacity Current products Past products

Aircraft manufacturing

Aircraft division, Bangalore Bangalore complex - Support for LCA Hawk Mk 132,

LCA (Tejas) division, Bangalore Bangalore complex 8 / 16 LCA Tejas

Aircraft Mfg division, Nasik MiG complex 12 Su-30 MKI MiG-21FL, MiG-21M, MiG-21BIS, MiG-27

Transport aircraft division, Kanpur Accessories complex 12 Dornier 228 (Civil) Dornier 228

Helicopter manufacturing

Helicopter division, Bangalore Helicopter complex 30 ALH MK III, ALH MK IV Rudra, Cheetal

Chetak, Cheetah, Lancer, Cheetal

Engine manufacturing

Engine division, Bangalore Bangalore complex Garret TPE -331 (Dornier 228), Shakti (ALH Dhruv)

Adour Mk 871 (Hawk Mk 132), Artouste III B (Chetak & Cheetah)

Engine division, Koraput MiG complex MRO RD-33 series 3 (MiG 29)

Sukhoi Engine division, Koraput MiG complex AL-31FP (Su-30 MKI)


HAL manufacturing complexes, production divisions, and R&D centres




Joint Ventures HAL has entered into 13 commercial joint ventures to improve its access to modern technology and grow its operations in new areas.

JV Company Stake (%) Partner Business

International Aerospace Manufacturing Pvt Ltd

50% Rolls-Royce Overseas Holdings

Manufacture shrouds and cones for compressor engine for civil aerospace application

Multirole Transport Aircraft Ltd

50% UAC-Transport Aircraft & Rosoboronexport

Design, develop and manufacture a multi-role transport aircraft for both the Indian and Russian Air Forces

BAeHAL Software Ltd 49% BAE - UK Software solutions and IT services

Indo Russian Aviation Ltd

48% PJSC (RAC MiG), GRPZ Ryazyan, Aviazapchast PLC & ICICI Bank

Source spare parts for repair and overhaul of equipment for aircraft, engine and accessories of Russian origin

Snecma HAL Aerospace Pvt Ltd

50% Snecma Aerospace To manufacture and supply engine parts to Safran Aircraft Engines and Safran Helicopter Engines

Samtel HAL Display Systems Ltd

40% Samtel Avionics Design, development, and manufacturing of display systems for airborne, military and ground applications

HAL Edgewood Technologies Pvt Ltd

50% Edgewood Ventures LLC & Edgewood Technologies

Develop and manufacture high technology miniature electronic modules and avionics systems for aerospace applications

HALBIT Avionics Pvt Ltd

50% Elbit Systems, Israel & Merlin Hawk Associates

Design, develop and manufacture simulators and avionic products

Infotech HAL Ltd 50% Cyient Ltd Design centre for aero-engines and to engage in the design and engineering services of aero-engines and technical publications

TATA HAL Technologies Ltd

50% Tata Technologies Engineering design services in aero-structures and take up captive offshore and on-site work load from OEMs

HATSOFF Helicopter Training Pvt Ltd

50% CAE Inc. Providing military and civil helicopter pilot training on full motion "Level D" simulators

Helicopter Engines MRO Pvt Ltd

50% Safran Helicopter Engines

MRO services for Safran Helicopters engines and engines installed on helicopters built by HAL

Indo-Russian Helicopters Ltd

51% Russian Helicopters & Rosoboronexport

Organise production of Ka-226T helicopters and its modification in India; to provide MRO and technical support for Ka-226T helicopters


JVs financial summary Stake Revenues PAT

Company (%) FY15 FY16 FY17 FY15 FY16 FY17

BAeHAL Software Ltd) 49% 237 218 211 15 (21) 5

Snecma HAL Aerospace 50% 589 695 738 38 77 27

Samtel HAL Display Systems 40% 151 419 157 (20) 1 (38)

HAL Edgewood Technologies 50% 14 9 11 (16) (12) (8)

HALBIT Avionics Pvt Ltd 50% 235 121 75 6 (63) 0

Indo Russian Aviation Ltd 48% 1,227 870 1,179 125 170 201

Infotech HAL Ltd 50% 60 61 66 7 10 10

HATSOFF Helicopter Training Pvt Ltd 50% 262 184 376 (111) (79) 105

TATA HAL Technologies Ltd 50% 127 94 51 14 3 (29)

International Aerospace Manufacturing 50% 1,168 1,394 1,912 (3) 53 164

Multirole Transport Aircraft 50% - 3 43 (128) 24 (1)

Helicopter Engines MRO Pvt Ltd 50% - - - - - (12)

Indo-Russian Helicopters Ltd 51% - - - - - -

Total

4,070 4,068 4,819 (73) 163 424




Key investment arguments

A play on India's defence HAL offers investors an opportunity to play the India defence sector, as it is the largest DPSU (defence public sector undertaking) in terms of production value. It derives more than 90% of its revenues from the Indian defence sector.

HAL derives a majority of its revenues from Indian defence services


US$ 43bn opportunity over 10 years...for products already developed Based on our estimates, HAL has a US$ 43bn (Rs 2,780bn) pipeline of orders over the next ten years for products that it has already developed. Our estimates exclude any orders for Su-30 upgrade, HTT-40 (basic trainer), and intermediate jet trainer (IJT), which only add to the opportunity list once there is greater clarity on these programs. The overarching demand driver for fighter aircrafts is India’s depleting fleet of squadrons, which currently stands at 31 against the desired 42. MIG’s (21 and 27), which currently account for 40% of India’s fighter aircraft fleet, will be fully phased out of active service by 2025, and will have to be mostly replaced with single-engine fighter aircrafts such as LCA Tejas. In the helicopter segment, HAL has clear visibility for ALH, LCH, LUH, and Kamov. More than 1,300 helicopters are required by India in the 3- and 5-tonne segments.

US$ 43bn opportunity from aircrafts and helicopters already developed Products Units Value (Rs bn)

Aircrafts

Tejas - LCA Mk1A (RFP received) 83 600

Tejas - LCA Mk1A 121 681

Total 204 1,281

Helicopters

ALH Dhruv & Rudra 500 863

Kamov 226T 100 40

LUH 600 276

LCH (RFP received) 15 45

LCH 125 277

Total 1,340 1,501

Total Opportunity 1,544 2,781

Total Opportunity (US$ bn)

43

Source: PhillipCapital India Research

92.6% 94.2% 93.3% 91.4%

0%

20%

40%

60%

80%

100%





Limited threat of competition in its area of competence

We believe that capabilities developed by HAL over the past five decades will keep it ahead of the domestic private sector, which is nowhere close to achieving that kind of knowhow in aircraft manufacturing, assembly, and overhaul.

HAL has been involved in manufacturing both Russian- and Western-origin fighter aircraft platforms, which gives it a unique advantage that new entrants from the private sector are unlikely to achieve.

HAL has developed strong capabilities for manufacturing, upgrade, repair and overhaul of both Russian- and Western-origin aircrafts, helicopters, and their engines



Where do HAL’s competencies lie? 3-5 tonne helicopter segment: HAL’s home turf HAL is the leader in the 5-tonne helicopter category, with almost a 100% market share across all three forces, with ALH-Dhruv and Rudra variants. Additionally, with its new light-utility helicopter (LUH) and its joint venture with Russian helicopters to locally manufacture the Kamov 226T, HAL will take the lead in the three-tonne helicopter segment. LUH and Kamov will replace India’s aged fleet of Chetak and Cheetah. LCA Tejas: Building a fighter aircraft ground up HAL’s involvement in the LCA is majorly in manufacture and assembly. However, it has also participated with the Aeronautical Development Agency (ADA) in designing the aircraft. Learning’s from the LCA will be a template for HAL to replicate in future indigenous programmes such as the AMCA (Advanced Medium Combat Aircraft). Sukhoi-30 MKI: Twin-engine aircraft in the +30 tonne category Even though Su-30 is a ToT project, in phase-6 manufacturing, HAL has built the plane right from the raw material stage, thereby giving it a deep knowledge of manufacturing a twin-engine heavyweight fighter aircraft.

Su-30 MKI

MiG-21 variants

MiG-27

Hawk Mk 132

Dornier 228

Jaguar

Mirage 2000

upgrade

Cheetah

Chetak

Cheetal

Lancer

AL-31FP

Adour Mk 871-07

Adour Mk

804E/811

Shakti 1H1

Garrett TPE-331-5

Artouste IIIB

LM-2500

Hindustan Aeronautics

LCA Tejas

Jaguar Darin-III

upgrade

HTT-40

Mini UAV - 8tn

ALH Dhruv

ALH Mk IV (Rudra)

LCH

LUH

Su-30 MKI

MiG

Hawk Mk 132

Dornier 228

Jaguar

Mirage 2000

AN-32

Cheetah

Chetak

AL-31FP

Adour Mk 871-07

Adour Mk

804E/811

Shakti 1H1

Garrett TPE-331-5

Artouste IIIB

LM-2500

RD-33

R-11/R-25

R-29B

TM333-2B2

Gnome1400

Industrial Avon

Industrial 501K

Aircrafts Helicopters Engines Aircrafts Helicopters Aircrafts HelicoptersEngines - HAL

ManufacturedEngines - Others

Manufactured under TOT/Licences Indigenously developed Repair & Overhaul (ROH)



Repair and overhaul Having delivered about 600 aircrafts in the past 10 years, HAL has developed a strong repair and overhaul business, which overhauls about 200 aircrafts and helicopters p.a.; it contributed 30% to its FY17 revenues in addition to the sale of spares. In terms of capabilities, HAL pulls apart a plane or helicopter, and repairs and overhauls the airframe, engine, and every part of the plane that undergoes active wear and tear.

HAL's own (produced) aircrafts and helicopters account for a significant portion of the fleets of the Indian defence forces. It supports around 75% of the Air-Force’s fleets, 66% of the Navy’s, and 100% of both Army and Coast-Guards fleets.

HAL has a strong fleet across the defence forces – 75% of Air Force, 66% of Navy, and 100% fleets of Army and Coast Guard

Source: Company, DIPAM, PhillipCapital India Research

Strong in-house design and development capabilities HAL has eleven dedicated R&D centres, which are capable of developing a wide range of products, upgrading them, and maintaining a pipeline of products to meet future needs. Also, it has two trademarks, seven patents, 11 design registrations, and 77 copyrights. Its board has mandated 10% of HAL's operating net profit for company-funded R&D expenditure. HAL is currently pursuing the design, development, and production of the LCH, LUH, Intermediate Jet Trainer (IJT), HTT-40 basic trainer aircraft, and a mini UAV. Additional opportunities include co-development programmes such as Fifth Generation Fighter Aircraft (FGFA) and research, design, and development of the HTFE-25 and HTSE-1200 engines. HAL’s consistent investment in R&D (~7% of revenues) helps it deploy funds in building a pipeline of future projects. Helicopters such as ALH, LCH and LUH are some of the products that it has developed. In FY17 alone, HAL achieved the following R&D milestones:

First flight of basic trainer aircraft (HTT-40)

First flight of light utility helicopter (LUH)

Full operational capability (FOC) for upgraded Mirage 2000

FOC for advanced jet trainer Hawk-i

Initial operational capability (IOC) for Jaguar Darin 3 upgrade

79%

38%

69%

40%

64%

100%

60%

100% 100% 100%

0%

20%

40%

60%

80%

100%

Figh

ters

Hel

ico

pte

rs

Trai

ner

s

Tran

spo

rt

Hel

ico

pte

rs

Trai

ner

s

Tran

spo

rt

Hel

ico

pte

rs

Hel

ico

pte

rs

Tran

spo

rt

Airforce Navy Army Coast Guard



R&D spends


Going back to its roots...focus on design, development, and assembly

In its early years of inception (1950 to the 1960s) HAL’s focus was on the indigenous design and development of aircrafts. This led to development of programs such as the HT-2 trainer, HF-24 jet fighter (Marut), and HJT-16 basic jet trainer (Kiran). However, from mid 1960s until 1980, with the license production of MIG-21, followed by Chetak and Cheetah helicopters, HAL’s focus shifted to technology-transfer projects that led to an increasing manufacturing footprint into the lowest component manufacturing. Since the 1990s, with the LCA and ALH programs gaining momentum, HAL began to focus on indigenous design and development. With the LCA Mark 1A, HAL will transition to the role of an assembler, as it has outsourced manufacturing almost 75% of the LRUs. Key suppliers for the LCA Mark 1A program are:

Wings: Larsen & Toubro

Central fuselage: VEM Technologies

Rear fuselage: Alpha Tocol

Front fuselage: Dynamatic Technologies

HAL is moving back to D&D

Source: RHP, E&Y, PhillipCapital India Research

19.5 10.8 10.4 11.9 12.8 5.1

12.9%

7.2% 6.7%

7.1% 7.4%

9.9%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

0

5

10

15

20

25


(Rs bn) R&D expenses (Rs bn) % of net sales



Service revenues to grow to 39% of sales in FY21 from 30% in FY17

Based on our interactions with industry experts, we gather that typically the capital cost of an aircraft accounts for less than 1/3

rd of its lifecycle cost. Hence, overhaul

and repairs over the life of an aircraft (usually 30-40 years) would entail 2x the capex over the capital cost of an aircraft. For programs such as Su-30, where HAL manages end-to-end repairs, it derives three revenue lines viz. 1. Airframe overhaul: Typically done after an aircraft completes 1500-2000 hours

of fly time. 2. Engine overhaul: Also after 1500-2000 hours of fly time and 3. Rotable spares: LRUs that have seen wear-and-tear before the mandated hours

of fly time.

Repair and overhaul revenue mix: HAL overhauled 197 aircrafts/helicopters and 473 engines in FY17


We expect HAL’s repair and overhaul revenues to increase to 39% in FY21 from 30% of total sales in FY17, driven by increased volumes from Su-30 repair programme. We believe ROH revenues should also entail higher margins since HAL amortises the fixed asset cost alongwith its normal man-hour rates to bill for ROH.

Expect ‘repair and overhaul’ revenues share to increase to 39%


Additionally, HAL has recently decided to increase its scope in overhaul and has started to undertake responsibility for performance-based logistic (PBL), which includes guaranteeing the readiness (uptime), and performance objectives of the aircraft. HAL recently signed its first contract for PBL with the Indian Coast Guard to manage 16 ALH Dhruv. Depending on its experience with the Coast Guard order, HAL will consider implementing PBL across other repair contracts as well. PBL should offer

Su-30

MIG Jaguar / Mirage

/ Hawk

ALH

Chetak/Cheetah

Engines

25%

28%

31%

34%

37%

40%

-

20

40

60

80

100

FY17 FY18e FY19e FY20e FY21e

(Rs bn) Repair & overhaul revenue (Rs bn) % of Net Sales



higher profitability, given that the risk of uptime of the asset would now move to HAL from the client.

We forecast 17% CAGR in FY18-22 earnings with improving quality HAL’s revenues should see 10% CAGR over FY18-22 driven by a growing share of service revenues and a pick up in the execution rate of LCAs even as the Su-30 program come to an end in FY20. Higher proportion of service revenues coupled with higher non ToT products on its manufacturing line should expand EBITDA margins by ~330bps over FY18-22 leading to a 16% EBITDA CAGR. In addition, the quality of earnings should improve as other income as a % of earnings declines to 26% in FY22 from 57% in FY13. Consequently, we expect HAL’s recurring earnings CAGR at 17%, though earnings could decline in FY21 because of the transition to manufacturing LCA-Tejas from Su-30.

10% CAGR in revenues over FY18-22 led by pick up in execution of LCA, LCH, and LUH, along with ROH revenues...

...EBITDA CAGR of 16% due to a 330ps margins expansion led by operating leverage...


...and recurring earnings to register 17% CAGR

...with improved quality of earnings as share of other income declines to 26% in FY22 from 57% in FY13


0%

5%

10%

15%

20%

25%

30%

35%

0

50

100

150

200

250

300

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e


10.2% CAGR

12%

14%

16%

18%

20%

0

10

20

30

40

50 F

Y16

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e

(Rs bn) EBITDA (Rs bn) EBITDA margin (%)

16% CAGR

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0

10

20

30

40

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e


17% CAGR

57% 55% 62%

50%

33% 33% 30% 31% 35%

26%

0%

10%

20%

30%

40%

50%

60%

70%

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e

Other income, net % of PAT



Robust operational cash flows even after capex and dividend

We estimate HAL to generate Rs 64bn of operational cash flows (excluding the impact of working capital, which tends to be volatile due to addition/depletion of customer advances) and after accounting for capex and dividends over FY18-22 (operational cash flows were Rs 55.5bn over FY13-17).

To generate robust operational cash flow of Rs 64bn over FY18-22 vs. Rs 55.5bn in FY13-17 (Rs bn) FY13 FY14 FY15 FY16 FY17 FY18e FY19e FY20e FY21e FY22e FY13-17 FY18-22e

Recurring PAT 35 26 17 20 22 17 17 23 24 31 120 112

Add: Depreciation 6 6 9 9 7 8 9 9 10 10 37 47

Less: Capex (9) (11) (9) (15) (15) (13) (10) (8) (8) (8) (59) (46)

Less: Dividend payment (10) (10) (6) (8) (10) (10) (8) (9) (10) (11) (43) (49)

Growth capital 22 11 12 6 5 3 8 16 16 22 55 64




Key risks

Lack of funds could delay order award timelines HAL depends primarily on a single customer – the Indian armed forces through the Ministry of Defence – which contributes more than 90% of its revenues. As growth in India’s capital defence budget has been a measly 2% in the past five years, there is limited headroom each year to place new orders; a majority of the budget (~84%) is set aside for meeting committed liabilities. With such a backdrop, we believe that awards of large projects (such as LCA Tejas Mark1A, Rs 500-600bn) could face delays, as it would imply Rs 50-60bn of customer advances to HAL. Our current estimates build in the LCA order in FY19, benefits of higher cash balances in FY20, and meaningful contribution to sales by FY22. Any deviation from these timelines would imply downside risks to our estimates.

HAL is primarily dependent on the MOD for orders


India's defence capital outlay has grown at meagre 2% CAGR over FY14-18

...of which committed liabilities constitute 84% of its budget


92.6% 94.2% 93.3% 91.4%

0%

20%

40%

60%

80%

100%



500

550

600

650

700

750

800

850

900

FY14A FY15A FY16A FY17A FY18RE

(Rs bn) India defence capital outlay

2.2% CAGR

90% 95% 88% 89% 86% 84%

10% 5% 12% 11% 14% 16%

0%

20%

40%

60%

80%

100%

FY13 FY14 FY15 FY16 FY17E FY18E

Committed liabilities New schemes



High imports due to significant contribution from ToT (Transfer of Technology) products HAL is significantly dependent on imports for the supply of critical components and raw materials due to licensed production of aircrafts, particularly Sukhoi-30, which accounted for 44% of its FY17 sales. Imports formed 86% of its raw material cost in FY17. However, imports should decline from their peak in FY11 (95%) due to completion of the Hawk Mk 132 program and with the completion of the Su-30 program in FY20.

Higher share of imported material due to dependence on ToT products


Long gestation cycle of defence contracts Typically, HAL receives large contracts from the Indian defence forces for manufacturing aircrafts and helicopters at a fixed price. These contracts are generally executable over a longer period, and hence, they are prone to various execution-related risks such as delays in technology absorption (Su-30 MKI) and production stabilization (LCAs).

Delay in execution may lead to liquidated damages HAL has provided/booked Rs 26.5bn of liquidated damages due to delayed deliveries since many of its contracts are fixed-price. For example, it provided Rs 11bn in FY15 for an ‘onerous contract’ on account of cost overruns due to delay in the delivery of 140 Sukhoi-30 (Block-IV) aircrafts. The schedule of delivery under the contract was FY13 to FY15; it is now expected to be delivered over FY18-20. Meeting timelines of delivery is hence essential to avoid large punitive levies by the end customer.

Higher share of imported material due to dependence on ToT products


88

.1%

92

.6%

95

.0%

80

.6%

90

.8%

89

.6%

89

.5%

88

.7%

86

.5%

84

.3%

0%

20%

40%

60%

80%

100%

FY0

9

FY1

0

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

1H

FY1

8

Imported raw material (%)

0%

1%

2%

3%

4%

5%

0

2

4

6

8

FY0

9

FY1

0

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

1H

FY1

8

(Rs bn) Liquidated damanges (Rs bn) % of Sales



Historical financial performance in charts

Production was driven by Su-30 MKI, Hawk Mk 132, LCA Tejas, Dornier Do-228, ALH Dhurv, Rudra, Cheetal

Finished products revenue was muted due to slow pick in LCA and completion of Hawk while ROH was strong...


... consequently, revenue CAGR over FY13-17 was 3.6%

Gross margins and EBITDA margins remained flat


... EBITDA grew in-line with sales growth

However, recurring PAT declined 11% yoy due to significant decline in interest income and higher taxes…


0

20

40

60

80

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

Aircrafts & Helicopter production (nos)

-

20

40

60

80

100

Finished products ROH services Spares sales

(Rs bn) FY13 FY17

-3% CAGR

3% CAGR

17% CAGR

151.2 151.3 156.5 167.6 174.1 51.7 0%

1%

2%

3%

4%

5%

6%

7%

8%

25

50

75

100

125

150

175

200



3.6% CAGR

47.2% 44.8%

47.3% 48.6% 47.2%

62.1%

15.7% 14.8% 12.5% 14.7% 15.6%

9.4%

0%

15%

30%

45%

60%

75%


Gross margins (%) EBITDA margins (%)

23.7 22.4 19.6 24.7 27.2 4.9 8%

10%

12%

14%

16%

18%

0

10

20

30



3.5% CAGR

35.2 25.5 17.3 20.0 22.4 4.0 -50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0

10

20

30

40



-10.7% CAGR



resulting in decline in RoE to 19% in FY17 (vs. 29% in FY13)…

...and weak FCF due to inventory built up, decline in customer advances, and higher capex...


...which, along with higher payout to shareholders (buyback and dividend), led to 50% decline in cash and bank balances

...leading to 55% decline in other income, which contributed 33% of PAT in FY17 (vs. 57% in FY13)


28.9%

18.6%

11.8%

15.5%

19.0%

0%

5%

10%

15%

20%

25%

30%

FY13 FY14 FY15 FY16 FY17

RoE (%)

(96.7)

19.4 4.1 1.1

(28.3)

11.7

(120)

(100)

(80)

(60)

(40)

(20)

-

20

40


(Rs bn) Free cash flow

219

111

(42)

(59)

(53)

(44)

89

-

50

100

150

200

250

Cas

h &

ban

k FY

12

CFO

Cap

ex

Shar

e b

uyb

ack

Div

iden

d

Inte

rest

&

oth

ers

Cas

h &

ban

k FY

17

(Rs bn)

-49%

0%

10%

20%

30%

40%

50%

60%

70%

0

5

10

15

20

25


(Rs bn) Other income Other income, net % of PAT

-55%



Financial outlook in charts

Production to be driven by the LCA, SU-30 MKI, DO-228, ALH, LCH, LUH along with Jaguar & Mirage upgrade over FY18-22

Order book to jump by 80% over FY18-20 led by large LCA order


Revenue mix: Share of ROH to grow in the interim

Finished products revenue CAGR at 12% over FY18-20, driven by ramp-up in production of LCA, LCH and LUH


ROH revenue CAGR of 9% CAGR led by SU-30 MKI...

... while revenues from spares to see 12% CAGR


0

10

20

30

40

50

60

70

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e

Aircrafts & Helicopter production (nos)

595

1,070

-

200

400

600

800

1,000

1,200

OB FY18E

Sales FY19E

Sales FY20E

LCA order

LCH order

Other orders

OB FY20E

(Rs bn)

80%

0%

20%

40%

60%

80%

100%

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e

Finished products ROH Spares Development & others Exports

-

20

40

60

80

100

120

140

160

FY13 FY17 FY18E FY22E

(Rs bn) Finished products

3% CAGR

12% CAGR

-

15

30

45

60

75

90


(Rs bn) ROH services

17% CAGR

9% CAGR

-

5

10

15

20

25

30


(Rs bn) Spares sales

-3% CAGR

12% CAGR



Hence, expect 10% CAGR in revenues over FY18-22

Gross margins to vary between 47-51% due to sales mix; EBITDA margins to expand by 330bps on operating leverage


...leading to 16% CAGR in EBITDA...

...and 17% CAGR in recurring PAT


... consequently, RoE to improve to 18% in FY22 after bottoming at 13% in FY18

Strong FCF in FY19-21 on large orders advances and execution pickup; inventory built up to impact FY22


0%

5%

10%

15%

20%

25%

30%

35%

0

50

100

150

200

250

300

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e


10.2% CAGR 47.2% 47.9% 48.9% 49.4% 50.6%

47.4%

15.6% 13.8% 14.1%

16.0% 16.4% 17.0%

0%

20%

40%

60%


Gross margins EBITDA margins

12%

14%

16%

18%

20%

0

10

20

30

40

50

FY1

6

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e


16% CAGR

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0

10

20

30

40 F

Y16

FY1

7

FY1

8e

FY1

9e

FY2

0e

FY2

1e

FY2

2e


17% CAGR

19.0%

13.5% 13.1%

16.9% 15.6%

18.3%

0%

3%

6%

9%

12%

15%

18%

21%


RoE (%)

(28.3)

(2.5)

79.7

13.4

24.8

(19.4) (40)

(20)

-

20

40

60

80

100





Our take on issues specific to HAL How should one analyse HAL’s cash? In FY17, HAL had a net cash of Rs 102bn, equivalent to 70% of its capital employed, or Rs 305/share. This may look high, and could prompt many investors to value the cash separately. However, we believe that a bulk of the reported cash balance is basically un-deployed advances from customers. Majority of the net cash flow generated by HAL in the past five years (~Rs 55bn) has been repatriated to the government in the form of share buy backs (Rs 61bn). Hence, we choose not to value cash per share separately, while we do acknowledge that our PE-based valuation does include impact of interest income generated on un-deployed advances on PAT. This, we believe, is part of the business model of defence PSUs, as MOD includes interest income in its margin assumptions while placing an order on defence PSUs.

65-70% of gross customers’ advances pertain to inventory, special tools, and various other receivables...

(Rs bn) FY13 FY14 FY15 FY16 FY17

Initial advances - Defence 76 92 81 75 78

Milestone advances - Defence 272 283 292 265 202

Advances from Defence customers 348 375 373 340 280

Others 7 6 6 8 8

Gross customer advances 355 381 379 348 287

Less: Utilisation of advances

- Inventory (131) (186) (204) (188) (147)

- Goods & services (38) (31) (13) (7) (5)

- Deferred revenue expenditure (22) (11) (10) (10) (9)

- Special tools & equipment (27) (31) (31) (34) (30)

- Trade receivables (7) (4) (6) (4) (2)

- Claims receivables (1) (3) (1) (0) (4)

Utilisation of advances (227) (265) (265) (244) (198)

% of gross advances 64% 70% 70% 70% 69%

Defence Customers 121 110 108 96 82

Others 7 6 6 8 8

Net Customer advances 128 116 114 104 90


No trend that links higher ROH revenues to higher gross margins - for a reason In order to back-test our thesis that increasing ROH revenues coupled with growing share of revenues from indigenous products lead to higher gross margins, we analysed data between FY10 and FY17, but the results were inconclusive. The reason for the benefits of higher ROH revenues not being visible in gross margins is on two counts

HAL has increased its provisions for liquidated damages from Rs 1.2bn to Rs 3bn between FY10-17; in FY15 it was even higher at Rs 7.3bn.

HAL is currently booking zero margins on the LCA Mark-1 as its cost of production is higher than the ASP. HAL has asked for a cost escalation which it expects should be approved by the government shortly.



In absence of these negatives (Rs 4-4.5bn annual drag on EBITDA in FY17-18) HAL’s profitability would adequately represent higher margins which would then correspond to increasing share of ROH sales.

ROH revenue, EBITDA margin and Adjusted EBITDA margins – no definite trend for a reason


0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

5%

10%

15%

20%

25%

30%

35%

FY0

9

FY1

0

FY1

1

FY1

2

FY1

3

FY1

4

FY1

5

FY1

6

FY1

7

ROH revenue share EBITDA margins Adj. EBITDA margin (ex-LD & LCA)



Outlook and valuation

Initiate coverage with a BUY rating and target price Rs 1,470

We initiate coverage on HAL with a BUY rating and a PE-based target price of Rs 1,470. HAL is India’s only fighter aircraft and helicopter manufacturer; we expect it to maintain it near monopoly in these segments due to the strong moats that it has built over time in the form of:

Capabilities to design and develop aircrafts ground up,

Handling complex ToT projects of both Western and Russian origin, and

Its ability to offer life-cycle support over a prolonged period. In addition, we expect HAL to seamlessly transition from the ramp-down of Su-30 manufacturing and ramp up in the production of LCAs in FY21-22, also supported by a growing share of high-margin service revenues. This should help HAL’s earnings CAGR to touch 17% over FY18-22 (vs. an 11% decline over FY13-17). Lastly, HAL should generate strong growth capital of Rs 64bn over FY18-22, excluding the impact of customer advances, after accounting for capex and dividends.

Valuations: Ample scope for re-rating At the higher end of its IPO price band of Rs 1,240, HAL trades at 18x FY20 PE. We value HAL at 21x FY20 PE to arrive at our target price of Rs 1,470. Our target PE is at a 20% premium to global peers, given its strong visibility on orders over the next ten years, coupled with earnings growth. We believe that a rerating will be led by – (1) visibility on HAL’s ability to grow earnings despite low revenue growth, (2) catalysts such as actual placement of the Rs 600bn LCA Mark 1A order, (3) visibility on ‘follow on’ orders for LCAs, and (4) higher-than-expected EBITDA-margin expansion. Due to the long gestation cycles in the aerospace industry, we also support our valuation with DCF-based target price.

Long term is the only way to play HAL We advise investors to take a five-year view on HAL, which is more than the traditional two-year view that we typically take on stocks. This is mainly because: (1) HAL is the first aircraft manufacturer to list, and the timelines on order awards and execution are spread over 10 to 15 years, and (2) the true return profile of these projects are seen over a five year block, which is the usual time to stabilise production of an aircraft and derive size benefits. Hence, in all our financial analysis, we have based our comments on FY18-22 rather than FY18-20.

DCF assumptions and valuation

(Rs bn)

WACC (%) 11.5%

Terminal growth (%) 5.0%

NPV - FY21-27E 65.0

Terminal value 230.5

Total value 295.5

Less: Net debt - FY20E (181.1)

Equity value 476.6

Shares outstanding (mn) 334

DCF value (Rs per share) 1,425

Free cash flow to firm working

FCFF (Rs bn) FY21e FY22e FY23e FY24e FY25e FY26e FY27e

EBIT 24 35 45 49 48 46 39

Less: Taxes (8) (12) (15) (17) (16) (16) (13)

NOPAT 16 23 30 32 32 30 26

Add: Depreciation 10 10 11 11 11 12 12

Working capital changes 11 (40) 13 (66) (19) (18) 12

Less: Capex (8) (8) (8) (8) (8) (8) (8)

FCFF 29 (15) 45 (30) 17 16 42




HAL vs. BEL vs. BDL vs. CSL With the recent IPOs of HAL, BDL (Bharat Dynamics), and Cochin Shipyard (CSL), investors have multiple avenues to play the defence theme in India. So far, BEL was the only pure play defence company. So comparisons between the three companies –HAL, BDL, and BEL – is inevitable, even though they each address completely distinct opportunities in the defence ecosystem.

Our take on this peer comparison is to BUY HAL, BEL and CSL while we have Neutral rating on BDL.

While we have detailed our rationale to BUY HAL, our thesis for BEL is also linked to the long-term visibility on new orders leading to linearity in revenues, aiding a 15% earnings growth over FY18-20. However, BEL could underperform in the near term, as it faces an adverse sales mix on execution of EVM orders, which would account for about 25% of its sales for the next three quarters. Hence, the surprise element on margins is limited in the near term.

In case of CSL we believe that execution of the IAC-1 will pick up pace over FY18-21. CSL is pursuing a intelligent geographic expansion in its ship repair segment that can potentially double its segment revenues over five years. Lastly, its efficient cost structure puts it at the top rank when compared to other defence shipyards of the government making it a contender for larger defence orders.

For BDL though, gains from new orders will be back-ended, while its near term earnings over FY18-21 should see -4% CAGR. Hence Neutral.

Financial matrix of Indian defence public sector companies

Book-to-bill EBITDA margin (%) RoE (%) CAGR FY18-20E

Company name FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E Sales EBITDA Rec PAT



Bharat Dynamics 2.0 3.5 7.0 18.2 17.6 14.5 27.9 27.2 17.2 (18.7) (27.6) (12.6)

Cochin Shipyard 4.1 5.2 3.7 19.0 17.5 15.8 14.8 14.1 13.6 28.4 16.9 14.6




Global peer comparison PE vs EPS CAGR - Indian peers

EV/EBITDA vs Margins - Indian peers

PE vs EPS CAGR - Global peers

EV/EBITDA vs Margins - Global peers

Source: Bloomberg consensus, PhillipCapital India Research

HAL

BEL

BDL

CSL

12

14

16

18

20

-20 -10 0 10 20

PE

FY2

0 (

x)

EPS CAGR FY18-20 (%)

HAL

BEL

BDL

CSL

0.0

2.0

4.0

6.0

8.0

10.0

12.0

12 14 16 18 20

EV/E

BIT

DA

FY

20

(x)

Margin FY20 (%)

HAL

Boeing LM

GD

NGC

Raytheon Rockwell

Elbit

Safran

BAE

Thales

Leonardo

Saab

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

- 5.0 10.0 15.0 20.0

PE

FY2

0 (

x)


HAL

Boeing LM GD

NGC

Raytheon Elbit

Airbus

Safran

BAE Thales

Leonardo

Saab

2

4

6

8

10

12

14

16

10.0 12.0 14.0 16.0 18.0 20.0

EV/E

FY

20

(x)

Margin FY20 (%)



Global valuation comparison

Sales (LC bn) EBITDA (LC bn) EBITDA margin (%) PAT (LC bn)


Indian companies



Bharat Dynamics 44.6 47.5 29.5 8.1 8.3 4.3 18.2 17.6 14.5 6.1 6.4 4.7

Cochin Shipyard 24.0 32.4 39.5 4.6 5.7 6.2 19.0 17.5 15.8 3.9 4.9 5.1

Average - Indian

17.6 16.9 16.3 US companies

Boeing 92.6 97.4 103.1 11.8 13.7 15.1 12.8 14.1 14.6 7.0 8.8 10.0

Lockheed Martin 50.6 51.0 53.4 7.1 8.0 8.6 13.9 15.6 16.0 3.8 4.4 4.9

General Dynamics 31.1 33.3 36.2 4.7 4.8 5.3 15.0 14.4 14.6 3.0 3.3 3.7

Northrop Grumman 25.5 28.2 31.0 3.8 4.2 4.8 14.9 15.0 15.3 2.3 2.8 3.2

Raytheon 25.4 26.7 28.0 3.9 4.9 5.2 15.3 18.3 18.4 2.2 2.8 3.2

Rockwell Collins 6.9 8.7 9.1 1.6 2.1 2.2 23.6 24.1 24.6 0.8 1.1 1.1

Elbit Systems 3.4 3.6 3.8 0.4 0.4 0.5 12.5 12.0 12.1 0.2 0.3 0.3

Average - US

15.4 16.2 16.5 European companies

Airbus Group 67.1 68.6 74.0 6.5 7.5 8.8 9.7 10.9 11.9 2.6 3.4 4.3

Safran 16.3 19.4 20.5 3.2 3.6 4.0 19.6 18.4 19.6 1.8 1.8 2.1

BAE Systems 19.8 18.6 19.2 2.3 2.2 2.3 11.7 12.0 12.1 1.4 1.4 1.4

Thales 15.6 16.2 17.7 1.9 2.1 2.3 12.4 12.9 13.2 1.0 1.1 1.3

Leonardo Finmeccanica 11.6 11.8 12.3 1.6 1.6 1.7 13.8 13.7 14.0 0.4 0.5 0.6

SAAB AB 31.4 33.4 36.1 3.3 3.6 4.2 10.5 10.8 11.6 1.7 1.8 2.2

Average - European

12.9 13.1 13.8 Average - Global

15.1 15.3 15.5

Price Shares Mkt cap PE (x) EV/EBITDA RoE (%)

Company name (LC) O/s (mn) (USD mn) FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E

Indian companies Hindustan Aeronautics 1,240 334 6,408 24.7 24.7 17.7 13.3 9.6 7.2 13.5 13.1 16.9


Bharat Dynamics 397 183 1,124 11.9 11.4 15.6 7.3 4.7 4.1 27.9 27.2 17.2

Cochin Shipyard 483 136 1,016 16.8 13.5 12.8 8.3 5.2 6.0 14.8 14.1 13.6

Average - Indian

19.1 17.9 16.2 11.0 8.3 7.1 18.8 18.2 16.7

US companies Boeing 326 587 1,91,321 31.9 23.2 19.5 16.4 14.0 12.6 1,948 385 216

Lockheed Martin 343 286 97,915 26.1 22.0 19.0 15.5 13.9 12.7 222.7 620.9 259.1

General Dynamics 223 298 66,367 22.7 19.9 17.9 14.6 14.7 13.2 26.7 29.9 36.4

Northrop Grumman 354 174 61,634 27.1 22.6 19.7 17.2 15.9 14.0 39.5 41.3 78.5

Raytheon 218 289 62,776 28.5 22.4 19.4 16.7 13.2 12.5 21.0 26.3 27.4

Rockwell Collins 135 164 22,168 22.2 18.7 17.8 17.8 13.3 12.1 22.4 25.1 19.0

Elbit Systems 124 43 5,282 21.7 20.1 18.3 13.2 12.8 11.9 14.0 13.0 13.0

Average - US

25.8 21.3 18.8 15.9 14.0 12.7 24.7* 27.1* 34.9*

European companies Airbus Group 93 775 89,523 28.3 21.1 16.8 9.5 8.1 6.6 54.5 31.3 31.3

Safran 82 417 45,274 20.4 18.6 15.7 10.9 10.5 9.2 26.0 20.6 24.0

BAE Systems 6 3,187 25,381 13.1 12.9 12.1 8.4 8.4 7.9 33.1 25.9 24.8

Thales 96 213 25,502 20.5 18.2 15.9 9.4 8.7 7.5 19.7 19.9 21.1

Leonardo Finmeccanica 9 578 6,717 12.5 10.8 9.1 5.0 4.9 4.5 9.5 9.6 10.8

SAAB AB 365 107 4,865 23.3 20.7 16.9 12.9 11.8 10.0 12.0 12.4 14.2

Average - European

19.7 17.1 14.4 9.3 8.7 7.6 25.8 20.0 21.0

Average - Global

22.1 19.0 16.6 12.4 10.8 9.6 23.6* 21.9* 24.5*




Financials Income Statement Y/E Mar, Rs mn FY17 FY18e FY19e FY20e

Net sales 1,74,138 1,78,730 1,82,158 2,02,809

Growth, % 3.9 2.6 1.9 11.3

Raw material expenses (92,030) (93,123) (93,088) (1,02,627)

Employee expenses (35,692) (40,452) (42,395) (44,412)

Other Operating expenses (19,181) (20,553) (20,947) (23,304)

EBITDA (Core) 27,235 24,602 25,729 32,466

Growth, % 10 (10) 5 26

Margin, % 16 14 14 16

Depreciation (7,129) (8,402) (8,998) (9,443)

EBIT 20,106 16,200 16,731 23,023

Growth, % 25.0 (19.4) 3.3 37.6

Margin, % 11.5 9.1 9.2 11.4

Interest paid (102) (12) - -

Other Income 10,442 7,798 7,204 10,413

Pre-tax profit 30,446 23,986 23,935 33,436

Tax provided (8,056) (7,196) (7,180) (10,031)

Net Profit (recurring) 22,390 16,790 16,754 23,405

Growth, % 12 (25) (0) 40

Net Profit (reported) 26,156 16,790 16,754 23,405

Unadj. shares (m) 334 334 334 334

Wtd avg shares (m) 334 334 334 334


Cash & bank 1,11,211 88,156 1,66,579 1,81,102

Debtors 42,205 44,070 44,916 50,008

Inventory 2,13,404 1,91,349 1,78,524 1,82,760

Loans & advances 51,128 49,319 49,915 69,096

Other current assets - - - -

Total current assets 4,17,948 3,72,895 4,39,934 4,82,965

Investments 9,808 9,808 9,808 9,808

Gross fixed assets 1,55,982 1,68,982 1,78,482 1,85,982

Less: Depreciation (74,785) (83,187) (92,185) (1,01,628)

Add: Capital WIP 6,211 6,211 6,211 6,211

Net fixed assets 87,408 92,006 92,508 90,565

Total assets 5,15,164 4,74,709 5,42,250 5,83,339

Current liabilities 3,21,740 2,90,688 3,48,787 3,71,980

Provisions 48,959 51,110 52,230 56,054

Total current liabilities 3,70,699 3,41,798 4,01,018 4,28,034

Non-current liabilities 19,099 9,599 9,599 9,599

Total liabilities 3,89,798 3,51,397 4,10,617 4,37,633

Paid-up capital 3,615 3,344 3,344 3,344

Reserves & surplus 1,21,751 1,19,967 1,28,290 1,42,362

Shareholders’ equity 1,25,366 1,23,311 1,31,634 1,45,706

Total equity & liabilities 5,15,164 4,74,709 5,42,250 5,83,339



Pre-tax profit 35,919 23,986 23,935 33,436

Depreciation 7,129 8,402 8,998 9,443

Chg in working capital (37,066) (6,902) 70,603 (1,492)

Total tax paid (10,372) (7,196) (7,180) (10,031)

Cash flow from operating activities (13,168) 10,504 89,151 20,943

Capital expenditure (15,138) (13,000) (9,500) (7,500)

Chg in investments (956) - - -

Cash flow from investing activities 39,169 (5,202) (2,296) 2,913

Free cash flow (28,306) (2,496) 79,651 13,443

Equity raised/(repaid) - (9,215) - -

Debt raised/(repaid) 9,500 (9,500) - -

Dividend (incl. tax) (11,041) (9,630) (8,432) (9,333)

Other financing activities (102) (12) - -

Cash flow from financing activities (1,643) (28,357) (8,432) (9,333)

Net chg in cash 24,358 (23,055) 78,423 14,523

Valuation Ratios


Per Share data

EPS (INR) 67.0 50.2 50.1 70.0

Growth, % 12.1 (25.0) (0.2) 39.7


FDEPS (INR) 67.0 50.2 50.1 70.0

CEPS (INR) 92.6 75.3 77.0 98.2

DPS (INR) 23.9 23.9 20.9 23.2


Return on equity (%) 19.0 13.5 13.1 16.9




Sales/Net FA (x) 2.2 2.1 2.1 2.4

Working capital/Sales (x) (0.4) (0.3) (0.7) (0.6)

Working capital days (134) (117) (256) (227)

Liquidity ratios

Current ratio (x) 1.1 1.1 1.1 1.1

Quick ratio (x) 0.6 0.5 0.7 0.7

Interest cover (x) 197.1 1,350.0 na na

Dividend cover (x) 2.8 2.1 2.4 3.0

Total debt/Equity (%) 0.1 - - -

Net debt/Equity (%) (0.8) (0.7) (1.3) (1.2)

Valuation

PER (x) 18.5 24.7 24.7 17.7

PEG (x) - y-o-y growth 1.5 (1.0) (116.6) 0.4

Price/Book (x) 3.3 3.4 3.1 2.8

Yield (%) 1.9 1.9 1.7 1.9

EV/Net sales (x) 1.8 1.8 1.4 1.2

EV/EBITDA (x) 11.5 13.3 9.6 7.2


HINDUSTAN AERONAUTICS INITIATING COVERAGE

ANNEXURE HAL key products details

Aircrafts

Sukhoi (Su-30 MKI)

HAL currently manufactures Su-30 MKI aircraft, under a licence agreement signed in 2000 with

Rosoboronexport (formerly State Corporation Rosvoorouzhenie). It is a heavy, long-range fighter

aircraft capable of flying under all-weather conditions with a short take-off and landing run featuring

fly-by-wire control in all axes and capability for in-flight refueling. SU-30MKI is powered by two AL-31

FP engines, which provide high thrust-to-weight ratio and have thrust vectoring capability. HAL

received the first work order for Su-30 MKI from Indian Defence Services (IDS) in 2003, and delivered

its first Su-30 MKI after completing repair and overhaul in 2015.

MiG Variants HAL manufactured variants of MiG pursuant to licence agreements with the USSR. MiG series of aircraft manufactured by HAL includes MiG 21, MiG-21FL, MiG-21M, MiG-21BIS and MiG-27M. HAL currently service and overhaul MiG aircrafts for IDS. It has also upgraded the MiG 21BIS and MiG-27M aircrafts with improved avionics and other systems and equipment to enhance their operational capabilities.

Hawk Mk 132

HAL has the capability to manufacture the Hawk Mk 132 advanced jet trainer, under license from

BAE Systems, UK. Hawk Mk 132 has a low wing structure powered by an Adour Mk 871 turbofan

engine manufactured under licence from Rolls Royce and Turbomeca Ltd. It is a transonic tandem-

seat ground attack/trainer aircraft. HAL delivered the first Hawk Mk 132 in 2008. Currently, it does

not manufacture additional Hawk Mk 132 aircraft and only provides MRO services to its customers.

Dornier 228

HAL has the capability to manufacture Dornier 228 aircraft, a 19-seater passenger aircraft, pursuant

to a technical know-how transfer agreement signed in 1983 with Dornier GmbH (presently known as

RUAG Holding AG). Dornier 228 aircraft has a high wing structure and is powered by twin Garrett TPE

33.051 turboprop engines. HAL delivered the first aircraft in 1986. It has received “Production

Organisation Approval” according to CAR-21 subpart G by DGCA to manufacture these aircraft for the

civil sector.

Light Combat Aircraft (LCA - Tejas)

LCA-Tejas is a single-engine, lightweight, and multi-role supersonic fighter. It has a quadruplex digital

fly-by-wire flight control system with associated advanced flight control features. Tejas, with its delta

wing, is designed for air combat and offensive air support with reconnaissance. Aeronautical

Development Agency is the designated project manager for the development of Tejas. Tejas Mk I was

accorded initial operational clearance in December 2013 and HAL is awaiting final operational

clearance. On March 2016 and April 2016, the first two LCA Tejas manufactured by HAL were

accepted by IAF.

Pilotless Target Aircraft Lakshya

HAL previously manufactured Pilotless Target Aircraft (PTA) - Lakshya, a remotely piloted high speed

reusable aerial target which simulates an airborne threat for the purposes of training fighter pilots in

air-to-air combat and ground crews on high calibre guns and surface-to-air missiles. It has a zero

length launcher with rocket assisted take-off and it can be launched from ship or land. Lakshya is

controllable up to 100km and has transportable or portable control station. It can carry two tow-

bodies and can be re-used for up to 10 missions. First delivery of the PTA Lakshya took place in 2005.

HAL currently service and overhaul Lakshya aircraft for the Indian Defence Forces.



Upgrade of Aircrafts

Jaguar DARIN-III Upgrade

HAL provides upgrade services on Jaguar aircraft, which it previously manufactured under licence

from BAE Systems, to implement DARIN Navigation & Attack System featuring advanced radar and

other avionics systems to significantly increase its mission capabilities.

The upgraded Jaguar aircrafts are designated as Jaguar DARIN-III. The aircraft has received an Initial

Operation Clearance in February 2017, and currently, HAL is in the process of conducting flight

testing to obtain a Final Operational Clearance and has simultaneously initiated series production.

Mirage 2000 Upgrade

Mirage 2000 aircraft is undergoing an avionics upgrade to increase its operational capabilities.

Enhancement of avionics and mission capabilities were developed by the OEM, Dassault Aviation.

HAL delivered the first of such upgraded Mirage 2000 aircraft to IAF in March 2016. Integration of

additional stores and systems are being developed by HAL under a Final Operational Clearance

upgrade. Currently, the project is in the development flight testing stage and HAL has simultaneously

initiated series production.

Helicopters

Advanced Light Helicopter (ALH) Dhruv

ALH Dhruv is a new generation multi-role, multi-mission, and all weather helicopter in the 5.5-tn

category powered by two turbo-shaft engines which provide increased safety. It is designed to meet

the requirements of both military and civil purpose. Military variants have been certified by CEMILAC

and civil variants by DGCA. HAL uses composite materials in manufacturing of Dhruv. It has four

variants:

Mk I: Conventional cockpit, with TM333-2B2 turbo-shaft engines

Mk II: With a glass cockpit

Mk III: an improved version with a glass cockpit and higher powered Shakti engines, along with

mission systems

Mk IV (Rudra): Weaponised platform designed for attack mode

ALH Mk IV Rudra

ALH Mk IV Rudra is a weaponised platform designed for attack mode with the capability to carry

external stores. It is equipped with an integrated architecture display system with multi-function

displays. The helicopter can be fitted with four rocket pods or two air-to-air missiles as well as a

20mm nose mounted turret gun. HAL delivered the first Rudra helicopter in 2013.

Light Combat Helicopter (LCH)

LCH is a 5.8tn class helicopter being designed to meet IAF’s and Indian Army's requirement for a

dedicated light helicopter for combat operations. It has a narrow fuselage, with pilot and co-

pilot/gunner set up in tandem configuration and incorporates a number of stealth features, armour

protection, night attack capability and crashworthy landing gear for better survivability.

Simultaneously, HAL further progressed the design and development activities to achieve

operational clearance.

Cheetal Helicopter

Cheetal is re-engined version of Cheetah helicopter manufactured by HAL, upgraded and fitted with

a fuel efficient engine and incorporates in-cockpit instruments. It is a single-engine, multi mission

helicopter in 2-tn class with a modern fuel-efficient and high performance TM333-2M2 engine which

provides for enhanced performance at high altitude. It has been certified by CEMILAC in July 2009 for

use in India. HAL delivered the first Cheetal helicopter in 2009 to the Indian Defence Forces.



Cheetah Helicopter

Cheetah helicopter has been manufactured by HAL pursuant to a licence agreement signed in 1970

with Societe Nationale Industrielle Aerospatiale, France, for manufacture of SA 315 helicopters,

renamed as 'Cheetah'. It is a five-seater multi-role, multi-purpose and highly manoeuvrable

helicopter for operations in a very wide range of weight and altitude conditions. It is powered by one

Artouste III B turbo shaft engine which HAL manufacture pursuant to agreement with Turbomeca

signed in 1962. HAL delivered the first Cheetah helicopter in 1973 to IDF and presently, only

providing MRO services.

Chetak Helicopter

Chetak is a multi-purpose, seven-seater helicopter manufactured by HAL pursuant to a licence

agreement signed in 1962 with SUD Aviation for the manufacture of SE-3160 Alouette III helicopters

renamed as 'Chetak'. It can be utilised for passenger transport, logistical support, casualty

evacuation, search and rescue operations. It is powered by the Artouste III B turbo shaft engine

manufacture pursuant to an agreement with Turbomeca dated in 1962.

HAL has delivered Chetak helicopters to IDF and also exported to several foreign countries. Presently,

it is only providing MRO services for Chetak helicopters. However, it intends to manufacture

additional Chetak helicopters.

Lancer Helicopter

Lancer is a weaponised version of the Cheetah helicopter as modified by HAL. It is a light attack

helicopter equipped with two jettisonable combination gun-cum-rocket pods and a gun sight for

accurate aiming and firing by the pilot. Lancer is optimised for anti-insurgency operations,

particularly in mountains and jungles.

Engines

Adour Mk 871-07: This is a twin spool turbofan engine of modular design. It is manufactured under

licence from Rolls Royce Turbomeca and is currently used in the Hawk Mk 132 aircraft. It has two

stage low pressure and five stage high pressure axial flow compressors which are driven by separate

single stage high pressure and low pressure turbines.

Adour Mk 804E/811: This is manufactured under licence from Rolls Royce Turbomeca and is

currently used in Jaguar aircraft. This engine has a twin spool turbofan of modular construction with

after burner provision.

AL-31FP: This is manufactured under licence from Rosoboronexport, Russia and is currently used in

the Su-30 MKI. It is a twin spool, axial flow, low bypass, turbo fan engine incorporating after burner

system, variable area jet nozzle with thrust vectoring, air-to-air heat exchanger, and anti-surge

system.

Shakti 1H1: This is a helicopter engine jointly developed by HAL and Turbomeca. It is currently used

in the Mk III Dhruv and Mk IV Rudra helicopters. It was developed to meet the high altitude

operational requirement and additional payload capacity of certain of ALH Dhruv.



Garrett TPE-331-5: This is a single-shaft engine manufactured by HAL pursuant to a licence from

Garrett Corporation and is currently used for Dornier aircraft. It has a single shaft centrifugal

compressor with a reverse flow gas turbine and has a small frontal area. Its other features include a

propeller control system, anti-icing and foreign object damage resistance, reverse thrust and

negative torque sensing facilities.

Artouste IIIB: This is a turbo shaft engine used for the Cheetah and Chetak helicopters. It is

manufactured under licence from Turbomeca. It features a side air intake, an axial and a centrifugal

compressor connected to a 3-stage turbine. A reduction gear box in the front transfers the power to

the helicopter.

PTAE-7: This is an indigenous single-shaft engine presently use for the PTA Lakshya. It is a light

weight, low cost turbojet engine, which can be remotely controlled during flight. It features a 4-stage

axial compressor driven by an axial turbine, annular combustor and power control unit. There is a

digital electronic fuel control system. This is the first aero-engine developed in India.

LM-2500: This is an industrial and marine gas turbine engine used for propulsion of marine vessel

and power generation. It is manufactured under licence from General Electric. It is a twin shaft gas

generator with free power turbine. Besides marine propulsion, the LM2500 is also used for gas

compression, power generation and co-generation.

Engines maintained but not manufactured by HAL RD-33 used in MiG 29

R-11/R-25 used for MiG-21

R-29B used for the MiG-27

TM333-2B2 turbo-shaft engine used on Dhruv MK I /MK II

Gnome1400 - IT turbo shaft engine used in

Sea King helicopter

Industrial Avon aero-derivative engine used in power generation

Industrial 501K single shaft, modular design engine for industrial applications



Products under development

Aircrafts under development

HTT-40 basic trainer aircraft

HAL is designing the HTT-40 basic trainer aircraft to fulfil various roles such as basic flight training,

aerobatics, instrument flying, navigation, night flying and close formation flying. It also intends to

develop a military variant of this aircraft in order to access export markets.

LCA Navy

LCA Navy aircraft is being developed to incorporate a drooped nose for better over-the-nose vision

and to feature strengthened fuselage structure, redesigned landing gear to cater to higher loads,

arrester hook for deck recovery, leading edge vortex control (LEVCON) surface to reduce approach

speed, fuel dump for emergency deck recovery and operational capability on an aircraft carrier by

way of ski-jump take-off.

LCA Mk 1A

LCA MK1A aircraft is an improved version of the LCA MK1 aircraft incorporating maintainability

improvement aspects and enhanced combat capability with integration of self-protection jammer

pod, air-to-air refuelling probe, AESA radar and modern missiles.

Fifth Generation Fighter Aircraft (FGFA)

Proposed FGFA is a joint development programme between India and Russia which is intended to

have air combat superiority, high tactical capability and group action capability. FGFA will have

advanced features such as increased stealth, supersonic cruise, super manoeuvrability and data link

and network centric warfare capability.

Intermediate Jet Trainer (IJT): HAL has undertaken development of IJT to replace the ageing Kiran

trainer aircraft. It is proposed to be used for stage II training of pilots. IJT has a cockpit with twin

tandem seats with good visibility for the pilots, modern active matrix liquid crystal displays and head-

up display. It is equipped with a mission computer and integrated avionics system. IJT has up to

1,000Kg of external stores carrying capacity which allows the fitment of various armaments and fuel

drop tanks on the aircraft for training.

Helicopters under development

Light Utility Helicopter (LUH)

LUH will be a single engine helicopter under development in the 3-tonne helicopter segment for the

IDS and will replace the fleet of Cheetah and Chetak helicopters. It is a lightweight helicopter with

design features to serve as a reconnaissance helicopter with high-end technology and to meet the

specific high altitude requirements.

Indian Multi Role Helicopter (IMRH)

IMRH will be co-designed and co-produced as a medium lift helicopter in the 10-12 tonne class to

meet the requirement of Indian Army and Indian Air Force. It will be powered by twin engines and

will feature blade folding option for ship deck operations. IMRH will support air assault, air transport,

combat logistics, combat search and rescue and casualty evacuation operations. HAL has yet to

select a technological partner for this project.



Engines under development

Hindustan Turbo Fan Engine (HTFE-25)

HAL has taken up the indigenous design and development of a 25 kN thrust class turbofan engine for

use in basic military trainer aircraft/business jets.

Hindustan Turbo Shaft Engine (HTSE-1200)

HAL has taken up the indigenous design and development of a 1,200KW shaft power engine for use

in the 3 to 6-ton class of helicopters.

Engine- 320 daN

HAL intend to undertake design, develop and manufacture of the 320 daN jet engine for aerospace

application with an Indian partner for manufacture in India.

Unmanned Aerial Vehicles (UAVs) under development

Mini UAV

HAL has taken up the indigenous design and development of mini UAV of 8Kg class. It consists of fully

composite structure, robust, rugged and man-portable system. It can be used for surveillance,

reconnaissance and target tracking mission. HAL has made product demonstrations to prospective

customers.

Medium-altitude, long-endurance UAV – Rustom-II

HAL intend to enter into the market of larger UAVs with Rustom-II medium-altitude, long-endurance

UAV which it is jointly developing with Aeronautical Development Establishment (ADE) in Bangalore.

Rustom-II UAV is being designed to meet the requirements of the Indian Defence Services as a multi-

role, multi-mission UAV with an operational endurance of up to 24hrs featuring the capability to

conduct surveillance and reconnaissance missions through gathering of high quality images and

signal intelligence on near real time basis.



Cochin Shipyard Ltd (COCHIN IN)

Keeping choppy waters at bay INDIA | DEFENCE | INITIATING COVERAGE

27 March 2018

We initiate coverage on Cochin Shipyard (CSL), a government-owned company engaged in ship building and ship-repair, with a BUY rating. With a cost efficient structure and a proactive management we expect CSL to be one of the prime beneficiaries of the future shipbuilding capex of the Indian Navy. In addition, CSL’s strategy to geographically diversify its ship repair business should help double its segment sales in five years. We expect CSL’s revenue/EBITDA to grow at 25%/18% CAGR over FY18-21E backed by a robust order book (4.1x revenues). Recent stock price correction makes CSL the cheapest stock amongst our defence coverage despite a strong growth outlook.

CSL is India’s largest public-sector shipyard by capacity CSL is the second-largest shipyard and the largest public-sector shipyard in India with a dock capacity to accommodate vessels up to 110,000 DWT. CSL also has the second-largest ship-repair capacity and largest among the public sector in India, which can accommodate vessels up to 125,000 DWT. Even though it is registered as a commercial shipyard, it derived 85% of its FY17 revenues from building/repairing defence ships. CSL is currently building India’s first Indigenous Aircraft Carrier (IAC-1) for the Indian Navy.

CSL is the most efficient amongst all government shipyards Due to its strategy to rely on contractual workforce rather than permanent employees, CSL is by far the most efficient shipyard amongst its public sector peers. Its employee cost accounted for 11% of revenues compared to 20%/31%/15%/22% for MDL/GRSE/GSL/HSL.

Geographical expansion to help double ship repair revenues in five years CSL is already the largest ship repair company in India by revenue (~40% market share). To further consolidate its leadership position CSL is embarking on a geographical expansion, which in our view should help it double its ship repair revenues in five years. Its recent arrangement with Mumbai Port Trust gives CSL access to service the western command ships of the Navy. Similarly it is looking to set up ship repair facilities in Kolkata, Andaman & Nicobar and per media reports even in Goa. This should allow CSL then to cater to the demand not only from commercial ships but also by the Indian Navy, which currently depends majorly on its own dockyards for ship repair.

Ship building should not just be about the IAC Even though IAC-1 will be a major revenue driver for CSL’s ship building segment over FY18-21, a robust pipeline of Rs 124bn in addition to Rs 58bn projects wherein CSL is the lowest bidder should also support its ship building business.

Expect strong 25%/18% CAGR in FY18-21E revenues/EBITDA We expect CSL’s revenues and EBITDA to grow by 25% and 18% respectively over FY18-21E driven by a 30% CAGR in ship building revenues. However earnings growth over this period will be a modest 12% due to declining other income as funds are deployed in capacity expansion projects. ROE’s should also be subdued on this count as revenues from its new capacities will be back ended.

Initiate coverage with a BUY rating and SOTP based target price of Rs 595 We initiate coverage on CSL with a BUY rating as we believe that over the next five years CSL will emerge from the shadows of just being seen as the ship yard that is building the IAC to a more diversified company. After the recent stock price correction, CSL trades at 13x FY20E, it is the cheapest stock amongst our defence coverage despite its healthy growth outlook. We derive our target price of Rs 595 by a sum of parts valuation. We value ship building at 14x PE FY20, a 30% premium to its regional peers. We assign a 25x PE to its annuity like ship repair business part of the premium is also to capture CSL’s expansion strategy in this segment.

BUY CMP RS 483

TARGET RS 595 (+23%) COMPANY DATA




52 - WK HI/LO (RS) : 599/ 435

LIQUIDITY 3M (USDMN) : 1.8

PAR VALUE (RS) : 10

SHARE HOLDING PATTERN, %

Dec 17 Sep 17 Jun 17

PROMOTERS : 75.0 75.0 100.0

FII / NRI : 3.5 3.3 0.0

FI / MF : 10.9 10.4 0.0

NON PRO : 2.0 2.3 0.0

PUBLIC & OTHERS : 8.6 9.0 0.0

PRICE PERFORMANCE, %

1MTH 3MTH 1YR

ABS -9.0 -11.7 NA

REL TO BSE -3.6 -7.6 NA

PRICE VS. SENSEX

Source: Phillip Capital India Research

KEY FINANCIALS


Net Sales 20.6 24.0 32.4

EBIDTA 3.8 4.6 5.7

Net Profit 3.2 3.9 4.9

EPS, Rs 23.7 28.8 35.9

PER, x 20.4 16.8 13.5

EV/EBIDTA, x 11.9 8.3 5.2

P/BV, x 3.2 2.0 1.8

ROE, % 16.7 14.8 14.1

Debt/Equity (%) 6.1 3.8 3.4


80

90

100

110

120

Aug-17 Oct-17 Dec-17 Feb-18

Cochin Shipyard BSE Sensex


COCHIN SHIPYARD LTD INITIATING COVERAGE

Focus charts & tables

Robust book to bill…

…to support 30% CAGR in Shipbuilding segment revenues

Source: Company, PhillipCapital India Research

New locations to help grow ship repair revenues

Hence total revenues to grow at 25% CAGR FY18-21 vs 9% FY15-18


EBITDA growth of 18% CAGR FY18-21…

…while PAT growth will be lower on declining other income


6.3

5.4

4.1

5.2

3.7

2.6

-

1

2

3

4

5

6

7

FY16 FY17 FY18E FY19E FY20E FY21E

Book to bill (x)

0

5

10

15

20

25

30

35

40

FY15 FY16 FY17 FY18E FY19E FY20E FY21E

(Rs bn) IAC Non-IAC

2% CAGR

29.7% CAGR

-40%

-20%

0%

20%

40%

60%

80%

100%

0

2

4

6

8

10

FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY21E

(Rs bn) Ship repair revenues % yoy

0%

10%

20%

30%

40%

-

5

10

15

20

25

30

35

40

45

50


(Rs bn) Revenues % yoy

25.3% CAGR

8.8% CAGR

12%

14%

16%

18%

20%

-

2

4

6

8


(Rs bn) EBITDA EBITDA margins (%)

17.6% CAGR

11.3% CAGR

-10%

0%

10%

20%

30%

40%

-

1

2

3

4

5

6


(Rs bn) Recurring PAT % yoy

11.5% CAGR

18.1% CAGR



ROE’s to contract on lower fixed asset turn as new capacities come onstream

CSL is entering a high capex phase which should impact FCF


15.3% 16.3% 16.1%

16.7%

14.8% 14.1% 13.6% 13.1%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%


RoE (%)

-10

-5

0

5

10

15

20





Key investment arguments

Pace of execution on the IAC-1 to pick up Based on our interactions with the management we gather that the issue pertaining to non availability of aeronautical equipment is now resolved. As a result we expect pace of execution on the IAC-1 to pick up. We estimate revenues from the project to grow at 21% CAGR over FY18-21 vs. 10% over FY15-18 as CSL looks to deliver the ship by FY21 (we have built in delivery by March 2022). The outstanding order book on the project as of 9MFY18 was Rs 81.5bn (Rs 9bn fixed price + Rs 73bn cost plus). In addition, CSL will be awarded the phase-3 fixed price portion of the IAC (Rs 30bn) in FY19. This healthy orderbook of Rs 110bn should support the revenue growth.

IAC project revenues to register a strong 21% CAGR


Ex-IAC pipeline is also robust in the near term... In the past six months investor concerns have partly been allayed as CSL has won Rs 58bn of orders that should provide revenue visibility beyond the IAC. In addition, based on our checks we have identified a Rs 124bn (US $ 1.9bn) of projects that should translate into a opportunity pipeline for CSL over the next two years. This should further ease concerns of revenue visibility.

Strong order pipeline of US$ 1.9bn over next 2-3 years Vessels Units Value (Rs bn)

8 Anti Submarine Warfare Shallow Water corvettes 8 54

56 small boats 56 4

L1 Orders

58

Pipeline over next 2 years 6 High Speed Landing Craft (HSLC) 6 30

6 Next generation offshore patrol vessels (NGOPVs) 6 5

8 Missile Cum Ammunition (MCA) Barges 8 6

1 Well stimulation vessel 1 12

1 Polar research vessel 1 12

1 Oceanographic research vessel 1 10

Cement carriers 2 4

Fishing vessels

45

Total

124


-

5

10

15

20

25

FY15 FY16 FY17 FY18E FY19E FY20E FY21E

(Rs bn) IAC revenue (cost plus) IAC revenue (fixed price)

10.3% CAGR

20.6% CAGR



Recent TPCR highlights long term opportunity pipeline from Navy In the recently published Technology Perspective and Capability Roadmap (TPCR-2018), which highlights the requirement of the Indian armed forces over the ten years, the Navy has identified a need for ~190 vessels of which 22 vessels have already been ordered based on our checks still leaving a strong pipeline. With its recent win to build eight Anti Submarine Warfare Corvettes (ASW), CSL should be a contender for future defence orders which until now was only restricted to the IAC-1.

TCPR 2018 highlights requirement of vessels by Navy over next 10 years

Projects Units Projects Units

Aircraft Carrier 1 1000 Ton Fuel Barge 3

Automatic Carrier Landing System (ACLS) 5 500 Ton POL Barge 5

Fresnel Lens Based Optical Landing System (FLBOLS) 5 300T Sullage Barges 5

Next Generation Destroyers (NGD) / Frigates 5-10 500 Ton Water Barge 5

Next Generation OPV (NGOPV) 6 200 Ton Water Barge 5

Next Generation Corvettes (NGC) 7 Ammunition Cum Torpedo Cum Missile Barge (ACTCM) > 10

Missile Boats/ Next Generation Missile Vessel (NGMV) 6 Missile Cum Ammunition (MCA) Barge 10

Mine Counter Measures Vessel (MCMV) > 10 100 Men Accommodation Barges 3

Fleet Support Ship (FSS) > 5 50 T BP Tugs 10

Replenishment at Sea (RAS) / Fuelling at Sea (FAS) (Supply Ship) 20-25 25 Ton BP Tugs 10

FAC/XFAC/FPV 20 250 Men Ferry Craft 5

Multi Purpose Vessel (MPV) 5 Floatsam Recovery Boat 10

Diving Support Craft 5 Total

181-191


Initial signs of IAC-2 emerging but still a long way to go

In the TPCR-2018 the Navy has also highlighted that it would require another aircraft carrier. This in a way is the initial acceptance that a IAC-2 would be required and should in a way address concerns of the need of the project at all. Though we do agree that the actual order for the IAC-2 still has a long way to go as the design and technology has not yet been selected. In addition the high cost of the platform (estimated ~Rs 500-600bn) would also be a near term deterrent given the limited headroom for new projects in the defence budget over the next few years.

JV with Hooghly docks to tap into the inland waterway opportunity

CSL has formed a joint venture with Hooghly Docks & Port Engineers, Kolkata to take over the operations at two of its (HDPE’s) facilities viz. Salkia and Nazirgunge. With this CSL will now be able to address opportunities for shipbuilding for the government’s inland waterways program. The JV would incur a capex of Rs 1-1.3bn to upgrade its facilities and should start yielding annual revenues of Rs 500mn from two years of start of operations.

Hooghly docks - Infrastructure Facilities Salkia Nazirgunge

Land area (acres) 10 18

Dry Dock 94 x 13.4 x 8.6m (deep) NA

Building ship ways 85 x 29m & 70 x 22m 90 x 30m (2 nos)

Jetty length (mtr) 45 36

Administrative building (sq ft) 21,000 33,000

Work shop (sq ft) 60,000 97,000

River front (mtr) 243 546

Source: HDPEL, PhillipCapital India Research

Salkia

Nazirgunge



Geographic diversification will help 2x ship repair revenues CSL ship repair revenues have grown at a 30% CAGR over FY12-17, accounting for 26% of CSL’s total revenues in FY17. CSL is a market leader in the domestic ship repair industry. Going forward CSL has adopted a strategy to increase its presence further with arrangements in Mumbai, Kolkata and Andaman & Nicobar and as per media reports could also expand to Gujarat and Goa. CSL is also adding new capacity at Cochin with the new International Ship Repair Facility (ISRF) which is likely to be commissioned by FY21. These initiatives in our view should help CSL double its ship repair revenues in five years.

Ship repair revenues of public sector shipyards

CSL expanding its presence across India

Source: Company, Media, PhillipCapital India Research

CSL is expanding its reach in ship repair through tie ups Remarks

New ISRF facility at Cochin Port Taken over from April 2013

Indira & Hughes dry dock at Mumbai Port MoU signed in Jan 2018

Ship repair facility at Portblair, A&N Likely to sign

Netaji Subhash dry dock at Kolkata Port Likely to sign

Ship repair & dry dock at Mormugao Port As per media

Shipbuilding & repair facility at Kandla Port As per media

New initiatives have revenue potential of Rs 6.8bn which is 2x the existing revenue

(Rs mn)

ISRF 3,500

Mumbai port 2,500

Port Blair 500

Kolkata Port 300

Total 6,800

Source: Company, Media, PhillipCapital India Research

Expect 11% CAGR in Ship repair revenues over FY18-21...


5.4

1.9 1.5

0 0 0.0

1.0

2.0

3.0

4.0

5.0

6.0

CSL GSL HSL GRSE MDL

FY17 Ship repair revenues (Rs bn)

-40%

-20%

0%

20%

40%

60%

80%

100%

0

2

4

6

8

10


(Rs bn) Ship repair revenues % yoy



Western command Navy and Coast Guard ship repair now a tangible opportunity

With its MOU with Mumbai Port Trust to utilise the Indira dock at Mumbai, CSL would now be within touching distance to service Western command naval ships. Until this arrangement CSL did not have access to this opportunity due to the distance between Mumbai and Kochi. CSL would have to invest on a floating dock to repair large naval vessels. Based on our interaction with the management of CSL, it expects this venture to generate Rs 2-2.5bn of revenues from year four of operations. It expects to commence operation in early FY19.

Eastern seaboard now on the horizon?

Currently, the Indian Navy currently has a fleet of 272 vessels (excluding Submarines) while the India coast guard has 152 ships and use services of its own dockyards in Mumbai, Karwar, Kochi, Vizag and Port Blair. They also use services of other government yards such as CSL, HSL and GSL to meet their repair requirements.

CSL is still lacking considerable presence on the eastern seaboard; this in our view would then help consolidate its position as a leading ship repair company. Currently Naval vessels use the facilities of HSL's and Indian Navy’s own yard in Vizag.

We believe that as CSL expands its reach and maintain its efficiency levels that it has achieved in its mother yard in Kochi, garnering incremental repair business from Navy will be relatively easy.

Current Indian Navy fleet Vessels type (nos)

Nuclear power submarines 2

Conventional submarines 14

Aircraft carrier 1

Destroyers 11

Frigates 13

Corvettes 22

Mine countermeasure vessels 4

Amphibious warfare ships (Landing ships/crafts) 15

Torpedo recovery vessels 1

Offshore patrol vessels 10

Patrol / Fast patrol vessels 19

Patrol / Interceptor boats 110

Replenishment ships 4

Support Ships 6

Research & survey vessels 9

Training vessels 4

Tugboats 19

Miscellaneous 24

Total 288

Indian Coast Guard fleet presently Vessels type (nos)

Offshore Patrol vessels 16

Pollution Control vessels 3

Fast Patrol Vessels 42

Air Cushion Vessels 18

Interceptor Boats 67

Auxiliary Barges 3

Harbour Crafts 3

Total 152

Source: Indian Navy, Indian Coast Guard, Media, PhillipCapital India Research

40% of commercial shipping fleet in India is more than 20 years old

Indian Navy and Coast Guard Ships repaired by CSL over last three years Vessel name Type

INS Guldar Landing ship

INS Cheetah Landing ship

INS Viraat Aircraft carrier

INS Vikramaditya Aircraft carrier

INS Aditya Replenishment & repair ship

INS Shardul Amphibious warfare vessels

INS Sukanya Patrol vessels

INS Sarvekshak Survey Ship

ICGS Samar Offshore patrol vessel

Source: MoS, Indian Navy, Indian Coast Guard, Media, PhillipCapital India Research

231

1,301

249 129

167

525

-

200

400

600

800

1,000

1,200

1,400

< 5 years 6-10 years 11-15 years

16-20 years

> 20 years Total

Aging of Indian shipping fleet - Dec'16



Efficient and cost-competitive compared to other public shipyards

CSL is able to execute projects efficiently due to its system of sub-contracting, which helps it in ship-repair projects and production planning. Against a full-time employee size of 1,824 (May 2017) it employs 612 contract employees and 3,178 daily sub-contract workers, which allows it to maintain a flexible work force. Its integrated structure (build yard and repair facilities in the same location) allows inter-changeability of employees, depending on workload on either business segments.

In our view, CSL is the most efficient shipyard among all public sector ones. We analysed its employee-cost intensity to revenues and gather that employee costs accounted for 11% of sales in FY17 vs. 20%/31%/15%/22% for MDL/GRSE/GSL/HSL. Also on the revenue per employee parameter, CSL ranks higher than all other shipyards at Rs 11.3mn vs. Rs 4.1/3.8/6.4/3.2mn for MDL/ GRSE/GSL/HSL. Its EBITDA margins are also better than the next public yard. Even compared to global listed shipyards, CSL’s margins are significantly higher than mean margins.

Public shipyards - Revenue per employee

Public shipyards - Employee costs as % of sales


CSL has maintained strong and consistent margins compared to other Indian public-sector shipyards EBITDA margins (%)

Company FY13 FY14 FY15 FY16 FY17

Cochin Shipyard 14.8 15.8 17.8 17.8 18.4

Mazgaon Dock 4.4 0.1 5.9 5.3 3.6

Garden Reach 8.6 7.7 1.3 4.9 (19.4)

Goa Shipyard 2.6 (12.9) (7.4) 12.7 16.0

Hindustan Shipyard (19.9) (20.1) (61.9) (3.9) (1.1)

Its margins are in line with its Singapore peers; other global peers had weak margins...

Source: Company, PhillipCapital India Research, Bloomberg, *Year ending March 2017

Healthy balance sheet compared to peers

Company _____Networth_____ _____RoE (%)_____ _______FCF_______

(Rs bn) FY13 FY14 FY15 FY16 FY17 FY13 FY14 FY15 FY16 FY17 FY13 FY14 FY15 FY16 FY17

Cochin Shipyard 11.8 13.5 15.6 18.1 20.3 16.9 15.3 16.3 16.1 16.7 (1.6) (4.7) 15.9 3.3 1.5

Mazagon Dock 18.1 20.9 24.6 23.2 26.1 24.4 20.2 21.6 27.3 21.6 4.0 (12.0) 20.3 6.2 (8.4)

Garden Reach 8.6 9.6 9.7 11.3 10.8 16.3 13.1 3.0 13.7 0.4 3.4 (6.4) 15.2 10.0 (3.6)

Goa Shipyard 6.4 5.8 6.2 6.9 8.1 2.4 (10.0) 13.0 9.5 15.8 (0.2) (0.8) (2.2) (3.1) 4.0

Hindustan Shipyard (7.7) (8.2) (10.2) (10.0) (7.5) nm nm nm nm nm (0.7) (0.4) 0.5 (2.0) (1.8)


11.3

4.1 3.8

6.4

3.2

0

2

4

6

8

10

12

14

CSL MDSL GRSE GSL HSL

Revenue per employee (FY17) (Rs mn)

11%

20%

31%

15%

22%

0%

5%

10%

15%

20%

25%

30%

35%

CSL MDSL GRSE GSL HSL

Employee costs as % of Sales (FY17)

18.4

31.4

17.4

11.0

2.3

(5.6)

34.2

(10.3)

6.4 1.6

8.7 4.3

9.0

-20

-10

0

10

20

30

40

CSL

*

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gziji

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Kep

pel

Sem

bco

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Ch

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Ship

.

Ch

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CSS

C

Jian

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Dae

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Hyu

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Sam

sun

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Mit

sub

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Fin

can

tier

i

Hav

yard

EBITDA margins (%)



Focuses on engineering heavy products The global ship building-industry is dominated by Asian shipyards in South Korea, Japan, and China due to their sheer size, government subsidies, and low interest costs to manage working capital. Asian shipyards accounted for 91% of global ship deliveries in CY15. This puts India at a disadvantage in bidding for large-sized ships such as VLCCs and LNG carriers.

However, the commercial shipping industry is in a prolonged downturn due to weak economic activity (mainly in China) and low oil prices. This has led to high competition among shipyards, leading to lower margins and even losses in some cases. As a result, CSL does not focus on aggressively bidding for standard commercial ships (bulk carriers or merchant vessels) but rather on engineering heavy products such as dredgers. This helps it to maintain high profitability, short construction timelines, and higher throughputs.

Robust revenue and EBITDA growth over FY18-21E

Backed by a 4.1x orderbook, pick up in execution of IAC-1 and steady growth in its ship repair sales we expect CSL’s revenues to grow at 25% CAGR over FY18-21E (vs. 7.5% FY14-18). Higher share of revenues from the cost plus contract on the IAC-1, should lead to a margin contraction of 330bps between FY18-21. Consequently, CSL’s EBITDA should grow at 18% CAGR (vs. 13% FY14-18), lower than the growth in revenues. Reported earnings growth would be impacted by lower other income due to utilizations of funds for capex as a result earnings growth would be relatively muted at 11.5% CAGR.

Strong order book - 4.1x book to bill FY18 led by IAC-1...

...expect 25% CAGR in revenues on pick up in execution of IAC-1...


...however, 18% CAGR in EBITDA due to contraction in margin on higher share of revenues from IAC's cost plus contract

... and 12% CAGR in PAT because of lower other income on account of higher capex for new facilities


6.3

5.4

4.1

5.2

3.7

2.6

-

1

2

3

4

5

6

7


Book to bill (x)

0%

10%

20%

30%

40%

-

5

10

15

20

25

30

35

40

45

50



25.3% CAGR

8.8% CAGR

12%

14%

16%

18%

20%

-

2

4

6

8



17.6% CAGR

11.3% CAGR

-10%

0%

10%

20%

30%

40%

-

1

2

3

4

5

6



11.5% CAGR

18.1% CAGR



Experienced management with bandwidth

CSL has a capable management. Its current Managing Director has been with the company for 28 years, with good credentials. Similarly, its Director Operations has been with the firm for 31 years.

Key management personnel

Name Designation

Age

(years)

Experience

(years) Qualification

Mr. Madhu S.

Nair

Chairman &

Managing Director

52 30 Joined CSL as a management trainee in June 1988

B. Tech in naval architecture and ship-building from Cochin University, master in

engineering with specialisation in naval architecture and ocean engineering from

Osaka University, Japan.

Training course in shipbuilding-production control at Ishikawajima Harima Heavy

Industries Overseas Vocational Training Association Mr. D. Paul

Ranjan

Director (Finance) 58 33 Joined CSL as an executive trainee in December 1984

B. Com from Madurai Kamaraj University

Chartered accountant; course in information systems audit from ICAI

Mr. Suresh

Babu N. V.

Director

(Operations)

57 32 Joined as an executive trainee in 1985

BE (mechanical) from the University of Kerala and a diploma in management

from IGNOU

Training course in shipbuilding, repairing, and maintenance conducted by Overseas Shipbuilding Cooperation Centre. Practical training course with shipyard in Sekaidu of Kawasaki Heavy Industries Ltd

Mr. Murugaiah

M

CGM

(Technical & HSE)

56 32 Joined as an executive trainee in August 1986

B. Tech (Mechanical) from University of Kerala and of MBA from the Madurai

Kamraj University

Certificate in project risk management from the Institute of Project Management Certification

Mr. Bejoy

Bhasker

CGM

(Design & Defence

Projects)

53 30 Joined in June 1988 as an executive trainee

Has been involved in ship-building outfit and ship-repair departments.

B. Tech (mechanical) from University of Kerala and M. Tech (mechanical) from IIT, Madras. Advanced diploma in management from IGNOU.




Key risks

Risk of stranded asset in case of delay or cancellation of IAC-2 CSL is investing Rs 18bn in building a new dry dock, in anticipation of the IAC-2, which due to its large size would not have fit in the existing dry dock where IAC-1 was built. This investment we believe is at risk of becoming a stranded asset until the IAC-2 is awarded to CSL. Though, CSL would look to utilise the new dock temporarily but the ROI would be minimal.

Over dependence on a single project (IAC) IAC forms a significant portion of CSL's current order book. This project has contributed 55% to company's revenues during FY13-17 and we expect it to contribute 53% of its FY18-21 revenues. A significant part of the contract is on a fixed-price basis. Consequently, any delays in execution and cost overruns may have a significant bearing on CSL’s profitability.

IAC continue to be the major contributor to CSL's revenues over FY18-21


Variability in profitability due to long execution period in shipbuilding Most of CSL's contracts are fixed-price, and all costs are forecasted at the time of entering into the contracts. Typically, its contract periods vary (depending on the size of vessels) from 18 to 24 months for small ones, 20-36 months for medium vessels, and 40-72 months for large ones. Given, the long execution cycle of the contracts, any adverse movement in the costs brings a risk to profitability.

Increased competition due to opening up of defence shipbuilding to private sector

CSL faces competition from both domestic and global players (particularly from South Korea, Japan, and China). Due to recent policies, private companies have been allowed to bid for vessels used in defence-related projects. In a first, recently, the Indian Coast Guard awarded an order for a series of FPVs to a private shipyard.

34%

56% 56% 58%

64%

58% 53% 53% 52%

0%

10%

20%

30%

40%

50%

60%

70%

FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY21E

IAC revenues share (%)



Capacity expansion plans

CSL is the largest public sector shipyard by capacity

CSL has an existing ship building capacity of 110,000 DWT, the largest amongst public sector shipyards. The dry dock measures 255 x 42.9 x 9M and follows the Japanese system of construction using the Integrated Hull Outfit and Painting (IHOP) system. Currently the company can cater to Aframax-sized tankers (ranging from 80,000 to 120,000 DWT).

Integrated shipbuilding infrastructure at the shipyard allows CSL to undertake structural, machinery, and electrical design and to prepare detailed production engineering drawings. During the shipbuilding design process 3D hull, piping and electrical models are created, ensuring optimum, error-free ship designs.

Its ship repair yard is also the largest within the public sector with a capacity of 125,000 DWT with a 270 x 45 x 12M size.

CSL is India's 2nd largest shipyard and largest among public sector

...and also has the 2nd largest in ship repair facility


Future expansions to meet growing demand particularly for ship repair The company is investing Rs 28bn over the next three years to set up a new Dry Dock and an ISRF. Out of the total capex, Rs 6.7bn will be funded through IPO proceeds and the rest through internal accruals.

Details of existing and planned capacities

Facilities

Ship

building

Ship

repair

New dry dock (ship

building & repair) ISRF

Dock Dock 2 Dock 1 Dry Dock ISRF

Capacity (DWT) 1,10,000 1,25,000

Length (mtr) 255 270 310 130

Width (mtr) 43 45 75-60

Depth (mtr) 9 12 13

Draught 9.5

Area (mtr) 255 x 43 x 9 270 x 45 x 12 310 x (75/60) x 13

Lifting capacity (tn) 6000

Capex and funding plan of new dry dock and ISRF (Rs mn) Total New dry dock ISRF

Capex (US$ mn) 408 265 143

Exchange rate (Rs / USD) 68 68 68

Capex for setting up dry dock & ISRF 27,684 17,990 9,694

Deployed till June 2017 458 141 317

Proposed to be financed from net proceeds 6,725 4,430 2,295

Balance funding required 20,501 13,419 7,082

Sanction of credit facility / term loan from SBI 8,610 4,190 4,420

Funds from existing identifiable internal accruals 12,349

Cash & bank balance on June 2017 20,032


0

75

150

225

300

375

450

RDEL CSL HSL BDIL Semb marine

L&T ABG Alcock Ashdown

GSL

Shipbuilding capacity ('000 DWT)

0

50

100

150

200

250

300

350

400

RDEL CSL HSL BDIL ABG GSL GRSE

Ship repair capacity

Length (mtr) Width (mtr) Depth (mtr)



New dry dock: Getting ready for IAC-2? The new dry dock will enable the company to build larger ships (such as Suez-size vs. Aframax presently) by using the ‘stepped’ dry-dock method. This method enables longer vessels to fill the length of the dock and wider, shorter vessels and rigs to be built or repaired at the wider part. The company will be investing Rs 18bn to construct the new facility.

The new dry dock will enable CSL to…

Construct complex technology-intensive vessels such as LNG carriers, large dredgers, high-end research vessels etc.

Venture into the entire LNG vessel spectrum of the country soon.

Construct the second Indigenous Aircraft Carrier (IAC-2) of a much larger capacity than IAC-1 for the Indian Navy (national interest).

Building ‘Green Ships’ such as LNG carriers in the country.

Existing and proposed dry-dock facility

Source: MOEF, PhillipCapital India Research

ISRF: Increasing the throughput of a profitable business The new International Ship Repair Facility will allow the company to increase its repair throughput by 60-70% as it includes a ship-lift and transfer system. It will allow CSL to repair 72 additional ships in the new ISRF and an additional 12 in the new dry dock. CSL will spend Rs 10bn on the ISRF.

Details of the ship-repair facility

Ship repair facility: Workstations

Number of workstations 6

Average laying time at workstation per ship 1 month

Ships possible to dock at work station annually (nos) 12

Total ships possible to dock annually at workstations 1-6 72

Ship repair facility: Dry dock

Number of workstations / work area 1

Average laying time at dry dock per ship 1 month

Ships possible to dock at dry dock annually (nos) 12

Total ships number of ship repair objects per year 84

Source: MOEF, PhillipCapital India Research

Estimated laying times for underwater repairs

Repair program

On shore

(workstation)

At repair

jetties

Total laying

time

Large program / Type 1 22 working days 8 working days 30 working days

Medium program /Type 2 18 working days 8 working days 26 working days

Small program / Type 3 14 working days 8 working days 22 working days

Estimated laying times for above-water repairs

Repair program

At repair

jetties

Large ship repair program 16 up to 20 working days

Medium ship repair program 12 up to 16 working days

Small repair program 10 up to 12 working days





CSL has a robust orderbook with a 4.1x book to bill...

...should support a 25% CAGR in FY18-21E revenues...


...higher share of cost plus revenues to lower EBITDA growth but should still be robust 18%CAGR

Earnings growth will be lower due to declining other income on uptick in capex


Consequently ROE’s would also be subdued due to lower margins and high capex leading to lower fixed asset turns

CSL is entering a phase of high capex impacting FCF


6.3

5.4

4.1

5.2

3.7

2.6

-

1

2

3

4

5

6

7


Book to bill (x)

0%

10%

20%

30%

40%

-

5

10

15

20

25

30

35

40

45

50



25.3% CAGR

8.8% CAGR

12%

14%

16%

18%

20%

-

2

4

6

8



17.6% CAGR

11.3% CAGR

-10%

0%

10%

20%

30%

40%

-

1

2

3

4

5

6



11.5% CAGR

18.1% CAGR

15.3% 16.3% 16.1%

16.7%

14.8% 14.1% 13.6% 13.1%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%


RoE (%)

-10

-5

0

5

10

15

20





Global peer comparison

PE vs EPS CAGR - Indian peers





HAL

BEL

BDL

CSL

12

14

16

18

20

-20 -10 0 10 20

PE

FY2

0 (

x)


HAL

BEL

BDL

CSL

0.0

2.0

4.0

6.0

8.0

10.0

12.0

12 14 16 18 20

EV/E

BIT

DA

FY2

0 (

x)

Margin FY20 (%)

CSL

Yangzijiang

Keppel

Sembcorp

China Shipbuilding

Jiangsu Daewoo

Hyundai

Mitsubishi

Fincantieri

0

10

20

30

40

50

60

70

(70.0) (50.0) (30.0) (10.0) 10.0 30.0 50.0

PE

FY2

0 (

x)


CSL Yangzijiang

Keppel

Sembcorp

China Shipbuilding

Jiangsu Daewoo

Hyundai

Mitsubishi

Fincantieri

China CSSC

Samsung

0

4

8

12

16

20

24

4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0

EV/E

FY2

0 (

x)

Margin FY20 (%)





Indian companies

Cochin Shipyard 24.0 32.4 39.5 4.6 5.7 6.2 19.0 17.5 15.8 3.9 4.9 5.1



Bharat Dynamics 44.6 47.5 29.5 8.1 8.3 4.3 18.2 17.6 14.5 6.1 6.4 4.7

Average - Indian

17.6 16.9 16.3 Singapore

Yangzijiang Shipbuilding 17.0 18.5 19.4 3.4 3.3 3.2 20.1 17.7 16.6 2.4 2.3 2.3

Keppel Corp 6.1 6.4 7.7 1.1 1.3 1.4 17.8 19.5 18.3 0.9 1.0 1.1

Sembcorp Marine 2.7 3.3 3.6 0.3 0.3 0.4 11.4 10.1 11.0 0.0 0.1 0.1

Average - Singapore

16.4 15.8 15.3 Chinese

China Shipbuilding 48.4 54.3 58.1 3.1 4.4 5.5 6.5 8.1 9.4 1.1 1.8 1.9

China CSSC 20.2 22.4 26.0 1.5 2.7 4.3 7.5 12.2 16.4 (1.2) 0.4 0.8

Jiangsu Guoxin 23.1 26.9 30.0 3.8 4.5 5.5 16.4 16.7 18.3 2.2 2.8 3.3

Average - Chinese

10.1 12.3 14.7 Korean

Daewoo Shipbuilding 10,837 9,110 8,065 1,247 523 522 11.5 5.7 6.5 1,326 285 267

Hyundai Heavy 16,122 13,596 15,627 666 511 833 4.1 3.8 5.3 1,691 (23) 231

Samsung Heavy 7,909 5,183 6,952 (87) 63 434 (1.1) 1.2 6.2 (313) (186) 113

Average - Korean

4.8 3.6 6.0 Mitsubishi Heavy 4,058 4,207 4,309 356 393 421 8.8 9.4 9.8 87.6 106.0 118.4

Fincantieri 5.0 5.5 5.9 0.3 0.4 0.4 6.5 7.0 7.5 0.1 0.1 0.2

Average - Others


12.0 11.9 12.7

Price Shares Mkt cap PE (x) EV/EBITDA RoE (%)


Indian companies Cochin Shipyard 483 136 1,016 16.8 13.5 12.8 8.3 5.2 6.0 14.8 14.1 13.6



Bharat Dynamics 397 183 1,124 11.9 11.4 15.6 7.3 4.7 4.1 27.9 27.2 17.2

Average - Indian

19.1 17.9 16.2 11.0* 8.3* 7.1* 18.8* 18.2* 16.7*

Singapore Yangzijiang Shipbuilding 1 3,969 3,757 9.4 10.0 10.1 6.8 6.4 6.3 10.5 9.2 8.4

Keppel Corp 8 1,811 10,759 15.6 14.5 13.3 18.6 15.9 14.4 6.1 8.1 8.4

Sembcorp Marine 2 2,088 3,554 92.9 67.6 42.1 23.4 21.3 17.1 2.1 2.5 4.1

Average - Singapore

39.3 30.7 21.8 16.3 14.6 12.6 6.2 6.6 7.0

Chinese China Shipbuilding 5 22,880 18,628 93.1 71.1 64.0 36.3 25.9 20.8 1.9 3.1 3.0

China CSSC 17 1,378 3,752

58.6 30.1 24.5 13.5 8.6 -9.1 3.0 5.1

Jiangsu Guoxin 9 3,253 4,454 12.5 10.1 8.5 12.2 10.2 8.4 12.2 13.4 14.2

Average - Chinese

52.8 46.6 34.2 24.3 16.5 12.6 1.7 6.5 7.4

Korean Daewoo Shipbuilding 29,000 107 2,873 2.2 11.1 12.2 5.6 12.8 12.2 54.1 8.5 7.0

Hyundai Heavy 1,47,500 57 8,070 5.3

42.9 18.3 21.4 12.7 11.7 0.0 1.9

Samsung Heavy 7,850 390 3,285

40.6 -75.8 76.5 10.6 -4.8 -2.6 1.6

Average - Korean

3.8 11.1 31.9 -17.3 36.9 11.8 20.3 2.0 3.5

Mitsubishi Heavy 3,965 337 12,724 15.9 13.2 11.4 6.6 5.9 5.5 4.8 5.4 5.8

Fincantieri 1 1,692 3,057 24.2 17.5 13.8 9.6 7.9 6.6 8.2 10.6 12.7

Average - Others

20.0 15.3 12.6 8.1 6.9 6.0 6.5 8.0 9.2

Average - Global

26.7 26.6 23.6 8.7* 16.7* 10.1* 11.5* 8.9* 9.3*




Outlook & Valuation

SOTP based target price of Rs 595 We use SOTP based valuation to arrive at our target price of Rs 595. We value CSL’s two primary businesses, i.e. Ship Building and Ship Repair, separately.

Our key assumptions to arrive at the respective segment earnings were

to allocate the other income to ship building segment since it is a beneficiary of long cycle customer advances.

Equally distributed unallocated expenses to both the segment and

allocated interest expenses to Ship repair.

Rationale for segment valuation Shipbuilding: We ascribe a target PE of 14x to our FY20 segment earnings. Our target multiple implies a 30% premium to its South East Asian peers due to CSL robust revenue visibility upto FY22, but at a 20% discount to the average PE of domestic defence companies such as BEL, HAL and BDL given a larger opportunity size for the latter.

Ship repair: We value CSL’s ship repair business at a 25x FY20 PE for its annuity kind of characteristics with higher margin profile. In addition our target multiple also tries to captures the efforts of the company to geographically diversify to garner a greater market share of the ship repair business in India.

CSL: Sum-of-the-parts valuation

__PAT (Rs mn)__ EPS (Rs) Target Value

Business FY19E FY20E FY20E multiple (x) (Rs / share)

Ship building 3,779 4,353 32.0 14 448

Ship repair 1,094 793 5.8 25 146

Total 4,873 5,146 37.9

594

Rounded off

595

Implied PE (x)

15.7


Initiate coverage with BUY rating We initiate coverage on CSL with a BUY rating as we believe that over the next five years CSL will emerge from the shadows of just being seen as the ship yard that is building the IAC to a more diversified company.

CSL is by far the most efficient ship yard amongst its public sector peers. Its strategy to expand the reach of its high margin ship repair business should yield benefits over the next five years. A strong order book, which is 4.1x FY18 revenues should aid a 25%/18% revenue/EBITDA CAGR over FY18-21E.

After the recent stock price correction, CSL trades at 13x FY20E, it is the cheapest stock amongst our defence coverage despite its healthy growth outlook.

CSL currently trades at below -1SD of its one year forward PE


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CSL 1-yr fwd PE (x) Average +1SD -1SD

17.1x

16.2x

15.2x



Annexure

Indian shipbuilding industry structure


Shipbuilding Process


Indian Shipbuilding Industry

Government Sector Private Sector

UnlistedListedState GovernmentCentral Government

L&T ShipyardPipavav ShipyardAlcock AshdownMinistry of DefenseMinistry of Shipping

Chowgule & Company LtdBharti ShipyardShalimar Works

Tebma Shipyard etc.AGB ShipyardMazagaon Dock LtdCochin Shipyard

Goa ShipyardHoogly Dock & Port Engineer Ltd

Garden Reach

Hindustan Shipyard

Planning & Production Control

CONTRACTS

DESIGN

PURCHASE

Inspection & Quality Control

CONSTRUCTION PROCESS

Steel Preparation Block Fabrication Block Outfitting Block Painting Grand Assembly

Trials & DeliveryEquipment

CommissioningTank Testing

Onboard Outfitting

Block Erection & Consolidation



About the company Cochin Shipyard Ltd (CSL), incorporated on March 29, 1972, is a government owned company with 'Miniratna' status. It is the second-largest shipyard and the largest public sector shipyard in India with dock capacity to accommodate vessels up to 110,000 DWT. CSL has also the second-largest ship repair capacity and largest among the public sector in India, which can accommodate vessels up to 125,000 DWT. Its shipyard is strategically located along the west coast of India, midway on the main sea route connecting Europe, West Asia, and the Pacific Rim – a busy international maritime route. In addition, its shipyard is located close to the Kochi port and to offshore oil fields on the western coast of India, and relatively close to the Middle East.

India's second-largest shipyard, largest in the public sector

Second-largest ship-repair capacity in India


Key milestones

Year Major events

Apr-72 Laid foundation for hull shop

Jul-75 Signed contract for the first bulk carrier

Jul-81 Delivered first ship ‘Rani Padmini’

Oct-90 Delivery first tanker ‘007 Motilal Nehru’

May-99 Delivered the Double Hull Motor Tanker ‘M.T. Abul Kalam Azad’ of 83576 DWT to Shipping Corporation of India

Feb-03 Delivered first export order, LB II Barge to National Petroleum Construction Co, Abu Dhabi

Jan-04 Contract for six bulk carriers for Clipper Group, Bahamas

Nov-06 Delivered nine fire-fighting tugs to Saudi Seaport Authority from December 2004

Feb-09 Keel laying of the first Indigenous Aircraft Carrier for the Indian Navy

Oct-10 Order of 20 Fast Patrol Vessels for Indian Coast Guard

Sep-11 Set up the 500 tn Bollard Pull facility at Vizhinjam, largest facility for bollard pull test in Asia

Dec-12 Signed contract for setting up of ISRF at Cochin Port Trust

Aug-13 Launched the first Indigenous Aircraft Carrier for the Indian Navy

Mar-14 Delivered the 100th ship built by our Company

Dec-15 Obtains license from GTT to build LNG Ships using the containment system known as the Mark-III Technology

Dec-16 Delivered last ship of the 20 Fast Patrol Vessel to Indian Coast Guard

Jun-17 Delivered double ended Ro-Ro ferry ‘Sethusagar – I and II’ to Kochi Municipal Corporation


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RDEL CSL HSL BDIL Semb marine

L&T ABG Alcock Ashdown

GSL

Shipbuilding capacity ('000 DWT)

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RDEL CSL HSL BDIL ABG GSL GRSE

Ship repair capacity

Length (mtr) Width (mtr) Depth (mtr)



Business segments CSL has two major business segments: (1) Shipbuilding, which has contributed 82% of its revenues over the last five years (FY13-17), and (2) ship repair (18% of revenues). It caters to clients from the defence sector in India and clients from commercial sectors globally for shipbuilding and ship repair. Defence shipbuilding is a complex and time-consuming activity. While commercial shipbuilding is relatively less complex, it is subject to cyclical weaknesses. Over the last five years, CSL’s defence clients have contributed to 80% of its revenues and have helped the company to overcome cyclical fluctuations or weaknesses in commercial shipbuilding.

Shipbuilding contributed 82% of its last five years revenues…

...driven by 80% contribution from defence-sector clients


Shipbuilding (82% of last five years’ revenues): CSL has begun its shipbuilding operations in 1975 and has transformed its capability from building bulk carriers to building smaller and more technically sophisticated vessels such as PSVs and AHTS’. It has built a wide range of vessels including bulk carriers, tankers, platform supply vessels (PSVs), anchor-handling tug-supply vessels (AHTSs), launch barges, tugs, passenger vessels, fast-patrol vessels (FPVs), and roll-on/roll-off (Ro-Ro) vessels. It has also worked with several leading technology firms including Rolls Royce Marine (Norway), and GTT (Gaztransport & Technigaz SA), which helped increase its credibility in international markets.

Defence shipbuilding: Indian Navy and Indian Coast Guard are its two clients from the defence sector. CSL is currently building India's first indigenous aircraft carrier (IAC-1) for the Indian Navy, which is a major contributor (79%) to its defence shipbuilding revenues. It has already completed phase-1 contract of IAC-1 and currently executing phase-2 contract. The phase-3 contract is yet to be signed, and as per CAG, the delivery of IAC-1 is likely to be completed by 2023. CSL has also completed the delivery of FPVs to the Indian Coast Guards. Defence has contributed 85% of its shipbuilding revenues in the last five years.

Commercial shipbuilding: CSL has derived 15% of its shipbuilding revenues in the last five years from this segment. Currently, it is constructing four passenger-cum-cargo vessels for the Andaman and Nicobar administration and a vessel for one of GoI's projects. It has delivered two of India's largest double-hull oil tankers to SCI. It has also exported 45 ships to various international clients such as NPCC, Clipper Group (Bahamas), Vroon Offshore (Netherlands), and SIGBA AS (Norway).

Shipbuilding 82%

Ship repair 18%

Segment-wise Revenue mix FY13-17

Defence 80%

Commercial 20%

Client-wise Revenue mix FY13-17



Defense contributed 85% to shipbuilding revenues driven by the execution of IAC-1


Ship repair (18% of last five years’ revenues): CSL started its ship-repair operations in 1978, and since then it has developed adequate capabilities to handle complex and sophisticated repair jobs. It has undertaken repairs of various types of vessels, including upgradation of ships for the oil-exploration industry and periodical maintenance, repairs, and life extension of ships. It has also partnered with Techcross Inc. for technical support, engineering, service support, and sharing of information in relation to the Ballast Water Treatment System (BWTS)’s products.

Defence ship repair: CSL undertakes ship repair for the Indian Navy. In FY14-16, it repaired about 15 naval ships with scope of work varying from routine to complex. It has also completed refits of INS Aditya, INS Sukanya, INS Shardul, INS Viraat, and INS Vikramaditya for the Indian Navy. It is the only commercial shipyard to have undertaken repair work of Indian Navy's aircraft carriers - INS Viraat and INS Vikramaditya.

Commercial ship repair: It has also undertaken major revamping and refurbishing of oil rigs in almost all major offshore vessels and rigs of ONGC, involving steel renewal, upgradation of drilling, cementing, mechanical, HVAC, and piping systems. It has MoUs with the Lakshadweep Development Corporation Ltd (LDCL), Directorate General of Lighthouses and Lightships (DGLL), and Dredging Corporation of India (DCI), to undertake ship-repair work on a bulk-volume basis. Key clients from the commercial sector include SCI, ONGC, and DCI.

Defense and commercial sector contributed 60% and 40% of revenues respectively


Commercial 15%

IAC 79%

Defence others 21%

Defence 85%

Shipbuilding revenues mix FY13-17

Defence 60%

Commercial 40%

Ship Repair Revenue mix FY13-17



Business segments’ outlook

Commercial shipbuilding Even as the global market for commercial ships is undergoing a prolonged downturn, the domestic-market outlook is buoyant. The government’s key initiatives should drive demand for small and midsized commercial ships. CSL is banking on the following to drive demand for ships in the domestic market:

Shipbuilding policy, 2015

Development of inland water ways

Sagarmala project

Make in India

Shipbuilding policy, 2015 The government approved the new shipbuilding policy in December 2015, granting financial assistance and infrastructure status to the industry. The government has set aside Rs 40bn to implement the scheme over the next 10 years. Key features of the policy include:

Granting infrastructure status to shipbuilding and ship-repair industry, making it entitled to various government incentives and tax benefits.

Financial assistance to both state-owned and private shipbuilders on each ship that they build, except for smaller boats and fishing vessels.

Financial assistance granted will be 20% of the lower of 'Contract Price' or the 'Fair Price' of vessel built commencing FY17 and will be reduced by 3% every three years.

Development of inland waterways Inland waterways account for only 3% of India’s total transport compared with about 9% in China, 8% in the USA, and 7% in the European Union. Inland-waterways transport is a viable alternative for existing modes of transportation, as it helps decongest these and results in fuel and cost savings. The government’s initiative to develop inland waterways is a big business opportunity for the Indian shipbuilding industry in the form of future orders for building dredgers and small bulk-carrier vessels. India has identified 111 inland waterways that will be developed progressively, depending on the financial viability of each project. The World Bank will fund 1,620kms National Waterway-1 on the Ganga from Haldia to Allahabad. Sagarmala project India’s Sagarmala project is expected to tackle underutilised ports by focusing on port modernisation, efficient evacuation, and coastal economic development. It will also complement the Golden Quadrilateral project and provide sea connectivity to major industrial centres. In the future, higher marine-transport activity will also lead to increased demand for commercial vessels. Notably, the project envisages setting up a shipbuilding and repair cluster. Make in India initiative Under the Make in India programme, Indian shipyards will have the right of first refusal for government purchases, implying that even if the shipyard is not the lowest bidder, an option is provided to the shipyard to match the lowest foreign bid and secure the contract. This is part of the New Shipbuilding Policy, 2015.



Defence shipbuilding Navy’s capital budget has seen 9% CAGR in the past 10 years... The CAGR for India’s allocation to the navy for capital expenditure has seen a decent pace of 9% in the past 10 years (FY09-19). …but the share in the total budget has largely been stagnant The navy’s share in the total capital budget, at 23% in FY19, is virtually the same as in FY09 (while the navy’s share did increase to 30% in FY12, it subsequently fell to current levels).

Indian navy’s capital budget saw 9% CAGR, but its share in the total is stagnant


Huge deficit in navy’s vessel strength, based on its 2027 perspective plan Navy’s aspirational force strength, as per a 2012 directive of the Defence Acquisition Council, is 198 ships and submarines by 2027 against a current strength of 121 ships and 15 submarines. This leaves a gap of 62 vessels to be constructed and delivered in the next 10 years. Based on our checks, 42 vessels are under construction, still leaving a deficit of 20 ships. This, we believe, offers an efficient shipyard like CSL a very strong opportunity for future orders.

Navy still has a deficit of 20 ships to meet its 2027 perspective plan target

(Nos.)

Current strength 136

Proposed in 2027 perspective plan 198

Gap 62

Already under construction 42

Deficit 20


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FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18RE FY19BE

(Rs bn)

Navy capital budget ex-land & construction % of Defense capital budget



Ship repair: A potent opportunity Global ship-repair industry According to the Ministry of Shipping, the global ship-repair market is approximately US$ 12bn. Shipyards in Singapore, Bahrain, Dubai, and the Middle East account for a major share of this market. These locations have achieved a dominant position despite higher cost of ship-repair services compared with other Asian countries, largely due to the availability of a skilled workforce and latest technology, which allows these shipyards to attract demand from other low-cost locations like India, Malaysia, and Indonesia. Indian ship-repair industry Cochin Shipyard (39% revenue share of India’s ship repair industry in FY15) leads in ship repairs, followed by Goa Shipyard (20% revenue share in FY15). Private-sector shipyards in this segment include Sembmarine Kakinada, Larsen & Toubro, and ABG Shipyard.

CSL has the highest domestic market share in ship repair


India’s strategic positional advantage and relatively low-cost structures makes it a viable option along the east-bound and west-bound international trade routes. Indian yards are also expected to benefit from the increasing strength of the Indian Navy along with the Coast Guard’s operational and support fleet, which will drive the repairs business. Moreover, higher indigenization in ships, for clients engaged in the defence sector, are likely to augment revenue per refit and repair – driving growth and increasing the proportion of defence repairs over the next five years. To cater to the growing demand for ship repairs, CSL is setting up an International Ship Repair Facility (ISRF) with a capex of Rs 9.7bn. It will take three years to complete and it will be funded through IPO proceeds and internal accruals. This new 130-mtrs facility will enable CSL to increase its annual throughput by 70-90 ships, translating into a 60-70% increase in volumes. According to the Ministry of Shipping, the Indian ship-repair industry’s market potential is approximately US$ 1.5bn (Rs 100bn). The domestic ship-repair industry is expected to see 8-10% CAGR in FY16-21 (Source: CRISIL).

39%

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11% 9% 9%

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CSL GSL SKL L&T HSL ABG Others

Market share in ship repair




Net sales 20,589 23,975 32,437 39,547

Growth, % 3.3 16.4 35.3 21.9

Raw material expenses (13,141) (15,149) (22,092) (28,272)



EBITDA (Core) 3,795 4,561 5,691 6,230

Growth, % 6.9 20.2 24.8 9.5

Margin, % 18.4 19.0 17.5 15.8

Depreciation (385) (389) (418) (462)

EBIT 3,410 4,172 5,273 5,769

Growth, % 7.3 22.4 26.4 9.4

Margin, % 16.6 17.4 16.3 14.6

Interest paid (105) (117) (117) (117)

Other Income 1,636 1,974 2,341 2,265

Pre-tax profit 4,940 6,029 7,497 7,917

Tax provided (1,723) (2,110) (2,624) (2,771)

Net Profit 3,217 3,919 4,873 5,146

Growth, % 18.3 21.8 24.4 5.6

Net Profit (adjusted) 3,217 3,919 4,873 5,146

Unadj. shares (m) 136 136 136 136

Wtd avg shares (m) 136 136 136 136


Cash & bank 21,813 29,128 37,420 29,342

Debtors 3,070 4,142 6,273 7,666

Inventory 1,865 2,516 3,810 4,657

Other assets, L&A 1,928 2,240 2,691 2,943

Total current assets 28,676 38,026 50,194 44,609

Investments 1 1 1 1


Less: Depreciation (3,236) (3,625) (4,043) (4,504)

Add: Capital WIP 539 1,989 7,989 18,116

Net fixed assets 4,245 5,557 11,939 22,404

Total assets 33,165 43,827 62,377 67,257

Current liabilities 9,305 7,153 21,378 22,134

Provisions 2,319 2,725 3,592 4,330

Total current liabilities 11,624 9,878 24,970 26,464

Non-current liabilities 1,230 1,230 1,230 1,230

Total liabilities 12,854 11,108 26,200 27,694

Paid-up capital 1,133 1,359 1,359 1,359

Reserves & surplus 19,178 31,359 34,818 38,204

Shareholders’ equity 20,311 32,719 36,177 39,563

Total equity & liabilities 33,165 43,827 62,377 67,257



Pre-tax profit 4,940 6,029 7,497 7,917

Depreciation 385 389 418 462

Chg in working capital (786) (3,781) 11,217 (999)

Total tax paid (1,639) (2,110) (2,624) (2,771)

Cash flow from operating activities 2,123 (1,331) 14,283 2,461

Capital expenditure (687) (1,700) (6,800) (10,927)

Chg in investments - - - -

Cash flow from investing activities 647 274 (4,459) (8,662)

Free cash flow 2,770 (1,057) 9,824 (6,201)

Equity raised/(repaid) 2,168 12,408 3,458 3,386

Debt raised/(repaid) - - - -


Other financing activities (2,070) (2,621) (3,231) (3,405)

Cash flow from financing activities (1,125) 8,372 (1,532) (1,876)

Net chg in cash 1,645 7,315 8,292 (8,078)

Valuation Ratios


Per Share data

EPS (INR) 23.7 28.8 35.9 37.9

Growth, % (1.5) 21.8 24.4 5.6


FDEPS (INR) 23.7 28.8 35.9 37.9

CEPS (INR) 26.5 31.7 38.9 41.2

CFPS (INR) 9.3 (10.6) 104.2 17.2

DPS (INR) 7.5 8.6 10.8 11.4


Return on equity (%) 16.7 14.8 14.1 13.6




Sales/Net FA (x) 5.0 4.9 3.7 2.3

Working capital/Sales (x) (0.1) 0.1 (0.3) (0.2)

Working capital days (43.3) 26.6 (96.8) (63.4)

Liquidity ratios

Current ratio (x) 3.1 5.3 2.3 2.0

Quick ratio (x) 2.9 5.0 2.2 1.8

Interest cover (x) 32.4 35.7 45.1 49.4


Total debt/Equity (%) 6.1 3.8 3.4 3.1

Net debt/Equity (%) (101.3) (85.3) (100.0) (71.1)

Valuation

PER (x) 20.4 16.8 13.5 12.8

PEG (x) - y-o-y growth (14.0) 0.8 0.6 2.3

Price/Book (x) 3.2 2.0 1.8 1.7

Yield (%) 1.5 1.8 2.2 2.3

EV/Net sales (x) 2.2 1.6 0.9 1.0

EV/EBITDA (x) 11.9 8.3 5.2 6.0



Bharat Dynamics Ltd (BDL IN)

Order inflows and ROEs offer valuation support despite weak earnings INDIA | DEFENCE | INITIATING COVERAGE

27 March 2018

We initiate coverage on Bharat Dynamics (BDL), a government-owned company engaged in the manufacturing of missiles and torpedoes, with a NEUTRAL rating. We expect BDL to report an earnings decline over FY18-21E on depletion of its current order book. However, BDL has significant order prospects over the next five years that can grow its order book by 5x over FY18-22. Additionally, despite the weak earnings outlook in the near term, BDL’s ROEs would still be at 19% on bottom-cycle earnings and should support valuations. Sole manufacturer of SAMs, ATGMs and torpedoes in India = robust order pipeline... BDL is currently the sole manufacturer for Surface to Air Missiles (SAMs), Anti Tank Guided Missiles (ATGMs), and torpedoes in India. It can address 54% of India’s US$ 24.5bn missile demand over the next 10 years (2017-26). It is nominated to win the following large projects over the next five years – VSHORAD (very short-range air defence systems), MRSAMs (medium-range surface-to-air missiles), and Akash SAM for the Army. With these, BDL can expand its product base in SAMs and torpedoes; its revenues will then be spread across multiple projects (currently, Akash is the only major project in its order book). ...however, large projects = Prone to delays. TOT = Lower initial profitability BDL is likely to win: VSHORAD (US$ 5bn order, including foreign OEM’s share), MRSAM (US$ 1.5bn), and Akash (US$ 1.8bn). However, large contract values and limited headroom in the defence capital budget could delay timelines beyond those baked into our estimates. In addition, VSHORADs and MRSAMs are transfer of technology projects (ToT); their execution should be back-ended and we believe that the initial profitability for these projects should be low, as there will be a steady ramp up in ToT and a learning curve impact for BDL. Weak financial performance in the near term but return ratios are still high... We estimate BDL’s revenues/EBITDA/PAT to decline by 12%/16%/4% over FY17-21, based on depletion of its existing order book. The decline in earnings is lower than EBITDA, mainly due to an increase in the interest income from customer advances on new orders. The share of other income is likely to increase to 63% of earnings in FY21 from 20% in FY18. However, ROE at 19% in FY21 (bottom-cycle earnings) vs. 33% in FY17 would still be reasonable compared to peers, despite an earnings decline over this period. ROE would be supported by other income, even as fixed-asset turns decline sharply on lower sales. Initiate coverage with a NEUTRAL rating In the near term, risks do overshadow rewards for BDL; but, its inexpensive valuations limit the downside risks. Even after our assumption of a decline in earnings over FY17-21, BDL would still trade at reasonable valuations of 15x FY20 PE vs. peers such as BEL (18x), HAL (18x), and Cochin Shipyard (14x). BDL should trade at a discount to local and global comparables due to its weak financial outlook; at the same time, we do not see a further de-rating risk as strong order inflows and healthy ROEs support its valuations. We use a mix of PE, DCF and EV/Orderbook to value BDL; Target price Rs 445 BDL faces a unique scenario – where earnings will be on a negative trajectory over the next three years, but the company could potentially multiply its order book. In order to capture this peculiarity, we adopt a hybrid valuation methodology, valuing the company on a mix of PE, DCF, and EV/orderbook. We currently assign 80% weight to PE and DCF-generated valuation and ascribe a 20% weight to EV/OB. Based on this method, we arrive at a FY20-based target of Rs 445, implying an exit PE of 18x. However, sometime over the next 18 months, BDL’s valuations will switch to EV/OB from PE, as pace of orders increase but earnings remain suppressed (due to execution of its legacy orderbook). At that point, we will increase the weight of our EV/OB valuation in our valuation methodology.

NEUTRAL CMP RS 397

TARGET RS 445 (+12%) COMPANY DATA




52 - WK HI/LO (RS) : 428 / 360

LIQUIDITY 3M (USDMN) : NA

PAR VALUE (RS) : 10

KEY FINANCIALS

Rs bn FY17 FY18E FY19E

Net Sales 46.30 44.58 47.49

EBIDTA 8.29 8.13 8.35

Net Profit 6.65 6.09 6.41

EPS, Rs 36.3 33.2 34.9

PER, x 10.9 11.9 11.4

EV/EBIDTA, x 6.7 7.3 4.7

P/BV, x 3.3 3.4 2.8

ROE, % 32.7 27.9 27.2

Source: PhillipCapital India Research Est.

Jonas Bhutta (+ 9122 6246 4119) [email protected] Vikram Rawat (+ 9122 6246 4120) [email protected]


BHARAT DYNAMICS LTD INITIATING COVERAGE

Focus Charts

BDL addresses 54% of India's missiles and torpedoes market

Segment Market

(US$ bn) % of total

Addressed by BDL (US$ bn)

Addressed by BDL (%)

Ballistic 0.7 3% - 0%

Tactical 19.6 80% 11.5 59%

Cruise 1.7 7% - 0%

Special mission 0.2 1% - 0%

Torpedo 2.2 9% 1.6 73%

Total 24.5 100% 13.1 54%

Order book to jump 5x over FY18-22 led by large orders for VSHORAD, Akash, and MRSAM...

Source: RHP, Frost & Sullivan, PhillipCapital India Research

...however, revenues to see 12% CAGR decline over FY18-21 due to initial slow pick up in execution of large orders

...and EBITDA by 16% on contraction in margins due to adverse sales mix and negative operating leverage


PAT decline will be lower than contraction in EBITDA due to higher other income, led by advances on large orders...

...resulting in weak quality of earnings as other income would account for 63% of PAT in FY21 vs. 23% in FY17...


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...Though RoE should still be 19% in FY21

Operational cash flow generation of Rs 9.8bn


32.1% 32.7%

27.9% 27.2%

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About the company Bharat Dynamics Ltd (BDL), incorporated in 1970, is a government-owned company with 'Miniratna (category-1)' status. It is engaged in the manufacturing of Surface to Air missiles (SAMs), Anti-Tank Guided Missiles (ATGMs), underwater weapons (torpedoes), launchers, countermeasures, and test equipment as well as the refurbishment and extension of the life of missiles. It is currently the sole manufacturer for SAMs, ATGMs, and torpedoes in India

and also the sole supplier of SAMs and ATGMs to the Indian armed forces. It is also the co-development partner with the DRDO for the next generation of

ATGMs and SAMs. BDL currently has three manufacturing facilities in Hyderabad, Bhanur, and

Vishakhapatnam. It is also in the process of setting up two new manufacturing facilities at: (1) Ibrahimpatnam, Telangana to manufacture SAMs, and (2) Amravati, Maharashtra, for VSHORADMs.

BDL manufacturing facilities Location Products

Operational

Hyderabad, Telangana SAMs, Milan 2T ATGMs, countermeasures, launchers and test equipment

Bhanur, Telangana Konkurs – M ATGMs, INVAR (3 UBK 20) ATGMs, launchers & spares

Vishakhapatnam, Andhra

Pradesh

Light weight torpedoes, C-303 anti torpedo system, countermeasures &

spares

Under planning

Ibrahimapatnam, Telangana SAMs

Amravati, Maharashtra Very Short Range Air Defence Missiles (VSHORADMs)

Source: Company, RHP, PhillipCapital India Research

Details of the infrastructure facilities at each of the three manufacturing units Hyderabad

> 6 Axis CNC machines > X-Ray building

> Robotic welding machine R&D facilities

> Electron beam welding machine > Aerodynamics / high performance computing facility for CFD

> 3D measuring machine > Computer aided design

> CNC flow forming machine > Optics and lasers spectral radiometry

> 5-Axis CNC machining center > RF lab

> Combined altitude temperature and humidity chamber > Embedded systems design

> Vibration test facility > Simulation and analysis facility

> Vacuum furnace for heat treatment > Electronic circuit design and simulation.

> Explosive storage and magazine building > Counter measures dispensing system lab

> Unification / automation of cold and hot conditioning of missiles / sub-systems including thermal shock capability.

> Missile simulation mode

> Spectro Radiometer

Bhanur

> Robotic welding machine > Armour room facility for high pressure testing

> 3D measuring machine > Hybrid micro circuits in place of conventional SMD technology.

> Tooled up CNC Turn-mill center for Outer gimble of Konkurs-M ATGM > Thin film hybrid technology for components of INVAR (3 UBK 20) ATGM

> Mill turn with multitask CNC machine. > Vacuum furnace for heat treatment

> X-Ray machine > Explosive storage and magazine Building

> Advanced universal testing machine > PLC based automatic loading & progression of jobs in electro plating production line > CNC flow forming machine

> Environmental stress screening chamber > Introduction of lithium based high reliable thermal batteries

> Vibration test facility > Flow forming in place of deep drawing process.

Vishakhapatnam

> Vibration test facility

> Pressure testing tank




BDL’s products portfolio


Surface to Air Missiles

Akash SAM is an all weather area defense system which can engage multiple targets simultaneously. It can

target helicopters, fighter aircraft and unmanned aerial vehicles. In addition to Akash SAM, BDL will also

supply the ground support system and construct infrastructure facilities for the Akash SAM.

BDL is currently supplying Akash SAMs to MoD for Indian Army.

LRSAM & MSRSAM is a high response quick reaction vertical launch supersonic missile to neutralise enemy

aerial threats such as missiles, aircraft, guided bombs and helicopters.

BDL is currently supplying LRSAMs and MRSAMs to MoD for Indian Army and Indian Navy respectively.

Anti-Tank Guided Missiles

Milan 2T ATGM is a man portable second generation ATGM with a tandem warhead to destroy tanks. It can

target both moving and stationary targets.

BDL is currently supplying Milan 2T ATGMs to MoD for Indian Army.

Konkurs - M ATGM is a second generation, semi-automatic tube launch optically tracked, wire guided and

canard controlled missile which has been designed to destroy moving and stationary armoured targets. It can

be launched from vehicles and ground launchers.

BDL is currently supplying Konkurs - M ATGMs to MoD for Indian Army.

INVAR (3 UBK 20) ATGM is a second generation plus mechanized infantry weapon which can be fired from

the gun barrel of a T-90 tank to destroy armored vehicles.

BDL is currently supplying the INVAR (3 UBK 20) ATGMs to MoD for Indian Army.

BDL Products

SAMs

Akash Missiles

ATGMs

MILAN 2T, Konkurs-M,

INVAR (3 UBK 20)

Torpedoes

Light Torpedoes

Launchers

Launchers for Konkus-M &

MILAN 2T ATGMs

Counter-measures

Chadd & flare based air defence

systems, C-303 topedo decoys

Decoy Systems

Submarine fired decoys

Test Equipment

Health monitoring

equipment for ATGMs



Underwater weapons

Light weight torpedo (TAL) is used for anti-submarine warfare and can be launched from a ship or a

helicopter.

BDL is currently exporting the light weight torpedo.

Launchers

Launchers for the Konkurs M ATGM and the Milan 2T ATGM.

FLAME (Fagot Launcher Adapted to Milan Equipment) is a

launcher for operation of Milan 2T ATGM.

Countermeasures

CMDS is a micro controller chaff and flare based airborne defence system. It can be activated by the pilot or

the radar warning receiver of the aircraft. CMDS provides protection to the aircraft against radar guided and

heat seeking missiles (air and ground) by dispensing chaff and / or flare payloads.

BDL is currently supplying the CMDS to a defence PSU engaged in the manufacture of fighter aircrafts.

C-303 Anti Torpedo Decoy launching system - Anti Torpedo System is meant to counter the threat posed to

any submarine by any active and / or passive homing torpedo.

BDL is currently supplying Anti Torpedo System to a defence PSU engaged in the construction of submarines

and warships.

Submarine Fired Decoy (SFD) acts as preferred target in the presence of an own submarine to a passive or

active homing torpedo.

Test Equipment

Konkurs missile and launcher test equipment monitor the

health of prior generation Konkurs ATGM and current

Konkurs-M ATGM.



Indian guided missile and torpedo market outlook

As per Frost & Sullivan, the Indian guided missiles and torpedoes market will be US$ 24.5bn during 2017-26, driven by: 1. Committed and planned missile procurement underway such as S-400 Triumf

advanced air defence systems, Barak-8 SAMs, Hellfire ASMs, Harpoon anti-ship missiles, and heavy weight torpedoes, etc.

2. Modernisation and refurbishment of deployed and stored missile systems used on existing air, land, and sea-based platforms such as missile system upgrades in existing Talwar class frigates (FFGs), ATGM upgrades, etc.

3. Missile procurements expected as a result of procurement programs initiated during the forecast timeline such as new fighter procurements, Project 28A (Next Generation Missile Corvette), Project 17A (FFG), Project 75I (Diesel Electric Submarines with Air Independent Propulsion), etc.

The Indian guided missile market will be dominated by Tactical missiles during 2017-26, with a share of 80%, followed by torpedo (9%) and cruise missile (7%) segments. Within tactical missiles, SAM (US$ 9.8bn, 50% share) and ASM (31%) will be the key contributors.

Tactical missiles (with 80% share) will be the key driver of the Indian guided missiles market during 2017-26...

....which will be driven by the surface-to-air (50% share) and air-to-surface (31%) missiles


Ballistic, $0.7bn

Tactical, $19.6bn

Cruise, $1.7bn

Special mission, $0.2bn

Torpedo, $2.2bn

Guided missiles & Topedoes market (2017-26)

Surface to Air, $9.8bn

Air to Surface, $6.1bn

Air to Air, $1.8bn

ATGM, $1.7bn

Surface to Surface, $0.6bn

Tactical missile market (2017-26)



India's major missile procurement and modernisation programs Program name &

procurement timeline Status Remarks

Akash missile

(2016-26)

Purchase

cleared

Cabinet Committee on Security (CCS) is set to clear the procurement of Akash missiles for IAF, enhancing

supersonic missile capability to intercept fighter jets, cruise missiles, ballistic missiles etc. The production of

Akash systems is also to enhance production capacity to meet demand / requirements.

Barak - 8

(2017-22)

Purchase

cleared

CSS has approved the procurement of MRSAM (Medium range - land /Long range -naval) systems, further

strengthening the defence capabilities to intercept aircraft, UAS and missile systems. IAI and DRDO have

partnered for co-development of both long range (Naval) and medium range (Land) versions of the missile. BDL is

manufacturer in India.

VSHORADS

(2018-23)

Planned Field trial for a US$ 5.2bn the weapon system contract under underway. The total contract is for the supply of

5175 missiles and 1276 single/multi-launchers with streamlined technology transfer for the DPSUs. MBDA, Saab

& Rosboronexport participating in bid. BDL is the nominated production agency for the program.

MRASM

(2018-21)

Planned Indian Navy has invited RFI for supply of medium range anti-ship missiles procurement of which is expected to

begin by early 2018. Combat missiles, practice missiles, training missiles, cut section missiles; dummy missiles and

systems for fitment on-board ships will be procured.

Heavy Weight Torpedo

(2018-21)

Planned As India is inducting Kalvari class submarines into the fleet, heavy weight torpedoes may be procured to improve

kill capabilities.

Barak - 1

(2017-22)

Purchase

cleared

GoI has approved procurement of Barak-1 missile systems. The contract is worth over US$ 78mn and will be

delivered over a period of 5 years from 2017 onwards.

S-400 Triumf

(2016-21)

Purchase

cleared

India & Russia have reached an agreement for over US$ 5bn for procuring S - 400 Triumf air defence system.

Technical discussion is underway post which contracts to be penned down. Contract is being executed by

Rosboronexport and deliveries are expected to be within 3 years from the agreement.

ATGM

(2017-21)

To be

approved

Mod has forwarded a request for the procurement of Spike ATGMs to Defence Acquisition Council (DAC) for

approval. This contract is expected to be worth US$ 1bn to be supplied by Rafael Advanced Defence Systems.

Arrow 2

(2018-23)

Planned Earlier, Indian interest for procuring the Arrow 2 missile was not addressed due to the MTCR regulations. An RFQ

can be expected to be released in the near future for procurement.

Stinger

(2015-22)

Purchase

cleared

GoI has approved the purchase of air to air missiles to be supplied by Raytheon, which is a part of US$ 3.1bn

India-US defence contract. Stingers will be equipped on the fleet of light attack and advanced light attack

helicopters, apart from the Apache-64 E helicopters being procured.

MICA

(2012-15)

Purchase

cleared

CCS approved procurement of MICA multi mission air to air missiles available in two configurations (IR & RF) for

upgrading Mirage 2000 jets and will be supplied by MBDA. The missiles will also be loaded on the Rafale combat

jets to be delivered from 2019 onwards. MBDA-L&T has also entered into a JV for joint development of missile

systems and high speed UAS.

AGM-114L-3 Hellfire

Longbow missile

(2015-22)

Purchase

cleared

CCS has approved the procurement of Hellfire 812 AGM-114L-3 missiles for Apache 64-E attack helicopter (part

of US$3bn contract between India & US which also includes 542 AGM-114R-3 Hellfire-II missiles along with

Chinook and AH-64 helicopters and associated electronics systems. As per DPP 2016, the contract will have a 30%

offset clause and the armaments have been procured through a contract under Foreign military sale (FMS)

agreement.




Competitive landscape and BDL's positioning

Global competitive landscape The guided missile and torpedo systems’ competitive landscape is dominated by 22 global players. However, most companies do not offer solutions across the entire gamut of guided missile product segments, and tend to specialize in segments where revenue opportunities are high. Also, export restrictions on theatre warfare weapons such as ICBMs and IRBMs prevent many firms from developing newer solutions in this segment as there is a constraint on realizable opportunities. In such cases, OEMs only start developing solutions as and when there is an explicit demand from respective MoDs for such systems.

Guided missile and torpedo market landscape


Ballistic missile: There are over 60 solutions available globally, with majority of solutions provided by Tactical Missiles Corporation (a holding corporation comprising over 20 Russian specialized munitions solution providers).

In the cruise missile segment, about 26 solutions (includes variants) are marketed today by eight major firms.

Tactical missile segment has a large expansion in terms of the number of solutions and the companies providing them.

ATGM is the most competitive, within the tactical missile segment, with majority of the companies having at least one solution because of the high demand and relatively low costs associated to it. It is also the segment straddling the lowest price points vis-à-vis other segments.

Surface-to-air and air-to-surface segments are both broad product lines indicating a high variation in customer requirements. There are over 480 solutions available for these two segments globally.

Air-to-air and anti-ship missile segments also exhibit similar characteristics. Increasing demand is also driving the production of specialized solutions within the segment. Also, as improved electronic countermeasures systems are deployed on aircraft, smarter new age air-to-air missiles impervious to jamming are being developed. Today, there are about 166 air-to-air missile solutions available in the market.

Within the surface-to-surface segment, there are more solutions and market players in the medium-range category as opposed to the long-range category. The two categories combined present over 250 solution types globally.



Torpedo: Light torpedo is a more competitive segment with more choice of naval solutions available in the market. There are only about 14 major heavy-water torpedo solutions available globally, while there are 30+ solutions available in the light water torpedo segment.

Guided missile and torpedo manufacturers and solutions


Main players, benchmarked by Frost & Sullivan, in the guided missile and torpedo market as per their capabilities


Note: CASIC is left empty because of opacity of the Chinese markets in identifying product portfolios



Indian competitive landscape Presently, the Indian guided missile and torpedo market is dominated by DPSU produced missiles and foreign solutions. Solutions from Russia, Israel, Europe, and US are well entrenched in the Indian market.

Indigenous development and manufacturing is carried out by three DPSUs – DRDO, BDL, and BEL. Amongst the three, BDL is the main player in manufacturing and is the sole manufacturer in India for SAMs, torpedoes, and ATGMs.

However, there is a drive within the establishment to indigenize missile production as much as possible in order to extricate the armed forces from any external dependencies for missile systems in the future.

Popular solutions for guided missile and torpedo in India

Key players in Indian guided missile & torpedo market

Source: RHP, Frost & Sullivan , PhillipCapital India Research

Strong opportunities in Indian market, coupled with the ‘Make in India’ initiative and DPP 2016 has stimulated an interesting market dynamic in India. Foreign OEMs accord high priority to the Indian market because of assured opportunities but has come to realize that partnering with DPSUs and private companies is the way ahead. This has resulted in many partnerships in the field, as well as stand-alone indigenous development.

Foreign OEMs have entered into arrangements with domestic companies Company Brief

Tata Advanced

Systems

Partnered with Raytheon to produce components for Stinger missile systems, which will be deployed at platoon levels and also

on-board AH-64 Apaches being procured by India

Reliance Defence Signed JV agreement with Rafael Advanced Systems to build Air to Air missile systems

Kalyani Strategic

Systems

Formed JV with Rafael Advanced Systems to manufacture high technology defence components in India.

Also, signed MoU with IAI to form a JV to build air defence, ground-to-ground and ground-to-sea munitions in India.

Punj Lloyd Acquired licenses for manufacturing missiles and rockets in India. Tie up with Weapon Industries (IWI) to manufacture small

arms and may venture into the guided missile space in the future.

L&T Entered into a JV with MBDA to produce 5th generation ATGMs in India.

Also, BDL and L&T entered into an agreement to export light torpedo solutions – BDL manufactures light torpedoes, whilst L&T

has expertise in tube torpedo launchers.

BDL Exploring possibilities of technology transfer with Thales with respect to the Star STREAK missile system.


RUSSIA

IglaStrelaS-400 Triumf2K12 Kub/KvadratAPR 3-E

INDIA

Invar, Konkurs, MILAN 2T(produced by BDL post TOT)

Light Weight Torpedo(produced by BDL)

EUROPE

MICABlackSharkExocetSea Eagle

ISRAEL

Barak 1Arrow 2SpikePython 5Spyder

NORTH AMERICA

HellFireHarpoonStingerHydra

MAJORSOLUTIONS

RUSSIA

INDIA - PRIVATE

EUROPE

ISRAEL

NORTH AMERICA

KEY PARTICIPANTS

INDIA - DPSU/Govt.



Key positives

Product offerings address 54% of the Indian guided missile and torpedoes market BDL is the leading DPSU in India in manufacturing guided missile systems. Its product offerings are capable of addressing 54% of the total guided missile and torpedoes market in India over 2017-26.

BDL’s product offerings can address 54% of the total missile market led by tactical missiles and torpedoes...

Segment Market

(US$ bn) % of total



Ballistic 0.7 3% - 0%

Tactical 19.6 80% 11.5 59%

Cruise 1.7 7% - 0%

Special mission 0.2 1% - 0%

Torpedo 2.2 9% 1.6 73%

Total 24.5 100% 13.1 54%

Unaddressed 19.4

...with strong presence in tactical missiles (largest segment) where it addresses 58% market of SAMs and ATGMs

Segment Market

(US$ bn) % of total



Surface to Air 9.8 49% 9.8 100%

Air to Surface 6.1 30% - 0%

Air to Air 1.8 9% - 0%

ATGM 1.7 9% 1.7 100%

Surface to Surface 0.6 3% - 0%

Tactical missiles 19.9 100% 11.5 58%


Developing new products and partners with DRDO BDL is planning to develop new products such as new-generation SAMs, ATGMs, and heavy-weight torpedoes to further increase its offerings. It is also the joint development partner with the DRDO for the next generation of ATGMs and SAMs. MoD has identified it as the production agency and the lead integrator for one of the new generation of SAMs and the nominated agency for the third-generation of ATGMs. Additionally, BDL has entered into license agreements, principles of cooperation, MoUs, and non-disclosure agreements with companies / organisations in France, Israel, Russia, and the UK for its existing products and for the development of new products. It is also exploring possibilities of technology transfer with Thales with respect to the StarSTREAK missile system

BDL partnership with DRDO and Foreign OEMs

Partner Type of agreement Scope of work

DRDO, GoI MoU Co-development of next generation man portable ATGM

DRDO, GoI MoU Co-development of next generation man portable SAM

DRDO, GoI MoU Co-development of next generation ATGM

DRDO, GoI MoU Enhancement of missile and other weapon support systems

Euro Missile, France Licence TOT Milan-2 ATGM and Milan-2T ATGM

KBP, Tula, Russia Licence TOT Konkurs ATGM and Konkurs-M ATGM


New infrastructure to aid execution of future orders Over the last five years, BDL has invested Rs 7bn for modernisation of its manufacturing plants. Its plants are equipped with robotic welding machines, four axis machines, flow-forming machines, vacuum furnace for heat treatment, automated electroplating shop, 3D-coordinating measuring machine, climatic chambers, and 800G acceleration measuring fixture. Its Hyderabad manufacturing unit has been automated for material handling and grain loading of SAMs. Its Vishakhapatnam plant is exclusively used for manufacturing torpedoes.



Rs 9.7bn of capex over last 5-6 years of which Rs 7bn is spent for modernisation of its manufacturing infrastructure facilities...


In order to address the expected demand of new products, BDL is setting up two new manufacturing facilities at: (1) Ibrahimapatnam, Telangana, for manufacturing SAMs (including new-gen SAMs), and (2) Amravati, Maharashtra, for manufacturing VSHORADMs. The company will be investing ~Rs 7bn over the next 3-4 years on these new facilities.

Planned new manufacturing facilities Location Products

Ibrahimapatnam, Telangana SAMs

Amravati, Maharashtra Very Short Range Air Defence Missiles (VSHORADMs)


It is also planning to automate production systems at its existing manufacturing facility in Hyderabad to increase the production of SAMs. It is also in the process of setting up a test-fire range in Rachakonda, Telangana, which will lead to operational advantages and cost efficiencies.

Exports market: An emerging opportunity GOI has set an ambitious target to export US$ 2bn worth of defence equipment by 2019. Consequently, policy changes have been made to ease exports. DPSUs have been allowed to export 10% of their annual production. The process of obtaining No Objection Certificates (NOCs) has also been streamlined, web-based, and time-bound.

BDL and L&T has entered into an agreement to export light torpedo solutions. BDL manufactures light torpedoes, whilst L&T has expertise in tube torpedo launchers.

1.3 1.2

2.9

2.2

1.4

0.7

0.0

0.5

1.0

1.5

2.0

2.5

3.0


(Rs bn) Capex (Rs bn)



Key risks

Large contracts could be prone to delays BDL is set to win three large contracts in the next three years – VSHORADS, a US$ 5bn project (including share of foreign OEM), MRSAM-Army, US$ 1.5bnm and Akash-Army, US$ 1.8bn. Given the large contract values, we see a risk of delays in award timelines, which is typically the case with such projects. In addition, the limited availability of funds for new schemes in the defence capital budget could further exacerbate delays. In fact, as per the recent Standing Committee report submitted to the parliament on the FY19 defence budget, the Army highlights that under-funding its budget share could result in the postponement of the VHSORAD program’s placement.

Budget approved is lower than the demand by armed forces... ___FY18___ ___FY19___

(Rs bn) Projection BE Allocation BE Allocation (%) Projection BE Allocation BE Allocation (%)

Army 425 252 59% 446 268 60%

Navy 286 193 68% 379 208 55%

Air force 620 336 54% 777 358 46%

Source: MOD, India Budget, PhillipCapital India Research

...consequently, VSHORAD should be impacted due to lack of funds to the army

Source: MoD, PhillipCapital India Research

BDL’s timeline for key order wins built into our estimates (Rs bn) FY19E FY20E FY21E FY22E

VSHORADMs 60 70 - -

Akash - Army - - 120 -

MRSAM - Army - - - 100

Akash - IAF 20 - - -

LRSAM - Navy 15 - 25 -

MRSAM - IAF - - 15 -

ATGMs 20 - 20 20

Torpedo 10 - - -

Total 125 70 180 120


Execution of new projects should be back ended Even though BDL would start winning mega projects from FY19 itself, material revenue contribution from these orders would only start from FY22. This is mainly because in the ToT projects (such as VSHORAD and MRSAM-Army) initially, execution happens directly by OEMs followed by domestic lead integrator – in this case BDL.



Risk to margins, which are at cyclically high levels We see a two-pronged risk to BDL’s EBITDA margins viz. a) Share of revenues from indigenously developed Akash SAM is expected to

reduce over the next two years, as the project reaches completion and the follow up order is still some time away. Akash contributed about 75% of BDL’s sales in FY17. Ever since its execution picked up, BDL’s margins have expanded 1,900bps between FY13 and FY17.

b) New order wins in the near term, such as VSHORAD (Rs 130bn) and MRSAM (Rs 100bn) would involve transfer of technology (ToT) initially, and should be low-margin projects.

BDL's EBITDA margins expanded 1,900bps over FY13-17, led by a pick up in execution of Akash


An example – look at the difference in work share in a ToT project currently being executed by BEL. As seen below, the value addition by the Indian lead integrator in the initial stages of the project is materially lower than the follow-on order.

Lower value addition by BEL in a recent ToT project TOT Phase-I TOT Phase-2

Outsourced (%) 62.0% 40.0%

Core product (%) 38.0% 60.0%

Blended EBITDA margin on that phase 13.8% 19.0%

Our margins for BDL incorporates negative operating leverage and lower margins on ToT projects


-1.2%

4.6%

9.9%

13.6%

17.9%

-5%

0%

5%

10%

15%

20%

-12

0

12

24

36

48


(Rs bn) Revenues (Rs bn) EBITDA margins (%)

13.6%

17.9% 17.8% 19.6%

16.7%

14.0%

0%

5%

10%

15%

20%

25%


EBITDA margin (%)



Relies on DRDO designed projects, no captive R&D strength to speak of BDL benefits from a strong relationship with DRDO and is part of the design and development stage of a project giving it a competitive advantage against other players. However, BDL has not yet developed in house design and development capabilities; its R&D expenditure is a meagre 0.7% of sales. This is low when compared to other DPSUs such as BEL (8.8% of sales) and HAL (7.4% of sales). In the long term, lack of contribution to a project’s know-how should reflect in a lower margin profile for BDL vs. other DPSUs that incur R&D investments.

R&D expenditure of BDL, BEL, and HAL


Delay in execution may lead to a penalty

Any delay in the supply of goods by BDL may lead to customers levying a charge of liquidated damages or invocation of the indemnity bond / performance bank guarantee (5-10% of the contract value). Moreover, BDL's contracts with MoD permit the latter to terminate the contract for any delay of more than 24 months after the scheduled delivery (unless attributable to force majeure) as well as for default in the event of any breach.

BDL has provided Rs 7bn for liquidated damages since FY13


0%

2%

4%

6%

8%

10%

BDL BEL HAL

R&D expenses % of gross sales FY17

0.3 0.6 1.1 2.5 1.9 1.0

2.6%

3.4%

3.9%

6.5%

4.1%

5.9%

2%

3%

4%

5%

6%

7%

0.0

0.5

1.0

1.5

2.0

2.5

3.0


(Rs bn) Liquidated damanges (Rs bn) % of Sales



Historical financial performance in charts

Order book depleted from FY11 due to absence of large new orders...

Revenue CAGR of 44% over FY13-17 led by execution of Akash missiles orders...


... resulting in strong growth in EBITDA because of execution-led operating leverage benefits

However, PAT CAGR at 24% due to decline in other income on lower cash balances


RoE expanded to 33% in FY17 from 31% in FY13, led by improved assets turnover

Generated Rs 10bn of operational cash flows over FY13-17


6.4

21.3

19.9

16.1

10.6

5.9

3.6 2.4 2.5

0

3

6

9

12

15

18

21

24

0

25

50

75

100

125

150

175

200

225

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Jan'18

(Rs bn) Order book (Rs bn) Book-to-bill (x)

Akash SAM for Army

0

10

20

30

40

50



44.0% CAGR

-1.2%

4.6%

9.9%

13.6%

17.9%

14.9%

-5%

0%

5%

10%

15%

20%

-2

0

2

4

6

8

10



2.8

3.6

4.4

5.6

6.6

1.7

0

2

4

6

8



24.3% CAGR

31.3% 30.9%

30.3%

32.1% 32.7%

25%

28%

31%

34%


RoE (%)

1.2

2.0

1.2

2.0

4.0

1.3

0.0

1.0

2.0

3.0

4.0

5.0






Expect strong orders over FY19-22 led by large orders for VSHORADs, Akash (IAF), and MRSAM (Army)…

...resulting in a 5x jump in order book


However, revenues CAGR at -12% over FY18-22 due to the initial slow pick up in execution of large order wins…

...and 16% decline in EBITDA on contraction in margins due to change in sales mix and negative operating leverage


PAT decline will be lower than contraction in EBITDA due to higher other income, led by advances on large orders...

...resulting in weak quality of earnings as other income would account for 63% of PAT in FY21 vs. 23% in FY17...


89.2

495.0

0

100

200

300

400

500

600

FY14-18E FY19-22e

(Rs bn) Order inflows (Rs bn)

88

444

-

100

200

300

400

500

OB

FY1

8E

VSH

OR

AD

s

Oth

er

ord

ers

Sale

s

FY1

9-2

0E

Aka

sh -

Arm

y

MR

SAM

-

Arm

y +

IAF

Oth

er

ord

ers

Sale

s

FY2

1-2

2E

OB

FY2

2E

(Rs bn)

37.9 46.3 44.6 47.5 29.5 27.8 0

10

20

30

40

50



-12.0% CAGR

13.6%

17.9% 18.2% 17.6%

14.5% 15.1%

5%

7%

9%

11%

13%

15%

17%

19%

21%

0

2

4

6

8

10



-15.7% CAGR

3.0

4.0

5.0

6.0

7.0



46%

23% 20%

22%

51%

63%

0%

10%

20%

30%

40%

50%

60%

70%





RoE to decline to 19% in FY21 from 33% in FY17 because of weak assets turnover...

... while operational cash flow to be muted at Rs 9.8bn


32.1% 32.7%

27.9% 27.2%

17.2% 18.6%

10%

15%

20%

25%

30%

35%


RoE (%)

2.0

4.0

3.2

2.6

0.7

3.4

0.0

1.0

2.0

3.0

4.0

5.0





Outlook and valuation

Initiate coverage with a Neutral rating In the near term, we believe that risks outweigh rewards for BDL. However,

reasonable valuations of 15x PE FY20 despite assuming an earnings decline over FY17-21,

coupled with decent ROEs of 19% even in FY21 at bottom-cycle earnings, and

prospects of Rs 475bn of order opportunities keep us at Neutral, as we believe that the above rationale would limit downside risks to valuations.

We use a mix of PE, DCF, and EV/OB to value BDL; target price of Rs 445

In BDL’s case, we face a unique scenario where earnings will see a negative trajectory over the next three years, but the company could potentially multiply its order book. In order to capture this peculiarity we adopted a hybrid valuation methodology – a mix of PE, DCF, and EV/Orderbook.

We currently assign 80% weight to PE and DCF-generated valuation, and ascribe a 20% weight to EV/OB. Based on this, we arrived at a FY20 based target price of Rs 445, implying an exit PE of 18x.

However, sometime over the next 18 months, BDL’s stock valuations will switch to EV/OB from PE, as the pace of orders increase, but earnings will remain suppressed due to execution of its legacy orderbook; then, we would increase our weight of the EV/OB valuation in our valuation methodology.

BDL - Weighted average target value Valuation methodology

Target multiple

EPS / OB (FY20E)

Value (Rs / share)

Weight share (%)

Value (Rs / share) Valuation basis

PE 13.0 25.4 330 40.0% 132 20% discount to global peers

DCF

468 40.0% 187 WACC 11.5% and terminal growth 5%

EV / OB 0.30 205.8 639 20.0% 128 25% discount to BEL average EV/OB

Target price

100.0% 447

Rounded off

445 Implied PE FY20 (x)

17.5


PE based valuation: 40% weight, Rs 330 We value BDL on 13x FY20 earnings at a 20% discount to global peers, to arrive at a target of Rs 330. We ascribe a higher weight of 40% to PE as it would reflect on the weak earnings profile of the company in the near term.

DCF based valuation – 40% weight – Rs 468

Given the long gestation timelines of execution for defence projects, we used DCF to capture the impact of execution of new orders – which is expected to be back-ended from FY22. Using 5% terminal growth and a WACC of 11.5%, we arrive at a value of Rs 468 and assign a 40% weight to this valuation.

DCF assumptions and valuation (Rs bn)

WACC (%) 11.5%

Terminal growth (%) 5.0%

NPV - FY21-27E 14

Terminal value 38

Total value 52

Less: Net debt - FY20E (34)

Equity value 86

Shares outstanding (mn) 183

DCF value (Rs per share) 468

Free cash flow to firm calculation

FCFF (Rs bn) FY20E FY21E FY22E FY23E FY24E FY25E

EBIT 3.46 3.17 3.89 5.97 7.49 9.30

Less: Taxes (1.18) (1.08) (1.32) (2.03) (2.55) (3.16)

NOPAT 2.29 2.09 2.57 3.94 4.94 6.14

Add: Depreciation 0.80 1.02 1.25 1.28 1.32 1.35

Less: Capex (3.10) (1.25) (0.50) (0.50) (0.50) (0.50)

FCFF (ex-changes in working capital) (0.02) 1.86 3.32 4.73 5.76 6.99




We even looked at EV/OB: 20% weight, Rs 640 We believe that as visibility on new orders increases, the stock valuation would follow orders and not near-term earnings. In order to capture this swing, we value BDL on EV/orderbook and pegged it at a 25% discount to BEL’s two-year forward EV/OB. We also assigned a lower weight of 20% compared to traditional valuation methods of PE and DCF to reflect the current lack of visibility on new orders.

BEL: Two-year forward EV/order book – average 0.4x


What would make us revisit our stance? BDL’s key valuation support is its strong order pipeline of Rs 495bn (US$ 7.6bn) over FY19-22. Any change in award timelines (advances or delays) will have a material impact on BDL’s stock price. We would closely monitor its order prospects for any change in our view.

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Ap

r-0

7

Oct

-07

Ap

r-0

8

Oct

-08

Ap

r-0

9

Oct

-09

Ap

r-1

0

Oct

-10

Ap

r-1

1

Oct

-11

Ap

r-1

2

Oct

-12

Ap

r-1

3

Oct

-13

Ap

r-1

4

Oct

-14

Ap

r-1

5

Oct

-15

Ap

r-1

6

Oct

-16

Ap

r-1

7

Oct

-17

2yr fwd EV/OB Average +1SD -1SD

+1SD 0.7x

Avg 0.4x

-1SD 0.1x



Global peer comparison

PE vs EPS CAGR - Indian peers





HAL

BEL

BDL

CSL

12

14

16

18

20

-20 -10 0 10 20

PE

FY2

0 (

x)


HAL

BEL

BDL

CSL

0.0

2.0

4.0

6.0

8.0

10.0

12.0

12 14 16 18 20

EV/E

BIT

DA

FY

20

(x)

Margin FY20 (%)

BDL

Boeing LM Raytheon

BAE

Thales

Leonardo

SAAB

5

7

9

11

13

15

17

19

21

(20.0) (10.0) - 10.0 20.0 30.0

PE

FY2

0 (

x)


BDL

Boeing LM Raytheon

BAE Thales

Leonardo

SAAB

2

4

6

8

10

12

14

10.0 12.0 14.0 16.0 18.0 20.0

EV/E

FY

20

(x)

Margin FY20 (%)



Global valuation comparison



Indian companies

Bharat Dynamics 44.6 47.5 29.5 8.1 8.3 4.3 18.2 17.6 14.5 6.1 6.4 4.7



Cochin Shipyard 24.0 32.4 39.5 4.6 5.7 6.2 19.0 17.5 15.8 3.9 4.9 5.1

Average - Indian

17.6 16.9 16.3 US companies

Boeing 92.6 97.4 103.1 11.8 13.7 15.1 12.8 14.1 14.6 7.0 8.8 10.0

Lockheed Martin 50.6 51.0 53.4 7.1 8.0 8.6 13.9 15.6 16.0 3.8 4.4 4.9

Raytheon 25.4 26.7 28.0 3.9 4.9 5.2 15.3 18.3 18.4 2.2 2.8 3.2

Average - US

14.0 16.0 16.4 European companies

BAE Systems 19.8 18.6 19.2 2.3 2.2 2.3 11.7 12.0 12.1 1.4 1.4 1.4

Thales 15.6 16.2 17.7 1.9 2.1 2.3 12.4 12.9 13.2 1.0 1.1 1.3

Leonardo Finmeccanica 11.6 11.8 12.3 1.6 1.6 1.7 13.8 13.7 14.0 0.4 0.5 0.6

SAAB AB 31.4 33.4 36.1 3.3 3.6 4.2 10.5 10.8 11.6 1.7 1.8 2.2

Average - European


14.6 15.0 15.0

Price Shares Mkt cap PE (x) EV/EBITDA (x) RoE (%)


Indian companies Bharat Dynamics 397 183 1,124 11.9 11.4 15.6 7.3 4.7 4.1 27.9 27.2 17.2



Cochin Shipyard 483 136 1,016 16.8 13.5 12.8 8.3 5.2 6.0 14.8 14.1 13.6

Average - Indian

19.1 17.9 16.2 11.0 8.3 7.1 18.8 18.2 16.7

US companies Boeing 326 587 1,91,321 31.9 23.2 19.5 16.4 14.0 12.6 1,948 385 216

Lockheed Martin 343 286 97,915 26.1 22.0 19.0 15.5 13.9 12.7 222.7 620.9 259.1

Raytheon 218 289 62,776 28.5 22.4 19.4 16.7 13.2 12.5 21.0 26.3 27.4

Average - US

28.9 22.5 19.3 16.2 13.7 12.6 21.0* 26.3* 27.4*

European companies BAE Systems 6 3,187 25,381 13.1 12.9 12.1 8.4 8.4 7.9 33.1 25.9 24.8

Thales 96 213 25,502 20.5 18.2 15.9 9.4 8.7 7.5 19.7 19.9 21.1

Leonardo Finmeccanica 9 578 6,717 12.5 10.8 9.1 5.0 4.9 4.5 9.5 9.6 10.8

SAAB AB 365 107 4,865 23.3 20.7 16.9 12.9 11.8 10.0 12.0 12.4 14.2

Average - European

17.4 15.7 13.5 8.9 8.5 7.5 18.6 17.0 17.7

Average - Global

21.2 18.3 16.1 11.7 9.8 8.7 19.0* 18.5* 18.4*




Annexure Frost & Sullivan has segmented the market into 5 major segments


Segment / sub segment Definition/ Brief Example

Ballistic Missile A missile delivery system, which follows a ballistic trajectory. Major part of its flight stage will be unpowered and governed by gravity and air friction. It may also have the capability to carry Multiple Independently Targetable Re-entry Vehicles (MIRVs). These missiles may be silo-launched, canister launched, ship launched or submarine launched. Some ballistic missiles (such as the Indian Dhanush) can perform mid-course missile correction manoeuvres.

• Minuteman ballistic missile systems of USA • Dongfeng missile systems of China

Intercontinental Ballistic Missile (ICBM)

Range over 5,500 kms • LGM-30 Minuteman II system of USA • Jericho III missile system of Israel

Intermediate Range Ballistic Missile (IRBM)

Range between 3,000 to 5,500 kms • DF-26 missile system of China • PGM-17 Thor missile system of USA (retired)

Medium Range Ballistic Missile (MRBM)

Range between 1,000 to 3,000 kms • Shaheen III missile system of Pakistan

Short Range Ballistic Missiles (SRBM)

Range between 300 to 1,000 kms • Jericho I of Israel • Grom missile of Ukraine (under development)

Tactical Ballistic Missile Systems (TBM)

Range of 500 kms or less • Nasr missile of Pakistan • 9K720 Iskander missile system of Russia

Tactical Missile Systems TMS are used to counter land, sea or air based threats. It has a shorter range and unlike ballistic missile, majority of its flight time is unguided.

• 9K720 Iskander • LORA

Surface to Surface Missiles (SSM)

Launched from man-portable packs, vehicle mounted, fixed or ship-based installations to destroy other stationary/mobile ground targets

• Lockheed Martin’s MGM-140 Army Tactical Missile System (ATacMS) used by USA Army

Surface to Air Missiles (SAM)

Launched from ground to destroy aircraft or other missiles under this category. Missile defence interceptors also fall in this category.

• MIM-104 Patriot • RIM-7 Sea Sparrow

Air to Air Missiles (AAM) Launched by air platforms intended to destroy other air targets in this category. These missiles may be visual range missiles or beyond visual range missiles. Certain modern Air to Air missiles are capable of mid mission course correction and active guidance.

• MBDA Meteor used in the Eurofighter Typhoons

Air to Surface Missiles (ASM)

Launched by air platforms intended to destroy other stationary or mobile ground targets

Anti Tank Guided Missiles (ATGM)

Man portable or platform launched missiles with a specific role of destroying armoured vehicles

• PARS 3 LR • FGM-148 Javelin

Cruise Missile Cruise missiles are used to destroy terrestrial targets and designed to glide at fairly constant speed in order to deliver heavy warheads with high precision. They can be hypersonic, supersonic or subsonic as far as speed is concerned.

• Tomahawk missile system of USA

Long Range With ranges in excess of 1000 kms • Kh-55 missile system of Russia

Medium Range With ranges in between 300 to 1000 kms • AGM-158C LRASM of USA • Babur missile system of Pakistan

Missile Systems and Torpedoes

Ballistic missile

Intercontinental (ICBM), Intermediate

range (IRBM), Medium range

(MRBM), Short range (SRBM), Tactical Ballistic Missiles

(TBM)

Tactical missile

Surface to Surface (SSM), Surface to Air

(SAM), Air to Air (AAM), Air to Surface

(ASM), Anti-Tank Guided Missiles

(ATGM)

Cruise missile

Long range, Medium range,

Short range

Special mission

Anti radiation, Anti Satellite,

Electro Magnetic Pulse

Torpedo systems

Light Torpedoes, Heavy Torpedoes



Short Range With range upto 300 kms • Nasr-1 missile system of Iran

Special Mission Missile These missiles are developed for a specific mission type. Standard missiles can also be modified to perform special missions

Raytheon’s Counter-electronics High-powered Advanced Missile Project (CHAMP) EMP weapon

Anti-Satellite Missiles Strategic military weapons used for destroying satellites Arrow-3 missile system used by Israel can be used for an exo-atmospheric interception role.

Anti-Radiation Missiles Detect enemy radio sources such as radar stations and home in on the target. They can be surface to surface, air to air or surface to air.

BAE System’s ALARM (Air Launched Anti-Radiation Missile) used by Saudi Arabia and UK

Electromagnetic Pulse Missiles

Missiles designed to produce a short burst of electromagnetic energy which will cripple or disable all electronic equipment.

Raytheon has tested an EMP missile weapon-Counter-electronics High powered Advanced Missile Project (CHAMP) in USA

Torpedo System Torpedoes are self-propelled weapons used to destroy or incapacitate ships, submarines and mines.

• Whitehead Alenia Sistemi Subacquei Blackshark torpedo system

Light Weight Torpedoes Warhead weight is less than 100 kg • Raytheon’s Mk 54 used by USA

Heavy Weight Torpedoes Warhead weight is greater than 100 kgs • Mark 48 torpedo used by USA





Net sales 46,301 44,582 47,494 29,474

Growth, % 22.3 (3.7) 6.5 (37.9)

Raw material expenses (30,195) (28,017) (30,027) (17,898)



EBITDA (Core) 8,293 8,127 8,346 4,262

Growth, % 61.6 (2.0) 2.7 (48.9)

Margin, % 17.9 18.2 17.6 14.5

Depreciation (622) (699) (762) (797)

EBIT 7,671 7,428 7,584 3,465

Growth, % 66.8 (3.2) 2.1 (54.3)

Margin, % 16.6 16.7 16.0 11.8

Interest paid (37) (38) (38) (39)

Other Income 2,298 1,841 2,159 3,623

Pre-tax profit 9,933 9,231 9,705 7,048

Tax provided (3,286) (3,139) (3,300) (2,396)

Net Profit (recurring) 6,647 6,093 6,405 4,652

Growth, % 18 (8) 5 (27)

Net Profit (reported) 4,903 6,093 6,405 4,652

Unadj. shares (m) 122 183 183 183

Wtd avg shares (m) 183 183 183 183


Cash & bank 17,380 13,617 33,919 55,365

Debtors 3,564 3,432 3,656 2,269

Inventory 22,511 20,888 22,387 13,344

Loans & advances - - - -

Other current assets 32,042 27,313 26,224 13,623

Total current assets 75,498 65,249 86,186 84,600

Investments 29 29 29 29


Less: Depreciation (1,812) (2,510) (3,272) (4,070)

Add: Capital WIP 1,312 1,812 3,212 6,212

Net fixed assets 8,967 9,669 11,207 13,509

Total assets 84,495 74,948 97,422 98,139

Current liabilities 57,472 48,730 66,704 66,848

Provisions 6,412 6,213 6,613 4,209

Total current liabilities 63,883 54,942 73,317 71,057

Non-current liabilities (1,513) (1,513) (1,513) (1,513)

Total liabilities 62,370 53,429 71,804 69,544

Paid-up capital 1,222 1,833 1,833 1,833

Reserves & surplus 20,903 19,686 23,785 26,762

Shareholders’ equity 22,125 21,519 25,618 28,595

Total equity & liabilities 84,495 74,948 97,422 98,139



Pre-tax profit 7,322 9,231 9,705 7,048

Depreciation 622 699 762 797

Chg in working capital (5,055) (2,456) 17,741 20,771

Total tax paid (3,349) (3,139) (3,300) (2,396)

Cash flow from operating activities (232) 2,532 22,788 22,636

Capital expenditure (1,360) (1,400) (2,300) (3,100)

Chg in investments - - - -

Cash flow from investing activities 31 441 (141) 523

Free cash flow (14,773) 1,132 20,488 19,536

Equity raised/(repaid) - (4,505) - -

Debt raised/(repaid) - - - -


Other financing activities (442) (38) (38) (39)

Cash flow from financing activities (1,662) (6,736) (2,344) (1,714)

Net chg in cash (1,863) (3,764) 20,303 21,445

Valuation Ratios


Per Share data

EPS (INR) 36.3 33.2 34.9 25.4

Growth, % 18.3 (8.3) 5.1 (27.4)


FDEPS (INR) 36.3 33.2 34.9 25.4

CEPS (INR) 35.8 37.1 39.1 29.7

DPS (INR) 8.6 10.0 10.5 7.6

Return ratios 32.1 30.0 30.0 30.0

Return on assets (%) 7.4 7.7 7.5 4.8

Return on equity (%) 32.7 27.9 27.2 17.2




Sales/Net FA (x) 6.3 5.7 6.0 3.9

Working capital/Sales (x) (0.1) (0.1) (0.4) (1.4)

Working capital days (45.5) (27.1) (161.8) (517.9)

Liquidity ratios

Current ratio (x) 1.2 1.2 1.2 1.2

Quick ratio (x) 0.8 0.8 0.9 1.0

Interest cover (x) 208.6 198.0 198.2 88.8


Total debt/Equity (%) - - - -

Net debt/Equity (%) (0.8) (0.6) (1.3) (1.9)

Valuation

PER (x) 10.9 11.9 11.4 15.6

PEG (x) - y-o-y growth 0.6 (1.4) 2.2 (0.6)

Price/Book (x) 3.3 3.4 2.8 2.5

Yield (%) 2.2 2.5 2.6 1.9

EV/Net sales (x) 1.2 1.3 0.8 0.6

EV/EBITDA (x) 6.7 7.3 4.7 4.1


DEFENCE SECTOR UPDATE & INITIATING

Stock Price, Price Target and Rating History (Bharat Electronics)

Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year.

Rating Criteria Definition

BUY >= +15% Target price is equal to or more than 15% of current market price

NEUTRAL -15% > to < +15% Target price is less than +15% but more than -15%

SELL <= -15% Target price is less than or equal to -15%.

B (TP 220)

B (TP 220)

B (TP 200)

120

130

140

150

160

170

180

190

200

J-17 F-17 A-17 M-17 J-17 A-17 O-17 N-17 J-18 F-18



Management Vineet Bhatnagar (Managing Director) (91 22) 2483 1919

Kinshuk Bharti Tiwari (Head – Institutional Equity) (91 22) 6246 4101

Jignesh Shah (Head – Equity Derivatives) (91 22) 6667 9735

Research

Automobiles

Engineering, Capital Goods

Pharma & Specialty Chem

Dhawal Doshi (9122) 6246 4128

Jonas Bhutta (9122) 6246 4119

Surya Patra (9122) 6246 4121

Nitesh Sharma, CFA (9122) 6246 4126

Vikram Rawat (9122) 6246 4120

Mehul Sheth (9122) 6246 4123

Agro Chemicals

IT Services

Raag Haria (9122) 6667 9943

Varun Vijayan (9122) 6246 4117

Vibhor Singhal (9122) 6246 4109

Strategy

Banking, NBFCs

Shyamal Dhruve (9122) 6246 4110

Naveen Kulkarni, CFA, FRM (9122) 6246 4122

Manish Agarwalla (9122) 6246 4125

Infrastructure

Neeraj Chadawar (9122) 6246 4116

Pradeep Agrawal (9122) 6246 4113

Vibhor Singhal (9122) 6246 4109

Telecom

Paresh Jain (9122) 6246 4114

Logistics, Transportation & Midcap


Consumer & Retail

Vikram Suryavanshi (9122) 6246 4111

Technicals


Media

Subodh Gupta, CMT (9122) 6246 4136

Preeyam Tolia (9122) 6246 4129


Production Manager

Vishal Gutka (9122) 6246 4118

Vishal Gutka (9122) 6246 4118

Ganesh Deorukhkar (9122) 6667 9966

Akshay Mokashe (9122) 6246 4130

Metals

Editor

Cement

Dhawal Doshi (9122) 6246 4128

Roshan Sony 98199 72726

Vaibhav Agarwal (9122) 6246 4124

Vipul Agrawal (9122) 6246 4127

Sr. Manager – Equities Support

Economics

Mid-Caps

Rosie Ferns (9122) 6667 9971

Anjali Verma (9122) 6246 4115

Deepak Agarwal (9122) 6246 4112

Sales & Distribution

Corporate Communications

Ashvin Patil (9122) 6246 4105

Asia Sales

Zarine Damania (9122) 6667 9976

Kishor Binwal (9122) 6246 4106

Dhawal Shah 8522 277 6747

Bhavin Shah (9122) 6246 4102

Sales Trader

Ashka Mehta Gulati (9122) 6246 4108

Dilesh Doshi (9122) 6667 9747

Execution

Archan Vyas (9122) 6246 4107

Suniil Pandit (9122) 6667 9745

Mayur Shah (9122) 6667 9945

Contact Information (Regional Member Companies)

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UNITED KINGDOM: King & Shaxson Ltd.

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AUSTRALIA: PhillipCapital Australia

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SRI LANKA: Asha Phillip Securities Limited

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Tel: (94) 11 2429 100 Fax: (94) 11 2429 199

www.ashaphillip.net/home.htm

INDIA

PhillipCapital (India) Private Limited

No. 1, 18th Floor, Urmi Estate, 95 Ganpatrao Kadam Marg, Lower Parel West, Mumbai 400013 Tel: (9122) 2483 1919 Fax: (9122) 6667 9955 www.phillipcapital.in

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http://www.phillipcapital.in/



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company (ies)covered in this report as of the end of the month immediately preceding the distribution of the research report. 3. The Research Analyst, his/her associate, his/her relative, and PCIL, do not have any other material conflict of interest at the time of publication of this

research report. 4. The Research Analyst, PCIL, and its associates have not received compensation for investment banking or merchant banking or brokerage services or for

any other products or services from the company(ies) covered in this report, in the past twelve months. 5. The Research Analyst, PCIL or its associates have not managed or co-managed in the previous twelve months, a private or public offering of securities for

the company (ies) covered in this report. 6. PCIL or its associates have not received compensation or other benefits from the company(ies) covered in this report or from any third party, in

connection with the research report. 7. The Research Analyst has not served as an Officer, Director, or employee of the company (ies) covered in the Research report. 8. The Research Analyst and PCIL has not been engaged in market making activity for the company(ies) covered in the Research report. 9. Details of PCIL, Research Analyst and its associates pertaining to the companies covered in the Research report:

Sr. no. Particulars Yes/No

1 Whether compensation has been received from the company(ies) covered in the Research report in the past 12 months for investment banking transaction by PCIL

No

2 Whether Research Analyst, PCIL or its associates or relatives of the Research Analyst affiliates collectively hold more than 1% of the company(ies) covered in the Research report

No

3 Whether compensation has been received by PCIL or its associates from the company(ies) covered in the Research report No

4 PCIL or its affiliates have managed or co-managed in the previous twelve months a private or public offering of securities for the company(ies) covered in the Research report

No

5 Research Analyst, his associate, PCIL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve months

No

Independence: PhillipCapital (India) Pvt. Ltd. has not had an investment banking relationship with, and has not received any compensation for investment banking services from, the subject issuers in the past twelve (12) months, and PhillipCapital (India) Pvt. Ltd does not anticipate receiving or intend to seek compensation for investment banking services from the subject issuers in the next three (3) months. PhillipCapital (India) Pvt. Ltd is not a market maker in the securities mentioned in this research report, although it, or its affiliates/employees, may have positions in, purchase or sell, or be materially interested in any of the securities covered in the report.

Suitability and Risks: This research report is for informational purposes only and is not tailored to the specific investment objectives, financial situation or particular requirements of any individual recipient hereof. Certain securities may give rise to substantial risks and may not be suitable for certain investors. Each investor must make its own determination as to the appropriateness of any securities referred to in this research report based upon the legal, tax and accounting considerations applicable to such investor and its own investment objectives or strategy, its financial situation and its investing experience. The value of any security may be positively or adversely affected by changes in foreign exchange or interest rates, as well as by other financial, economic, or political factors. Past performance is not necessarily indicative of future performance or results.



Sources, Completeness and Accuracy: The material herein is based upon information obtained from sources that PCIPL and the research analyst believe to be reliable, but neither PCIPL nor the research analyst represents or guarantees that the information contained herein is accurate or complete and it should not be relied upon as such. Opinions expressed herein are current opinions as of the date appearing on this material, and are subject to change without notice. Furthermore, PCIPL is under no obligation to update or keep the information current. Without limiting any of the foregoing, in no event shall PCIL, any of its affiliates/employees or any third party involved in, or related to computing or compiling the information have any liability for any damages of any kind including but not limited to any direct or consequential loss or damage, however arising, from the use of this document.

Copyright: The copyright in this research report belongs exclusively to PCIPL. All rights are reserved. Any unauthorised use or disclosure is prohibited. No reprinting or reproduction, in whole or in part, is permitted without the PCIPL’s prior consent, except that a recipient may reprint it for internal circulation only and only if it is reprinted in its entirety.

Caution: Risk of loss in trading/investment can be substantial and even more than the amount / margin given by you. Investment in securities market are subject to market risks, you are requested to read all the related documents carefully before investing. You should carefully consider whether trading/investment is appropriate for you in light of your experience, objectives, financial resources and other relevant circumstances. PhillipCapital and any of its employees, directors, associates, group entities, or affiliates shall not be liable for losses, if any, incurred by you. You are further cautioned that trading/investments in financial markets are subject to market risks and are advised to seek independent third party trading/investment advice outside PhillipCapital/group/associates/affiliates/directors/employees before and during your trading/investment. There is no guarantee/assurance as to returns or profits or capital protection or appreciation. PhillipCapital and any of its employees, directors, associates, and/or employees, directors, associates of PhillipCapital’s group entities or affiliates is not inducing you for trading/investing in the financial market(s). Trading/Investment decision is your sole responsibility. You must also read the Risk Disclosure Document and Do’s and Don’ts before investing.

Kindly note that past performance is not necessarily a guide to future performance.

For Detailed Disclaimer: Please visit our website www.phillipcapital.in

For U.S. persons only: This research report is a product of PhillipCapital (India) Pvt Ltd., which is the employer of the research analyst(s) who has prepared the research report. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S.-regulated broker-dealer and therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances, and trading securities held by a research analyst account.

This report is intended for distribution by PhillipCapital (India) Pvt Ltd. only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the U.S. Securities and Exchange Act, 1934 (the Exchange Act) and interpretations thereof by the U.S. Securities and Exchange Commission (SEC) in reliance on Rule 15a 6(a)(2). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated, and/or transmitted onward to any U.S. person, which is not a Major Institutional Investor. In reliance on the exemption from registration provided by Rule 15a-6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain

business with Major Institutional Investors, PhillipCapital (India) Pvt Ltd. has entered into an agreement with a U.S. registered broker-dealer, Decker & Co, LLC. Transactions in securities discussed in this research report should be effected through Decker & Co, LLC or another U.S. registered broker dealer.

If Distribution is to Australian Investors This report is produced by PhillipCapital (India) Pvt Ltd and is being distributed in Australia by Phillip Capital Limited (Australian Financial Services Licence No. 246827).

This report contains general securities advice and does not take into account your personal objectives, situation and needs. Please read the Disclosures and Disclaimers set out above. By receiving or reading this report, you agree to be bound by the terms and limitations set out above. Any failure to comply with

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