Investment Shastra

Hindustan Aeronautics Ltd (HAL) IPO: Good company; Modest valuations

IPO Details:

  • Issue size:  Rs.4,113 Cr – 4198 Cr
  • No. of shares:  34,107,525 Equity Shares
  • Price band:  Rs. 1,215 – 1,240
  • Bid Lot:  12 Shares and in multiple
  • Retail & Employee Discount:  Rs.25/per share
  • Issue opens on:  Friday, 16th March’18
  • Issue closes on:  Tuesday, 20th March’18

Objective of the issue
This is an offer for sale of Equity Shares by the Selling Shareholder i.e. The Government of India, the proceeds from this Offer will not be received by the company.

About the Company
Hindustan Aeronautics Limited (“HAL”) has been conferred with the “Navratna” status by the GoI in June 2007, and is the largest DPSU in terms of value of production according to the MoD Annual Report 2016-2017. It is the 39th largest Aerospace Company in the world in terms of revenue (in USD million) in 2016 according to Flight International. HAL is engaged in the design, development, manufacture, repair, overhaul, upgrade and servicing of a wide range of products including, Aircraft, Helicopters, Aero-Engines, Avionics, Accessories and Aerospace Structures.

Their operations are organised into 5 complexes, namely the Bangalore Complex, MiG Complex, Helicopter Complex, Accessories Complex, and Design Complex, which together include 20 production divisions and 11 Research and Design centres (“R&D Centres”) located across India. HAL is relying on indigenous research as well as enters into technology transfer and licence agreements to manufacture their products. In addition, they have entered into 13 commercial joint ventures to grow their operations.

HAL has a sustained track record of profitability and has paid dividends every year for over 4 decades. As of December 31, 2017, the order book was Rs.68,461 crore, which generally includes products and services to be manufactured and delivered and excludes anticipated revenues from their joint ventures and subsidiaries.

In addition to sales to the Indian Defence Services, which accounted for 91.4%, 93.3%, 94.2% and 92.6% of their total sales from sales to the Indian Defence Services in the 6 month period ended September 30, 2017 and in the Financial Years 2017, 2016 and 2015, respectively.

HAL sell their products and provide services to state governments, para-military forces and corporates. In addition, during the Financial Year 2017, HAL exported their products and services, primarily spares, to more than 13 countries. During the 6 month period ended September 30, 2017 and during the Financial Years 2017 and 2016, exports of products and services accounted for 3%, 2.6% and 2.7%, of the revenue from operations (net of excise duty) respectively.

MoneyWorks4me Opinion

HAL has very good capability and talent. However, its scaling up ability is quite limited to orders from Indian Air force. We have seen the company doesn’t cater to other markets or private players. Government willingness to grow the business is low.

Order book is Rs 68,000 Cr as on Dec’17. This might look high but it has been above Rs. 60,000 Cr+ since 2013. We haven’t seen much of help in terms of execution. Defense orders are large but slow moving. While we do have visibility of revenues over 3-5 years, but the speed of execution remains uncertain.

Most of the contracts are cost plus contracts. This makes is easy to forecast gross margins. We believe that the company can sustain profitability. After excluding other income from profits and accumulated depreciation from investments, its return on investment is around 20-30% across years. This is real return on investment as opposed to accounting ROE. However, if we see the growth, the company has no opportunity to redeploy profits. This leads to poor returns on reinvestment. We believe after getting listed the company would return cash through dividends or shares buyback.

Considering upper cap of IPO bid price, market cap is coming around Rs. 42,000 Cr or Rs. 31,000 Cr excluding cash. Excluding other income and including only maintenance capex, we believe the stock trades at around 15-17X Earnings per share. We find these valuations reasonable.

We believe that the company is currently operating at high margins. This may or may not last when the execution slows. This would have downside risk to company’s stock price. The government’s push of Make in India or private partnerships may give more upside to revenues. But, the government policies are very dynamic depending on who is the ruling party.

One can earn 10% CAGR in base case and 15-17% CAGR in best case scenario. But due to government holding and low liquidity, this company may get neglected by the market at times which could make it volatile. We usually prefer growing companies with higher ROCE. This company does have high ROCE but less opportunity to deploy the capital. We believe having modest allocation of 3% of portfolio for now is fair for such a company.

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