Recommendation Subscribe BACKGROUND Price Band Bidding Date Book Running Lead Manager Registrar Sector Rs.1215 Rs.1240 16-20 March SBI Capital Markets, Axis Capital Ltd Karvy Defense Capital Goods Minimum Retail Application- Detail At Cut off Price Number of Shares 12 Minimum Application Money Rs. 14,580 Discount to retail Payment Mode Rs. 25 per share Consolidated Financials (Rs Cr) FY16 FY17 ASBA Total Income 16759 17952 EBITDA 3519 4068 PAT 2004 2625 Lower Upper Valuations Band Band Market Cap (Rs Cr) 40628 41464 EPS* 78.5 78.5 P/E Ratio* 15.5 15.8 EV/ EBITDA* 7.6 7.8 Enterprise Value (Rs Cr) 30868 31704 *calculated on FY17 Post Issue Shareholding Pattern Promoters 89.8% Institutions 5.0% Bodies Corporates & Public 5.2% Offer structure for different categories QIB (Including Mutual Fund) 50% Non-Institutional Investors 15% Retail 35% Post Issue Equity (Rs. in cr) 361.5 Issue Size (Rs in cr) 4144-4229 Face Value (Rs) 10 Jehan Bhadha (+91 22 6273 8174) Research Analyst jehankersi.bhadha@nirmalbang.com Hindustan Aeronautics Limited (HAL) is the largest Defence Public Sector Undertakings ( DPSU ) in terms of value of production. HAL is engaged in design, development, manufacture, repair, overhaul, upgrade and servicing of a wide range of products including Aircraft, Helicopters, Aero-Engines, Avionics, Accessories and Aerospace Structures. HAL relies on indigenous R&D as well as on technology transfer and license agreements to manufacture their products. 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 stood at Rs.68,461 Cr (3.8x FY17 Sales). Details and Objects of the Issue The entire public issue consists of offer for sale of Rs. 4229 Cr by the GoI. Investment Rationale: Leadership position in the Indian aeronautical industry Rising mix of fast growing Services business Expansion into engines, UAVs, civil aircrafts and exports Proven design and development capabilities Strong financial track record with robust order book position Valuation and Recommendation HAL is the largest defense PSU and the only one to manufacture defense aircrafts and helicopters. It thus faces no competition domestically and only from international players. HAL has the following positives in its favor - wide portfolio comprising of indigenous and licensed products, rising share of the fast growing services business (40% mix today from 21% in FY15), long credible history of proven design and development capabilities, expansion and diversification into new growth areas of engines, UAVs, civil aircrafts and exports, strong balance sheet and a robust order book to sales of 3.8x. HAL is being offered at a valuation at PE of 15.8x FY17 (vs. domestic peer average of 22.6x) and EV/EBITDA of 7.8x FY17 (vs. domestic peer average of 16.1x). Thus based on the business capabilities, industry growth prospects and valuations, we believe HAL is attractively priced and recommend subscribing to the issue. Financial Snapshot FY15 FY16 FY17 H1FY18 Net Revenues 15648 16759 17952 5173 Growth 7% 7% EBIDTA 3048 3519 4068 830 EBITDA Margins 19.5% 21.0% 22.7% 16.1% PAT 994 2004 2625 391 Growth 102% 31% ROCE 11.0% 27.9% 25.8% EV/EBIDTA @ Rs 1240 7.8 P/E @ Rs 1240 15.8 P/BV @ Rs 1240 3.3 Source: Company data, NB Research H1:H2 mix in HAL s case is ~25:75; to that extent, annualizing the numbers shall not give the right perspective. 1
Investment Rationale Leadership position in the Indian aeronautical industry with strong GoI support HAL is the largest Defence Public Sector Undertakings ( DPSU ) in terms of value of production in the Indian defence sector according to the MoD. They have their longstanding relationships, particularly with the Indian Defence Services and the DRDO as well as with various academic institutions and regulatory agencies. They have also developed a deep knowledge base and understanding of the aeronautical industry, particularly in India. The GoI is the promoter of the company and HAL derives a substantial portion of their revenue from the Indian Defence Services (93% of sales in FY17). HAL has cultivated a relationship of trust and reliability with their customers, including the GoI and the Indian Defence Services which allows HAL to understand their requirements and generate products and services which are responsive to their demands. Diversified product portfolio HAL s products portfolio includes fighter aircraft, trainer aircraft, transport aircraft, military helicopter and civil helicopters and their engines, avionics and accessories (such as special test equipment and ground handling equipment and ground support equipment), which are both indigenously designed or manufactured under license. INDIGENOUS PRODUCTS (~2/3 rd of product sales) Light Combat Aircraft Tejas Jaguar DARIN-III Upgrade Mirage 2000 Upgrade ALH Dhruv ALH MkIV Rudra Cheetal Light Combat Helicopter LICENSED PRODUCTS (~1/3 rd of product sales) Sukhoi Su-30 MKI Dornier-228 Hawk Mk-132 Aircraft Cheetah Chetak Lancer Source: Company 2
Rising share of Services revenues augurs well for future growth visibility due to its counter cyclical nature HAL intends to increase its presence in the high value services market, given its countercyclical nature and opportunities for sustained growth. They intend to leverage the opportunities arising from the rapid expansion of the defense fleet. As a result, HAL has developed a wide range of value added and customised services that customers can select. FY15 FY16 FY17 H1FY18 Product Revenue 12194 12892 12393 3049 Growth 6% -4% Mix in total revenue 78% 75% 67% 58% Service Revenue 3345 4095 5816 2114 Growth 22% 42% Mix in total revenue 21% 24% 31% 40% Others 109 172 346 114 Total Gross Revenue 15648 17159 18555 5277 Growth 10% 8% Source: Company, NB Research Tejas to be an important growth driver for HAL The Light Combat Aircraft ("LCA", also known as Tejas) is a single-engine, light weight and multi-role supersonic fighter. It has a quadruplex digital fly-by-wire flight control system with associated advanced flight control features. The aircraft, with its delta wing, is designed for air combat and offensive air support with reconnaissance. Currently, HAL has capacity to manufacture 8 Tejas LCAs per annum which is slated to increase to 16 shortly, which would propel growth for HAL. (The approximate cost of a Tejas Mark I aircraft is ~Rs. 160 Cr and that of Tejas Mark IA is ~Rs. 240 Cr). Expansion and diversification into new growth areas of engines, UAVs, civil aircrafts and exports In order to meet the demand for aircraft and helicopter engines, HAL has initiated the indigenous design and development of the Hindustan Turbo Fan Engine ( HTFE-25 ), a 25 kn thrust class turbofan engine, and the Hindustan Turbo Shaft Engine ("HTSE-1200"), a 1,200 KW shaft power engine. In addition, they have initiated the indigenous design and development of a mini UAV (Unmanned Aerial Vehicle) of the 8 kilograms class to meet the emerging requirements of military, paramilitary, police and civil sectors, and intend to subsequently enter into the market of larger UAVs with the Rustom-II medium-altitude, long-endurance UAV which they are jointly developing with the Aeronautical Development Establishment (ADE). Moreover, given the growth in civil aviation in India, an opportunity exists for them to position the Dornier Do-228 aircraft for civil application. As the development of their indigenous aircraft and helicopter platforms continue to progress and mature, HAL also intends to expand their export sales of these products as well as aerostructures, avionics, spares and services in international markets. 3
Proven design and development capabilities HAL has 11 dedicated R&D Centres and these R&D Centres are capable of developing a wide range of products, upgrading products with combat operational capability and operational performance and maintaining a pipeline of products to meet their future needs. These R&D Centres have facilities for research and prototype activities and are co-located with their production divisions to provide effective concurrent manufacturing, design and development support. Their design capabilities provide them with a significant competitive advantage in the Indian aeronautical industry. The R&D Centres are approved by, among others, the Department of Scientific and Industrial Research and the Centre for Military Airworthiness and Certification (CEMILAC). HAL conducts research, design and development activities under customer funded contracts as well as their own independent funds. For H1FY18 and FY17 and FY16, the research, design and development expenses were Rs. 510 Cr, Rs. 1,284 Cr and Rs. 1,191 Cr, respectively, which accounted for 9.7%, 6.9 % and 6.9%, respectively of their revenue from operations. Strong financial track record with robust order book position HAL has demonstrated a strong financial track record. As of September 30, 2017, HAL had cash and cash equivalents of Rs.11,699 Cr. The company has grown its net sales and operating profits at a CAGR of 7% and 16% respectively over FY15-17 and generated an average ROCE of 27% over the same period. As of December 31, 2017, HAL s order book stood at Rs.68,461 Cr (3.8x FY17 sales) thus providing strong visibility of earnings growth in coming years. Concerns Competitive intensity to rise in the long run GoI is encouraging private companies to enter and participate in defense contracts. In May 2017, the Government has introduced a strategic partnership model under DPP 2016 (the "DPP Strategic Partnership Model") under which the GoI seeks to identify a few Indian private companies as strategic partners who would initially tie up with shortlisted foreign OEMs to manufacture military platforms and equipments. These policies have raised the level of competition and pose a threat to the growth of HAL, although in the long run. Tepid revenue momentum Although HAL has a robust order book of Rs. 68,461 Cr which is 3.8x its FY17 sales; we do not expect a significant acceleration in sales in coming years owing to the slow pace of execution as well as the longer delivery schedule of orders (~4 years). Over FY15-17, HAL s net sales have grown at a meager pace of 7% CAGR. 4
Valuation and Recommendation We note that HAL s capabilities in manufacturing and servicing of defense aircrafts and helicopters makes it a direct comparable to established International defense players. HAL is the largest DPSU and the only one to manufacture defense aircrafts and helicopters. It thus faces no competition domestically and only from international players. HAL has the following positives in its favor - wide portfolio comprising of indigenous and licensed products, rising share of the fast growing services business (40% mix today from 21% in FY15), long credible history of proven design and development capabilities, expansion and diversification into new growth areas of engines, UAVs, civil aircrafts and exports, strong balance sheet and a robust order book to sales of 3.8x. HAL is being offered at a valuation at PE of 15.8x FY17 (vs. domestic peer average of 22.6x) and EV/EBITDA of 7.8x FY17 (vs. domestic peer average of 16.1x). Thus based on the business capabilities, industry growth prospects and valuations, we believe HAL is attractively priced and recommend subscribing to the issue. Peer Comparison W.C / Sales Total Asset Turns EBITDA Margins ROE OB / Sales PE EV/EBITDA Sales D/E Domestic - FY17 figures in Rs Cr Bharat Electronics 8654 0.0 12% 1.9 21.7% 17.6% 4.7 23.5 18.9 Cochin Shipyard 2059 0.1-16% 0.6 18.5% 16.8% 3.9 21.6 13.3 Average 0.0-2% 1.3 20.1% 17.2% 4.3 22.6 16.1 Hindustan Aeronautics 17952 0.0 14% 2.2 15.9% 31.2% 2.2 11.3 7.9 International CY17 figures in USD Bn Lockheed Martin 51.1 NA 2% 1.1 13.9% 16.3% 2.0 26.0 15.5 Raytheon 25.4 3.1 4% 0.8 15.3% 20.2% 1.3 25.5 15.0 BAE Systems* 18.5 6.7 7% 0.8 10.2% 35.2% 2.1 17.1 10.5 Thales* 14.9 4.9 8% 0.7 11.7% 20.4% 2.0 21.3 9.3 Kongsberg Gruppen* 14.7 3.0-18% 0.7 8.4% 8.2% 4.3 37.6 18.5 SAAB* 3.8 3.0-22% 0.8 9.5% 11.7% 3.4 26.3 18.2 Average 4.1-3% 0.8 11.5% 18.7% 2.5 25.6 14.5 Source: Company Data, Morningstar, Nirmal Bang Research *Denotes TTM figures Note: Working Capital excludes cash and cash equivalents 5
Financials P&L (Rs. Cr) FY15 FY16 FY17 H1FY18 Balance Sheet (Rs. Cr) FY15 FY16 FY17 H1FY18 Net Revenue 15648 16759 17952 5173 Share Capital 482.0 361.5 361.5 361.5 % Growth 7% 7% Reserve & Surplus 14,362 10,671 12,198 12,582 COGS 8249 8613 9206 1961 Networth 14,844 11,032 12,559 12,944 % of Revenues 52.7% 51.4% 51.3% 37.9% Total Loans 452 477 1,394 413 Employee Cost 3281 3274 3570 1798 Long term provisions 2,573 2,483 2,030 1,921 % of Revenues 21.0% 19.5% 19.9% 34.8% Adv & Milest. Receipts 38,110 35,942 28,909 31,570 Other expenses 1070 1352 1107 583 Trade payable 2,271 2,151 1,797 2,091 % of Revenues 6.8% 8.1% 6.2% 11.3% Deferred Tax Liabilities 661 815 960 960 EBITDA 3048 3519 4068 830 Other Current Liab 1,039 994 1,026 884 EBITDA Margin 19.5% 21.0% 22.7% 16.1% Short term provisions 2,472 2,638 2,878 3,061 Provisions 2197 1051 812 352 Total Current Liab. 43,891 41,725 34,610 37,606 Depreciation 883 863 713 258 Total Equity & Liab. 62,420 56,532 51,552 53,843 Other Income 1713 1608 1059 390 Fixed Assets & CWIP 7,341 7,951 8,741 8,878 Interest 8 0 10 1 Investments in JVs 195 190 205 204 PBT 1673 3213 3592 610 Other Invests. & L&A 622 778 848 871 Tax 679 1209 967 219 Other non Curr. assets 1,730 1,888 1,578 1,871 Tax rate 41% 38% 27% 36% Bank - - - - PAT 994 2004 2625 391 Cash 17,671 13,303 11,153 11,699 Adj. PAT Margin 6.4% 12.0% 14.6% 7.6% Inventories 24,953 23,982 21,321 22,184 % Growth 102% 31% Debtors 6,051 4,837 4,221 4,265 EPS (Post Issue) 29.7 59.9 78.5 Short term Advances 176 98 99 107 Performance Ratios FY15 FY16 FY17 H1FY18 Other Current assets 3,681 3,506 3,387 3,763 EBITDA Margin (%) 19.5% 21.0% 22.7% 16.1% Total Assets 62,420 56,532 51,552 53,843 PAT Margin (%) 6.4% 12.0% 14.6% 7.6% Cash Flow (Rs. Cr) FY15 FY16 FY17 H1FY18 ROE (%) 7% 18% 21% EBITDA 3,048 3,519 4,068 830 ROCE (%) 11.0% 27.9% 25.8% Provisions & Others (580) 580 264 30 Net D/E (x) -1.2-1.2-0.8-0.9 Op. profit before WC 2,468 4,099 4,332 860 Sales Growth (%) 7% 7% Change in WC 1,514 (90) (3,700) 1,441 EBITDA Growth (%) 15% 16% Less: Tax (1,065) (861) (1,037) (384) PAT Growth (%) 102% 31% CF from operations 2,917 3,148 (405) 1,917 Turnover Ratios FY15 FY16 FY17 H1FY18 Addition to assets (917) (1,636) (1,581) (420) Debtors Days 141 105 86 (Invest.)/Maturity of Dep (10,183) 2,983 4,596 (116) Inventory Days 582 522 434 CF from Investing (11,100) 1,347 3,014 (536) Creditor Days 100 91 71 Buyback of shares - (5,266) - - Asset Turnover (x) 1.0 1.5 1.3 Loan from banks (679) - 950 (950) Valuation Ratio FY15 FY16 FY17 H1FY18 Dividend Paid (576) (614) (1,104) (0) Price/Earnings (x) 15.8 Interest paid (8) - (10) (1) EV/EBITDA (x) 7.8 CF from Financing (1,264) (5,880) (164) (951) Price/BV (x) 3.3 Net Change in cash (9,447) (1,385) 2,446 430 Mkt cap/sales (x) 2.3 Cash at beginning 27,118 14,688 8,708 11,270 EV/Sales (x) 1.8 Cash at end 17,671 13,303 11,153 11,699 Source: Company Data, Nirmal Bang Research Note: As H1:H2 mix is ~25:75, we believe annualizing the numbers shall not give the right perspective. 6
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