HAL IPO Analysis: Clear skies ahead for this public-sector defence major

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India’s largest defence public-sector company Hindustan Aeronautics (HAL) has many things going for it. The maker of the indigenous light combat aircraft or the Tejas will be the biggest beneficiary of rising defence budgets and the ‘Make in India’ programme, as 60 per cent of India’s defence-related requirements are currently met through imports. With the defence acquisition council clearing capital acquisitions to the tune of Rs 820 billion, the company’s products, which range from light combat aircraft to helicopters and trainers, stand to benefit.

The company, which gets revenues from products and services, has a hefty order book of Rs 685 billion. This is just under four times its FY17 sales and offers revenue visibility, given average execution period of 24-30 months. Going ahead, in the near term, there are two new order possibilities. The company is looking to supply 83 light combat aircraft (LCA Mk1A) and 15 light combat helicopters which are in the request-for-proposal stage. If the company gets a go-ahead, its order book would get a substantial boost, as the LCA order is worth about Rs 600 billion, and the helicopter contract value is pegged at Rs 45 billion.

The margin expansion for the company (first half of FY18 at 15 per cent) could come through operating leverage and cost advantage, given that the plants and research facilities are located in India. A higher level of indigenisation, currently at 60-70 per cent of the content by value, could also improve profitability. The company is debt-free as most of the working capital is funded by customers, who make upfront payments. In fact, of the Rs 110 billion cash on the balance sheet, Rs 90 billion is coming from customer advances.

Though the company had revenues of Rs 185 billion in FY17, given the order flow and revenue recognition happening towards the end of the project, sales can be lumpy. The first half of FY18, for example, has sales of only Rs 52.7 billion, though the company indicated the second half typically was better than the first and so sales should look up.

However, this lumpy nature of revenues makes valuing the company on the basis of the latest numbers difficult. While the company is valued at 16 times its diluted FY17 earnings at the upper end of the pricing band, it is 53 times the annualised FY18 revenues. With Bharat Electronics, another defence public-sector player, valued at 23 times its trailing earnings per share estimates, the issue price of HAL is reasonable, with retail customers getting a Rs 25 discount.

While the defence services are its key customers and account for over 90 per cent for revenues, the company is diversifying into the civilian segment could open up new revenue opportunities. HAL has started the production of the civilian variant Dornier Do-228 aircraft, and given a thrust on connecting the regional routes through the Udaan scheme, there could be good demand for these aircraft, believes the company’s management. Beyond this, the company is diversifying into new areas such as the indigenous design and development of aircraft and helicopter engines, as well as unmanned aerial vehicles. The development of indigenous aircraft and helicopter platforms also opens up the export market of not just the core products but also spares and services. This should improve the proportion of export revenues, currently at under 3 per cent, and diversify its risk.

In addition to indigenous production, the company also gets revenue from manufacture and maintenance of products under licence from defence companies in Russia and Western countries. 

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