Buy Hindustan Aeronautics Ltd For Target Rs.819 - HDFC Securities
Hindustan Aeronautics Ltd. (HAL) is the largest Defence Public Sector Unit (DPSU) and has been conferred with “Navratna” status by the Government of India (GOI) in June 2007. HAL is of strategic importance to the Indian defence forces comprising the Indian Army, Indian Airforce, Indian Navy and Indian Coast Guard, on account of it being sole domestic supplier of aircrafts, helicopters, engines, avionics and other accessories. Both military and commercial aerospace sectors have good growth potential in India and the defence budget allocation has been continuously increasing over the years.
The GoI’s increased focus on indigenisation with the Make in India policy and the establishment of defence corridors and mandatory offset policy for defence procurement by GoI (though diluted recently), augur well for the company’s future growth. HAL has a robust order book of Rs. 52,965 crore which translates into ~2.4x FY20 revenues. HAL anticipates new orders for 83 light-combat aircraft and 15 light-combat helicopters in the near term. Recently, in order to promote the defence industry and boost indigenization, Government has announced restrictions on import of 101 weapons and military platforms including light combat helicopters, transport aircraft, conventional submarines and cruise missiles by 2024. As per the estimates, domestic defence industry would receive contracts worth almost Rs. 4 lakh crore within the next five to seven years as a result of the decision to prune the import list.
Valuations and View:
Hindustan Aeronautics Ltd. (HAL) has strong order book of Rs. 52,965 crore as on March 31, 2020; which translates into ~2.4x FY20 revenues. Order book is a key indicator for the revenue visibility for the company. The effect of pandemic on Defence aerospace is not as severe as compared to other industries. The company also earns large chunk of revenues and profit in the fourth quarter, thereby facing seasonality. The execution of orders will face some headwinds due to the pandemic as there will be delay or deferral in a few projects. The company also faces stress in working capital cycle due to the receivables issues as receivables continues to rise. The increasing trend in ROH (Repair and over-hauling) order book where the gross margins are relatively higher augurs well for the company.
The government’s Make in India and Aatmanirbhar Bharat initiatives along with rising spends for modernizing defence aerospace equipment will support earnings growth in the coming years. HAL was listed on stock exchanges in March 2018, government held 89.97% stake in the company, which has been reduced to 75% post recent OFS.
As per the orders which are in pipeline, the MD of HAL feels that it will double the order book position from the present that is around Rs 52,900 crore to more than 1 lakh crore by end of FY21. However the margins for all new orders will be at 7.50 percent which is down from 10 percent which was earlier. Unless the company wins large platform orders soon revenue visibility may not improve.
The stock is currently trading at ~9.2x FY22E earnings. We feel investors can buy stock on dips to Rs.647-655 band (8.75xFY22E EPS) and add more on dips to Rs.573-581 band (7.75xFY22E EPS) for base case target of Rs. 745 (10.0x FY22E EPS) and bull case target of Rs. 819 (11.0x FY22E EPS) over the next two quarters.
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