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A defence unicorn in making

Established in 1985, Data Patterns is among the few vertically integrated defence and aerospace electronics solutions provider having design capabilities across the entire spectrum (air, land and sea). Its capabilities span across avionics, missile systems, radars, electronic warfare, satellites and communications. We believe it will be a key beneficiary of decadal growth opportunity in defence electronics market (16% CAGR), thrust on local procurement (imports >60%) and increased usage of electronics (25-35% of the cost of platforms currently)

Its strength lies in designing complex products with reusable building blocks (military grade COTS), which allows the company to keep low development costs and win a large number of orders on single vendor basis, thus raising entry barriers for competitors. Over FY18-21, its order book has posted a 41% CAGR, reaching INR 4.9 bn (2.2x sales) and is poised for robust growth by 18% CAGR the next 3 years given a) progress of orders from development to production phase, b) expansion of scope of orders to subsystems integration vs products, and c) growth in areas like nano satellites and exports.

We believe expansion in its manufacturing base (doubling of floor area) and an experienced management team (average experience of 20yrs+) with skilled employee base of 500+ engineers (of 818 total employees) will help the company achieve sales and EPS CAGR of 28% and 31% CAGR respectively, over FY21-24E. With the recent fund infusion of INR 3bn, easing out of NWC cycle, we expect the company to deliver healthy RoE/RoIC of 18%/29% by FY24E. We initiate coverage on Data Patterns with a BUY rating and TP of INR800 (30x FY24E EPS), implying 19% upside. Key risks: Budgetary cuts or delays by the government and technology disruption

Robust order book buildup; high share of single vendor contracts depicts business strength: Data Patterns reported strong order book growth of 41% CAGR over FY18-21, led by progress of large orders from development to production phase, particularly in EW and radars space. Order book at end Dec’21 stood at INR 5.8 bn (1.9x TTM sales), led by a healthy mix of orders from MoD, BrahMos, DRDO, ISRO, HAL etc. We expect the company to maintain moat around its business as more than 50% of forecasted revenue consists of single vendor contracts, resulting in better revenue as well as margin visibility.

Adding scale through systems integration; diversifying risk through nano satellites and exports: The Company expects to gain scale as it undertakes systems integration work, currently the domain of DPSUs, with in-house low cost design using reusable building blocks (COTS). Further, 30% of revenue is currently being derived from space/exports, diversifying risks from domestic defence budget allocation. These segments are likely to be ramped up faster through new products (nano satellites) and government push for defence exports (40%+ CAGR forecasted)

Beneficiary of defence indigenization opportunity: We believe Data Patterns is well placed to benefit from decadal growth opportunity in defence electronics (16% CAGR), thrust on local procurement/indigenization through policy changes (imports >60%) and rising usage of electronics in defence (25-35% of platforms currently).

Strong earning growth and improving balance sheet to drive RoICs: NWC improved from 438 days in FY19 to 326 days in FY21, we expect it to further reduce to 300 days over FY22-24E on the back of evening out of revenue across quarters and higher share of production contracts. Improving balance sheet and strong earnings CAGR of 31% over FY21-24E is likely to drive RoICs to 30% vs average of 12% in last 5 years.

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