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5G, Defence and Railways…All set for the next leg of growth

We interacted with the management of HFCL to understand the company’s growth prospects and future outlook. A number of bullish factors have come together which ensures bright prospects for HFCL in the long term. We remain optimistic about the company’s future performance due to:

• 5G rollout in metros, 4G expansion in remote areas, FTTH/broadband penetration and BharatNet are expected to be an INR 3.0 lac cr opportunity in the OFC space. HFCL is expanding its OFC capacity from 23.4 fibre km (fkm) to 34.8 fkm. As part of its backward integration, HFCL is also expanding its optic fibre capacities from the current 8 mn fkm to 10 mn fkm in FY23, which will be further enhanced to 22 mn fkm, while the remaining 12 mn fkm will be outsourced to reduce the capex burden.

• HFCL has forayed into telecom equipment for the 5G spectrum, Indian Railways and metro rail. The equipment will be supplied to domestic as well as European and US companies, which are expected to increase export revenue from INR 350 cr in FY22 to INR 1,500 cr in FY24.

• HFCL has also entered defence electronics which are used in night vision devices, electronic fuses, radio communication equipment, etc. The defence electronics and telecommunication market is estimated to be INR 1.0 lac cr and the company is expected to be benefited from the new Defence Procurement Policy of the government.

• Diversification in these new verticals is expected to improve business opportunities for HFCL and de-risk the overall business model. In addition, both telecom equipment and defence electronics are high-margin businesses (more than 14% EBIT margin), compared to OFC (11-12% EBIT margin). Hence, an increase in revenue share from new verticals could improve the operating profitability and cash flow of the company.

Over the period of FY22-25E, we are expecting revenue/ EBITDA/ net profit to grow at a CAGR of 20.0%/ 21.7%/ 30.4% to INR 8,167 cr/ INR 1,172 cr / INR 695 cr respectively. EBITDA and net profit margins are expected to improve by 60bps to 14.4% and 188bps to 8.5%, respectively.

Despite a capex plan of INR 350-400 cr during FY23-25 for the new capacities and product development, the net debt to equity and net debt to EBITDA are expected to remain flat at 0.1X and 0.4X in FY25 due to higher operating cash flows. Subsequently, return ratios – RoE and RoIC are expected to improve by 473bps to 15.9% and 361bps to 22.6%, respectively.

Valuation

Given the favourable outlook and growth opportunities across all business segments, we value HFCL at INR 86 per share (FY25 EV/EBITDA of 10.5X) and recommend a BUY at a CMP of INR 67, representing an upside of 28.4% over the next 24 months.

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