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Undertaking an ambitious business pivot

We believe HFCL is well poised to grow at a healthy pace given the opportunities in 1) optical fibre/optical fibre cables, 2) telecom and networking, 3) defence, 4) railways and 5) security and surveillance segments. Management maintains revenue growth outlook of 15-20% for FY22 and similar growth outlook for the medium term.

Further, the company is changing its product mix by adding more revenue from product segments, which will strengthen its margin and reduce working capital intensity. HFCL targets 45% revenue from product sales during FY22, which will increase to 60% in next 2-3 years and correspondingly reduce revenue proportion from turnkey projects. Nearly Rs10bn of ambitious capex programme will bootstrap this transition over FY22-24E (including ~Rs3bn capex under PLI scheme for telecom equipment). Initiate coverage on the stock with a target price of Rs92/share. Execution remains key risk in our view.

* Industry growth (domestic + export opportunity) is providing a healthy orderbook outlook with 1) rollout of 5G network (across the world including India), 2) BharatNet project of GoI, 3) allotment of 4G network to India Railways, 4) modernisation of Indian Armed Forces, 5) higher requirement of surveillance security, 6) PLI and 7) Open RAN. We expect the company to grow by 15-20% over next 2-3 years (given better industry outlook).

* Change in product mix, undertaking an ambitious business pivot through Rs10bn of capex programme. HFCL is targetting higher share of revenue in products (optical fibre cables, FTTH, WI-FI, routers, switches, fuses, micro and macro cells and other access products as well as defence). It has progressively expanded capacity in OFC/FTTH segment with latest expansion targetting to reach 32.5mn fibre km of OFC capacity [12mn fibre km in HFCL (standalone), 10.5mn fibre km in SGCL (74% sub) and 10mn fibre km in HFCL Tech – 100% subsidiary] by Q4FY22. HFCL is undertaking an aggressive expansion of Rs10bn over FY22-24E to undertake expansion across OFC, telecom equipment (access products) under the PLI scheme as well as a new defence facility. Defence equipment manufacturing starts finding mention in HFCL annual report from FY16 – when the company secured seven licences for manufacturing defence equipment, including radars, communication systems, weapons, night vision systems, fuses etc.

* Business pivot can face execution risks. The business pivot towards products contributing 60%+ revenues consists of familiar OFC/FTTH revenue segment and an increasing contribution from access products and defence (expected to reach 20% of revenues from ~3% in FY21). To add to the business lines, management expects to take OFC and accessories exports to ~10% from ~0% at present over next 3-4 years. We see execution risks given established high profile networking peers (domestic and abroad). Our base case valuation of HFCL is Rs92/share. Growth adjusted, scenario 2 highlights a target of Rs78/share (slow rampup scenario).

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