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Orberbook driven growth visibility to drive rerating

Hindustan Aeronautics’ (HAL) order inflows have meaningfully improved over the past year. Single biggest indigenous defence order worth Rs480bn was awarded for delivery of 83 Mk 1A light combat aircraft (LCAs). HAL’s capability as a defence prime and a OEM for fighter aircraft/helicopters/trainers was always undisputed. Visibility on order inflow and a corresponding visibility on growth were the stunting factors. HAL’s revenue was ~41% of the Indian capital budget for air platforms.

Near stagnation of defence capital spending was adding to the uncertainty; exigencies and thrust towards indigenisation have allowed the same to change. We see HAL’s potential book to bill at 5x at FY22E-end (Table 1) and will lead to a significant growth opportunity FY23E onwards. We initiate coverage on the stock with BUY rating and target price of Rs2,618/share( ~140% upside).

* The possible salience in defence budget with key platforms accruing to HAL. HAL has been awarded with Rs480bn contract for 73 Tejas MK1A and 10 Tejas Mk1 recently. Increase in aircraft budget and increased headroom left post the induction of last batch of Su-30 MKIs leave potential order capture for HAL. Management has highlighted the possibility of i) Rs20bn of order for 15 LCH, ii) Rs70bn of HTT-40 orders, iii) Rs160bn of light utility helicopter (LUH) orders and iii) 12 Su-30 imported from Russia and contract manufactured in India worth Rs100bn. This will adequately offset the previous order of 272 plans worth Rs63bn of Sukhoi-30 MKI execution p.a coming to an end. Tejas Mk 1A order will also ensure adequate utilisation of Nasik facility as Su-30 MKI execution ends.

* The future potential orders which may keep book to bill elevated for years to come. The future development projects including Tejas Mk 2 (first prototype be rolled out in June 21), Advanced Multirole Combat aircraft (AMCA), unmanned systems controlled from mother aircraft i.e Combat Air Teaming system (CATS), unveiled in the recent Aero Show 2021 and Indian Multirole Helicopters (IMRH) will add to the orderbook. HAL sees meaningful opportunity in helicopters.

While RoH forms a major part of the helicopter division orderbook (apart from ALH manufacturing order), HAL is going to be a big beneficiary of i) consolidation of attack helicopters in the portfolio of Indian Army/Airforce via LCH and ii) consolidation of transport and reconnaissance i.e multirole helicopters with IA/IAF via IMRH and ALH (non-weaponised version of LCH).

* Cost optimisation and better growth may lead to higher margins. We expect topline growth to pick up FY23 onwards and employee costs, which reduced to ~19- 20% of revenue now from ~24-25%, 2-3 years back, is adding to visibility of higher margins as revenue growth picks up.

* The only possible story in fighter aircraft OEM in India. We believe HAL will be the only defence prime with any meaningful scale in the aerospace business in India. There is little scope of any meaningful competition till the time the current and the expected orderbook gets executed over the next 5-7 years. The key risk, as per us, to HAL’s business model is increased acceptance of unmanned aerial vehicles or UAVs – if recent examples of Armenia Azerbaijan war or attack on Saudi Arabian oil-fields by Houdi rebels are to be cited.

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