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Setting up for bigger future

About the stock: Mazagon Dock Shipbuilders (MDL) is engaged in the construction and repair of warships and submarines for the Ministry of Defence (MoD) to be used by the Indian Navy along with other vessels for commercial clients.

* MDL is India’s only shipyard to have built destroyers and conventional submarines for the Indian Navy

* The company has an order backlog of | 43,343 crore as of August 2022 (6.4x TTM revenues), of which | 19,795 crore of backlog is in Project-17A (Nilgiri class frigates), | 18,897 crore in Project-15B (Visakhapatnam class Destroyers), | 4,400 crore in Project-75 (Kalvari class submarines)

* Over the last 10 years, MDL’s revenue increased at 10.5% CAGR over FY13- 22 while EBITDA and PAT increased 3.6% and 3.9% CAGR, respectively, during the same period due to a fall in operating margins

What should investors do? MDL’s execution capability is set to improve in the coming period led by increasing indigenisation of platforms and sub-systems. Next two year’s revenue CAGR is expected at 18.2% vs. 7.5% CAGR in FY19-22. FY24E margin is set to improve substantially led by positive operating leverage

* We initiate coverage under the Stock Tales format with a BUY rating

Target Price and Valuation: We value MDL at | 560 i.e. 14x FY24E EPS

Key triggers for future price performance:

* Total defence equipment procurement budget was at | 1.24 lakh crore for FY23E of which | 84,598 crore (68% of procurement budget) has been kept for purchasing locally produced weapons and systems to boost self-reliance in the defence sector. The defence procurement budget is likely to increase considerably for FY24E with the share of imports coming down further

* With an already strong order backlog of | 43,343 crore as of August 2022 (6.4x TTM revenues), MDL is well placed to benefit from Indian Navy’s big procurement plan for the next three tom four years

* Indian Navy’s major projects in the pipeline are next generation destroyers, next generation frigates, conventional submarines and next generation corvettes. The estimated cost of these four projects is ~| 1.8 lakh crore. Thus, it provides a huge opportunity for MDL given its strength across building submarines and major warships (mainly destroyers and frigates)

* Out of 1238 sub-systems/components notified for indigenisation, 144 such components are used in submarines & warships manufactured by MDL. Execution is expected to pick up in the coming period led by indigenous manufacturing of large platforms (submarines, surface warships) and the associated sub-systems/components

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