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Strategic investment in UAS start-up

Solar Industries (SOIL) surprised with an investment (undisclosed amount) in an unarmed aerial solutions (UAS) company ZMotion Autonomous (ZM) incorporated in CY18. This is the second announced start-up investment by SOIL after a strategic stake (Rs175mn) into Skyroot – a space start-up helping ISRO with propulsion systems (SOIL incidentally also received ToT on 7th Apr’22 (propellant casting for Dual Pulse propulsion system). The rationale for the strategic investment has been shown as “will strengthen SOIL’s initiative to introduce weaponised unmanned aerial vehicle (UAVs) for offensive and counter drone system for defensive roles”. ZM will become an associate company after the investment (45% stake by Mar’25; 25.11% upfront acquisition, rest through investment in CCPS). We hosted Mr. Ankit Mehta, CEO and cofounder of Ideaforge to discuss the developing UAV space in India. We are sharing some of the key takeaways in this report. This in our view, sufficiently addresses, the scope and opportunity of investment in the domain. Maintain HOLD on SOIL.

Scale of the market. Revenue from the sector (drone manufacturing) was Rs600mn in FY21 and is expected to reach Rs3,000-5,000mn in FY22E. Revenues are expected to increase further.

Ordering till date. Of the 5-6 large contracts given to Indian companies by Indian armed forces (all contracts being given to Indian companies), 3 went to Ideaforge and rest to individual players developing swarming and loitering munitions capability. Local value addition is 70-80% for Idea Forge. Ankit's estimate for indigenisation across the country was 40-50%. He mentioned that Ideaforge doesn’t use engines.

Explicit import ban underway. Earlier there has been an influx of Chinese and other small drones in the country. India is signatory to Wassenar arrangement where export of drones is controlled (China is not). Hence, China is seeing increasing import bans from across countries.

Larger drones and loitering munitions imported. India has continued to import larger drones from Israel (Herons) and also loitering munitions like Harop in the past. India manufacturing is largely for micro and mini drones. Only HAL is trying with larger UAVs i.e. Rustam

Budgeting and scope. Two of the contracts which Ideaforge received were under the emergency procurement and emergency powers granted after Galwan incident. The other contracts were from the capital budget. Contract which the company has recently won from Indian Army (US$20mn for Switch UAV - TOW of 7kg) was serving only 1/3rd of IA’s original envisioned scale. Management expects more procurement for the balanced scale. Beyond 3x numbers as per IA’s own envisioned requirement, Ankit highlighted the possibility of another 4-5x growth in numbers as more procurement starts to happen only for the platforms that Ideaforge received the contract for (cont’d).

Budgeting and scope (Cont’d). The other types of platform, meant for company and platoon level deployment and personal reconnaissance, will have a large scale requirement. The systems for long range reconnaissance and surveillance (MALE and HALE category) scale will be few dozens of number but will be higher value. At each scale and size of the drone market, the size is very similar.

Maintain HOLD; valuation methodology and key risks

We value SOIL on a consolidated P/E of 35x on FY24E. We maintain HOLD with a target price of Rs2,850/share. Despite strong volumes for Q3FY22, we see earnings downgrade for FY22/23E as we rebase margins given the margin loss for 9MFY22. We hope SOIL to make it up eventually in FY24E.

Key risks

Key upside risks: i) Higher volume growth driven by better-than-expected domestic demand revival, ii) higher margins, iii) better-than-expected ramp-up in overseas and defence operations and iv) valuation surprise at Skyroot.

Key downside risks: i) Expected trends in domestic demand continue, ii) ramp-up in overseas operations getting delayed and iii) no meaningful traction witnessed in defence revenues apart from the MMHG order that’s already received.

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