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Earnings outlook nebulous

We attended the analyst meet organised by Garden Reach Shipbuilders & Engineers’ (GRSE) to discuss its Q3FY23 performance and outlook. Key highlights: 1) Management sees benefits from the ongoing fleet expansion drive in defence; 2) EBITDA margin during the quarter was lower due to all the recent orders coming via competitive bidding; 3) Orderbook is expected to rise to Rs250bn by FY23-end (from Rs222.4bn at Dec’22 end); and 4) by FY27, the current orderbook would be fully executed. Going ahead, while we see good potential from several opportunities in the pipeline, cash generation is likely to peak out in FY25E as the high-value P-17 advanced frigates surpass the peak revenue booking threshold of 65%. The stock has corrected in line with our expectations and we see the downside relatively limited hereon, as the possibility of earnings going downhill post FY27E is being factored-in. Our unchanged target price of Rs385 (on DCF framework) implies a downside of 7.5%; hence we upgrade the stock to REDUCE (earlier: Sell).

* Plethora of opportunities, but order award is critical: GRSE’s orderbook worth Rs224bn as of Dec’22 is concentrated on shipbuilding (98% of total). Going ahead, management sees opportunities worth Rs850bn-860bn (100 platforms) in the shipbuilding space over next 3-5 years. Key points: 1) Next-gen corvette order worth Rs360bn (8 ship projects) with L1 getting 5 ships and L2 getting 3 ships; 2) an order for 14 ‘fast patrol vessels’ (FPV) worth Rs10bn-12bn and RFP for 25 next-gen FPVs (Rs50bn) is expected in H1FY24 and FY25 respectively from Indian Coast Guard (ICG); 3) ICG is likely to come up with RFP for 6 ocean-going patrol vessels for which Acceptance of Necessity (AoN) was accorded by Defence Acquisition Council (DAC) two months back; 4) Indian Navy is exploring building 20 waterjet ‘fast attack crafts’ (FAC) worth Rs20bn for which RFP is expected in FY24; and 5) Indian Navy is also expected to come up with RFP for 5 next-gen vessels soon. While we expect the company to bag a good share of these orders, we see timing as critical for the company’s cashflows since the current orderbook implies peak earnings by FY25 and exhaustion by FY27.

* Competitive bidding to keep margins constrained. During the call, management indicated that the latest orders have been won via competitive bidding, hence margins might be lower than the 7.5% in nomination contracts. Despite the efforts at cost control and higher ‘other income’, which has resulted in margins at 8-10%, we do not see margins exceeding 11% in the medium term since ‘other income’ is likely to decline as cash against advance reduces and incremental orders (especially exports) are won through competitive bidding.

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