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Earnings outlook hazy...

Garden Reach Shipbuilders & Engineers’ (GRSE) Q4FY23 EBITDA performance was below street estimates by ~50.5%. Key highlights: 1) revenues rose 10.7% YoY largely on the back of delivery of two ships (cargo-cum-ferry vessel for the government of Guyana and fast patrol vessel {FPV} for Indian Coast Guard), and P-17A advanced frigates entering their peak billing phase; 2) EBITDA was down 37.4% YoY at Rs204mn due to decline in gross margins and higher ‘other expenses’ (project- related); 3) ‘other income’ rose 70.3% YoY and 39.2% QoQ to Rs699mn mainly due to higher advances; 4) Board has recommended a final dividend of Rs0.70/share in addition to interim payout of Rs5.5/share, taking total dividend to Rs6.2/share.

Going ahead, we believe GRSE will be one of the beneficiaries in next-gen corvette contracts worth Rs364bn to be awarded by the Indian Navy by FY25. We expect earnings growth in GRSE until CY25E as construction of high-value P-17A advanced frigates would then be in the peak billing period. However, owing to the lack of visibility on major orders post FY25, we expect earnings to decline thereafter. We introduce FY25E numbers at this stage. Our revised DCF-based target price works out to Rs370 (earlier: Rs385). At CMP, the stock reflects significant (misplaced) optimism on potential earnings growth. Hence, we downgrade it to SELL (earlier: REDUCE).

* Revenues pick up; EBITDA underwhelms: GRSE’s Q4FY23 performance undershot street expectations. Key highlights: 1) EBITDA margin contracted further to 3.4% (Q4FY22: 6%, Q3FY23: 6.7%) owing to higher ‘other expenses’ (project-related); 2) revenues rose 10.7% YoY, down (13.9% QoQ) to Rs6bn on the back of delivery of two ships (cargo-cum-ferry vessel for the government of Guyana, and fast patrol vessel (FPV) for Indian Coast Guard), and construction of two P-17A advanced frigates reaches peak revenue booking threshold of 35-60% as construction progress; 3) ‘other income’ rose 70.3% YoY and 39.2% QoQ to Rs699mn mainly due to higher advances; 4) Board has recommended a final dividend of Rs0.7/share in addition to an interim payout of Rs5.5/share, taking the total dividend to Rs6.2/share, 5) GRSE has entered into contract with Indian Navy for supply of ten 30mm Naval Surface Gun (NSG) with Electro Optical Fire Control System (EOFCS) and ammunition, at a cost of Rs2.5bn. Further, GRSE has also received an order to supply four Next-Generation Offshore Patrol Vessels in Mar’23 (order value ~Rs35bn). Going ahead, we expect the revenue trajectory to improve as revenue booking from P-17A advanced frigates rises further.

* Major milestones achieved in FY23. Major production milestones achieved in FY23 include: 1) mega-ship launches for the Indian Navy such as the 2nd P17A Advanced Frigate Dunagiri, 2) two Anti-Submarine Warfare Shallow Water Craft, and 3) two Survey Vessels (Large). One Ocean-Going Passenger & Cargo Vessel for the Cooperative Republic of Guyana and one fast patrol vessel (FPV) for the Indian Coast Guard were also launched and delivered in FY23. The shipyard is presently undertaking concurrent construction of 22 ships including: i) three P17A Stealth Frigates, ii) four Survey Vessels (Large), iii) eight ASW SWCs, iv) one New-Generation Electric Ferry, and v) six patrol boats.
 

Outlook: Upside capped. Going ahead, while GRSE would be one of the beneficiaries of next-gen corvettes order, valued at Rs364bn, we believe that, at CMP, the stock has run well past its earnings growth potential. Besides, we also believe revenue execution is likely to peak out by FY26. We introduce FY25E numbers at this stage resulting in a revised DCF-based target price of Rs370 (earlier: Rs385). Downgrade to SELL.

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