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Harnessing its combat Zen

Zen Technologies (ZEN IN) is an Intellectual Property (IP)-led defence company, making military simulators and counter drone systems. It is the undisputed leader in land-based simulators with a 90% share and is now foraying into naval simulators through new acquisitions. ZEN is set to leverage: 1) in-house R&D and IP-led asset light business model with high ROE, 2) large addressable market for core categories (simulators and anti-drones) and new segments (AI-led defence solutions), and 3) value unlocking through new acquisitions.

ZEN is currently trading at an attractive 21x one-year forward P/E, significantly lower than that for other private players, thus offering a good entry point. Initiate with Buy and a TP of INR 1,535, on 25x March FY27E P/E.

Simulators – ZEN’s edge despite increasing competition: Demand is robust for the domestic simulator market, led by regulatory tailwinds such as the Simulation Framework, Indigenization Plan and the Agnipath Yojana (recruits youth for four-year service in armed forces). Also, as the simulators market is expected to reach INR 150bn by FY29, at a 20%+ CAGR through FY24-29 (source: ZEN), prospects are promising. ZEN is #1 in land-based simulators with FY24 market share at 90%, and the new acquisition should open up opportunities in naval simulators. ZEN enjoys high margin in this category due to own IP that contributes 25-40% to Bill of Materials and 80% outsourcing model.

CDS – Demand strong due to rising geopolitical flashpoints: During the Israel-Iran conflict, ~150 drones were fired. This parenthetical, along with various other geopolitical flashpoints, indicates heightened demand for counter drone systems (CDSs). So, expect the domestic CDS market to post a CAGR of 24% to INR 150bn in FY29 (source: ZEN). ZEN, with products such as Vyom Kavach, enjoys an edge in the CDS market. It also seeks to increase its export presence as its products are 20-25% cheaper than those of global OEMs.

Diversification play – AI defence solutions, drones, EW Systems, a potent blend: The domestic drone market may post a CAGR of 22% through FY25-29 to INR 20bn in FY29 (source: Ministry of Civil Aviation). ZEN has thus forayed into drones with 100% indigenization and on the wings of new acquisitions. It is diversifying into new areas of electronic warfare (EW) and AI-led defence solutions (market size: ~INR 80bn). ZEN seeks to grow its exports via a new tie-up in the US and through setting up a subsidiary there with a view to establish a dedicated supply chain to manufacture in that country

Initiate with Buy; TP at INR 1,535: We initiate coverage on ZEN with a Buy and a TP of INR 1,535, based on 25x March FY27E P/E. The P/E is 10% discount to private defence industry P/E of 27x. ZEN is a private player and operates in the niche categories of simulators and counter drone systems.

ZEN is currently trading at an attractive 21x one-year forward P/E, significantly lower than that for other private players, which presents a good entry point. We expect an earnings CAGR of 60% through FY24-27E with an average ROE and ROCE of 42% each through FY25E-27E. Key risks to our call are delay in awarding of tenders and shift in defence budget allocation away from simulators.

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