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Steady performance

Zen Technologies (ZEN) reported better-than-expected performance of 277%/265%/276% YoY increase in revenue/EBITDA/PAT in 2QFY25, driven by strong execution. EBITDA margin at 32.9% declined YoY, mainly due to the project and geography mix. Strong revenue performance, higher other income, and lower-thanexpected tax rate resulted in outperformance at PAT level too. PAT margin came at 27%. Order inflows were weak in 1HFY25 and will start ramping up from 2HFY25 onward. We marginally revise our estimates to factor in the 1H performance and reiterate BUY rating on ZEN with a TP of INR2,200, based on 40x two year forward EPS (vs. INR1,900 earlier). ZEN has the advantage of a faster CAGR in revenue and PAT, stronger margins, and reasonable NWC. Reiterate BUY.

Better-than-expected results

ZEN reported a strong YoY jump in revenue of 277% to INR2.42b, exceeding our estimates by 21%. Absolute EBITDA surged 265% YoY to INR794m, beating our estimates by 13%, while margin contracted 110bp YoY to 32.9% vs. our estimate of 35.0%. The company’s PAT was 32% above our estimate at INR652m (our estimate at INR495m). PAT margin was flat YoY at 27.0%, but 230bp higher than our estimates of 24.7%. The value of the orders on hand as of 30th Sep’24 was ~INR9.6b. Operational cash flow declined YoY during 1HFY25 due to higher receivables, which we believe will come down in the coming quarters as payments are released. The company has allotted 6.2m equity shares for cash to qualified eligible buyers pursuant to a Qualified Institutional Placement. This has resulted in an increase of INR6.25m in the issued and paid-up equity share capital and INR9.8b (net of share issue expenses) in the share premium account. For 2HFY25, we expect revenue/EBITDA/PAT growth of 118%/123%/107% YoY.

Visibility on order inflows and acquisitions to come in a few months

There is an order pipeline of INR35b in the market, of which the management expects INR12b worth of orders to be received in FY25, starting from end of 3QFY25. These orders will be a mix of training simulators and anti-drone systems but the demand is expected to be more biased toward anti-drone systems. Further, the management added that it is also looking for opportunities to cater to the Navy and Air Force segments organically as well as through acquisitions. Management also stated that, off the underlying cash balance of INR11b, ~INR4b will be used for acquisitions, ~INR1b for capex, and due to the extreme growth in recent quarters, ~INR3-4b would be for working capital requirements.

Eyeing opportunities in the US market

ZEN is looking to expand its geographical reach into the North and South American market by setting up a manufacturing unit in the region. Currently, the company outsources 85% of its manufacturing to multiple supply chains, while it takes on the responsibilities of looking after the final integration, testing, and assembly before dispatching the orders. The company plans to follow a similar business model where a supply chain is built and ready to execute the orders, which helps the company’s capital requirement to be not stuck in setting up a whole manufacturing unit with huge PP&E. The management mentioned that it is already in the process of identifying the supply chains and in about 8-9 months, it should be able to identify these supply chains and start testing them for the production of orders. These orders are, however, expected to largely reflect from FY27 onwards in the books.

Patents granted during the quarter

During the quarter, ZEN received patent grants for:

* Infantry Virtual Training Simulation System: An advanced, state-of-art simulation system that provides military personnel with a highly realistic and immersive virtual training environment

* TacSim: A Force Training System designed to evaluate and enhance the operational capabilities of the defense forces

* Mine Detection System: Designed to function in extreme environmental conditions, operating at temperatures ranging from -25°C to +45°C and altitudes up to 15,000 feet above the mean sea level

Strong market opportunity for new systems

ZEN also launched four ground-breaking remote-controlled weapon and surveillance systems in the end of Sep’24, both of which have a TAM of USD1b each:

* Parashu: A versatile remote-controlled weapon system featuring advanced thermal imaging and anti-drone capabilities, optimized for vehicles and ships

* Fanish: Boosts firepower of T-72 and T-90 tanks with its sophisticated thermal targeting system, ensuring precision in challenging weather conditions

* Sharur: A robust naval weapon system capable of engaging both surface and aerial threats up to 2 kilometers away, boasting advanced stabilization technology for accuracy in low-visibility scenarios

* Durgam: A surveillance camera system equipped with day/night vision technology to detect potential dangers in real time, making it an ideal solution for armored vehicles and high-threat zones

The company also introduced an AI-powered robot along with new self-reliant, IPowned, and innovative defense products for global security:

* Hawkeye: An anti-drone system camera with multiple sensors tracking up to a range of 15km.

* Barbarik – URCWS: The world’s lightest remote-controlled weapon station offering precise targeting capabilities for ground and naval vessels

* Prahasta: An AI-driven quadruped robot to create real-time 3D terrain mapping for unparalleled mission planning, navigation, and threat assessment

* Sthir Stab 640: A rugged stabilized sight designed mainly for armored vehicles, ICVs, and boats

Financial outlook

We expect a revenue/EBITDA/PAT CAGR of 67%/63%/65% during FY24-27. This growth will be led by: 1) order inflow growth of 31%, due to a strong pipeline across simulators and anti-drones, 2) EBITDA margin of 38% for FY25, FY26, and FY27, and 3) enhanced control over working capital due to improved collections.

Valuation and recommendation

The stock currently trades at 39.8x/28.7 P/E on FY26/27E earnings. We marginally revise our estimates to factor in the 1H performance and reiterate BUY rating ZEN with a TP of INR2,200, based on 40x two year forward EPS (vs. INR1,900 earlier). ZEN has the advantage of a faster CAGR in revenue and PAT, stronger margins, and reasonable NWC. Reiterate BUY.

Key risk and concerns

Any slowdown in procurement from the defense industry, especially for simulators, can expose the company to the risk of reduced order inflows and hinder its growth. ZEN is also exposed to foreign currency risks for its export revenue. High working capital can also pose risks to cash flows, as historically ZEN’s working capital has remained high due to issues related to high debtors and high inventories. This is likely to come down due to improved collections and lower inventory, according to the management. However, any delays in the same can affect cash flows for FY25/26.

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