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Growth plans intact

Acquisition plans and ordering to firm up from 4QFY25

Our recent interactions with Zen management indicate that ordering in key areas of Zen will start ramping up in the coming months. The company is also close to finalizing the plans for an inorganic acquisition for simulator or anti-drone business and is looking at the US as one of the key markets in the future. Recently, Zen has signed an MoU with AVT Simulation, which is into air simulation systems, and Zen intends to complement its ground simulation system portfolio through this MoU. Zen also expects improved traction in its recently launched products on remote-controlled weapon and battle surveillance systems. We maintain our estimates and roll forward to Dec, 26 earnings and arrive at a revised TP of INR2,400 based on 40x two-year forward earnings. Retain BUY

Prospect pipeline is healthy, awarding to be back-ended in this fiscal

Zen has an order prospect pipeline of INR35b where AoNs have already been accorded. Out of these, Zen expects inflows of nearly INR12b from the domestic market, followed by few orders from export markets. For large prospect orders, such as weapon training simulators and air defense fire control radars, Zen is already in the process of giving prototypes to the MoD and expects to get these tenders after the trial period. Further, since the majority of its manufacturing is outsourced, Zen is constantly looking to expand its vendor base in order to be able to smoothly cater to future inflows. In one of the interactions, Union minister has highlighted the need for increasing usage of anti-drones for preventing the attack from drones. Government wants to establish a comprehensive anti-drone unit, covering nearly 1,800 km in the near term. This results in a near term addressable market of INR18b. Overall, in order to protect the borderline of 12,000km over next years, an addressable market of INR120b opens up for players for developing anti-drones, resulting in an yearly TAM of INR24b. We have currently factored in inflows of INR17.8b/INR25.0b/INR35.0b for FY25/FY26/FY27 and expect a CAGR of 67% in revenues over FY24-27.

Working capital moved up in 1HFY25 in line with other defense players

Working capital was higher in 1HFY25 compared to FY24 for the majority of defense players (Exhibit 3). Zen’s NWC days have increased to 200 in 1HFY25 from 173 in FY24, on account of higher receivables and lower payables. Similar to Zen, NWC days of BEL/BDL/Data Pattern have also increased, moving from 2/-240/332 days to 66/-129/394, driven by higher inventory and receivables and lower payables. Though inventory shot up for HAL in 1HFY25, it was more or less offset by increased payables and lower receivables compared to FY24. We believe the increased working capital is a result of delayed payments from the MOD, which are expected to come to normal levels by FY25 end.

Orders for remote-controlled- weapon- systems expected from in FY26 onwards

As of Sep’24 end, Zen, in partnership with its subsidiary AI Turing Technologies, launched four state-of-the-art remote-controlled weapon systems, namely Parashu, Fanish, Sharur and Durgam. The TAM for these products is more than USD1b, including both domestic and export orders.

As per the management, Zen’s remote-controlled weapon systems are the lightest in the market (at 42kg) followed by a Turkish competitor, whose systems weigh around 70-75kg. Further, management stated that these systems have already been tested, but few large OEMs (potential customers) want to integrate their own system with Zen’s products. Zen is in talks with these OEMs and expects orders to start coming in from FY26 onwards.

Plans to capitalize on US opportunities along with domestic acquisitions

For the US market, the company can target an addressable market of USD500m and is in the process of responding to few RFPs. Zen is planning to target orders worth USD25-50m and is looking to develop the similar ecosystem of vendors in the US market to scale up. The company is setting up an office in Orlando and identifying the supply chains. Recently, Zen signed an MOU with AVT Simulation, under which AVT Simulation will help Zen penetrate the US defense market and Zen will help AVT expand its international business. Zen is known for its ground simulation technology, while AVT Simulation is known for its air simulation systems. Together, the collaboration aims to provide next-generation solutions by developing advanced training and simulation solutions for defense, emergency response, and commercial applications. We expect benefits of these initiatives to reflect from FY27 onwards. The management is also looking for opportunities to cater to the Navy and Air Force segments organically, as well as through acquisitions. From QIP proceeds earlier this year, the company is targeting two acquisitions, of which one is expected to be finalized in 4QFY25 and another one in FY26

inancial outlook

We expect a CAGR of 67%/63%/65% in revenue/EBITDA/PAT 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 view

The stock currently trades at 45.0x/32.5x P/E on FY26E/FY27E earnings. We maintain our estimates and reiterate BUY rating on ZEN with a revised TP of INR2,400, based on 40x Dec’26E EPS. ZEN has the advantage of a faster CAGR in revenue and PAT, stronger margins and reasonable NWC.

Key risks 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, as per the management. However, any delays in the same can affect cash flows for FY25/26.

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