CRISIL assigns fundamental grade 4/5 to Astra Microwave

CRISIL Research has assigned a CRISIL IER fundamental grade of '4/5’ to Astra Microwave Products Ltd (Astra). The grade indicates that the company's fundamentals are 'Superior' relative to other listed equity securities in India. CRISIL Research has assigned a valuation grade of 5/5, indicating that market price has 'strong upside' from the current levels. Our one-year fair value of the stock is Rs 55 per share. It is currently trading at Rs 40. The grades are not a recommendation to buy, sell or hold the graded instrument, or a comment on the graded instrument's future market price or its suitability for a particular investor.

Astra is one of the few private players that designs, develops and manufactures sub-systems for defence and space applications. The assigned fundamental grade reflects its technical capability in this niche space and the established record of developing critical products (like radar components) in association with government agencies. This partnership is bolstered by the Union government's increasing focus on indigenous manufacturing and healthy growth in defence capex. India's expenditure on defence equipment has increased at a CAGR of 12% over the past 10 years. In the 2012 Union Budget, military spending has been increased by 17% to ~US$40 bn. Further, in order to improve self-dependency, the government has introduced an offset clause, which mandates foreign vendors winning a defence contract above Rs 3 bn to source at least 30% of the contract value from India, the largest importer of arms and equipment in the world. This opens up sizeable opportunities for Indian players like Astra and ensures a steady flow of orders.

Astra's current order book of Rs 7.3 bn (3x FY12 revenues) provides visibility for the next two years. We believe the order book will continue to be healthy in the next three-four years supported by recurring demand from ongoing defence projects and fresh orders. Astra, in association with Centre for Air Borne System, has developed AESA radar. It is more efficient than the old radars and considered a big achievement for India. It is currently in the testing phase and will be in high demand from the defence and other sectors once approved.

However, an unclear succession plan and increasing competition in the sub-system manufacturing industry are concerns. Astra, a knowledge-driven company, has grown manifold by leveraging on its promoters' knowledge and experience; all are scientists with two decades of experience in government agencies like Defence Research and Development Organisation and Indian Space Research Organisation. These promoters are fast approaching retirement age and, according to the management, so far they have not inked a succession plan. Further, with increasing opportunities, attractive margins and the government's focus on diversifying vendor base, competition is expected to increase. This will a) reduce Astra's share in the order flow and b) impact its margins due to aggressive bidding.

Financial outlook
CRISIL Research expects Astra's revenues to grow at a two-year CAGR of 41% to Rs 4,038 mn in FY14 largely driven by the execution of its current order book; the defence segment is likely to remain the biggest contributor. EBITDA margin is expected to contract by 570 bps in FY13 to 26% and by 560 bps in FY14 to 21% due to execution of the relatively lower-margin offset orders. We expect the company to report 15% PAT margin in FY13 and 11% in FY14, in line with operating performance. EPS is expected to be Rs 5.2 in FY13 and Rs 5.5 in FY14. The company is expected to report RoE of 22% and 20% in FY13 and FY14, respectively.

Valuation (the current market price has strong upside)
CRISIL Research has used the price-to-earnings (P/E) method to value Astra. We have assigned a P/E multiple of 10x FY14E EPS of Rs 5.5 to arrive at a fair value of Rs 55.

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