SENSEX NIFTY
Jul 13, 2005, 11.19 AM IST | Source: Moneycontrol.com

Zen Technologies is a buy at Rs 208

Broking houses are bullish on Zen Technologies. Karvy Stock Broking has initiated coverage of the company with a "BUY rating". It has a price target of Rs 285.

Broking houses are bullish on Zen Technologies . Karvy Stock Broking has initiated coverage of the company with a "BUY rating". It has a price target of Rs 285.

A report by Karvy Stock Broking says that "as a manufacturer of advanced training simulators for the security forces is a major beneficiary of the increasing capital expenditure allocated for the military and the police. The law and order situation in certain troubled states and the subsequent need to equip the police forces coupled with the modernization of the security forces is expected to drive the company's top line."

It says, "We expect the demand for training simulators to surge from the armed forces on account of its cost effectiveness. Demand for simulators from states where insurgency is high and from specialized police forces which have disproportionately higher expenditure is likely to drive Zen's sales. Paramilitary forces deployed in troubled states like Jammu and Kashmir (J&K) and in the north east are prime candidates for Zenís products. Similarly we expect the specialised anti-terrorist forces to also become major clients of the company. We expect the company's turnover to grow at a CAGR of 42% from FY05 to FY07."

The report says "a tender has been submitted for a product for the Indian army which Zen Technologies has manufactured in alliance with a public sector company. Though Zen Technologiesí product is technologically superior among the existing players, we have not factored this order into our earnings projections. If this order materialises, our EPS target will be revised upwards to Rs14.5 for FY06 and Rs23.6 for FY07."

The report says "the turnover of Zen Technologies is expected to gather further momentum as a result of introduction of novel products such as the Driving Training Simulator, Tactical Engagement Simulator and other products like Unarmed Aerial Vehicle/Remote Pilot Vehicle which are still in the R&D stage. These products have enormous market potential which will boost its turnover in the years to come."

About the company's valuations, the report says "strong EPS growth is expected to the tune of 50% in FY06, and 41% in FY07. At current levels of Rs 208, the stock looks attractive at a PEG of 0.41x FY06 and 0.29x FY07. What makes the stock further attractive is the strong RoCE of 50% in FY06 and 51% in FY07 as well as a firm RoE of 36% in both years. At the price target of Rs285, the stock is valued at a PEG 0.56x FY06 and 0.40x FY07. So it initiated a coverage on the company with a BUY."

Their report lists out several investments positives, some of the main ones are listed below: -
"Zen Technologies, based in Secunderabad, is engaged in the business of developing, designing and manufacturing advanced training simulators required by security forces like the Military, Paramilitary, Police and other forces involved in similar functions. Most of these forces have integrated these training simulators into their training cycle. Since incorporation in 1993, Zen Technologies has been manufacturing the Firearms Training Simulator, which is necessary for the security forces. A Firearms Training Simulator essentially replaces a "Firing Range" which has been the key mode of training used by these security forces. Presently, the use of a Firing Range has become complex due to the difficulties involved in obtaining open space and the danger caused to the people and cattle living in the vicinity due to accidents which may occur during these training sessions. This has made the use of a Firearms Training Simulator indispensable. Along with overcoming the difficulties of training on a Firing Range, the Firearms Training Simulator proves to be a cost effective method of training as it saves on the ammunition cost.

"The Small Arms Training Simulator (SATS) was the first Firearms Training Simulator that Zen Technologies launched in 1993. This was designed to develop the firing skills of the security forces. It proved to be very effective, enabling practice on a variety of small arms including AK-47, .303mm rifle, 7.62mm rifle, 9mm pistol, carbine, Light Machine Gun (LMG) and revolvers. The SATS simulates different firing scenarios, weather conditions, recoil of weapons. It enables shooting in different positions and helps in analyzing shooting accuracy and progress of individuals. Having sold close to 140 SATS till date, this product has been very successful for the company. Priced approximately at Rs 1.5 million, it contributed to 17% of the company's turnover in FY05 and is expected to contribute close to 20% in FY06. Strong demand for this system is seen primarily from different Police and Para-military forces at district levels."

"Introduced in 2002, the Interactive Firearms Simulator, (iFATS) was well accepted. Six systems were sold in the year of the launch itself. Priced at Rs 4.5 million, the iFATS is an advanced version of the SATS system. It enables eight simultaneous firers and is networkable up to 32 firers. It is far more realistic than its previous counterpart and enables pre-recorded live scenarios customized for different forces and varied situations. Along with replacing a firing range it also enables the creation of life-like situations and diverse weather and visibility conditions. The success of this system can be established from the fact that many organizations have preferred this system to that of established global players like Fats Inc. of the US. Some organizations using foreign (imported) systems have later upgraded to the iFATS system. Contributing to 58% in FY05 of the revenues, iFATS was the key product for Zen Technologies. Even with new products being introduced, we expect this product to contribute to 35% of the company's revenue."

"In spite of global competitors like, Amcoram (Israel), Saab Simulation and Training System (Sweden) and others, Zen Technologies is successful on the basis of its cost competitiveness which makes its systems one third the price of systems manufactured by foreign companies. Again Zen Technologies makes products which are specifically customized for the Indian security forces which foreign companies are unable to do. Another significant reason as to why Zen Technologies is preferred to foreign players, is the impeding threat of sanctions from foreign counties whereby the supply of foreign products and spares in this crucial sector of defence could dry up making the investment in foreign systems useless. The future prospects of Zen Technologies look strong, keeping in mind the Indian Government's move towards indigenization in the defence sector, proving to be very beneficial for defence companies engaged in this sector."

However, the concern is that "the defence and police orders can get delayed and visibility of sales. Moreover, the secrecy associated with defence orders could prove to be a negative for the company. Majority of the business of Zen Technologies is government oriented, thus a drastic change in the government policies can adversely affect its revenues. In spite of its cost competitiveness and compatibility to the Indian Security Forces, the threat from foreign companies always remains. Presently, domestic competition is insignificant, but going forward new players in the domestic market can pose a challenge to Zen Technologies."

About the company itself, the report says "Zen Technologies in association with a public sector company has manufactured a novel product for training the military forces. The competition for this product comes from other public sector companies. This product priced at an average of Rs10 Million is a very cost effective method of training army personnel. This could prove to be a major upside for Zen Technologies as currently a tender has been submitted for an Rs 400 million order from the army of which Rs 200 million will add to the company's turnover. The revenues from this order will be spread over a period of 12 months. Though the odds for this order seem to be in favour of Zen Technologies as their product is technologically superior, we have not factored the upside from this order into our earning estimates. On a positive note, if we assume the order comes through, our EPS targets will be revised upwards to Rs14.5 for FY06 and Rs23.6 for FY07."

The report says "the long term outlook for the company stimulated by their introduction of innovative products looks very promising. It aims to introduce a new product every year on an average from now on. In 1999, the company launched its Hand-Grenade simulator (HE-36S). This is ideal for practice of timing and lobbing hand-grenades used by the military and para-military forces. Hand-grenades have been a major cause of casualty during training and the forces have been using pebbles to learn the art of throwing hand grenades. This product has made inroads in the para-military forces and is currently being marketed to the military. Approval by the military forces could result in sizable orders."

The report says "in FY05, the company launched another product, the Driving Training Simulator, used for driving training on a wide range of vehicles. Potential users of this product are security forces requiring training in convoy exercises and the State Road Transport Authorities (SRTA). The product has taken off successfully with eight of them being sold in the year of launch itself."

The report says, "Zen Technologies is on the threshold of introducing a novel product called the Tactical Engagement Simulator (TacSim). It is a very innovative product with an enormous market potential of Rs.2000 Million (company estimates) from the army. TacSim, is a small arms firing skill enhancer which allows trainees to simulate various indoor and outdoor engagement scenarios in a very realistic manner. The training can be conducted in one-to-one combat situation or in groups as well. The long term prospects for Zen Technologies look bright with several products like the Unmanned Aerial Vehicle/Remote Pilot Vehicle (UAV/RPV) and others which are under wraps in the R&D stage. With advanced training gaining importance, Zen Technologies products are positioned for significant growth."

The report says "the company enjoys phenomenally high margins which have firmed up from 42% in FY03 to 55% in FY05. We expect margins to remain strong at 54% in FY06 and 53% in FY07. Strong margins coupled with an increase in turnover at a CAGR of 42% over the next two financial years will keep growth in net profits very strong at 50% in FY06 and 42% in FY07."
The report says "to leverage on its cost advantage, it is aggressively looking at the overseas market. Its strategy is to tie up with local players in other countries to market its range of products. The company has set up a marketing office in London and is further looking at setting up offices in other countries as well. The company wants to target countries in South East Asia, Middle East, Latin America and Africa. It has been participating in international exhibitions as well. Zen Technologies exported worth Rs.8.4 Million in FY05 and is targeting exports worth Rs.25 Million in FY06."

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