Jitendra Kumar Gupta Moneycontrol Research
The government’s much publicised defence indigenisation programme continues to remain a promise and distant dream as is evident from the financial performance of companies operating in this space. They suffered a huge setback as a result of delays in the execution and inflows of major defence projects as against expectations at the beginning of FY18. Companies report delays in approval for the deliveries, which in turn impacts sales.
Order inflows going through a low point
Companies like Bharat Dynamics, manufacturer of missile systems, has an order book of close to Rs 11,200 crore at FY17-end. The same fell to Rs 10,500 crore by January-end and Rs 8,500 crore by March-end. Due to lower order inflows, companies have been trying to book additional revenues through execution of existing orders.
Bharat Dynamics, for instance, reported 25 percent sales growth led by higher execution and improvement in deliveries. Profits rose three-fold led by higher margins, lower depreciation and taxes. Depleting order book and valuation at about 12 times FY19 earnings, leaves very little room for appreciation in the near term.
Others were not as lucky. Bharat Electronics (BEL), which reported a 16 percent year-on-year decline in sales during Q4 FY18, had earlier guided to order inflows of about Rs 14,000-16,000 crore, which turned out to be Rs 10,000 crore in FY18 as programmes such as Akash missile system and long-range surface missile (LRSM) got shifted. Order are now expected to flow in this fiscal.
Lack of growth
Most companies are sitting on a huge order backlog but haven’t been able to book revenues. BEL, which is sitting on an order book of close to Rs 40,000 crore, but failed to grow its revenues. “BEL’s healthy order book at the end of FY18 (4 times revenues) would be realised slowly over FY19-23 as execution depends upon approvals, delivery schedules and execution of its main product,” an analyst tracking the company at Axis Capital said.
Nevertheless, as and when the demand picks up, the company would be a key beneficiary in terms of earnings and a valuation re-rating. At present, the stock is trading at 14 times FY20e earnings, which is attractive given the company’s positioning in the industry and long term attractiveness of the industry.
Recently listed Hindustan Aeronautics, despite having an order book 4 times sales, reported a 6 percent YoY decline in Q4 sales. Depreciation rose because of the new capacities being added, resulting in a 22 percent YoY decline in profit. In the case of HAL, it is more an issue of delays from the client end as its revenues are booked on an accrual basis. Since it is present is in high value segments, it could suffer due to fluctuation in deliveries in a particular quarter. Its fate is also contingent on speed of government’s decision making in large defence projects. In this scenario, investors should have lower expectations in the medium term.
The management of Cochin Shipyard too sounded constrained about defence deliveries getting delayed because of approvals. The shipbuilding segment reported YoY sales growth of 10 percent, which was largely compensated by the repair business reporting a 53 percent spike in sales. Given the high operating leverage in the ship repair business, operating margins expanded and led to 122 percent YoY increase in net profits. Expanding capacity, strong order book and robust growth in repair business makes it an ideal investment.
A spillover effect
A spillover effect is being witnessed in downstream companies like Astra Micro which depend on orders from the larger defence integrators like BEL. Astra Micro, which is sitting on underutilised capacities for the last few quarters, has been guiding for delays and waiting for some of the larger projects to fructify. During Q4, its sales remained flat while margins shrunk by 580 bps because of lower scale of operations. Higher depreciation too eroded its profits by 23.5 percent. The current situation might continue till about the first half of the current fiscal. In this a scenario companies like Astra Micro may not do well in the markets.
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