Hindustan Aeronautics is entering the primary market on Friday 16^th March 2018 with an offer for sale (OFS) of up to 3.41 crore equity shares of Rs. 10 each by Government of India, in the price band of Rs.1,215 to Rs. 1,240 per share, with Rs. 25 per share retail and employee discount. Representing 10.2% of the post issue paid-up share capital, Government is expected to rake in Rs. 4,200 crore at the upper end of the price band. The issue is closing on Tuesday 20^th March and listing is likely on 28^thMarch.

Company Overview:

India’s largest defence PSU and world’s 39th largest aerospace, Navratna company Hindustan Aeronautics designs, develops, manufactures and maintains aircraft, helicopters, aero-engines, avionics, accessories and aerospace structures, including military aircrafts, such as MiG-21, MiG-27, Hawk Mk 132 and Su-30MKI. Over 90% of company’s Rs. 18,000 crore revenue is derived from Indian Defence Services, while exports account for about 3%. Business operations are divided into five verticals (Bangalore, MiG, Helicopter, Accessories and Design) comprising 20 production divisions and 11 R&D centres located across India, in addition to establishing 13 commercial JVs with American, Russian, Israeli and Canadian counterparts. Relying on both indigenous research as well as technology transfer and licence agreements with third parties, company spends ~7% of revenue annually towards R&D. Its Rs. 68,461 crore order book, as of 31-12-17, representing 4x annual topline, is also very encouraging.

Financials:

Company’s financial performance has shown slow yet steady growth, with FY17 revenue rising 8% YoY to Rs. 18,555 crore and PBT improving 12% YoY to Rs.3,592 crore, leading to very strong 18% margin at the PBT level. Due to lower tax outgo in FY17 (27% effective tax rate), net margins were also very robust at 14%, on PAT of Rs. 2,625 crore, translating into an EPS of Rs. 73 for FY17, 30% of which was paid out as dividend, as per CPSE Capital Restructuring Guidelines. Share of treasury profits, which accounted for over 60% of net profits in FY13 have shrunk to 25% in FY17, which is a good trend, as core operations are contributing higher towards earnings, and will further reduce to 20% going forward, with surplus cash being deployed towards share buyback. The company has, in Nov 2017, spent Rs. 1,128 crore on buy-back of 2.71 crore equity shares from the Govt. at Rs. 340 per share, while in March 2016, it spent as much as Rs.5,266 crore to buy-back 12.05 crore equity shares at Rs.355/share. Thus, surplus cash has been partly put to good use in addition to improving return ratios. For H1FY18, revenue of Rs. 5,277 crore was clocked and PBT of Rs. 610 crore has been earned. Since substantial defense revenue gets booked in Q4 of the fiscal, not much must be read into the financial performance for the first half.

Post-Nov 2017 buy-back, company’s equity stands reduced to 334.39 crore (from Rs. 361.50 as of 30-9-17) while current net worth is at Rs.11,816 crore, translating into BVPS of Rs. 353. The company is debt free with surplus cash of Rs. 10,571 or Rs. 316 per share, after accounting for share buy-back. Its return on net worth improved from 7% in FY15 to 18% in FY16 and 21% in FY17, despite a lower share of treasury income. Post listing, Govt of India’s holding will decline to 89.80%, from current 100%.

Valuation:

At Rs. 1,240 per share, company’s market cap will be Rs. 41,464 crore, with an enterprise value of Rs. 30,893 crore, which is approximately 1.6 times the company’s annual topline. This leads to historic FY17 EV/EBITDA and PE multiples of 7x and 17x respectively. On one year forward earnings, EV/EBITDA and PE multiples are 6x and 15x which are extremely attractive, given the company’s unmatched strategic position and huge untapped potential in defence sector. On peer comparison, defence communication, radar and electronic warfare systems maker Bharat Electronics, with annual topline of Rs. 10,000 crore and 66.7% Govt. holding, is currently trading at historic EV/EBITDA multiple of 13x and historic PE multiple of 23x, making issue pricing of Hindustan Aeronautics very attractive. Retail discount of Rs. 25 per share is an added sweetener in the IPO.

Conclusion:

Being India’s largest military aircraft and helicopter maker, company’s technological skills and strategic position is unmatched. Sector tailwinds in the form of huge demand from Indian armed forces for military aircraft and their maintenance results in an enormous potential for the company. All this, at an attractive pricing.

Subdued secondary market conditions may not yield a pop on listing, but the share can be a good long-term bet, as a quality portfolio stock. Hence, one can subscribe to the IPO with a long-term view!