Robust order book lifts HAL
Light combat aircraft orders stand at ~47,000 crore; fair valuation, healthy ROE other triggers
Shares of Hindustan Aeronautics (HAL), the state-owned aerospace and defence equipment company, jumped close to 14 per cent intra-day on Thursday, after the Union Cabinet approved procuring its 83 light combat aircraft (LCA) — Tejas — for the Indian Air Force (IAF). While this enhances long-term growth prospects, the government’s intention to reduce imports of defence equipment could translate into more orders for HAL.
Reasonable valuations, healthy returns on equity, and consistent dividend payouts are other positives.
The Cabinet Committee on Security (CCS) on Wednesday approved procuring 73 LCA Tejas MK1A fighter aircraft and 10 LCA Tejas Mk-1 Trainer aircraft at ~45,696 crore, along with the design and development of infrastructure sanctions worth ~1,202 crore.
“The manufacturing of light combat aircraft by HAL will give a push to the Atmanirbhar Bharat initiative and boost the indigenisation of defence production and the defence industry in the country,” the Press Information Bureau statement said.
The CCS approval comes 10 months after the ministry gave the green light to the purchase. The firm is expected to deliver the first MK-1A to the IAF three years after the deal is signed, with the remaining to be delivered by 2028-29.
“The order comes as a major boost for HAL and could see the company’s order book exceed ~1 trillion,” said Arafat Saiyed, assistant vicepresident, Reliance Securities.
“We sense a more serious intent from the government this time around with a series of new measures (re-aligning DAP, 2020, with longterm goals, import embargo on 101 items), along with their strict implementation timelines,” said Harshit Mehta, research analyst, Equirus Securities. He estimates a pipeline of more than ~6 trillion over the next 78 years for over 50 major weapon systems — offering a massive opportunity for both PSUS and private firms.
All this is positive for the company’s order book, which had seen a steady decline in each of the last three years — from ~64,613 crore in FY17 to ~52,965 crore in FY20 — because the defence outlay remained muted. As a result, HAL’S manufacturing sales declined from ~9,800 crore in FY16 to ~8,500 crore in FY20.
Recent border clashes, the fleet modernisation drive, and a focus on domestic manufacturing have led to increased defence spends in the past 12 months. Subsequently, HAL’S order book has seen some increase in FY21. It was at ~54,100 crore as of September 2020, approximately 2.5x its trailing 12-month revenue.
Of this, nearly 65 per cent comprises manufacturing orders, about 31 per cent was repair and overhauling services (ROH), and the rest development and exports.
HAL’S largest source of revenue — the ROH segment (55 per cent of FY20 revenue) — has seen steady growth over the last few years. With a robust order book, a focus on execution, and continued momentum in ROH, Mehta estimates revenue to grow at a CAGR of 8 per cent from FY20-23.
While it has the first-mover advantage, it is also continually investing in research and development (R&D) and capacity expansion, an important cornerstone in this business.
In FY20, HAL spent ~1,232 crore on R&D and a further ~254 crore was set aside for developing in-house capabilities in FY21. Despite these, the return ratios in the past five years have averaged in high teens and the company has maintained a healthy track record of dividend payout.
A major drawback, according to Shikher Jain, research analyst, Anand Rathi, is the pressure on working capital cycles due to delays in receivables.
Historically, cash conversion has been poor. As a result, its working capital position deteriorated from 10 days (of sales) in FY16 to 273 days in FY20. Inconsistent ordering and adverse currency movement are the other key risks, say analysts.
Jain issued a ‘buy’ note last week on HAL, with a target price of ~1,152. The stock is currently trading at ~1,009.