Verdict: Good for Long Term  

IPO Snapshot:

Bharat Dynamics is entering the primary market on Tuesday 13^th March 2018 with an offer for sale (OFS) of up to 2.25 crore equity shares of Rs. 10 each by Government of India, in the price band of Rs.413 to Rs. 428 per share, with Rs. 10 per share retail and employee discount. Representing ~12.25% of the post issue paid-up share capital, Govt will garner Rs. 953 crore from the sale, at the upper end of the price band. Issue is closing on Thursday 15^th March and listing is likely on 23^rd March.

Company Overview:

Government of India’s wholly owned subsidiary, Bharat Dynamics, is a Category 1 Mini-Ratna company and the sole indigenous missile manufacturer for India, making surface to air missiles (SAM), anti-tank guided missiles (ATGM), underwater weapons, launchers and test equipment for the country’s defence sector. This 1970 established Hyderabad head quartered company has 3 manufacturing facilities in Hyderabad, Bhanur and Vishakhapatnam, and is setting up two additional facilities near Hyderabad and Amravati (Maharashtra) to manufacture Surface-to-Air Missiles and Very Short Range Air Defence Missiles respectively, to be funded via internal accruals. Its current order book of Rs. 10,543 crore, represents 2.2x of FY17 revenue of Rs. 4,833 crore, is quite healthy.

Financials:

While company’s revenue has posted 30% CAGR over FY14-17, growing from Rs. 1,784 crore to Rs. 4,833 crore, its net profit has grown at a slower pace of 11% CAGR during this period, from Rs. 360 crore in FY14 to Rs. 490 crore in FY17, due to lower interest income, on company’s declining cash balance. If one were to exclude the interest income (which is a non-core activity), net profit has risen at a whopping 60% CAGR during FY14-17, from Rs. 86 crore to Rs. 355 crore, which is very healthy. Put it other way, interest income as a percentage to net profit declined from 76% in FY14 to 28% in FY17 and is expected to go below 20% for FY18, which spells good news for shareholders, as core operations have started yielding healthy earnings.

However, on a YoY basis, FY17 performance was not too encouraging, as, on 18% revenue growth, net profit excluding interest income remained stagnant at Rs.350 crore (reported net profit actually delined 13% YoY due to fall in other income). Adjusted for 1:1 bonus declared in Feb 2018, EPS for FY17 stands at Rs.21.57. For H1FY18, company’s revenue stood at Rs. 1,806 crore, while net profit is reported at Rs. 173 crore, including pre-tax interest income of Rs. 63 crore. EPS of the first half of the year stands at Rs. 7.21. Since substantial defence revenue gets booked in Q4 of the fiscal, first half performance must not be a cause of too much worry. However, one must wait and watch the full year FY18 performance to check if FY17 earnings stagnation was a one-off.

Company’s current outstanding equity is Rs. 183 crore and net worth Rs. 1,631 crore, translating into BVPS of Rs. 89. Post IPO, Govt. of India’s holding will contract to 87.75%. Being debt free, company has surplus cash of Rs. 1,311 crore, or Rs. 72 per share. In the recent past, it has completed 2 equity share buy-backs, during Sept 2017 (worth Rs. 550 crore) and Mar 2016 (Rs. 240 crore). Thanks to high treasury income, its RoE has been healthy, at 22% in FY17.  

Valuation:

At Rs. 428 per share, company’s market cap will be Rs. 7,844 crore, with EV of Rs. 6,533 crore, which discounts historic earnings by an EV/EBITDA multiple of 8x and PE of 20x. Estimating double digit topline growth, on one year forward earnings, EV/EBITDA and PE multiples are 7.5x and 15x, which are not expensive. On peer comparison, defence communication, radar and electronic warfare systems maker Bharat Electronics, with annual topline of Rs. 10,000 crore, 66.7% Govt. holding, and stronger net margins of 17% for FY17, is currently trading at historic EV/EBITDA multiple of 13x and historic PE multiple of 23x, making Bharat Dynamics’ issue pricing appear attractive.

Conclusion:

Company has the old world charm of a PSU (3% dividend yield + sovereign trust), coupled with enormous potential indigenous defence companies hold. However, short term triggers depend on H2FY18 financial performance. Hence, those considering the IPO with a short term view may give it a miss. However, since defence sector holds a lot of potential, it will be incorrect to rule out this company ab initio. And for long term investors, we advise to consider the IPO.

Disclosure: No interest.