January 30, 2020 INITIATING COVERAGE
Garden Reach Shipbuilders & Engineers | Defence Emerging Goliath in building warships...
Garden Reach Shipbuilders & Engineers (GRSE), a public listed company is a pioneer in defence shipbuilding, the first to deliver 100 warships to the Indian Navy and Indian Coast Rating Buy Guard Services. Due to its expertise in shipbuilding and strong, long lasting relations with its key clients, the company is well placed to provide important warship products in the coming Current Market Price(₹) 213 years. The order book size of these projects is at a humungous ₹275 bn to be delivered till 12 M Price Target (₹) 318 FY2027. This visibility shell ansure jump in revenues and profitability. Considering its strong order book, expectations of more order wins through RFP bidding, we expect a significant Potential upside (%) 49 escalation of topline, margins and bottomline from FY21E over an elongated period of 5-6 years. On profitability front too we expect good traction driven by higher contribution from competitively bid projects, positive operating leverage, lower LD provisions and modernization of facilities. With robust cash surplus and zero debt, we anticipate a turnaround in return ratios with maintenance of healthy dividend payouts and yield. We expect FY19-22E revenue Stock Data CAGR at 39%, while the bottomline is expected to grow at 43% CAGR during the same period. FV (₹) 10 At 7.3x the valuations looks compelling. Hence, we initiate the company with a BUY rating and Market Cap Full (₹ bn) 24 a target of ₹318 (valued at 11x FY22E earnings) Market Cap Free Float (₹ bn) 6 Margins and bottomline to improve with higher volumes and better operating leverage 52-Week High / Low (₹) 249 / 79 The most important driver of the company is its huge order book. As the bulk of stage payments BSE Code / NSE Symbol 542011 / GRSE of various projects overlap with each other from FY21 onwards, the volumes and topline will significantly move up. Big projects like P17A will start adding significantly from FY21 till FY25, Bloomberg GRSE IN while the projects won through competitive based bidding (high margins) like the ASW SWC and SVL will add up to margins as well. The contribution coming through the latter was negligible till date; however they are now contributing 32% of the order book. Also, modernization of Price Performance (%) shipbuilding facilities, shift to modular construction process from sequential block building (%) 1M 3M 6M 1YR would help GRSE to reduce Liquidity damage provisions in coming years. Therefore, we expect GRSE 7% 1% 61% 153% margins to improve from 3% in FY19 to 7% in FY22E. Nifty 50 -1% 3% 8% 14% Strong cash flows, zero debt to lift up return ratios from FY21E onwards * To date / current date : January 29, 2020 Rapid increase in cash flows, zero debt, low capex guidance, modernization of facilities improving efficiencies resulting into timely execution; shall culminate into higher return ratios and negative Shareholding pattern (%) working capital cycle. We expect ROEs to zoom up above 20% in FY21 from 9.6% in FY19. The company with huge cash surplus has been doling out hefty dividends historically, which in our Dec-19 Sep-19 Jun-19 Mar-19 view protects downside Promoter (GOI) 74.50 74.50 74.50 74.50 Business diversification a key during slack in shipbuilding industry FPIs 1.81 1.36 0.07 0.00 In order to hedge its position, in case the market conditions in shipbuilding industry become MFs 10.20 9.79 6.56 6.13 challenging, the company would bet on businesses such as building portable bridges, deck Insurance 5.94 7.78 10.27 10.27 machinery items, pumps and engines (~10% of total business in FY19). The company has got Others 7.55 6.57 8.60 9.10 orders to build double lane bridge in states such as Maharashtra, Orissa and Bihar. GRSE has 68% Source: BSE market share in bridge building.
YE Mar FY 18 FY 19 FY 20E FY 21E FY 22E GRSE vs Nifty 50 Total sales(₹ bn) 13.5 13.9 14.5 23.9 37.1 300 EBITDA margins(%) -1.3% 3.0% 4.0% 5.5% 7.0% 250 PAT margins (%) 7.0% 8.1% 11.4% 9.6% 8.9% 200 EPS (₹) 8.1 9.8 14.4 20.1 28.9 150 P/E (x) 25.4 20.9 14.2 10.2 7.1 100 P/BV (x) 2.3 2.3 2.1 1.9 1.7 50 EV/EBITDA (x) (143.0) 55.5 38.7 16.9 6.5 GRSE NIFTY 50 ROE (%) 8.1% 9.6% 14.4% 20.1% 28.9% 0 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 ROCE (%) -4.2% 1.3% 2.3% 7.2% 14.4%
Ashwin Patil | [email protected] LKP Research +91 22 6635 1271 Garden Reach Shipbuilders & Engineers | Initiating Coverage
Industry Global Defence Shipbuilding The global naval shipbuilding market has witnessed a slowdown in the past few years due to the cutback on military spending by major western countries dealing with the aftereffects of the global economic crisis. However, the global shipbuilding market is expected to turn around given the need to replace older vessels in the naval fleet in major economies and the increase in the level of sophistication in combat technology. The global naval shipbuilding market would peak in 2021 driven by demand for both surface combatants and submarines. Globally, the average age of warships is as high as twenty-five years and around 180 procurement programs are under execution in various countries. Global fleet strength Country Aircraft Carriers Destroyers Frigates Corvettes Submarines Others* Total Fleet United States 19 63 8 0 70 255 415 Russia 1 15 6 81 63 186 352 China 1 35 51 35 68 524 714 India 2 11 14 23 15 230 295** Japan 4 42 0 6 17 62 131 South Korea 1 12 13 16 15 109 166 UK 2 6 13 0 11 44 76 France 4 4 11 0 10 89 118 Germany 0 0 10 5 6 60 81 Source: globalfirepower.com; DRHP *Others include Fleet Support Ships, Landing Platform Docks, Landing Craft Utilities, Offshore Support Vessels, etc. **includes both Indian Navy and Indian Coast Guard
Indian Defence Shipbuilding- Defence shipbuilding in India is emerging as an area of focus for public and private sector shipyards alike. While, the public sector shipyards such as Garden Reach Shipbuilders & Engineers Limited (GRSE), Mazagon Dock Shipbuilders Limited (MDL), Goa Shipyard Limited (GSL) and Cochin Shipyard Limited (CSL) are the frontrunners in the defence shipbuilding space, an increasing number of private shipyards are undertaking specific measures to enhance competence and modify their existing shipbuilding repair facilities to suit the needs of the Indian Navy and the Indian Coast Guard. Among the private shipyards, Reliance Naval and Engineering Limited (RNEL), L&T Shipbuilding, and ABG Shipyard Limited, which entered the shipbuilding market as commercial shipbuilders, have been repositioning themselves as companies with defence shipbuilding capabilities.
The Indian Navy fleet includes mainly three categories of vessels/combat platforms: 1. Surface ships 2. Naval aviation 3. Sub-surface vessels/submarines
The Indian Navy fleet also includes landing platform docks such as the Austin Class (Jalashwa) and landing ship tanks such as the Shardul Class (built by GRSE) and Magar Class (built by Hindustan Shipyard Ltd.), fleet tankers, torpedo recovery vessels, ocean going tugs, offshore patrol vessels, etc. The Indian Navy categorises all warship equipment into three key categories, float (all systems and equipment related to the hull structures and fittings); move (the propulsion systems such as engines, alternators, etc.) and fight (all kinds of ship-borne weapons and sensor systems).
LKP Research 2 Garden Reach Shipbuilders & Engineers | Initiating Coverage
Level of indigenisation 100% 90% 90% Indigenous Content (%) Import Content (%) 80% 70% 70% 60% 60% 50% 40% 40% 30% 30% 20% 10% 10% 0% Float Move Fight
Source: Indian Navy Indigenisation Plan; DRHP
Defence Orders Potential up to 2027 Currently, the Indian Navy fleet includes 135-140 ships and submarines while the Indian Coast Guard fleet includes another 120 vessels. The Indian Navy and Indian Coastal Guardfleet are each expected to grow to about 200 vessels by 2027. The two defence units have jointly approved a shipbuilding programme spanning over fifteen years, under which they would place orders for 165 warships and 400 aerial resources by 2022. The Indian Coast Guard (ICG), with an existing fleet of 130 ships and 62 aircraft, plans to take its fleet strength to 200 ships and 100 aircraft by 2022. Currently, 70 ships for the ICG are under construction in 6 shipyards, while the bidding process for 30 more ships is in process. For the ICG, the government has approved a ₹320 bn action plan. The ICG recently acquired 34 interceptor boats out of the 36 being built by L&T Shipbuilding. These contracts for these boats are worth ₹300 mn each. According to industry sources, Indian Navy’s estimated capital budget for up to 2027 amounts to ₹4.5 tn approximately. The planned expenditure includes a separate estimate for various vessel categories including submarines (₹ 2.2 tn approx.), destroyers/frigates (₹900 bn – ₹ 1 tn), aircraft carriers (₹450 bn – ₹ 500 bn), corvettes, landing platform docks, etc.
Review of Indian Defence Spending The defence budget for FY20 stood at ₹3.18 tn. The allocation made in the Union Budget is an increase of 6.87% over revised estimates of ₹2.98 tn given in FY19. The allocation of ₹3.18 tn has been estimated at around 1.6 % of the GDP. In a significant move, import of defence equipment not manufactured in India has been exempted from basic customs duty. This will have an impact of augmenting the defence budget by approximately ₹250 bn on account of savings in expenditure on customs duty over the next five years. Out of the total allocation, ₹1.08 tn has been set aside for capital outlay to purchase new weapons, platforms and military hardware. Under capital outlay, the Army was granted ₹294.5 bn, the Navy was given ₹ 231.6 bn and the Indian Air Force got an allocation of Rs 393.02 bn. There was a reduction in Navy allocation due to overall financial stress in the economy. However, we believe that this will hardly impact GRSE’s order book as the orders given are for the long term and stage payments do happen from the clients. Hence, as the economy improves hereon, we are not overly worried about this scenario.
LKP Research 3 Garden Reach Shipbuilders & Engineers | Initiating Coverage
Budgetary allocation for defence sector(₹ bn)
3500 Defense orders (Rs bn) Growth (% yoy) 14% 11.9% 3000 12% 10.9% 9.3% 2500 10% 7.6% 7.8% 2000 6.8% 8% 6.0% 4.8% 1500 6%
1000 4%
500 2% 1,702 1,818 2,034 2,224 2,467 2,586 2,741 2,950 3,181 0 0% FY 12 FY 13 FY 14 FY 15 FY 16 FY 17 FY 18 FY 19 FY 20
Source: Company, LKP Research
Company background GRSE is a shipbuilding company in India under the administrative control of the MoD and primarily adhere to the shipbuilding requirements of the Indian Navy and the Indian Coast Guard. In addition to its ship and warship building capabilities, it is engaged in engineering and engine production activities. As a part of its engineering division, it manufactures deck machinery items, pre-fabricated portable steel bridges and marine pumps. Its shipbuilding division contributes a significant majority of its revenue from operations. GRSE’s shipbuilding product line spans from technologically sophisticated Frigates and Corvettes to Fast Patrol Vessels. In last five decades, it has built and delivered ships ranging from small to large and advanced vessels including frigates, antisubmarine warfare corvettes, missile corvettes, landing ship tanks, landing craft utilities, survey vessels, fleet replenishment tankers, fast patrol vessels, offshore patrol vessels, inshore patrol vessels, WJ-FAC, hover crafts and fast interceptor boats to the Indian Navy, Indian Coast Guard, MHA and Governments of other countries. It has built and supplied more than seven hundred fifty vessels to carry men and materials as well as for the surveillance of the coast line.
Presently, GRSE has three separate facilities for shipbuilding, all of which are located in close vicinity of each other at Kolkata, India. It build its ships at the Main Works Unit and the Rajabagan Dockyard. Its third facility, the FOJ Unit is primarily used for fitting out and repair of ships. Company’s Engineering segment is engaged in the manufacturing and fabrication of portable steel bridges, deck machineries of ships and marine pumps. Over the years, the Company has been credited with many firsts in the Indian shipbuilding industry. It has in the past and continued to associate with several technology firms in its industry like MTU and other international/ domestic entities for its different business segments such as diesel engines and deck machinery, which has added to its credibility in the international market.
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Product portfolio
Frigate Frigates are indigenously designed and has a tonnage of 3,650T. GRSE has supplied three P-16A Brahmaputra Class frigates to the Indian Navy having names INS Brahmaputra, INS Betwa and INS Beas.
Anti-Submarine Warfare Corvette ASWC (Anti-Submarine Warfare Corvette) are indigenously designed having around 90% indigenous content and has a tonnage of 3,250T. The company has delivered three ASWC to the Indian Navy. The P-28 class of ASWC that they have supplied to the Indian Navy consists of INS Kamorta, INS Kadmat and INS Kiltan. GRSE has delivered the INS Kiltan to the Indian Navy in October 2017, which is the first Indian warship with a superstructure entirely made of composite material.
Corvette Missile GRSE’s missile corvettes are indigenously designed having a tonnage of 1,370T. We have delivered five P-25 and P-25A class missile corvettes to the Indian Navy named asINS Kirpan, INS Khanjar, INS Kora, INS Kulish and INS Karmuk.
Landing Ship Tank The company’s landing ship tanks are indigenously designed having a tonnage of 5,650T. It is a vehicle and troop carrier capable of beaching at beach gradient of 1 in 40 or steeper. GRSE has supplied five large ship tanks to the Indian Navy, INS Magar, INS Ghariyal, INS Shardul, INS Kesari and Airavat.
Landing Craft Utility GRSE’s landing craft utility vessels are used to transport, deploy and recover troops and equipment from ship to shore and vice versa. The LCUs are indigenously designed with over 90% indigenous content and have a tonnage of 910T.
Survey Vessel The company’s survey vessels are indigenously designed having a tonnage of 1,929T. Survey vessels are capable of all types of oceanographic research and hydrographic survey. These vessels are in service with the Chief Hydrographer, Indian Navy and have also executed overseas assignments in the Middle East. GRSE has supplied six survey vessels to the Indian Navy named as INS Sandhyak, INS Nirdeshak, INS Nirupak, INS Investigator, INS Jamuna and INS Sutlej
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Fleet Tanker The company’s fleet replenishment tanker was designed by a German company with a tonnage of 24,600T. It is used in replenishing warships at sea with fuel, ammunition, fresh water, provisions, hospital facilities, and other essential items. GRSE has supplied one fleet replenishment tanker to the Indian Navy named INS Aditya.
Offshore Patrol Vessele GRSE’s offshore patrol vessels are indigenously designed and these are capable of carrying multi-purpose roles. These are used by the defence forces for anti-piracy operations, search and rescue operation, anti-smuggling and anti-drug surveillance, anti-poaching operation of exclusive economic zones including fisheries protection, logistics support operations including transportation of dry cargo, fuel oil and fresh water and refrigerated fresh food, transportation of small detachment of troops/ personnel, helicopter operation, pollution response operation and external fire lighting. In 2011, the company became the first Indian shipyard, to have received an export order for a warship from the Government of Mauritius for the construction of an Offshore Patrol Vessel and on December 20, 2014 they became the first Indian company to have built and exported—CGS Barracuda—to the Mauritian National Coast Guard.
Hovercraft GRSE’s hover crafts are suitable for amphibious operations. GRSE has delivered a total of six hover crafts to the Indian Coast Guard, of which the first two hover crafts were imported from UK in fully assembled condition. The remaining 4 hover crafts were imported in completely knocked down kit and the company assembled them. Due to inadequate demand for hover crafts in the Indian market GRSE decided to discontinue with further efforts to indigenize hover craft building. However, the company has been providing assistance to Indian Coast Guard for repair and maintenance of these hovercrafts (through annual maintenance contracts), to keep them operational.
Inshore Patrol Vessel and Fast Patrol Vessel The company’s inshore patrol vessels and patrol vessels are indigenously designed having a tonnage of 280-304T. These are cost effective platforms suited for marine surveillance and rescue operation. These vessels allow its user to equip the vessels with armaments for use in combat, and this is suited for interception of fast moving surface craft and performs anti- smuggling, fishery protection and search and rescue operations. GRSE has delivered eight inshore patrol vessels and seventeen fast patrol vessels to Indian Coast Guard. In addition, GRSE has also delivered twenty Fast Patrol Vessels to Indian Navy.
Water Jet Fast Attack Craft GRSE’s WJFAC are indigenously designed with a tonnage of 288T. It promises to transform naval shoreline operation by packing a powerhouse punch of agility and speed. These ships meet critical requirement of crafts with improved stealth at networking capabilities. These WJFACs are ideally suited for interception of fast moving surface craft and also performs surveillance activities like anti-smuggling, fishery protection and search and rescue operations. GRSE has delivered fourteen WJFACs to the Indian Navy.
Fast Interceptor Boat The company’s fast interceptor boats are indigenously designed having a tonnage of 5T and 12T. These can be used as day/ night surveillance-cum-investigation vessel, which operate in shallow water for coastal policing, anti-smuggling, fishery protection and search and rescue operations. GRSE has built and delivered eighty-eight (58 numbers of 12 tonnes and 30 numbers of 5 tonnes) fast interceptor boats to the Ministry of Home Affairs, Government of India for coastal security. In addition to the aforesaid shipbuilding products, GRSE has also supplied various boats, pontoons, barge, sailing dinghy, fishing trawler, fire float, tug, dredger, passenger ferry, motor cutter, deck whaler, launch etc. to various customers over the years.
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ENGINEERING
Portable Bridges • Steel Suspension Bridge • Single Lane Portable Steel Bridge • Portable Steel Bridge
Deck Machinery Items • Windlass • Steering Gears • LCA Davit • Electro Hydraulic Deck Crane • Underslung Anchor Capstan • Designed and built to meet customer specific requirement to • Helicopter Traversing System support individual vessel. • Rail-less and rail-based helo traversing system
Engine & Pumps • Diesel Engines • Engine parts
Shipbuilding process in brief Construction and delivery of a warship typically takes twenty-three months to sixty-six months time. On signing of contract, PP&C department prepares a build strategy and finalise the cardinal dates for construction. Thereafter, schedules are prepared for preparation of drawings, indenting & procurement of material and construction activities. Accordingly, the design department progresses design, drawing preparation and preparation of statement of technical requirements. Material department progresses the procurement and production department progresses the physical construction as per the promulgated schedule. Construction commences with cutting of duly blasted and primed plates as per the nesting plan generated by design department. The cut plates and sections are used to fabricate hull units and blocks. Outfitting also progresses during the block fabrication stage depending on availability of outfitting drawings and relevant material. The blocks are consolidated in the building berth/ dry dock to form the hull structure. Once the hull structure is ready and pre-launch equipment are installed, the ship is launched to the water. All the balance outfitting, installation of balance equipment, testing tuning and trials are completed thereafter. Once all trials are completed, the ship is handed over to the customer.
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Shipbuilding Process Flow Chart
Contract
Design Purchase
Construction Process
Block Steel Erection & Preparation consolidation
Unit Onboard Fabrication Outfitting Planning & Quality Production Assurance control Unit outfitting Tank Testing
Equipment Block Painting Commissioning
Unit Trails & Consolidation Delivery to Block
Order procurement methodology of shipbuilding GRSE source’s its shipbuilding projects either through the nomination process or through competitive bidding. The timeline for product delivery ranges from twenty-three to sixty-six months. Their large ships are manufactured at their Main Works facility while the small ships are constructed at the Rajabagan Dockyard. The steel for ships is fabricated on-location and welded, either utilizing traditional shipbuilding techniques or their new modular construction process. The distribution method typically results in their customers taking possession of the ship after harbor and sea trials. GRSE depends on aluminum, composite, and equipment from original equipment manufacturers as raw materials for ships. They source their raw materials from numerous suppliers and providers. It may be noted that pursuant to the SEBI Exemption Letter-I, GRSE being an entity under the administrative control of the MoD has been exempted from the disclosure of the principal terms of the contracts 150 with the suppliers and providers of raw materials which may compromise national interests.
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Investment Argument • Emerging Goliath in warship manufacturing for Indian Navy and Indian Coast Guard services GRSE commands installed capacity of five dry docks and two wet basins, primarily catering to the Indian Navy and the Indian Coast Guards Services. It is also engaged in engineering and engine production activities. GRSE built India’s first indigenous warship, the INS Ajay in 1961. In 2019, GRSE has become the first shipyard in India to deliver 100 warships. The company has been manufacturing small warships/vessels (having tonnage of <3,500 T) like missile corvettes, fast interceptor boats to large warships (having tonnage of ~7,000 T) like stealth frigates which are harder to detect by radar, visual, sonar and infra-red methods. The company earns about 90% of its topline from shipbuilding services while the rest from engineering and engine production. The company has come a long way as it has increased its order book from ₹70 bn in FY12 to ₹274 bn by the end of Q2FY20. The timely execution of this big order book now remains the key to success of GRSE, and the company is targeting this through integrated modular construction methodology. With robust execution of this multitude of order book, the management expects the revenues to reach ₹60 bn in FY23 from ₹14 bn in FY19. We believe that the chances of achieving this target are high considering the company’s ability to execute big orders. GRSE is targeting to explore global opportunities by exporting small and medium sized warships and patrol vessels to countries in Africa (Mozambique, Egypt) and South East Asia (Vietnam, Phillippines). This business currently is negligible and at a nascent stage.
Order book size
Order book size (Rs bn) 302 301 282 275
215 203
115 104
2013 2014 2015 2016 2017 2018 2019 2020
Source: Company, LKP Research
• Mammoth order book gives a long and strong visibility, pick up in projects to start from FY21 onwards GRSE’s order book stood at ₹274 bn as of Q2 FY20. More than 90% of this order book belongs to ship building. In the last 25 months the company has delivered 8 ships to the Navy and Indian Coast Guard Services. Currently, the company has on hand to supply 22 ships in the coming 4-5 years. The project P17A stealth frigates comprises major chunk of this order book (66% or ₹182bn). Work on this project has been started in FY18 and has added ₹744 cr in FY19 and ₹92 cr in Q1FY20. Majority of the projects including P17A are gained by GRSE on nomination business from the government, while through competitive bidding, the company has recently gained projects such as the 8 ASW SWC (Anti -Submarine Warcraft Shallow Water Corvette – P28) and 4 Survey Vessel Large (SLV) which would be contributing 32% of the order book. The shipbuilding on an average takes 2-3 three years to complete. The company receives stage payment on a particular project at different stages of completion. At 60-70% completion stage, the company receives maximum of its payment. In FY20, GRSE has delivered 3 ships in the first nine months, while 3 more deliveries are scheduled for delivery by March 2020 (1 P28/ASWC, 1 Landing Craft Utility (LCU) and one Fast Patrol Vehicle (FPV) for Indian Coast Guard). Post FY20, the work related with the three main projects – P17A, ASW SWC and
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SVL will start gaining momentum. The stage wise payment of all these warships will start adding up simultaneously to the topline. This will provide an instant kicker to the topline and profitability too as most of these ships are large and advanced vessels that deliver significant profit margins (especially the contracts won in competitive bidding).
Order book schedule Number of Amount Sr No. Project Customer Time line of delivery Ship units (₹ bn) 1) ASW SWC 8 63.11 Indian Navy 1st Proj. - Oct 22 8th Proj. - Oct 26 2) Survey Vessel large 4 24.3 Indian Navy 1st Proj. - Oct 21 4th Proj. - April 23 3) P17Alpha 3 182 Indian Navy 1st Proj. - Aug 23 2nd Proj.- Aug 24 3rd Proj. - Aug 25 4) ASWC (P28) 1 1.5 Indian Navy Delivery by end of Jan 20 5) LCU 2 1.8 Indian Navy Delivery of one ship by FY 20 end 6) Fast Patrol Vessels 4 1.7 Indian Coastal Guard Delivery of one ship by FY 20 end 274.41 Source: Company, LKP Research
Revenues & Growth Rate
40,000 55.1% 80% Net sales (Rs bn) Growth (% yoy) 65.1% 35,000 60% 46.2% 30,000 40% 25,000 20% 4.4% 20,000 2.9% -28.2% 37,090 0% 15,000 -44.3% 23,912 -20% 10,000 16,555 14,481 13,478 13,864 -40% 5,000 9,218 - -60% FY 16 FY 17 FY 18 FY 19 FY 20E FY 21E FY 22E
Source: Company, LKP Research
New projects if materialized will provide an exponential jump in numbers GRSE has received RFPs (Request for Proposal) from Ministry of Defence (MoD) to bid for the following projects – 1). Pollution Control Vessels for Indian Coast Guard – 2nos. 2). Fast Patrol Vessels – 8nos. 3). Air Cushion Vessels for both Indian Navy as well as Indian Coast Guard – 12 nos. 4). New Generation Missile Vehicle (NGMV) – 6nos – worth ₹135 bn
All these projects will enter competitive, aggressive bidding from all the public and private players including GRSE. Any project win, especially in the NGMV category will elevate GRSE’s order book and topline further. This will be additional positive for the company. We await the outcome of this in the near future. Modernization of platforms and integrated ship building facilities to meet the delivery schedule on time GRSE’s modern infrastructure facilities available at its shipyard coupled with vast expertise would give a significant edge over other domestic defence shipyard. It has undertaken major modernization of its infrastructure. The company has developed a new integrated shipbuilding facility at the Main Works Unit that allows using modular construction when building warships, which enables it to reduce the shipbuilding period, improve quality and to construct ships in line with the global practices in the shipbuilding industry. These facilities would allow GRSE to
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produce 8 large ships and 12 medium/small ships concurrently. To further increase its construction capacity, company may use Rajabagan Dockyard (RBD) exclusively for the construction and fitting out of small ships. GRSE completed the modernization of its DEP unit in Ranchi in 2016. The modernization was intended to create a new, state-of-the-art diesel engine assembly shop that would enable carrying out overhaul and assembly of engines in a dust and moisture proof environment. The company management believes that its DEP unit is poised to take up work on next generation of marine diesel engines and move ahead on to manufacture of marine diesel engines under ‘Make in India’ initiatives. Significant indigenization to provide a hedge from currency fluctuations GRSE spends on average 10-12% of PAT on R&D activities thus enhancing indigenization, design capability and operational improvements in form of reduced wastage and re-work inship construction. In line with ‘Make in India’ initiative the company has maintained 94-95% level of indigenization in products such as P28 ASWC and LCU vehicles in FY19. Now the company has planned to maintain a similar kind of levels in P17A and ASW SWC projects too. We believe this initiative will prevent the company against any foreign currency fluctuations and the profitability will move in line with the domestic operation performance only.
Indigenisation v/s R&D expenses as a % of PAT
100 15.00 16.0 14.00 13.00 94.20 14.0 95 12.00 12.0 90 91.10 11.00 10.0 85 87.70 8.0 84.50 6.0 80 80.80 Indigenisation (%) 4.0 75 R&D expenses as a % of PAT 2.0 70 0.0 FY 15 FY 16 FY 17 FY 18 FY 19
Source: Company, LKP Research
Other businesses also find favor in GRSE’s portfolio In order to hedge its position, if market conditions in shipbuilding industry become challenging, the company would bet on businesses such as building portable bridges, deck machinery items, pumps and engines. The company has won contracts to build double lane bridge in states such as Maharashtra, Orissa and Bihar. GRSE has 68% market share in bridge building. Further, we are not aware of any other shipyard in India that has a dedicated deck machinery equipment facility or an engine assembling and testing process. GRSE’s rivals outsource such tasks related with deck machinery and engine assembly and testing. This in-house function/vertical integration enables GRSE to be self-dependent to produce and deliver products in a timely and efficient fashion. Hence we can say that GRSE is focusing on increasing its mote across product verticals and diversifying its segment profile. EBITDA margins to improve on higher volumes and competitive business GRSE has reported superb set of numbers between FY11-17, which was led by a whole host of projects including LCU and ASWC. Over this period, revenues and profits grew strongly at 25% and 5% CAGR respectively. This trend was reversed in FY17 as the company reported losses at EBIT levels followed by a net sales drop of 44%. This was a result of delay in execution of ASWC and LCU projects from Indian Navy as they made unplanned and unscheduled changes in design and technology. This caused GRSE to make significant provisions of ₹780 mn and ₹360 mn for
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Liquidity Damages (LD) in FY17 and FY18 respectively. Therefore, profitability in FY17 was badly impacted. However, in FY18, the company geared up its order execution and posted a robust 46% sales growth and profitability improved from ₹190 mn in FY17 to ₹943 mn in FY18. In FY19, GRSE delivered 3% growth, with EBITDA margins improving from -16.7% and -1.3% in FY17 and FY18 respectively to 3%. The profitability improved as provisions for LD reduced in FY19 (₹ 150 mn).
For FY20, the LD provisions are expected to come around ₹200 mn, which are expected to fall going forward, as GRSE has shifted its shipbuilding from sequential to modular construction process. Secondly, we know that businesses based on nomination basis (including P17A) have PBT margins fixed at 7.5%. Historically, majority of GRSE’s projects have been nomination based, hence we saw low margins in the recent past. However, the two recent project wins of ASW SWC and SVL (32% of order book) are based on competitive bidding, which have high margins. Execution of these two projects would surely result in significant improvement in margin profile of GRSE. Also, higher volumes through jump in order book would result in better operating leverage in coming years.
EBITDA margins & Liquidity Damages PAT & PAT margins
LD (Rs mn) 3500 PAT (Rs mn) 11.4% 8.9% 12.0% 900 EBITDA margins ( %) 10.0% PAT margins (%) 3000 9.2% 9.6% 800 10.0% 5.0% 8.1% 700 7.0% 2500 5.5% 7.0% 8.0% 600 3.0% 4.0% 0.0% 2000 500 -1.3% 3,311 6.0% -5.0% 1500 400 780 2.1% 2,298 4.0% 300 -10.0% 1000 200 -16.7% 1,529 1,651 360 2.0% -15.0% 500 943 1,121 100 150 200 175 150 0 -20.0% 0 190 0.0% FY 17 FY 18 FY 19 FY 20E FY 21E FY 22E FY 16 FY 17 FY 18 FY 19 FY 20E FY 21E FY 22E
Source: Company, LKP Research Source: Company, LKP Research
Healthy balance sheet, minimal debt , strong cash flow, super dividend yield GRSE produced strong cash flows of ₹19.9 bn (including cash and cash equivalents and bank deposits) in FY19, which has zoomed up from ₹10.2 bn in FY18. The cash position of GRSE at the end of Q2 FY20 lies at a whopping ₹28.4 bn. Further, as compared to its private sector shipyard peers like Reliance Defence, ABG shipyard and Bharti Shipyard, which have huge debt liability, GRSE is a zero debt company. Going forward, with strong government backing and huge order inflows resulting in sizeable stage payments, balance sheet strength will further increase leading to negative working capital cycle. The company has plans to invest ₹2.5-3 bn in next 2-3 years for modernization of existing ship building facilities, mainly at Rajabagan Dockyard, replacement of the damaged Goliath cranes, maintenance capex and modification of certain capabilities of ships constructions, block fabrication etc. Given its strong balance sheet, funding its capex programs is never an isuue with GRSE. The company paid dividend of ₹7.6 /share in FY19, which implies a healthy dividend of 3.7% .
LKP Research 12 Garden Reach Shipbuilders & Engineers | Initiating Coverage
Cash v/s ROE
Cash (Rs mn) ROE (%) 25000 35.0% 20,912 19,894 19,270 30.0% 20000 17,476 16,203 16,203 28.9% 25.0% 20.1% 15000 20.0% 14.4% 13.1% 10,222 10000 15.0% 9.6% 8.1% 10.0% 5000 0.9% 5.0% 0 0.0% FY 16 FY 17 FY 18 FY 19 FY 20E FY 21E FY 22E Source: Company, LKP Research
Outlook and valuation GRSE is well poised to execute the orders they have received from their clients. Considering its strong order book, expectations of more order wins through RFP bidding, we expect a significant escalation of topline, margins and bottomline from FY21E over an elongated period of5-6 years. On profitability front too we expect solid movement driven by higher contribution from competitively bid projects, positive operating leverage, lower LD provisions and modernization of facilities. With robust cash surplus and zero debt, we anticipate a turnaround in return ratios with maintenance of healthy dividend payouts and yield. We expect FY19-22E revenue CAGR at 39%, while the bottomline is expected to grow at 43% CAGR during the same period. At 7.3x the valuations seems compeling. Hence, we initiate the company with a BUY rating and a target of ₹318 (valued at 11x FY22E earnings) Key investment risks • Any delay in execution may result in higher LD provisions and lower than expected revenues. • Any unplanned, unscheduled changes may result in missing the target • Competition in the defence shipbuilding sector has increased as it has been opened for private sector • Change in government policy regarding bidding or payment mode may impact the financials. • Single client (Ministry of Defence) concentration. • No hike in budgetary allocation for Navy may hamper growth
LKP Research 13 Garden Reach Shipbuilders & Engineers | Initiating Coverage
Consolidated Financial
Income Statement Balance Sheet YE Mar (₹ mn) FY 18 FY 19 FY 20E FY 21E FY 22E YE Mar (₹. mn) FY 18 FY 19 FY 20E FY 21E FY 22E Total Revenues 13,478 13,864 14,481 23,912 37,090 Equity and Liabilities Raw Material Cost 2,694 1,747 5,068 8,967 14,094 Equity Share Capital 1,146 1,146 1,146 1,146 1,146 Employee Cost 2,986 2,915 3,910 5,978 8,902 Reserves & Surplus 9,070 9,238 10,063 11,212 12,868 Other Exp 7,985 8,781 4,924 7,652 11,498 Total Networth 10,215 10,383 11,208 12,358 14,013 EBITDA (169) 421 579 1,315 2,596 Total debt 0 0 0 0 0 EBITDA Margin(%) -1.3% 3.0% 4.0% 5.5% 7.0% Net Deferred Tax 115 112 112 112 112 Depreciation 290 271 298 336 372 Long term provisions 686 719 919 1,119 1,319 EBIT (458) 150 281 980 2,225 Current Liab & Prov EBIT Margin(%) -3.4% 1.1% 1.9% 4.1% 6.0% Trade payables 6,888 3,701 4,166 6,224 8,637 Other Income 1,832 1,712 2,000 2,100 2,200 Short term prov+ borrowings 1,433 1,408 1,408 1,408 1,408 Interest 77 51 20 15 10 Other current liabilities 23,850 25,575 32,533 37,997 50,809 PBT 1,296 1,812 2,261 3,065 4,415 Total current liab and privs 32,172 30,685 38,487 46,029 61,274 PBT Margin(%) 9.6% 13.1% 15.6% 12.8% 11.9% Total Equity & Liabilities 43,188 41,899 50,727 59,618 76,719 Tax 353 690 610 766 1,104 Assets Adjusted PAT 943 1,121 1,651 2,298 3,311 Net block 3,830 2,973 3,075 3,139 3,268 APAT Margins (%) 7.0% 8.1% 11.4% 9.6% 8.9% Capital WIP 160 342 442 542 642 Exceptional items 0 -22 0 0 0 Other non current assets 14,100 2,870 2,870 2,870 2,870 PAT 943 1,099 1,651 2,298 3,311 Total fixed assets 18,090 6,186 6,387 6,552 6,780 PAT Margins (%) 7.0% 8.1% 11.4% 9.6% 8.9% Cash and cash equivalents(i) 118 93 1,469 1,675 7,111 Bank deposits other than (i) 10,104 19,801 17,801 15,801 13,801 Inventories 5,131 3,496 5,554 9,827 17,377 Key Ratios Trade receivables 2,021 2,199 1,389 1,638 1,524 Other current assets 7,726 10,107 18,107 24,107 30,107 YE Mar FY 18 FY 19 FY 20E FY 21E FY 22E Total current Assets 25,099 35,714 44,339 53,066 69,939 Per Share Data (₹) Total Assets 43,188 41,899 50,727 59,618 76,719 Adj. EPS 8.1 9.8 14.4 20.1 28.9 CEPS 60.0 11.7 17.0 23.0 32.1 BVPS 87.4 90.6 97.8 107.9 122.3 DPS 5.6 7.6 7.2 10.0 14.5 Cash Flow Growth Ratios(%) YE Mar (₹ mn) FY 18 FY 19 FY 20E FY 21E FY 22E Total revenues 45.2% 2.7% 4.4% 65.1% 55.1% PBT 1,277 1,790 2,261 3,065 4,415 EBITDA -89.0% -349.9% 37.5% 127.0% 97.4% Depreciation 290 271 298 336 372 EBIT -74.6% -132.8% 86.9% 248.6% 127.1% Interest 77 51 20 15 10 PAT 396.0% 18.9% 47.2% 39.3% 44.1% Chng in working capital (996) (2,787) (1,677) (2,849) 1,939 Valuation Ratios (X) Tax paid 369 1,259 610 766 1,104 PE 25.4 20.9 14.2 10.2 7.1 Other operating activities (1,758) (1,700) 0 0 0 P/CEPS 3.4 17.5 12.1 8.9 6.4 Cash flow from operations (a) (741) (1,116) 292 (200) 5,632 P/BV 2.3 2.3 2.1 1.9 1.7 Capital expenditure (502) (525) (500) (500) (600) EV/Sales 1.8 1.7 1.5 0.9 0.5 Chng in investments 1,513 1,111 2,000 2,000 2,000 EV/EBITDA (143.0) 55.5 38.7 16.9 6.5 Other investing activities 1,663 1,392 0 0 0 Operating Ratios (Days) Cash flow from investing (b) 2,674 1,978 1,500 1,500 1,400 Inventory days 695.2 730.4 400.0 400.0 450.0 Free cash flow (a+b) 1,933 862 1,792 1,300 7,032 Recievable Days 54.7 57.9 35.0 25.0 15.0 Inc/dec in borrowings 0 0 430 70 70 Payables day 186.5 97.4 105.0 95.0 85.0 Dividend paid (incl. tax) (651) (868) (825) (1,149) (1,656) Net Debt/Equity (x) 0.00 0.00 0.02 0.02 0.02 Interest paid (77) (20) (20) (15) (10) Profitability Ratios (%) Other financing activities (1,205) 0 0 0 0 ROCE -4.2% 1.3% 2.3% 7.2% 14.4% Cash flow from financing (c) (0) (26) 1,377 205 5,436 ROE 8.1% 9.6% 14.4% 20.1% 28.9% Net chng in cash (a+b+c) 118 118 93 1,469 1,675 Dividend payout 2.7% 3.7% 3.5% 4.9% 7.0% Closing cash & cash equiv 118 93 1,469 1,675 7,111
Source: Company, LKP Research
LKP Research 14 Garden Reach Shipbuilders & Engineers | Initiating Coverage
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