idirect_pipavavdefence

March 13, 2015

ICICI Securities Ltd | Retail Equity Research

Event Update

Play on long term defence opportunity Unparalleled infrastructure provides scope for defence orders Pipavav Defence and Offshore Engineering (PDOECL), spanning over 861 acres of land with two dry docking facilities of 662 m x 65 m (Dry Dock-1) and 750 m x 60 m (Dry Dock-2 under construction), is one of the largest defence shipbuilding facilities in India. The shipyard is capable of accommodating 400,000 dwt capacity ships along with construction and repair of a wide range of vessels starting from coastal and naval vessels together with repair and fabrication of offshore platforms and rigs. It also has a dedicated offshore yard with 175 m x 16.89 m quay consisting of both launching and loading platform together with installation of bollard and mooring rings. Recently, along with Larsen & Toubro, PDOECL was shortlisted for a potential | 60000 crore order to build six submarines for Indian Navy. Strategic tie-ups to enable capturing of forthcoming opportunity PDOECL formed a JV with Mazagaon Dock (MDL) providing exposure to MDLs ~$20 billion order book to capture the defence shipbuilding opportunity in India. Further, to enhance its position, PDOECL formed several strategic tie-ups with a slew of foreign partners to provide integrated solution. PDOECLs tie-up with multinational players like SAAB, DCNS, Babcock, etc. that have a proven track record in defence shipbuilding provide it the ability to bid for defence projects. Further, the government raised the FDI cap from 26% to 49% with its focus on enhancing indigenous capacity and capability of defence shipbuilding. Hence, PDOECL with its robust infrastructure may be a prime candidate for stake sale and, thereby, significantly de-leverage itself. Acquisition by Reliance Infrastructure positive over long term PDOECL, in spite of having one of the largest dry dock in the world, was unable to ramp up its revenues owing to sluggish execution on account of varied factors like an initial delay in setting up the yard and delayed payments by clients. As revenue growth slackened, delayed payments by clients led to pressure on working capital and increase in interest cost. With the global shipping scenario remaining bleak and defence orders announcements being delayed, PDOECL ran into a severe financial crisis with lenders suggesting it be referred to corporate debt restructuring cell (CDR). Recently, Reliance Infrastructure announced that it would acquire ~18% stake in PDOECL at | 63 per share at a total consideration of | 819 crore. Also, Reliance Infrastructure launched an open offer to acquire a further 26% stake at | 66/share. The acquisition by Reliance Infrastructure would provide requisite strength to PDOECL to withstand the financial difficulties in the near term and provide support for capturing the long term opportunity in the defence sector. Stronger promoter group augurs well for capturing long term opportunity The government has approved 49% FDI in defence and is expediting indigenisation of defence procurement. PDOECL stands at a vantage point for the same owing to its superior infrastructure. Defence projects are usually long gestation. With Reliance Infra at the helm, we believe PDOECL is better placed than before to capture the humongous opportunity presented by the indigenisation of Indian defence procurement. We value PDOECL at 2.7x FY17 P/BV to arrive at a target price of | 80 with a BUY recommendation on the stock. We recommend that investors with a long term view not tender their shares in the open offer.

Pipavav Defence & Offshore (PIPSHI) | 62 Rating matrix Rating : BuyTarget : | 80Target Period : 12 monthsPotential Upside : 29%

Whats changed? Target Changed from Under Review to | 80EPS FY15E Changed for | -2.4 to | -2.6EPS FY16E Changed for | -2.2 to | -0.4EPS FY17E Introduced at | 0.7Rating Changed from Under Review to Buy

Key financials | Crore FY14 FY15E FY16E FY17ENet Sales 1,064 1,064 1,751 2,098 EBITDA 626 280 441 555 Net Profit 3 (194) (26) 48 EPS (|) 0.0 (2.6) (0.4) 0.7

Valuation summary

FY14 FY15E FY16E FY17EP/E 1639.3 NA NA 93.4Target P/E 2,123.0 NA NA 120.9 EV / EBITDA 14.6 33.2 21.2 16.9P/BV 1.9 2.1 2.2 2.1 RoNW (%) 0.1 -9.0 -1.2 2.2RoCE (%) 6.0 2.0 4.1 5.4

Stock data Particular AmountMarket Capitalization (| Crore) 4,490.9 Total Debt (FY14) (| Crore) 5,674.9 Cash and Investments (FY14) (| Crore) 384.4 EV (| Crore) 9,781.4 52 week H/L 85 / 33 Equity capital 736.2 Face value 10.0

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Pipavav (R.H.S) Nifty (L.H.S)

Research Analysts

Bharat Chhoda [email protected]

Ankit Panchmatia [email protected]

ICICI Securities Ltd | Retail Equity Research Page 2

Variance analysis Q3FY15 Q3FY14 YoY (%) Q2FY15 QoQ (%) Comments

Revenue 252.0 318.1 -20.8 212.2 18.8 Revenue declined YoY on account of lower shipbuilding revenue

Cost of material 17.5 38.2 -54.1 31.5 -44.3Purchase of stock in trade 102.0 21.7 369.9 12.4 720.4Employee benefit 14.5 13.1 10.6 14.1 3.0Other expenses 74.0 120.0 -38.4 114.4 -35.3

EBITDA 44.0 125.0 -64.8 39.8 10.7

EBITDA Margin (%) 17.5 39.3 -2183 bps 18.8 -128 bpsDepreciation 33.5 40.0 -16.3 13.4 150.1Interest 113.1 102.0 10.9 106.4 6.4 Interest cost continues to remain elevated Other income 9.1 10.0 -9.1 4.1 120.5Extra-ordinary gain/loss 0.0 0.0 0.0Total Tax -23.3 -2.2 -7.5PAT -70.2 -4.8 NA -68.3 NA

Source: Company, ICICIdirect.com Research Change in estimates

FY15E FY16E FY17E(| Crore) Old New % Change Old New % Change IntroducedRevenue 1,092.0 1,064.0 -2.6 1,164.0 1,751.1 50.4 2,097.7EBITDA 261.0 279.9 7.2 305.0 440.5 44.4 554.6EBITDA Margin (%) 23.9 25.2 125 bps 26.2 25.2 -105 bps 26.4PAT -175.0 -194.1 NA -160.0 -26.0 -83.7 48.0EPS (|) -2.4 -2.6 NA -2.2 -0.4 -83.9 0.7

Source: Company, ICICIdirect.com Research CDR to provide relief Over the past two years, PDOECLs operational performance was impacted due to slow execution and delay in payments from clients, which resulted in stressed working capital position and escalation of interest cost. Lower EBITDA generation and higher interest cost negatively impacted the profitability. More than 70% of EBITDA was eaten up by interest expense. The lenders (banks) have referred PDOECL to the CDR cell to enable it to improve the profitability. The CDR would likely entail deferral of loan repayment and reduction in cost of borrowing. This would provide PDOECL some breathing space and enable it to improve its cash flows. Key features of acquisition and open offer

Reliance Infrastructure together with its wholly-owned subsidiary Reliance Defence Systems Pvt Ltd has decided to acquire 13,00,00,000 equity shares from the promoters of PDOECL at | 63/share aggregating to ~18% shareholding in the company with an investment to the tune of | 819 crore

Reliance Defence Systems, a subsidiary of Reliance Infrastructure, has launched a mandatory open offer to acquire a 26% stake from the public shareholders of the company at | 66/share aggregating to | 1263 crore

In case Reliance Infrastructure is unable to acquire a total shareholding of 25.1%, it will acquire additional shares to the extent of the shortfall from the promoters at | 63/share

Post the transaction, existing promoters of PDOECL will continue to hold a minority stake in the company, together with two non-executive Board seats

The acquisition would result in a change in management and control of the company Post completion of the transaction, Anil D Ambani, will become the chairman of PDOECL


Company Analysis Strategic joint venture, indigenous focus to support PDOECL PDOECLs joint venture (JV) with Mazagaon Dock (MDL) provides scope for the JV to co-bid for the existing order book of MDL, which is upwards of ~$20 billion. Also, PDOECL has formed a strategic partnership with SAAB (part of Wallenberg Group) to enhance its capability to build and provide maintenance of equipment for the Indian armed forces. All this places PDOECL in a very sweet spot as the government focus shifts to buy & make Indian in the Defence Procurement Policy (DPP). Also, as the government has raised the FDI cap to 49% from the present 26% it opens up an opportunity window of ~$12 billion market size of defence orders over the years. Exhibit 1: Strategic tie-ups with multiple players Company Country ExpertiseBabcock UK Engineering Support ServicesDCNS France Naval Defence, submarineFinmeccanica Italy Aeronautics, Space, Defence and Security, Electronics & TransportationNortthrop Grumman Israel Naval weapon platforms and missile systemsSaab AB, Sweden Aeronautics, Dynamics, Electronic Defence SystemsSembcorp Marine Singapore Marine and offshore engineeringRosoboronexport Russia Export/import of military/dual use equipment and strategic raw materialSagem France Defence electronics and communication systems Source: Company, ICICIdirect.com Research

Exhibit 2: Indian navy pipeline Item Estimated Cost (US$)18 Diesel Electric Submarine $24 Billion7 Stealth Frigates $12 Billion4 Destroyers $6 Billion4 Landing Platforms $4 Billion32 Corvettes $8 Billion2 Aircraft Carriers $10 Billion7 Offshore Patrol Vessel $1.5 Billion

Source: Company, ICICIdirect.com Research

Offshore engineering, fabrication provide firm footing

PDOECL with its dedicated offshore yard infrastructure of 175 m x 16.9 m of both launching and loading platform together with 280 m long fixed and variable tracks is well poised to serve the strong growing offshore segment. With PSUs like ONGC and OIL together with players such as Gail, Cairn and RIL estimated to spend nearly $10-20 billion over the next three to four years, this provides a footing for the offshore segment business in India. Consequently, PDOECL received orders to the tune of $240 million from ONGC for conversion to mobile offshore production unit and maintenance of rigs. Besides, it has also received an order for rig maintenance from global players such as Trans-ocean and Noble. Going ahead, we believe, as there is significant growth in the oil & gas business, PDOECL can be a direct beneficiary of the same.


Valuation PDOECL, with one of the largest shipyards in the country, is well placed to take advantage of any policy change towards foreign direct investment (FDI) in the defence segment as the company already has a significant presence in the defence sector. The Government of India has approved 49% FDI in defence and is expediting indigenisation of defence procurement. PDOECL stands at a vantage point for the same owing to its superior infrastructure. Defence projects are usually long gestation. With Reliance Infra at the helm, we believe PDOECL is better placed than before to capture the humongous opportunity presented by the indigenisation of Indian defence procurement. We value PDOECL at 2.7x FY17 P/BV to arrive at a target price of | 80 with a BUY recommendation on the stock. We recommend that investors with a long term view not tender their shares in the open offer.

Exhibit 3: P/BV trend

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Exhibit 4: Valuations

Sales Sales EPS EPS PE EV/EBITDA RoNW RoCE(| cr) Growth (%) (|) Growth (%) (x) (x) (%) (%)

FY14 2533.9 -2.0 0.04 -91.6 1639 14.6 0.1 6.0FY15E 1064.0 -58.0 -2.6 NA NA 33.2 -9.0 2.0FY16E 1751.1 64.6 -0.4 NA NA 21.2 -1.2 4.1

FY17E 2097.7 19.8 0.7 NA 93 16.9 2.2 5.4



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Financial summary Profit and loss statement | Crore (Year-end March) FY14 FY15E FY16E FY17ETotal operating Income 2,533.9 1,064.0 1,751.1 2,097.7Growth (%) -2.0 -58.0 64.6 19.8Raw Material Expenses 997.1 267.9 440.7 505.8Employee Expenses 57.4 63.8 52.5 62.9Others Expense 853.8 452.4 817.4 974.3Total Operating Expenditure 1,908.3 784.1 1,310.6 1,543.0EBITDA 625.5 279.9 440.5 554.6Growth (%) 14.9 -55.3 57.4 25.9Depreciation 166.5 131.0 138.6 146.2Interest 477.5 430.1 360.6 370.5Other Income 39.0 38.4 21.3 30.7PBT 20.6 -242.8 -37.3 68.6Exceptional loss/gain 0.0 0.0 0.0 0.0Total Tax 18.0 -48.6 -11.2 20.6PAT 2.6 -194.2 -26.1 48.0Growth (%) -91.5 NA NA NAEPS (|) 0.04 -2.6 -0.4 0.7


Cash flow statement | Crore (Year-end March) FY14 FY15E FY16E FY17EProfit after Tax 2.6 -194.2 -26.1 48.0Add: Depreciation 166.5 131.0 138.6 146.2(Inc)/dec in Current Assets 673.0 -1,206.9 652.4 448.1Inc/(dec) in CL and Provisions 1,720.5 -1,458.9 766.5 465.5Others 0.0 0.0 0.0 0.0CF from operating activities 742.0 -633.5 -106.3 -133.1(Inc)/dec in Investments 284.2 397.4 39.7 35.8(Inc)/dec in Fixed Assets -829.8 -69.0 -61.4 -53.8Others -242.7 40.5 -29.2 -24.9CF from investing activities -788.3 368.9 -50.9 -43.0Issue/(Buy back) of Equity 262.4 0.0 0.0 0.0Inc/(dec) in loan funds 541.2 53.0 150.1 141.8Others -756.9 94.1 123.4 123.4CF from financing activities 384.8 147.0 273.5 265.2Net Cash flow 338.5 -117.6 116.4 89.2Opening Cash 45.9 384.4 266.8 383.2Closing Cash 384.4 266.8 383.2 472.4


Balance sheet | Crore (Year-end March) FY14 FY15E FY16E FY17ELiabilitiesEquity Capital 736.2 736.2 736.2 736.2Reserve and Surplus 1,606.8 1,412.7 1,386.6 1,434.7Total Shareholders funds 2,343.0 2,148.9 2,122.9 2,170.9Total Debt 1,919.6 2,099.8 2,149.9 2,191.6Deferred Tax Liability 99.0 99.0 99.0 99.0Other liabilities & prov 327.5 147.5 147.5 147.5Total Liabilities 4,689.1 4,495.1 4,519.2 4,609.0

AssetsGross Block 3,346.4 3,546.4 3,746.4 3,946.4Less: Acc Depreciation 495.6 626.6 765.1 911.3Net Block 2,850.8 2,919.9 2,981.3 3,035.1Total Fixed Assets 6,879.4 6,551.0 6,572.7 6,590.8Inventory 230.9 96.2 153.5 183.9Debtors 1,395.6 1,020.3 1,343.3 1,609.2Loans and Advances 395.9 174.9 287.9 344.8Other Current Assets 796.6 320.7 479.8 574.7Cash 384.4 266.8 383.2 472.4Total Current Assets 3,203.3 1,878.8 2,647.7 3,184.9Creditors 316.1 160.3 215.9 258.6Other Liab & Provisions 1,646.9 1,020.3 1,631.2 1,954.0Short term borrowing 3,430.6 2,754.1 2,854.1 2,954.1Total Current Liabilities 5,393.6 3,934.7 4,701.2 5,166.7Net Current Assets -2,190.3 -2,055.9 -2,053.5 -1,981.8Application of Funds 4,689.1 4,495.1 4,519.2 4,609.0


Key ratios (Year-end March) FY14 FY15E FY16E FY17EPer share data (|)EPS 0.04 -2.6 -0.4 0.7Cash EPS 2.3 -0.9 1.5 2.6BV 31.8 29.2 28.8 29.5DPS 0.0 0.0 0.0 0.0Cash Per Share 2.3 -0.9 1.5 2.6Operating Ratios (%)EBITDA Margin 24.7 26.3 25.2 26.4PBT / Total Operating income 0.8 -22.8 -2.1 3.3PAT Margin 0.1 -18.3 -1.5 2.3Inventory days 33.3 33.0 32.0 32.0Debtor days 201.0 350.0 280.0 280.0Creditor days 45.5 55.0 45.0 45.0Return Ratios (%)RoE 0.1 -9.0 -1.2 2.2RoCE 6.0 2.0 4.1 5.4RoIC 6.6 2.2 4.4 5.8Valuation Ratios (x)P/E 1,639.3 NA NA 93.4EV / EBITDA 14.6 33.2 21.2 16.9EV / Net Sales 3.6 8.7 5.3 4.5Market Cap / Sales 1.8 4.3 2.6 2.2Price to Book Value 1.9 2.1 2.2 2.1Solvency RatiosDebt/EBITDA 3.6 8.0 5.2 4.2Long term Debt / Equity 2.1 2.3 2.4 2.4Current Ratio 0.6 1.0 1.0 1.0Quick Ratio 9.4 11.1 11.6 11.6



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[email protected]


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