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PSU Bharat Dynamics IPO opens: Here's why you might consider subscribing
The IPO of state-owned Bharat Dynamics (BDL) is now open for subscription at a price band of Rs 413-428 per share. The government will dilute its stake in the Hyderabad-based defence contractor by 12 percent, selling 22.45 million equity shares for up to Rs 960.94 crore in the upper price band.
PSU Bharat Dynamics IPO opens: Here's why you might consider subscribing

The IPO of state-owned Bharat Dynamics (BDL) is now open for subscription at a price band of Rs 413-428 per share. The government will dilute its stake in the Hyderabad-based defence contractor by 12 percent, selling 22.45 million equity shares for up to Rs 960.94 crore in the upper price band. However, the company may reserve a portion of 458,203 equity shares for allocation and allotment to eligible employees. The IPO, which closes on March 15, is a part of Finance Minister Arun Jaitley's hiked up disinvestment estimate of Rs 1 lakh crore for 2017-18.

BDL is offering a discount of Rs 10 per equity share and retail investors can reportedly bid for a minimum lot of 35 equity shares and in multiples of 35 shares thereafter. According to Motilal Oswal, the floor price is 41.3 times the face value and the cap price is 42.8 times the face value. SBI Capital Markets, IDBI Capital Markets & Securities and YES Securities (India) are the book-running lead managers to the IPO. Here are 4 factors to keep in mind before you subscribe:

Company background

According to Edelweiss, BDL is a leading defence PSU engaged in the manufacture of Surface to Air missiles (SAMs), Anti-Tank Guided Missiles (ATGMs), underwater weapons, launchers, countermeasures and test equipment. It is the sole manufacturer in India for SAMs, torpedoes, ATGMs. It is also the sole supplier of SAMs and ATGMs to the Indian armed forces. Additionally, it is engaged in the business of refurbishment and life extension of missiles manufactured. The Mini-ratna (Category -1) boasts three manufacturing facilities - located in Hyderabad, Bhanur and Vishakhapatnam -and is in the process of setting up two more. Furthermore, BDL reportedly had a visible order book of around Rs 11,100 crore as of last October, equivalent to 3.3 years of revenue from product manufactured.

Market and business outlook

Everyone knows that Indian defence spending is mushrooming, thanks to neighbours like China and Pakistan as well as technology obsolescence. This, along with the government's Make in India, thrust bodes well for the company. "BDL's 2017 revenue of Rs 34 bn (Rs 3,400 crore) from products manufactured suggests that BDL accounted 33 percent of the entire guided missile market and 41 per cent of the tactical missile system market (in India)," writes Smartkarma Insight Provider Ke Yan in a recent report. "If we include sales of products traded (products not manufactured by BDL, but are provided along with BDL products to customers), BDL accounted for 46 percent of guided missile market and 58 percent of tactical missile market in 2017." Significantly, Frost and Sullivan expects the missile market to pick up in the next few years before peaking in 2021, which is positive for the company's mid-term performance. The company's top line is likely to grow at 4 percent per annum versus an industry growth rate of 5 percent.

Company financials

The company's revenue has been growing rapidly in the past five years, at a CAGR of 33 percent from FY2013 to FY2017. "But there's a slowdown in 2017 with a growth of 13 percent YoY (year-on-year)," says Ke Yan, explaining that its revenue in the first half of 2018 is equal to only 42 percent of 2017 revenue. Also, the company's net profit grew at 15 percent CAGR between FY2013 and FY2017. But this lags behind its revenue growth rate.

In the same period, gross margins trended down from 52 percent in 2013 to 40 percent in FY2017 but improved to 42.4 percent in 1HFY2018. Net margins similarly have dropped from 17 percent to 7.9 percent. "We find that the key income statement expense affecting the net margins is the other expense which includes the liquidated damages, which accounts for payment slippage. Once payment slippage has happened in a given year, liquidated damages will be used to account for it, regardless of the year of actual sales. If we adjust for the effect of such payment slippage, the company would have a net margin of... 14.2 percent and 12.8 percent in FY2017 and 1HFY2018 (respectively), which we think is decent," he adds.

Last but not the least, BDL's management has committed to a minimum dividend payout of 30 per cent.

Peer comparison

The company has a better gross margin and net margin than its peers like Lockheed Martin, Bharat Electronics, Cochin Shipyard and Raytheon. Also, the stock's past 3-year average EBITDA margin is 4 percent higher than its peers.

"The company has a similar ROA (return on assets) as peers but much higher ROE (return on equity) due to its high leverage. This is because the company has a large inventory (Rs 2,100 crore) and other current assets (Rs 1,500 crore), which is mainly advances to vendors. These two items accounted for 44 percent of total assets as of 1HFY2018," says Ke Yan.

According to him, at the higher end of the price band of Rs 428, the issue is priced at PE of 15.4 times on FY18 (expected), which is lower than the average PER valuation for the peer group at 20.8 times. "For the purpose of valuation comparison, we make the following assumptions: Revenue growth at -12 percent in FY2018E and +15 percent in FY2019E and net profit growth of -22 percent and +34 percent in FY2018 and FY2019 respectively. We make this assumption to account for both the slowdown of sales in 1HFY2018 and reversal of net margins. Our 2019E net profit of Rs 5.1bn (Rs 510 crore) is still lower than the company's 2016 PATMI of Rs 5.6bn (Rs 560 crore). Therefore we think our assumption is not aggressive," he explains, adding, "Hence, we think there is substantial upside for the company post-listing."

Previous IPOs in India - listed over the past six months with similar market cap - have returned 17.5 percent and 10.8 percent on average at open and in one month.

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