Mazagon Dock a solid play on growing defence focus

ET Intelligence Group: Long-term investors may consider investing in the initial public offering (IPO) of public sector undertaking (PSU) Mazagon Dock Shipbuilders. A healthy order backlog and reasonable valuations are two key investment arguments.BusinessThe Mumbai-based PSU, which is a part of the defence ministry, will be raising Rs 444 crore from the primary market. The IPO is an offer for sale by the Government of India, which will bring down its holding to 85 per cent. The company builds warships and submarines for the Indian Navy. It recently started ship repair activity.Since 1960, Mazagon Dock has built a total of 795 vessels which include advanced destroyers to missile boats and three submarines and 25 warships. Besides, it has delivered cargo ships, passenger ships, supply vessels, multipurpose support vessels, water tankers, tugs, dredgers, fishing trawlers, barges and border outposts for customers in domestic and overseas markets. In 2017 and 2019, the company delivered two Scorpene submarines INS Kalvari and INS Khanderi to the Indian Navy.The order book stood at Rs 54,074 crore at the end of July, which mainly comprises building and construction of the four ‘P-15B’ destroyers and four ‘P-17A’ stealth frigates, four Scorpene-class submarines. This is equivalent to 11 times FY20 revenues. The dock modernisation programme has increased its warship building capacity to 10 from eight earlier. Besides, its submarine capacity has increased from six to 11 submarines. The order pipeline from the Indian Navy is expected to be strong in the near future.FinancialsThe company’s revenue grew annually by 12.2 per cent to Rs 4,977 crore between FY16 and FY20, while the profit dropped annually 7.2 per cent to Rs 477 crore in the same period. The company is having cash and bank balance of Rs 5,798 crore at the end of FY20, which is higher than implied market capitalisation. In the past four years, the dividend payout ratio was 85.15 per cent.RisksThe company is highly dependent on orders from the Indian Navy. Any moderation in orders or delay in the commissioning of ships could impact its financials. The government plans to bring more private players in shipbuilding, which could impact the company's ability to win orders.ValuationAt the higher end of the price band, the issue is commanding price-earnings multiple of 6.1 times FY20 earnings, which is 34 per cent discount to the sector average of 9.3 based on the current valuation of the Cochin Shipyard and Garden Reach Shipbuilders.Mazagon Dock has a bigger scale in revenue and order backlog, superior return on equity and a large addressable market to cater to the Indian Navy new programmes. Hence, the gap in P/E valuation with its listed peers may narrow down.Defence stocks have generated high interest from investors after the recent tensions with China. This may prompt the government to increase allocation to defence’s capital outlay which may provide incremental orders to Mazagon Dock.

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