Pipavav: Positives priced in

Company could be a major beneficiary if FDI cap in defence sector is raised, but investors should be cautious

India's defence sector has seen a large dependence on imports. This could undergo a sea change. After the department of industrial policy & promotion (DIPP)'s draft note suggesting 100 per cent foreign direct investment (FDI) in the sector from 26 per cent, markets are hopeful of better days for defence equipment makers. Pipavav Defence and Offshore Engineering Company, on the rise since May 16, could be among major beneficiaries if FDI cap is raised.

The company has the largest defence shipyard and is among the first private companies to get contract for construction of warship as well as form a joint venture with public-sector shipyard Mazagon Dock.

If FDI is raised, the technological gap between Indian and global companies may shrink over time. So, a large requirement of defence forces could be met by the domestic market.

Pipavav has made inroads in this direction as it has got related clearances, technical tie-ups and modern infrastructure.

Order book is Rs 6,600 crore (2.6 times its 2013-14 revenue), of which 60 per cent are defence orders. Analysts are expecting its order book to reach Rs 12,000 crore by 2015-16 as a result of the thrust on domestic market. As a result, they expect revenue momentum to improve and have a positive impact on asset utilisation enabling the company to absorb fixed and interest costs. The company has fixed assets of Rs 6,073 crore, which helped generate net profit of Rs 2.72 crore on sales turnover of Rs 2,522 crore in 2013-14. A large part of this is due to the debt of Rs 4,800 crore (debt-equity ratio of two).

In 2013-14, Pipavav paid Rs 478 crore as interest expenses on earnings before interest and tax of Rs 498 crore indicating very low interest coverage ratio. But this could change on declining interest cost. Growing sales turnover will boost earnings and return ratios, now depressed. Analysts expect the return on capital employed to move from 6.2 per cent in 2012-13 to nine-10 per cent in 2015-16. By 2015-16, sales turnover is expected to grow to Rs 4,300 crore. Net profit could jump to Rs 280-290 crore.

But investors should be cautious as a large part of the FDI news and earnings growth expectations are reflected in its share. At Rs 65, the stock is trading at 17 times 2015-16 estimated earnings and 1.8 times its book value. Investors with a medium- to long-term perspective may consider the stock on correction.