HAL IPO: quality business, attractive valuations make it a long-term bet

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There are many PSUs known for the quality of businesses and safety of returns, but there are very few offering growth as well. Hindustan Aeronautics (HAL) is a rare combination of all the three attributes.

HAL, which manufactures aircraft, helicopters, passenger aircraft largely catering to the Indian defence requirements (accounting for 93 percent of sales) has grown its sales at a CAGR of 9 percent over the financial year 2015-17. Today, it is sitting on an order book of Rs 68,461 crore, which is almost 4 times its annual sales turnover of Rs 18,500 crore. Since the order execution cycle is in the region of about 18-36 months that gives strong earnings visibility.

Strong capabilities

Started in 1940, over the years, HAL has developed its own technologies and capabilities through aggressive spending on the research and development. It spends close to Rs 1,000 crore, or 6.9 percent of sales, on R&D annually and developed in house products and technologies to cater to domestic requirements and reducing India’s dependence on imports.

That apart, it has also got licence agreements with some of the global leaders like Rosoboron of Russia for manufacturing Sukhoi, HAWK from BAE Systems UK, Dornier from RUAG Holding AG. These licences are also part of the services business which accounts for 31 percent of the revenue.

Services business, which grew 32 percent annually over the last three years, makes relatively higher margins. The company is currently sitting on an order book of close to Rs 7,000 crore.


Efficient business model

HAL has an interesting business model where they charge on a cost plus basis and the money is taken in advance for the each of the projects placed with the company. Because of this, despite being a capital intensive business, the company has a negative working capital and thus conserve a lot of cash.

It is sitting on cash and cash equivalent of close to Rs 11000 crore which includes customer advance of close to Rs 9000 crore and Rs 2000 crore of free cash. The company generates close to Rs 1000 crore of other income from its cash in the books. This is precisely the reason that it has zero debt in the books and return ratios are superior. Adjusting for cash the company is making 25% return on equity.

What is more, the company is self-sufficient in funding its future growth as a result of strong internal cash generation from the business. It is expanding its product capabilities and capacities through partnership and additional manufacturing capacities to meet the demand and prepare itself to participate in the upcoming future defence programmes. That apart it is also looking for other segments like civil aircrafts and exports market.



At the upper band of the issue price of Rs 1,215-1,240 per share, the company will be having market capitalisation of close to Rs 41,400 crore, which is about 16 times its FY17 earnings. Valuations are attractive considering that the company has strong moat or competitive advantages with entry barriers in a growing domestic aerospace market, which has huge opportunities for growth.

Its strong order book, good return ratios, cash in the books, strategic growth initiatives and scope for higher dividend makes it a perfect candidate for the long-term investors. Retail investors are offered a discount of Rs 25 per share, or 2 percent of the upper band of the offer price.