Mazagon Dock is entering the primary market on Tuesday 29th September 2020, to raise Rs. 444 crore, via an offer for sale (OFS) of up to 3.06 crore equity shares of Rs. 10 each by Govt. of India in the price band of Rs. 135-145 per share. The issue represents 15.17% of the post-issue share capital and will close on Thursday 1st October, with listing likely on 12th October. Company has been a disinvestment target for a long time and is finally seeing the light of the day.
What is surprising is no retail discount has been announced, despite RHP as recent as 19th September 2020 stating retail discount may be offered. Absence of retail discount is also unusual ,since all 13 PSU IPOs in past 3 years offered anywhere between 2%-5% retail discount on offer price.
Mazagon Dock, a Mini-ratna public sector undertaking (PSU) under the Ministry of Defence, specializes in building warships and submarines, with 40,000 DWT capacity shipyard on India’s west coast. Company has 2 business divisions:
- Shipbuilding for defence needs, for customers such as India Navy and Coast Guard. This segment accounted for 70% of FY20 revenue of Rs. 4,978 crore.
- Submarine and heavy engineering: Only public sector defence shipyard constructing conventional submarines. Accounted for 30% of revenue.
As part of the Rs, 900 crore Mazdock Modernisation Project, company has increased production capacity from 8 warship in 2014 to 10 and from 6 submarines in 2016 to 11 now. Order book (31-7-20) is very healthy at Rs. 54,000 crore, mainly for 4 P15B Destroyers and 4 P17A Stealth Frigates for the Ministry of Defence, to be executed over the next 8 years. Company’s future growth areas (i) exports (ii) indigenization under government’s ‘Make in India’ initiative and (iii) ship repair, where revenue is healthy with quick turnaround. Company aims to increase share of ship repair in its revenue to 15-20% in 5 years, from current 3.5%.
Objects of Issue and Shareholding:
Since the IPO is a 100% OFS, no proceeds will flow into the company. Government of India’s shareholding will contract to 84.83% post listing, from current 100%. Post buy back of 2.24 crore shares at Rs. 124 per share in March 2020 for Rs. 278 crore, company’s equity stands at Rs. 202 crore (FV Rs. 10). Prior to this, buyback was undertaken at Rs. 101.80 per share in Dec 2017 for Rs. 253 crore.
Between FY16 to FY20, revenue has grown at 5% CAGR from Rs. 4,127 crore to Rs. 4,978 crore, but PBT contracted at a 5% CAGR from Rs. 917 crore in FY16 to Rs. 735 crore in FY20, mainly on account of drop in interest income from Rs.678 crore in FY16 to Rs. 528 crore in FY20. Reported FY20 PBT was down 6% YoY to Rs. 735 crore, due to Rs. 12 crore covid related expenses, while FY19 PBT was higher by Rs. Rs.48 crore, due to write back of provision of earlier years. Excluding these, FY20 PBT grew 2% YoY on 8% YoY revenue growth. FY20 PAT stood at Rs. 477 crore, after a one-time Rs. 160 crore reduction in deferred tax asset (DTA) on moving to the new income tax regime, translating into net margin of 10%, which although down from 11% couple of years ago, is nevertheless comparable to peer Garden Reach (11% net margin). Company wins most of its orders on nomination basis, where profit margins are 7.5-8%. Balance accrues from interest income. FY20 EPS stood at Rs. 21.4 and RoE at 15.5%.
Q1FY21 financials are not reported by the company, but April and May its operations were completely shut, which resumed from 8thJune 20. Currently it is operating at 50-60% capacity, implying FY21 financials will be adversely impacted due to covid-induced lockdown. Since the revenue peaks in the middle of a typical contract duration of 6-7 years, profitability and cash flows are dis-proportionate, with debtors and inventory outstanding very high at 3.5 months and 11 months respectively. Net worth (31-3-20) stood at Rs. 3,069 crore, translating into BVPS of Rs. 152. While it has cash and equivalents of Rs. 287 per share, nearly double the BVPS, there are related to business operations and not really surplus profits.
Company is required to pay a minimal annual dividend of 30% of its PAT or 5% of its net worth, whichever is higher. For FY20, it paid Rs. 11 per share as dividend, translating into 61% payout ratio, including dividend distribution tax. At Rs.145, this works out to 7.4% dividend yield which is one of the highest. Coal India (~10%) and Hindustan Zinc (~8%) have the highest dividend yields in public and private sector respectively. For FY21 so far, Mazagon has paid dividend of Rs. 2.3 per share. Thus, Mazagon can be a dividend play, but we do not advise investing solely on the dividend theme.
At 145, company’s market cap will be Rs. 2,925 crore, which is 5% below the net worth i.e. shares are being offered at 5% discount to book value, although defence stocks are not valued on PBV multiple. On FY20 basis, PE multiple works out to 7x. Even on other parameters like revenue multiple and dividend yield, pricing of Mazagon is undemanding, via-a-vis PSU ship building peers:
Cochin Shipyard, falling under the Ministry of Shipping, builds commercial and defence ships as well as undertakes ship repair work, is trading at FY20 PE multiple of 7x, despite strong revenue growth and healthy margins. Share price has remained flat in last 1 year and has corrected 23% since its IPO in Aug 2017.
Garden Reach, falling under the Ministry of Defence, also builds only defence ships like Mazagon, but is trading at much higher FY20 PE multiple of 13x. Mazagon Dock with over 3 times Garden Reach’s revenue and similar margin and return profile is available at much lower valuation multiples. In Sept 2018, Garden Reach had come out with its IPO at then historic PE multiple of 16x vs 7x for Mazagon Dock now, and share price has risen 55% in 2 years, although flat in last 1 year.
However, if one were to track share price performance of other defence PSUs, they have not rewarded investors, despite healthy order books, margin profile and industry tailwinds such as ‘Make in India’:
HAL (Hindustan Aeronautics) and Bharat Dynamics had come out with IPO 2.5 years back and both are ruling 31-37% below their respective IPO prices. In last 5 years, share price of BEL has corrected about 9%. Returns in the last 1 year too have not been meaningful for all the 3 defence PSUs, except for HAL which undertook OFS last month, but share has corrected 20% from OFS price.
Mazagon valuation is attractive on all 3 parameters - revenue multiple, PE, dividend yield, both in relation to shipbuilding PSUs and other defence PSUs. However, based on past returns, defence PSUs enjoy nation’s pride, but not investor patronage.
Pricing of the issue is not demanding, and those looking at listing gains may apply in the IPO, although stock does not qualify as a portfolio stock.
Grey Market Premium (GMP) of Mazagon Dock: Grey Market Premium of Mazagon Dock is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in Pathshala column.
Disclosure: No Interest.