HAL stock takes flight on robust order book, indigenisation focus

The over Rs 47,000 cr light combat aircraft order has boosted growth prospects, while valuation remains reasonable

Shares of Hindustan Aeronautics (HAL), the state-owned aerospace and defence equipment company, jumped close to 14 per cent intra-day on Thursday, after the Union Cabinet approved procuring its 83 light combat aircraft (LCA) — Tejas — for the Indian Air Force (IAF). While this enhances long-term growth prospects, the government’s intention to reduce imports of defence equipment could translate into more orders for HAL. 

Reasonable valuations, healthy returns on equity, and consistent dividend payouts are other positives.

The Cabinet Committee on Security (CCS) on Wednesday approved procuring 73 LCA Tejas Mk-1A fighter aircraft and 10 LCA Tejas Mk-1 Trainer aircraft at Rs 45,696 crore, along with the design and development of infrastructure sanctions worth Rs 1,202 crore.

“The manufacturing of light combat aircraft by HAL will give a push to the Atmanirbhar Bharat initiative and boost the indigenisation of defence production and the defence industry in the country,” the Press Information Bureau statement said.

The CCS approval comes 10 months after the ministry gave the green light to the purchase. The firm is expected to deliver the first Mk-1A to the IAF three years after the deal is signed, with the remaining to be delivered by 2028-29.

“The order comes as a major boost for HAL and could see the company’s order book exceed Rs 1 trillion,” said Arafat Saiyed, assistant vice-president, Reliance Securities.

“We sense a more serious intent from the government this time around with a series of new measures (re-aligning DAP, 2020, with long-term goals, import embargo on 101 items), along with their strict implementation timelines,” said Harshit Mehta, research analyst, Equirus Securities. He estimates a pipeline of more than Rs 6 trillion over the next 7-8 years for over 50 major weapon systems — offering a massive opportunity for both PSUs and private firms.

All this is positive for the company’s order book, which had seen a steady decline in each of the last three years — from Rs 64,613 crore in FY17 to Rs 52,965 crore in FY20 — because the defence outlay remained muted. As a result, HAL’s manufacturing sales declined from Rs 9,800 crore in FY16 to Rs 8,500 crore in FY20.

Recent border clashes, the fleet modernisation drive, and a focus on domestic manufacturing have led to increased defence spends in the past 12 months. Subsequently, HAL’s order book has seen some increase in FY21. It was at Rs 54,100 crore as of September 2020, approximately 2.5x its trailing 12-month revenue. 

Of this, nearly 65 per cent comprises manufacturing orders, about 31 per cent was repair and overhauling services (ROH), and the rest development and exports.

HAL’s largest source of revenue — the ROH segment (55 per cent of FY20 revenue) — has seen steady growth over the last few years. With a robust order book, a focus on execution, and continued momentum in ROH, Mehta estimates revenue to grow at a CAGR of 8 per cent from FY20-23.

While it has the first-mover advantage, it is also continually investing in research and development (R&D) and capacity expansion, an important cornerstone in this business. 

In FY20, HAL spent Rs 1,232 crore on R&D and a further Rs 254 crore was set aside for developing in-house capabilities in FY21. Despite these, the return ratios in the past five years have averaged in high teens and the company has maintained a healthy track record of dividend payout.

A major drawback, according to Shikher Jain, research analyst, Anand Rathi, is the pressure on working capital cycles due to delays in receivables. 

Historically, cash conversion has been poor. As a result, its working capital position deteriorated from 10 days (of sales) in FY16 to 273 days in FY20. Inconsistent ordering and adverse currency movement are the other key risks, say analysts.

Jain issued a ‘buy’ note last week on HAL, with a target price of Rs 1,152. The stock is currently trading at Rs 1,009.