HAL's prospects are brighter than ever; board announces stock split

But stock appears to have fully priced in the near-term gains

Hindustan Aeronautics (HAL) is one of the major beneficiaries of the focus on indigenisation of the defence sector. The public sector undertaking (PSU) has outstanding orders of over Rs. 82,000 crore, and has strong financials and proven technical expertise. One of the gaps in the technology value chain has also been plugged with the announcement of a deal with GE to produce 99 engines for fighter aircraft. 

In addition, the licensing terms include transfer of technology, which will include transfer of multiple critical technologies which were previously blocked. As a result, India could develop expertise in aero engine design – an area where it was previously lacking. The manufacture of engines under license will commence in around 3 years, and the GE 414 engines will be used to power the LCA Mk2 – India intends to induct around 130 of these aircraft. 

The company has reported compounded annual growth rate (CAGR) in revenue, Ebitda (earnings before interest, tax, depreciation and amortisation) and profit after tax (PAT) of 7.9 per cent, 10.9 per cent and 19 per cent, respectively, between FY20-23 (between financial years 2019-20 and 2022-23).

In FY23, repair & overhaul contributed about 70 per cent to total revenues while manufacturing contributed about 18 per cent. But these numbers may not be indicative of the future since defence contracts are lumpy and there can be large surges in revenue when deliveries occur.

Executing contracts to deliver orders is going to be crucial. Also, depreciation can be high in an engineering outfit like HAL and wear and tear in such a business is a genuine expense since outmoded equipment needs replacement.

As of the fourth quarter (Q4) FY23, the Ebitda margin improved 435 basis points (bps) year-on-year (YoY) to 26 per cent on better contract mix and Ebitda growth was 29.8 per cent YoY to Rs. 3,245.8 crore. But PAT declined 8.8 per cent YoY to Rs. 2,831.2 crore due to higher depreciation.

The order book for the PSU is three times its FY23 revenues. There are large scale orders in manufacturing aircraft/helicopters (LCA, LCH, ALH) and continuous order inflows in maintenance, repair & overhaul (MRO) with a strong order pipeline in manufacturing for the next three to four years (led by LCH, ALH, Dornier, HTT-40 and engines for Su-30 & MiG-29). The LCA Mk1 (Tejas) deliveries are expected to commence from FY24 end. 

Moreover, order inflows of Rs. 48,000 crore for manufacturing and another Rs. 17,000 crore for MRO is expected in FY24. The management says supplies of LCA Mk1A will start from February ’24, followed by 16 aircrafts per annum. The HTT-40 (turbo trainer aircraft) will be supplied in phases, starting from September ’25 with 12 in the first year and steady supply of 20 per year from the third.

As a result, management expects double-digit revenue growth of around 14-15 per cent. One potential concern lies around the LUH Dhruv, which has been involved in some crashes, but management is confident that safety remains within acceptable margins. As of now, there is no real competitor in aerospace, but opening up of the sector could eventually result in competition.

The firm’s stock has surged 21 per cent in a month. According to Bloomberg, all four analysts polled in June are bullish on HAL, with an average target price of Rs. 3,718, which is a tad above the current market price of Rs. 3,661.25. The company on Tuesday announced a split (subject to shareholder approval), wherein investors will be given two shares of at Rs. 5 each, for every one share of face value of Rs. 10.