Good start to R-Infra defence foray

Focus on divesting non-core businesses will help it turn lighter on debt, while improving prospects in the sector also favours Pipavav

A day which was flat for the broader market indices turned out to be a bumper one for the stocks of Reliance Infrastructure and Pipavav Defence and Offshore Engineering.

Positive news flows regarding its tie-up with a Russian firm in the defence segment and divestment of cement units pepped R-Infra’s stock price by 7.5 per cent on Thursday. Given its moves in recent months, analysts are turning positive on the stock.

On Thursday, R-Infra entered into an agreement with Russia’s United Shipbuilding Company (USC) for manufacturing four frigates for the Indian Navy, boosting Street sentiment. The agreement worth Rs 30,000 crore, spread over five to 10 years, marks the company’s entry into the defence segment, in the wake of its 35 per cent stake acquisition in Pipavav Defence.

  The warships are likely to be built at the shipyard of Pipavav and this took the latter's stock up nearly 20 per cent, to a 52-week high. Details of the contract are awaited but it could give needed relief to Pipavav’s financials, as its revenue had fallen 75 per cent in the September quarter, leading to a third quarterly loss in a row.  

However, analysts also believe it might be too early to attribute any value to the defence business of either company, and that one needs to wait till the business becomes revenue-accretive. “We factor in a zero value for (their) defence (business), pending clarity on the business model, and make no adjustment for cash and cash equivalents net of non-SPV (Special Purpose Vehicle) debt,” said a JP Morgan analyst in a recent report.

The analysts have an overweight rating on R-Infra, with a target price of Rs 580.

R-Infra is also closer to divesting stake in its cement business. The deal is likely to fetch Rs 2,600 crore in cash, and a reduction in debt by Rs 2,400 crore (to be taken over by the potential acquirer). About a month earlier, R-Infra had announced it would offload 49 per cent stake in its Mumbai power distribution business.

Analysts suggest as the deals materialise, it could significantly slash the overall debt of R-Infra by Rs 16,500 crore and thereby spruce the return on equity from its current level of seven per cent. R-Infra currently enjoys a reasonable debt to equity level (0.7-0.8 times on a consolidated and standalone basis), well within industry standards.

Exiting from non-core businesses such as cement and BOT-road projects will help the company lighten its debt and focus on the defence and EPC (engineering, procurement and construction) businesses. The management has indicated the defence business will be negative on working capital, with an asset-turnover potential of around four times.

Analysts at IDFC Securities believe R-Infra’s focus on the defence equipment business, with steady cash flow from the power distribution business, can create value for shareholders in the long term. Analysts at JP Morgan also feel with limited capital expenditure commitment, the residual portfolio is set to generate cash. The research firm says, “Earnings visibility is high and valuation cheap at 0.4 times the price to book value.”

Christmas cheer for defence stocks

The ministry of defence came up with a fresh set of policies on Thursday which could provide greater flexibility to vendors in offset contracts and provide a level field to Indian vendors in fulfilling offset obligations.

Offsets clause requires a minimum proportion of project value to be manufactured in the country. These measures would allow vendors to finalise a more realistic offset offer and enable them to change their Indian Offset Partner or their offset component according to requirement of the contract.

Further, to promote the ‘Make in India’ initiative, Indian vendors have been brought at par with the foreign players to fulfil offset obligations. This announcement helped the stocks with exposure to the defence sector such as Bharat Electronics, Walchandnagar Industries, Pipavav Defence and Astra Microwave Products gain between four and 20 per cent in trade on Thursday.