Apollo Micro Systems IPO Review: Solid play on defense

India’s primary market is starting activity in 2018 with the launch of Apollo Micro Systems IPO on 10 January. Following a hugely successful year in 2017, IPO investors are looking forward to continued returns this year too. Nevertheless, allotments were difficult for investors last year and Apollo Micro Systems IPO’s small size of just INR156 crore may not offer much hope either. Like the massively subscribed IPO of Astron Paper & Board Mill, Apollo Micro Systems’ public offer is expected to garner strong demand. Priced in the range of INR270 – 275 per share, the IPO will offer a discount of INR12 per share to retail investors. Through Apollo Micro Systems IPO review, we try to find out if placing an application in the offer is a good option.

Apollo Micro Systems IPO Review: no OFS

Being the first IPO of the year, Apollo Micro Systems sets a good precedence of not having any Offer For Sale (OFS) component. All the shares offered in the IPO will be fresh shares and thus, all proceeds will go to the company. Apollo Micro Systems plans to use the funds towards meeting additional working capital requirement (INR118.92 crore) and general corporate purposes.

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As the table below indicates, promoter Karunakar Reddy Baddam holds 13,271,690 shares or 88.48% equity stake in Apollo Micro Systems.

The company has no private equity or venture investors except two firms controlled by Amal Niranjan Parikh. Combined stake of Ohm Commodity Broker Private Limited and Ohm Equity Solution India Private Limited is at 6.66% but none of the companies will participate in the IPO. Parekh is a Mumbai-based stock broker whose claim to fame is buying flats previously owned by Harshad Mehta.

Apollo Micro Systems IPO Review: Defense play

Apollo Micro Systems is a manufacturer and supplier of electronic, electro-mechanical, engineering designs. These solutions are supplied to Ministry of Defence, government controlled public sector undertakings and private sectors for Defence, Space and Home Land Security. The company has participated in several Indigenous missile programmes, underwater electronic warfare, underwater missiles, surface to air missiles, nuclear missile programmes, and surface to surface missiles.

The company’s manufacturing facility is located at Hyderabad and its production operations are ISO 9001: 2015 certified. The company gets a lot of business from existing clients and top 10 customers accounted for 51.22% of its revenues in FY2017. Nevertheless, the figure rocketed to 79.86% for the six months ended 30 September 2017.

Apollo Micro Systems IPO Review: Soaring profitability

The company has posted strong sales growth in the recent years and has managed to grow the top line in each of the last four years. From just INR37.5 crore in FY2013, revenues increased to INR211.8 crore in FY2017. Although revenue growth has slowed in recent years, it is still quite robust. Profits have also kept pace with earnings growing from INR3 crore in FY2013 to INR18.6 crore in FY2017. This translates into net profit margin of 8.8% – the company’s best profitability in the last five years.

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As of 30 September 2017, the company’s debt equity ratio stood at 1.38 but this has got down following the conversion of compulsorily convertible debentures (CCDs). This is likely to have a positive impact on the company’s profitability, although the new shares are going to result in some earnings dilution as well.

Apollo Micro Systems IPO Review: Should you invest?

In recent years, defense has emerged as an area of critical importance and the number of business deals, joint ventures large business houses have cut is a great indicator of this. The government’s ambitious target of achieving 70% indigenization in defense by 2027 has set in motion a chain reaction that is likely to help Apollo Micro Systems. Although much of it is already visible in the company’s financial performance, an order book of INR97.5 crore (nearly six months of sales) as of November 2017 indicates that there are better times ahead for Apollo Micro Systems. Among specifics, it is well positioned to address the growing requirements in defense electronics through Indigenous programmes in which it has been partner for past several years.

In addition to the structural story of defense industry, Apollo Micro Systems has other positives. Steadily improving margins is one of them and this is largely due to the proprietary nature of exclusively developed solutions for a programme. With increasing number of such deals, it tends to start an operating leverage of its own. Meanwhile, the company is looking forward to diversify beyond defense by increasingly tapping railways and homeland security. Growth opportunities offered by Digital India and the Make-in-India programs are on horizon and it is not difficult to see Apollo Micro Systems making use of some of its technical expertise in emerging market like electric vehicles. As noted above, high business concentration with certain clients is a concern but growing top line is expected to take care of this aspect.

All said, Apollo Micro Systems comes across as a decent play on defense and its pricing of INR270 – 275 per share values the business in the price to earnings (P/E) ratio range of 19.94 to 20.31. Retail investors will get a discount of INR12 per share and this brings down the valuation to the range of 19.05 – 19.42. This is slightly higher than 17.99 of Astra Microwave Products but less than 27.55 for Centum Electronics. Apollo Micro Systems has also listed Bharat Electronics Ltd among its peers but the latter’s much bigger size renders all comparison useless. It is worth highlighting that Apollo Micro Systems’ earnings profile is better than that of Centum Electronics’, although Astra Microwave Products is ahead of it in terms of margins. Among the three companies, Apollo Micro Systems has the best Return on Net Worth (RONW) of 29.3%.

Overall, Apollo Micro Systems IPO review reveals that Apollo Micro Systems may be a nice way to play the defense rally, provided investors get allotment.