Garden Reach Shipbuilders IPO Review: Should you invest?

Defence shipbuilder Garden Reach Shipbuilders will initiate its maiden public offer for subscription on 24 September and investors have time till 26 September to file their applications. The public sector undertaking (PSU), acting under the Ministry of Defence, has priced the issue in the range of INR115 to 118 per share. Retail investors (defined as those with applications smaller than INR200,000) and employees will be offered a discount of INR5 per share. Investors can make applications for minimum 120 shares and in multiples thereafter. In total, Garden Reach Shipbuilders IPO will mobilize up to INR236.55 crore.

Garden Reach Shipbuilders IPO Review: All OFS

The IPO is part of the government’s divestment program and thus, there are no fresh shares being issued. At the same time, the company is debt-free so it doesn’t need fresh funds.

Garden Reach Shipbuilders IPO Review: Mini Ratna Shipbuilder for Indian Navy and Coast Guard

Having incorporated in 1934, the Kolkata-based company has a long history of making ships and serving defence forces. After being acquired by the government of India in 1960, the company caters to the shipbuilding requirements of the Indian Navy and the Indian Coast Guard. In addition to ship and warship building capabilities, the company is engaged in engineering and engine production activities. As a part of its engineering division, it manufactures deck machinery items, pre-fabricated portable steel bridges and marine pumps. It derived 94.14% of its gross revenue from operations in FY2018 from the shipbuilding division.

In the past several decades, the company has established capabilities for in-house design and shipbuilding and has made considerable contributions to the indigenous warship construction program of India. Its shipbuilding product line spans from technologically sophisticated Frigates and Corvettes to Fast Patrol Vessels.  In the last 50 years, Garden Reach Shipbuilders has built and delivered more than 750 vessels ranging from small to large and advanced vessels to carry men and materials as well as for the surveillance of the coast line.

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The company has 3 separate facilities for shipbuilding, all of which are located in close vicinity of each other at Kolkata. It builds ships at the Main Works Unit and the Rajabagan Dockyard. The third facility, the FOJ Unit is primarily used for fitting out and repair of ships. Its installed capacity comprises of five docks (including dry docks and inclined berths) and two wet basins shipyard has an engineering division which manufactures portable steel bridges, marine pumps, deck machinery items, helo traversing systems, etc. The company acquired the Rajabagan Dockyard from Central Inland Water Transport Corporation Limited in the year 2006. The DEP Unit (Diesel Engine Plant) in Ranchi is engaged in the testing and overhauling of marine propulsion engines and assembly of semi-knocked down units of diesel engines.

Garden Reach Shipbuilders IPO Review: Uneven financial performance

As the table below depicts, the company’s financial performance has been uneven with revenues rising in FY2014, FY2016, and FY2018 but declining in FY2015 and FY2017. Similarly, earnings have seen some wild swings in the last five years and profitability dipped to just 2.8% in FY2015 and 1% in FY2017 before settling at a decent 6.2% in FY2018. This is despite a deleveraged balance sheet.

* Figures of FY2013 and FY2014 are based on Indian GAAP. Figures for subsequent years are based on Ind AS.

This is explainable as shipbuilding is a highly cyclical business in terms of revenues as well as expenses. Typically, shipbuilding projects have an order-to-delivery period of anywhere from 23 to 66 months and recognition of revenue and expenses take place in large parts during the middle period of the project, when expensive equipment and sophisticated systems are installed in the vessels. As a result, the revenue and expense recognition is heavily weighted toward five year cycles of one to two year periods of lower revenue and expense recognition, followed by one to two year periods of significantly higher revenue and expense recognition, followed again by one to two year periods of lower expense recognition.

Garden Reach Shipbuilders IPO Review: Strong order book but should you invest?

As explained above, the business is highly cyclical and thus, it is better to be analyzed over a longer timeframe. On this front, Garden Reach Shipbuilders comes across as an average performer with FY2018 revenues still a notch below its FY2013 top line. The above explanation indicates that this situation might change for good in the coming years.

The strong order book of INR20,313.6 crore across all product categories as of 31 July 2018 also indicate the same.

This order book is spread over 13 vessels. Outside of the order book, the company has been adjudged the lowest bidder for four Survey Vessel (Large) and eight Anti Sub Marine Warfare Shallow Water Craft (ASW SWC) and one Ferry for Guyana. Nevertheless, given the capacity constraints and the capital extensive nature of the business, it would be prudent for IPO investors to not expect a radically different situation in the coming years.

The fact that the company operates under the Ministry of Defence further adds to its credentials. At the same time, there have been recent changes in defence procurement which may have long-term implications for the company. Here is something important from Garden Reach Shipbuilders’ prospectus:

In May 2017, the GoI introduced a strategic partnership model under DPP under which the GoI seeks to identify a few Indian private companies as strategic partners who would initially tie up with a few shortlisted foreign OEM to manufacture military platforms and equipment. Although these policies do not apply to warship building sector as of now, however as and when the same are applied to the warship building sector, it will raise the level of competition and we cannot assure you that we will be as competitive under the new policy and we will continue to be awarded contracts.

In terms of valuations, the company has Earnings Per Share (EPS) of INR7.14 which means that the IPO is priced at the Price/Earnings (P/E) ratio range of 16.10 – 16.52. For the latest year, its Return on Net Worth (RONW) stood at 8.54% while Net Asset Value (NAV) or book value was INR88.69 per share. At the upper end of the price band, the Book Value/Price ratio is at an attractive 1.33. Retail investors also get a discount which should make these metrics even more attractive but investors will do well to not base their investment decision on the discount. The company is a dividend payer and its dividend yield of 3.76% at the upper price band (without discount) is pretty attractive.

Although there are no listed shipbuilders catering to defence sector in India, Garden Reach will be valued closely on the lines of Cochin Shipyard which trades at P/E ratio of 13.8 and has a much better margin profile.

Overall, Garden Reach Shipbuilders IPO Review reveals that the company is a decent play on the defence sector and while valuations are not very aggressive, there isn’t a lot of value on the table as well. At the same time, a cyclical play like Garden Reach can go places as situation improves going forward. A direct implication for investors is to not expect immediate fireworks and hold it for couple of years. Please head to this discussion page to see what the street is expecting out of the IPO.