Over the last few weeks, Mazagon Dock Shipbuilders has fallen by 25%, causing a polarised reaction - anxiety for existing holders, and a hint of opportunity for those who have missed out on any bit of the whopping 26x return the stock has delivered since its IPO back in October 2020.
Most critics have consistently highlighted scepticism over valuations being beyond reasonable, but have also been persistently proven wrong. A good example of this is the recent research report by a leading broker, which became rather popular for its 77% downside target on Mazagon Dock, post its results.
The broker had changed its rating on the stock to a ‘Sell’ back in November 2022, when the stock was at Rs. 773. And in the most recent report (at ~Rs. 5,000), it raised its EPS estimates by more than 50%, but still reiterated its Sell rating. The struggle is real for anyone trying to make sense of the stock’s ‘high’ valuations - which we might have strongly opposite views on!
At Rupeeting, we’ve been holding the stock in our Value Migration smallcase since May 2023, when the stock was at Rs. 769. And despite having made nearly 6x for our investors, we are quite unperturbed by the fall. Here’s why!
The Usual Stuff on Defence
Everyone already knows about how India is focusing on defence spend, and indigenisation, and the export opportunity, and the usual yada yada. To avoid repetition of the same thesis, we will highlight a few relevant numbers, and move on.
India is the fourth largest spender on defence, after the United States, China and Russia. However, our defence budget at US$ 84 billion is 1/11th that of the US, 1/4th that of China and 20% lower than Russia’s
We spend only 30% of our total defence budget on capital outlay, which includes the purchase of new weapons, aircraft, warships, and other military equipment. The aim of the government is to reduce the burden of salaries and pensions, and optimise the spend
India has reduced its import reliance from 70% of all defence equipment to now <50%. With this, India’s domestic production hit a high of Rs. 1 lakh crore in FY23, more than 2x of what was in FY19
Already, on a small base, India’s defence exports have grown more than 10x in the last 6 years. The government has set an export target of Rs. 35,000 crore by 2025, from the current Rs. 16,000 crore
The Focus is on the Navy
Now coming to the good part! There is enough data and statistics indicating a need for addition and upgrades to India’s defence fleet, especially on the naval front. The government seems to be taking action on this, and is evidenced well in the recent budget numbers.
Split of Defence Budget
Year | Army | Navy | Air Force |
2020-21 | 63% | 13% | 18% |
2021-22 | 61% | 14% | 20% |
2022-23 | 58% | 16% | 19% |
2023-24 | 57% | 17% | 19% |
India’s defence spending on the Navy has increased to nearly Rs. 1 lakh crore, which is a 1.6x growth since 2020, marking the highest growth amongst all defence segments.
India currently has a fleet of 150 vessels, with more than 50 currently under construction, and expected to be deployed before 2030.
Mazagon Dock is a Clear Winner
There are a tonne of state-owned and private players in the shipping business. The long list includes the likes of ABG Shipyard, Bharati Defence and Infrastructure, Cochin Shipyard, Garden Reach Shipbuilders, Goa Shipyard, Hindustan Shipyard, L&T Shipyard and Reliance Defence and Engineering.
However, Mazagon Dock has emerged to be a formidable player. It boasts an order book that’s hovering around Rs. 40,000 crore since the last two years, despite a strong pace of delivery, as new inflow remains strong.
As part of large orders, it has already done an exceptional job at delivering some state-of-the art equipment, on a timely basis, and by delivering beyond the government’s ambitious indigenisation targets.
Order Book of Mazagon Dock
Project Value (in Rs. crore) | Contracted | Delivered | Pending | Balance Order Book (in Rs. crore) | |
P15B Destroyers | 32,087 | 4 | 3 | 1 | 9,847 |
P17A Stealth Frigates | 26,898 | 4 | 0 | 4 | 16,634 |
P75 Kalvari Submarines | 29,155 | 6 | 5 | 1 | 3,590 |
The Party Isn’t Over
A common argument by the Mazagon-Dock-skeptics has been of the order book drying up in a few years, and consequently revenue growth getting stalled and of cash flows peaking out. This is where intelligent-but-visibility-deficient financial models usually falter, and the locus of control tilts in the favour of the yet-to-come.
However, we do feel comfortable relying on structural factors mentioned above in order to make the assumption that order inflows will continue remaining healthy, and hence will financial performance, and hence will valuations. Here’s an example.
A majority of the P75 Kalvari submarines have been delivered by Mazagon Dock already. However, there is expectation of:
An additional order of 3 more P75 subs, worth >Rs. 40,000 crore (according to reports)
An order of 6 advanced submarines, as part of the P75(I) project, which the government seems to be making strides towards
While at current pace, the first delivery under the P75(I) can’t be expected before 2030, the order is expected to be to the tune of upwards of Rs. 40,000 crore. Mazagon Dock has partnered with German Thyssenkrupp for bidding for this contract.
Additionally, there also is buzz around an order north of Rs. 70,000 crore for the construction of P17B Stealth Frigates.
And Hence the Numbers Still Make Sense
The near-term picture for Mazagon Dock isn’t questioned - after all, the order book numbers overrule any form of apprehension. However, analysts usually fail at accommodating for numbers that are still soft - like the Rs. 1.5 lakh crore potential addition above.
However, given the direction of the industry, support from the government, proven credibility of Mazagon Dock, an order book of Rs. 40,000 crore, and resorting to some rational extrapolation can lend us the ability to assume a sustained revenue growth of >30% for at least the next 5 years.
For this, the stock is trading at a PE of 26x on FY26 EPS estimates. Not a sign of worry per us since (i) EPS CAGR over FY24-26 is expected at 45%, and (ii) current order book of 4x of revenue, provides ample near-term visibility.
For now the long run, investors have two choices:
Be reactive - bank on what’s visible and believe Mazagon Dock to peak out when the current order book gets delivered, and then wait for the Rs. 1.5 lakh crore to be awarded over time for it to be accommodated in financial models
Be proactive - keep the structural picture in sight, bake in probable order awarding over time, and stay invested
As far as we are concerned, the approach is clear - be ahead of the market, make rational assumptions, see the story unfold, and make boatloads of money on the way!
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