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Dropping The Anchor at Mazagon Docks 🚢

If you have visited Mumbai, you may have used the Eastern Freeway that takes you straight to the Southernmost parts of Mumbai, where one’s flex is having seen the Gateway of India and the Taj Hotel. What you may not have noticed while taking that route is the Mazagon Dock, a famed location of the city and a company whose stock has gone up by more than 5x in the past year!

Mazagon Dock Shipbuilders Limited, with its roots dating back 250 years, is a government-backed company that hoists the Indian flag at seas by creating state-of-the-art warships and vessels for the Indian Navy and Coast Guard - yes, it is a defence company!

And like every other defence company, Mazagon Dock has been in the news for various contracts from refitting the INS Shankush submarine to extend its life, to jointly bidding for making 6 submarines for the Indian Navy along with Thyssenkrupp.

But, with the stock already up 5x in the last year, are we a little too late to show interest in it? Perhaps not - this may just be the beginning of a very long voyage for Mazagon Dock!

Why Has The Stock Rallied?

The primary reason for Mazagon Dock’s rally so far has been its order book. The math is pretty simple in the case of defence stocks: more orders = higher revenue + stronger visibility, which leads to both earnings growth acceleration and valuation re-rating.

Mazagon Dock has the advantage of being the only manufacturer of conventional submarines and the Destroyer range of ships in the country.

Its order book currently stands at Rs. 38,500 crore, which is 5x of its FY23 revenue, and is executable over the next 2-3 years.

Additionally, its deal pipeline has the potential of further increasing the order book by a whopping Rs. 50,000 crore, led by repeat orders from the P75 line and vessels for the Coast Guard!

  • The capacity to build 11 submarines and 10 warships simultaneously, and having a track record of punctual execution, the order book will continue to see inflows as repeat orders for P75s (about Rs. 4,200 crore per ship) and ships for the Coat Guard (about Rs. 1,000 crore per ship)

  • Discussions for the supply of 6 submarines to the Indian Navy, an order worth around Rs. 43,000 crore, which Mazagon Dock is bidding for, with the German company Thyssenkrupp AG

  • A potential order by the US Navy to service and repair a majority of its vessels in its Indo-Pacific fleet

The above orders materialising would simply imply a higher order book, which results in higher growth and stronger visibility, potentially leading to further upside in the stock.

What’s Leading to the Surge in Orders?

Key drivers of this mad growth in order book for Mazagon Dock are on the same three pillars as for other defence companies like HAL (Hindustan Aeronautics Limited) and BDL (Bharat Dynamics Limited).

1. Increasing Defence Budget

India set aside Rs. 5.94 lakh crore for defence spending in FY23, including a capital outlay which is higher by 8% compared to the previous year. The capital allocation is where money is spent on aircrafts, helicopters, missiles, submarines, warships, etc.

Within this growing budget, there has been a focus being driven towards the Indian Navy in the last few years.

The Rs. 99,000 crore being allocated to the Navy as of the latest budget stands to have grown by 1.6x since 2020, making this the highest growth among all defence segments!

With various conflicts around the Indian Ocean and the South China Sea, India’s Naval prowess is the need of the hour, and is likely to result in a sustained growth for the money being spent here for years to come.

2. Make in India

India has reduced its import reliance from 70% of all defence equipment to now less than 50%. India’s defence production hit a high of Rs. 1 lakh crore in FY23, more than double the amount that was recorded in FY19.

India has been achieving a higher amount of indigenisation by listing out items that need to be stopped from being imported, and rather be locally made or sourced.

Mazagon Dock is responsible for the indigenisation of more than 40% (the largest stake) of the 2,000 items that the government has included in import-replacement.

3. India’s Focus on Exports

India’s defence exports have grown more than 10x in the last 6 years, and are set to hit a Rs. 35,000 mark in FY25 from the current Rs. 16,000 crore (28% 5 year CAGR).

Although the relevance of exports for Mazagon Dock has been low so far, ongoing discussions and deals (like that of the MRO contract for the US Navy) make this a promising growth driver for the future.

Is There Any More Juice Left in Mazagon Dock?

A lot of the performance of any defence stock depends on how strong the order book is. In the case of Mazagon Dock, while the current order book stands at Rs. 38,500 crore (5x of revenue), there is potential for the order book to grow multi-fold from here.

However, even before the current order book, Mazagon Dock’s performance has been better than listed peers - HAL and BDL.

With the recent surge in order book, and potential expansion in the same, the financial performance for Mazagon Dock can be even more superior compared to what it has delivered in the past, and even relative to its peer set.

Despite better performance compared to other defence companies, Mazagon Dock is currently trading at a two-year forward PE of 14x - versus 14x for HAL and 28x for BDL. The deep discount has the potential to wane, and the stock theoretically can trade at valuations equivalent to those that its peers’ command.

Forget peers, even if you were to compare Mazagon Dock’s valuations to its own growth, the stock appears undervalued. With a projected earnings CAGR of 19% over the next two years, and with the stock trading at 14x two-year forward PE, the PEG turns out to be 0.6x. Anything below 1x would be considered undervalued, especially given (i) multi-year growth visibility, (ii) monopolistic position, (iii) zero debt, and (iv) strong return ratios.

The average two-year forward PE of peers (21x) and implied PE if PEG were to be 1x (19x) are both materially higher than the 14x PE that Mazagon Dock currently trades at.

If you weren’t lucky enough to be anchored to this shipbuilder’s story yet, it might be a good time to look into the company’s “mast” -er plan (we held back on the puns throughout the blog).

Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. The securities quoted are for illustration only and are not recommendatory. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

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