by Aakash Athawasya

Closing off the IPO-heavy month of September, and ringing in the last quarter of the calendar year is the public offering of Mazagon Dock Shipbuilders. Scheduled for the same time as UTI Asset Management, the markets will be busy with the subscription of two massive pioneers in distinct industries opening their doors to the public.

Mazagon Dock Shipbuilders (MDL) is a public sector undertaking under the Ministry of Defence (MOD), which manufactures and repairs warships and submarines for the Indian Navy and the Coast Guard. It was incorporated in 1934, and taken over by the government of India in 1960. Since then, the company has built 795 vessels, which includes 25 warships. The company has also built and delivered cargo ships, passenger ships, supply vessels, multipurpose support vessels, water tankers, fishing trawlers for several domestic and international customers. Domestic competitors in the shipbuilding industry for MDL are Cochin Shipyard (CSL), Garden Reach Shipbuilders and Engineers (GRSE), Goa Shipyard (GSL), Hindustan Shipyard (HSL), ABG Shipyard, Reliance Defence and Engineering (RDEL), Bharti Defence and Infrastructure (BDIL), and Larsen & Toubro (L&T).

The public offering is not a fresh issue and is a complete offer for sale (OFS) as the promoter group, the President of India acting through the Ministry of Defence, Government of India, is disinvesting part of its stake in the company.

IPO breakdown

The IPO is scheduled for September 29 to October 1, with an issue size of over 3 crore shares at a price band of Rs. 135 to Rs. 145. The issue would amount to between Rs. 410 crores at the lower price band to Rs. 443 crores at the upper price band. The minimum bid is one lot of 103 shares, amounting to Rs. 14,935 and a maximum bid of 13 lots of 1,339 shares amounting to Rs. 1.9 lakhs.

Between qualified institutional buyers (QIBs), retail investors, non-institutional investors, and the employees, the offering is divided as 49.4%, 34.6%, 14.8%, and 1.1% respectively. Of the QIB portion, 5%, or just over 7 lakh shares is the mutual fund portion.

The President of India through the Ministry of Defence is the sole shareholder of the company on the date of the draft red-herring prospectus. The prospectus also states that the entire pre-offer equity share capital of the company will be locked-in for a period of 1 year from the date of allotment, neither the company, the directors, or the BRLMs will have existing buyback arrangements or any similar arrangements for the purchase of equity shares being offered.

A total of 3,05,99,017 shares will be offered via the OFS, with 3,45,517 shares kept aside as the Employee Reservation portion. The net offer or the offer after the employee reservation portion will constitute 12.5% of the post-offer paid-up capital of the company. 

Since this is a pure OFS, the objective of the offering is limited to the sale of equity shares by the promoter of the company and achieve the benefits of being a listed company on the BSE and the NSE.

The book running lead managers (BRLMs) to the issue are Yes Securities, Axis Capital, Edelweiss Financial Services, IDFC Securities, JM Financial, and the registrar to the issue is Alankit Assignments.

Strengths

1. Sole manufacturer of conventional submarines and destroyers for the Indian Navy
2. Capable infrastructure to meet MoD requirements
3. Strategic location allowing closer association with vendors and customers
4. Increased indigenisation under the ‘Make in India’ campaign
5. Strong order book and financial position: Consistently growing revenue from the shipbuilding division and submarine division
6. Experienced board and senior management

Risk factors

1. Dependent on MoD for defense orders on a nomination basis: 100% of the company’s order book of Rs. 54,282.7 crores were from orders from the MoD, as of June 2019.
2. Contracts provide for liquidated damages in case of delivery delay, and bank guarantee/indemnity bonds against payments releases
3. Future revenues under multi-year contracts reliant on MoD budgetary appropriations: As of March 2019, the company is owed Rs. 1,471.3 crores from the Indian Navy/MoD
4. Certain business and operational information is ‘secret and confidential’ because of national securities concerns
5. Future growth may be limited by the location of operations: The company’s capacity is surrounded by Mumbai Port Trust (MbPT), Indian Railways, and the Arabian Sea, limiting expansion
6. Environmental law regulations could lead to costs and impact earnings
7. Outstanding legal and tax proceedings involving company and directors: 102 litigation cases against the company, out of which 83 are tax proceedings amounting to Rs. 1,456.1 crores
8. Entire business operations based out of a single yard in Mumbai 
9. Subject to extensive government regulation requiring several licenses and approvals
10. Negative net cash flow from operating activities: The company recorded a negative cash flow of Rs. 1,009.2 crores for FY17.

Data source: Mazagon Dock Shipbuilders, draft red-herring prospectus

Data source: Mazagon Dock Shipbuilders, draft red-herring prospectus

Data source: Mazagon Dock Shipbuilders, draft red-herring prospectus

Management

Financials

The total income for the company for FY20 stood at Rs. 5,535.5 crores, representing an increase of Rs. 330.6 crores or 6.4% from the previous year. The total income for FY19 and FY18 was Rs. 5,204.6 and Rs. 5,027.5 respectively. 

EBITDA for FY20 stood at Rs. 268 crores, a marginal increase of 2.6% from the previous year’s EBITDA, which was Rs. 261 crores. EBITDA for FY18 and FY17 were Rs. 155 crores and Rs. 126 crores respectively. The EBITDA margin for FY20 stood at Rs. 4.8%, compared to 5% for the previous financial year.

The net profit for the company stood at Rs. 477 crores for FY20, a drop of 10% against the previous year’s net profit at Rs. 532 crores. The net profit rose from FY18 to FY19 by 8.7% but fell by 18.2% between FY17 to FY18.

Data source: Mazagon Dock Shipbuilders, draft red-herring prospectus

Data source: Mazagon Dock Shipbuilders, draft red-herring prospectus

Valuation

As per the company, the basic and diluted EPS for FY19 stood at Rs. 23.8 per share, an increase of 15.7% against the EPS of the previous financial year at Rs. 20.6. The weighted average EPS, taking the past earnings is 22.7 per share.

Taking the upper price band of Rs. 145 per share, and the weighted average EPS of Rs. 22.7 per share, the price to earnings ratio of the company is 6.3 times. 

As per the company’s DHRP, the average industry’s P/E ratio if 11.4 times, with an upper extreme of 12.2 times and a lower extreme of 10.6 times.

Here’s how Mazagon Dock Shipbuilders’ P/E ratio compares to its competitors in the shipping industry:

Industry overview

The international shipbuilding industry has shifted from Europe to Asia owing to cheaper labor, competitive manufacturing, and steel-making sectors with China, South Korea, and Japan accounting for 91% of global deliveries. China alone accounted for over a third of the global share.

The global order book declined for most vessel types in 2015 and 2016, the CAGR of the decline between 2012 to 2016 was 8.9%. From the peaks of 2008 and 2009, vessel types including container ships, oil tankers, dry bulk carriers, and general cargo have declined by 46%, 51%, 61%, and 82% respectively. Ships delivered have also fallen between 2011 to 2015 at a CAGR of 12.3%.

The Indian private sector accounted for two-thirds of the total shipbuilding order book as of March 2016. In 2015-16, private sector shipyards delivered 23 ships with a total tonnage of 9.45 lakh DWT (deadweight), Reliance Defence and Engineering (RDEL) had the highest share in tonnage delivered. The private sector’s capacity grew at a CAGR of 3% between 2011 to 2016 owing to the entry of L&T with a capacity of 30,000 DWT.

According to the Ministry of Shipping, the global ship repair market is worth an estimated $12 billion, with shipyards in Singapore, Bahrain, Dubai, and other parts of the Middle East forming majority of the market. The report also estimated that the Indian ship repair industry can potentially reach $1.5 billion (~Rs. 11,061 crores), in 2015-16, India’s ship repair industry stood at Rs. 934.4 crores. Between 2012 to 2016 the CAGR for the ship repair industry was 13.4%.

In 2017, it was estimated that India’s commercial order book would grow at a modest CAGR of 1% to 3% till FY22, with the domestic order book accounting for  87% of the DWT capacity, and exports accounting for 13%. Of this, the non-cargo segment is estimated to drive the order book, growing at 4% to 6% CAGR till FY22.

On the defense front, the domestic shipbuilding industry’s order book is set to receive a boost as the Indian Navy and the Coast Guard plan to acquire fleets of 200 ships each by the end of FY21. However, a potential obstacle to this could be the constrained capacities of the defense PSUs, and the weak financial position of private players.