Garden Reach Shipbuilders and Engineers Limited (GRSE) (NSE: GRSE, BSE: 542011) , a shipbuilding company, primarily caters to the shipbuilding requirements of Indian Navy and Indian Coast Guard (ICG). GRSE is a Schedule B company conferred with Mini Ratna-Category I status since September 2006. The company has three divisions namely (1) Shipbuilding, (2) Engineering, and (3) Engine Production. As on Feb 19, 2020 the company has delivered 104 warships since its inception in 1960. The company boasts of various firsts in Indian defence shipbuilding: Built India’s first indigenous warship, the INS Ajay in 1961, In 2019, became the first Indian shipyard to deliver 100 warships and First shipyard in the country to export a warship.

Key Triggers

• Government’s focus on Defense Shipbuilding – Defense shipbuilding in India is emerging as an area of focus for public and private sector shipyards alike. Currently, the Indian Navy fleet includes 135-140 ships and submarines while the Indian Coast Guard fleet includes another 120 vessels. The Indian Navy and Indian Coastal Guard fleet are each expected to grow to about 200 vessels by 2027. The two defence units have jointly approved a shipbuilding programme spanning over fifteen years, under which they would place orders for 165 warships and 400 aerial resources by 2022. For the ICG, the government has approved INR 32,000 crores action plan. According to industry sources, Indian Navy’s estimated capital budget for up to 2027 amounts to INR 4,50,000 crores approximately.
• Technological expertise and Huge Order Book – GRSE commands installed capacity of five dry docks and two wet basins, primarily catering to the Indian Navy and the Indian Coast Guards Services. It is also engaged in engineering and engine production activities. At present, the company has the capacity to build 20 warships (8 large warships and 12 small warships) concurrently and they are expanding their facilities to build 24 warships simultaneously. The timeline for product delivery ranges from 23 to 66 months. Their large ships are manufactured at their Main Works facility while the small ships are constructed at the Rajabagan Dockyard. The steel for ships is fabricated on-location and welded, either utilizing traditional shipbuilding techniques or their new modular construction process. The distribution method typically results in their customers taking possession of the ship after harbour and sea trials. The company’s orderbook consists of 22 ships of which three projects account for >90% of the backlog.  The orders are as follows:  3 nos. Project‐17A Frigates (INR 18,500 crores), 4 nos. Survey vessels (INR 2,400 crores) and 8 nos. ASW (Anti-Submarine War) Corvettes (INR 6,300 crores). GRSE plans to complete its legacy, liquidated damages (LD) laden, orderbook of seven ships in FY20 while the delivery of the above‐mentioned projects will commence in FY23‐24. GRSE has already delivered 4 of the ASW Corvettes as on February 18, 2020.

• Business Diversification – In order to hedge its position, in case the market conditions in shipbuilding industry become challenging, the company will bet on businesses such as building portable bridges, deck machinery items, pumps and engines (~10% of total business in FY19). As on March 31, 2019, GRSE has an order book of INR 314 crores for Engineering and Engine division. The company has got orders to build double lane bridges in states such as Maharashtra, Orissa and Bihar. This in-house function/vertical integration enables GRSE to be self-dependent to produce and deliver products in a timely and efficient fashion.

• Huge cash chest to offer Capacity to Suffer – As on December 2019, the company has a cash balance of INR 2,850.88 Cr. and zero long-term debt on its balance sheet. We believe this cash balance and unleveraged position will help the company to overcome the cyclical nature of shipbuilding process and provide a capacity to suffer. Going forward, with strong government backing and huge order inflows resulting in sizeable stage payments, balance sheet strength will further increase leading to negative working capital cycle. The company has plans to invest INR 250 - 300 crores in next 2-3 years for modernization of existing ship building facilities, mainly at Rajabagan Dockyard, replacement of the damaged Goliath cranes, maintenance capital expenditures and modification of certain capabilities of ships constructions, block fabrication etc. Given its strong balance sheet, funding its capital expenditure programs is never an issue with GRSE. As on December 2019, the company had capital expenditures of approx. INR 36 crores.

	FY15	FY16	FY17	FY18	FY19	9MFY20
Operating Revenue (INR Cr.)	2,304.35	1,655.50	9,21.77	1,347.76	1,386.42	1,465.82
Operating Margins (%)	3.90	16.05	6.06	12.20	15.39	17.72
Net Profit Margins (%)	1.83	8.81	1.01	6.04	7.06	8.73
Cash and bank (INR Cr.)	1,979.05	1,281.40	1,620.26	1,022.15	1,989.40	2,850.88
ROCE (%)	7.89	23.87	2.61	12.72	17.87
ROE (%)	4.52	15.42	1.03	8.78	10.67

• Focus on indigenization – GRSE spends on an average 10-12% of PAT on R&D activities thus enhancing indigenization, design capability and operational improvements in form of reduced wastage and re-work in ship construction. In line with ‘Make in India’ initiative the company has maintained 94-95% level of indigenization in products such as P28 ASWC and Landing Craft Utility (LCU) vehicles in FY19. I believe this initiative will prevent the company against any foreign currency fluctuations and the profitability will move in line with the domestic operation performance only.

• Liquidated Damages to reduce - In FY17 the company reported losses at EBIT levels followed by a net sales drop of 44%. This was a result of delay in execution of ASWC and LCU projects from Indian Navy as they made unplanned and unscheduled changes in design and technology. This caused GRSE to make significant provisions of INR 78 crores and INR 36 crores for Liquidated Damages (LD) in FY17 and FY18 respectively. Therefore, profitability in FY17 was badly impacted. As on FY19, the provisions for LD stood at INR 15 crores. The management believes that going forward LD provisions are expected to fall as the company has shifted from its shipbuilding from sequential to modular construction process. In FY19 LD’s accounted for 1.1% of sales in FY19 vs. 8.5% and 2.7% in FY17 and 18 respectively. As per Q3 FY20 analyst’s conference call, the company has incurred a LD of INR 2.33 crores. Businesses based on nomination basis (including P17A) have PBT margins fixed at 7.5%. Historically, majority of GRSE’s projects have been nomination based, hence we saw low margins in the recent past. However, the two recent project wins of ASW SWC and Survey Vessel Large (SVL) are based on competitive bidding, which have high margins. These account for 30% of the orderbook. Execution of these two projects would surely result in significant improvement in margin profile of GRSE. Moreover, as per management the government is moving towards more competitive bidding deals.

• Diversifying revenue mix – The management has been keen to pursuing new market opportunities for other products including ship repair, deck machinery, marine pumps, bridges and marine engines.

• Export Market – GRSE is targeting to explore global opportunities by exporting small and medium sized warships and patrol vessels to countries in Africa (Mozambique, Egypt) and South East Asia (Vietnam, Philippines). This business currently is negligible and at a nascent stage. GRSE is the first shipyard to export a warship from India – the CGS Barracuda to Mauritius in 2014.

Negatives

• Any delay in execution may result in higher LD provisions and lower than expected revenues.
• Any unplanned, unscheduled changes may result in missing the target.
• Competition in the defence shipbuilding sector has increased as it has been opened for private sector.
• Change in government policy regarding bidding or payment mode may impact the financials.
• Single client (Ministry of Defence) concentration.
• Any reduction in budgetary allocation for Navy may hamper growth.

The Verdict

GRSE is well poised to execute its huge order book given its technological expertise and past track record. Focus on indigenization will enable the company to have improved margins in the coming years. The management’s continuous drive to de-risk the revenue flow through diversification of businesses and plans to enter into export business will bear fruit in the long term. This will also reduce the company’s single client concentration.

The huge cash balance, zero debt and good dividend yield provides adequate margin of safety for this long-term play stock. The dividend yields as on March 31, 2019 stood at 7.13%. What GRSE lacks in size compared to other defense yards it makes up for in agility and ability to bring about change in processes. I believe GRSE offers the highest revenue growth visibility amongst all PSU yards. It is also a turnaround candidate as current orderbook offers higher margins with lower risk of liquidated damages. I believe going forward, GRSE stands to capture more upcoming defense orders given its increasing capacity and aforementioned track record. Give the revised focus on defense spending by the Modi Government and “Make in India” initiatives, GRSE positions itself to be the prime partner for India’s defense shipbuilding dreams.

GRSE is currently available at a CMP of INR 129.55 (as on March 31, 2020) at a PE of 10.04.

Team 3C Capitals

Sources

• Value Research Online
• Annual Reports and Investor Presentations
• Blogs
• Financial Articles