A Hero in the making

Though there are options galore in the current market for long term investors with quite a few stocks at mouth-watering levels, some do catch attention since they were doing quite well not too long ago. One of them is Hero MotoCorp. It has again come down to levels of around 1800 where I personally think it is a screaming buy for a 20%+ annual returns going forward. Post the split with Honda, it had reached similar levels but the moves made by Munjals have been well accepted by the stakeholders as well as the markets. And when things didn’t look as bad as they do now, it had again climbed to levels of close to 2200-2400 in a short span. Of course the timeframe may be longer this time than it was last time, but with Indian markets, one never knows.

Freedom to export where they please (which makes for a good long term business model much like happened in IT) and to tie up with whosoever they prefer to choose without any restrictions are obviously the factors which will make or mar its prospects.

So far, they have made the right moves with intentions to expand in SE Asia, Africa, Central and Latin America which are supposedly lucrative markets for 2 wheelers esp. in the 100-125 cc range which are Hero’s forte. The company is sprucing up its sales network in these export markets. Of course it must be remembered that though lucrative, they are no easy pickings with a strong field of not only global giants such as their erstwhile partner Honda and other Japanese biggies such as Yamaha, not to mention Italians such as Vespa but also our own home-grown giants such as Bajaj Auto and TVS. And the point to note is that this has been a mixed bag for our players at least in SE Asia with Bajaj enjoying reasonable success and TVS Motors still struggling to get its act together. So how Hero gets going in these markets would be the key thing to watch.

In line with this strategy, it has also chalked out moves for capex to cater to these export markets. Its first plant will be set-up at Neemrana, Rajasthan, commencing operations from 1QFY14. The second plant will be set-up in Gujarat commencing operations from 2QFY14. It will also be setting up a R&D center with at a 250-acre location near Jaipur in Rajasthan.

Post its break-up with Honda, it was obvious that Hero would need a strong technology partner for its 2 wheelers since its own R&D is yet to pick up on a significant scale. To address this, it has already tied-up with Erik Buell Racing (EBR) and AVL (Austria). While EBR brings technology for premium motorcycles and development of new models, AVL gives access to know-how on engine technologies and would be focused on modifying existing engines.

The Indian market predominantly favors 100cc motorcycles; almost 75% of total sales belong to this category. Splendor and Passion continue to drive HMC’s sales, contributing 45% to volumes. Hero Honda currently sells around 36,000 scooters a month. With only one model, it is already the second largest player in this segment also. It has recently launched ‘Maestro’ to appeal to the male segment. However the concerns are on margins since they have would already have spent resources on their new brand building. Ad-spends would be high for some time in the near future.

Thus, though near-term concerns remain on margins and factors beyond their control such as the macro-economic situation in the country as well as globally, with the right plans and strategy in place for volume as well as margin expansion, Hero should make a rewarding investment now.

Energetic profitability and growth

Videocon Industries, incorporated in 1979, is well known for its consumer goods and has been a well-entrenched player in the Indian market in this space.  It is engaged in the manufacture, marketing, and distribution of consumer durables, color picture and cathode ray tube glasses in domestic and international market where it has access to facilities in Italy, Poland, Oman, China and Mexico. It is also the third largest picture tube manufacturer in the world.

A few years back, it also made a foray into the telecom space albeit with limited success.  Its handsets may be doing well, but as a mobile service provider, it hasn’t made any waves at least in the major metros against stiff competition from established players such as Bharti Airtel and Vodafone. It hasn’t been able to leverage its brand strength to make many inroads in this area, unlike Idea which in a short time has given the established players a tough time.

The Company has interest in four major sectors:

• Consumer durables
• Display industry and its components
• Color picture tube glass
• Oil and gas.

On the consumer good side, the company is firmly established, at least in India. A few years back, the company acquired Thomson CPT Ltd, which has got manufacturing operations in four countries for CPTs. Though the current market trend in developed and developing markets is towards new generation high-end technology like LCD/LED, there are enough countries in places like Africa and even in the interior rural parts/non-metros of major countries like India which continue to thrive on CPT-based TVs. Also, they acquired the Indian operations of the Swedish goods major Electolux. It has an average market share of 17 per cent across categories like color TVs, refrigerators and washing machines.

However, what is not very well known is that it has a significant oil & gas business where it holds stakes in various oil fields across the world. This company has got 25% stake in the Rawa Oil field, which is on the eastern Coast of Andhra Pradesh and produces close to about 50,000 barrels per day. Besides this it has significant interest in oil fields in Oman, Timor, Southern Australia and Western Australia. It has also taken over the South American assets of a Canadian company called EnCana Corporation. The Brazilian company has got about ten offshore blocks in Brazil. However, its biggest and most profitable catch appears to be its 10% stake each in 6 blocks of deep water Rovuma Block Area-1, offshore Mozambique where state-owned Bharat Petroleum also has a similar 10% stake in these blocks thru its wholly owned subsidiary Bharat Petro Resources Ltd. Videocon bought this stake in 2007-08 for $75 million from Texas-based Anadarko Petroleum thru its wholly-owned subsidiary Videocon Hydrocarbon Holdings. The other partners are Japan’s Mitsui & Co (20 percent Thai group PTT Exploration and Production which bought Irish company Cove Energy’s stake (8.5 percent) and the Mozambican state-owned Empresa Nacional de Hidrocarbonetos (15 percent). Recently, Andarko, announced a significant upgrade in estimated reserves in the basin from 60 tcf to nearly 100 tcf. The new discovery in two gas wells off the coast of Mozambique is being considered as one of the largest gas finds in the world and would make the basin's reserves 20 times the size of India's KG-D6 (to put the find in perspective) and make Mozambique a major exporter of liquefied natural gas (LNG). This can sharply raise supplies and calm LNG prices at a time US gas prices have crashed after supplies surged with shale gas. The good news doesn’t end here. Just one-third area of Mozambique has been discovered so far. Mozambique is now approaching to be as big as Qatar.

In a filing to SEBI on 20^th Aug., Videocon valued its 10 percent stake in the Mozambican block with large natural gas reserves at US $2.26 billion. Videocon’s initial investment here was just $75 million in 2008. The company based its calculation on Cove Energy Plc.’s recent 8.5% stake sale in the block to Thai group PTT Exploration and Production for $1.92 billion after a nearly 6 month aggressive bidding war with Royal Dutch Shell Plc. Videocon also said that the valuation, excluded “the large gas discoveries which took place during the period when the Cove Energy sale process was on, which might or might not have been (taken) into account by PTT, and on which we base our valuation,” which eventually won the bid. The total valuation thus could be far more than US $2.26 billion when other things are also taken into account.

The telecom story is by now well known. Videocon had licenses for 22 circles which have now been cancelled and are under litigation. However, since Videocon was not affected as deeply as some of the others, the impact on it was not too much. It has also forayed into another promising and sunrise sector of Digital TV. As per latest reports, it had 12% of the market share for digital TV. While active base/ARPU for this business are not known, anecdotal evidence praises both the quality and the distribution efficacy of the business (with firms like Edelweiss giving a thumbs up to the DTH operations). Besides its other businesses are doing pretty well, though over the last 2 years, consumer durables has taken somewhat of a beating.

Dhoot has headed Videocon’s transformation from a maker of consumer electronics products into a multi-business group centred on hydrocarbon exploration. The diversification, however, has come at a price: the group had borrowed Rs. 18,656 crore as on 31 December, an increase of 58.5% from a year earlier. Its current liabilities, or obligations due within a year, rose 175% to Rs. 2,511.2 crore in 2011 from Rs. 912.05 crore in the previous year, while cash balances fell 61% to Rs. 504.5 crore in 2011, according to the company’s latest annual report.

The energy assets, tipped to be a cash cow for the firm once the Mozambique block goes into production in fiscal 2016, could help in reducing debt.

Recently, Videocon board has proposed to demerger its Oil & Gas business as a separate entity. In an energy-deficient country like India, Oil & Gas sector especially the private producers (Reliance, Essar etc) would always have a future for a long time to come. When the above proposal is implemented, the shareholders of Videocon would have exposure to 2 high-growth businesses – Consumer durables and Oil & Gas. While the former will take as much time as the economy to bounce back to its former position, the latter should pick up sooner than later especially with the moves planned by the management.

To summarize, the upside triggers for the stock seems.

1. Sale of DTH business-if rumor like this one comes true (http://www.dealcurry.com/2012076-Videocon-To-Exit-DTH-Biz.htm).

2. Spinoff of oil and gas assets-no more expensive capex. Also, it may reduce the complexity discount/conglomerate discount attached to the stock. 

3.  Resolution of telecom 2G auction issues and possible compensation.

Delisting bets - still holding promise

I had written about delisting bets in March ’12 when the de-listing fever was at its peak with 1 major de-listing of Atlas Copco gone thru successfully (and I might add at an astonishing price, way beyond what was generally expected and at very high valuations). This frenzy continued with Alfa Laval, incidentally another Swedish company, offering an astonishing Rs. 4000/share to its shareholder for getting rid of them for good!

However this bubble did not last beyond the next 2 months when Fresenius Kabi, a German pharma company specializing in Oncology (cancer) drugs, announced in June ’12 that it is not going ahead with delisting but would offer its shares for sale through stock exchanges to increase the public holding in the company. This was a rude shock to the hopefuls who had made bets on this very premise. And predictably, it had a cascading effect with the few other hopefuls (AstraZeneca Pharma, BOC (India), Honeywell Auto, Blue Dart Express and Elantas Beck) also tumbling in varying proportions (2.5% to 9.4% in BOC India, showing the pecking order), though not as much as 20% which FK did (it later recovered somewhat, but is still close to its 52 week-low).

Having said all this, there does appear to be a silver lining to this issue. The key thing to do would be to focus on the factors which would lead to a company to go the delisting way, other than the independence factor which it would bring to it. I have 2 such factors in mind:

1.  Business imperatives – Consider the case of BOC (India). Going by comments made by Sanjiv Lamba, BOC’s chairman and member of the executive board of Linde, in May, de-listing could be a preferred choice though he clarified that no firm decision had been taken as yet. The decision could be taken close to June 2013 deadline set by the SEBI for companies to bring down promoter holdings below 75%. Considering that it takes anywhere from 3-6 months for an offer to complete, things should start moving by Dec. ’12 if not earlier.

BOC plans to on bidding for large businesses where PSUs are asking them to bid from (the position of) a 100% owned entity. The option they have to get around this is to bid as Linde Global, otherwise they won’t be technically qualified. Generally, PSUs ask for 100% guarantee for 20 years from the parent company. How would they get 100% guarantee from a parent for a company in which it owns 80%?  As a separate entity, BOC, which is now trying to diversify its client base beyond steel industry, would face challenges in bidding for petrochemical sector as it would then have to source technologies it has not used earlier, something that the oil PSUs won’t be comfortable with. Obviously BOC India doesn’t have the breadth that Linde AG has in its product offerings. So for BOC, de-listing looks to be a business imperative rather than just getting its independence from Indian laws and shareholders as is the case with most others.

2.  Large institutional or single shareholding – As per SEBI rules, if the promoters of a company want to de-list it, they have to buyout at least 50% of the minority shares AND reduce the minority shareholding to less than 10% (take the promoter shareholding to above 90%).

Consider the case of Fairfield Atlas which has been in the news for the last year or so purely for this reason. Needless to say, it has also run up hugely (around double) from levels then. This was not on my radar initially (as you can see from the first list), but came to my notice recently when it started moving up in huge spurts.

Here, the promoter shareholding is 83.91% and public shareholding is 16.09%. Out of this, Reliance Capital Trustee Company holds 4.14%. If the promoters want to delist the company, they have to buy at least 50% of the public shares (approx 8.05% of the total shares). If they are able to buy 8.05% of the shares, 90% condition will be met too. If Reliance Capital is convinced to sell its stake at an acceptable price to both parties, that will leave only 3.91% (8.05-4.14) to be cobbled up from the public, from the remaining 11.95%, which is only about 1/3^rd. I would think this is more than a fair chance of attaining, more so if it is at a good or even a reasonable price (and it would be safe to assume that Reliance will not settle for anything less than that). Being an institution, the price Reliance would expect would be a function of fair valuation of the stock as well as its own acquisition cost, which can be hugely different from what the public would expect. And @160, @P/E of < 12 (on ttm earnings), it is quoting at less than fair valuation (purely my thoughts – considering that other MNCs peers like WABCO @1500 quotes @P/E of about 18, Bosch @8800 quotes @ P/E 23) even after last year’s run-up. 

This makes a very good case for Fairfield Atlas to be considered as a promising de-listing candidate which could succeed in its efforts. Of course, the price is a factor which should be considered, since as already mentioned, it has run up significantly. However, as has been seen before in the Indian markets, once the news is out, sky is the limit and stocks have doubled from already huge levels against all rationale (look at Alfa Laval and Atlas Copco). This could play out the same way since the payout may not be too huge for the promoters.

Midcap carnage (26-July-12)

This is turning out to be a different kind of 7/26 at D-Street. While this has happened before with predictable results, this time I think it may prove rewarding to be wiser by latching onto the ones which have been ground to dust. While in all cases, the businesses may not be sound (as in real estate), in others, there definitely is potential.

Look at Parsvnath Developers @46 (down 20%). Though much has been written about real estate and probably rightly so, in my view, PD surely doesn’t deserve this price. I also believe that it may come back to 55-60 levels in a very short time once this brouhaha dies down.

Another one that merits attention is Tulip Telecom, down 28% @85. If nothing was wrong with it yesterday @108, I just can’t see anything wrong with it today @85!! The only thing for this knee-jerk reaction is that a couple of brokers who are facing a liquidity crisis have sold pledged shares of this company (and others who have crashed), triggering a sell-off in their shares. And this has a good business of enterprise data connectivity going, where it is doing pretty well.

Another on my list is Pipavav Offshore (of Nikhil Gandhi who also owns Everonn) which is again down 20% @62. Their JV with Mazgaon dock was challenged by other bidders (Bharti Shipyard, L&T and ABG Shipyard) but the challenge was rejected and the JV is still on. It is only a matter of time before they start getting orders from Mazgaon Dock. Also they have placed equity with a few PE funds and other investors some time back at much higher prices. Among the prospective investors they are having talks with is DCNS, the French defence major, owned by the French government and specialist in manufacturing surface combatants, submarines, systems and equipments. It is likely to pick up a little less than 10% equity stake as per news reports a few weeks back. They have stated their intent to place their shares with institutional investors @110/share. Looking at all this, it would make sense to buy into this in such times of crises.

There may be other stories like above where there is nothing wrong with fundamentals but only the sentiment which is playing havoc with their share prices. Once the dust dies down, they will be back to their original prices, and probably more. All in all, a good time to lock into these now or on any further fall.

Low profile, high growth?

South India-based financial services companies, be it banks, NBFCs, other lenders, or any other financial service providers, have gained reputation for their integrity, fair business practices, dedicated customer service leading to customer loyalty and conservative style of operation. Families such as the TVS group, Murugappa group, Shriram group to name a few, are still spoken with respect not only in India but also overseas due to these reasons.

While much attention has been focused on Sundaram Finance and Shriram Transport Finance, the listed finance arms of TVS and Shriram groups respectively, by analysts and media alike due to their superior performance and returns over the years, not much is talked about another entity coming from a similar parentage – CIFCO of the Murugappa group. The reasons could be many including its slightly turbulent past few years, but it has silently gone about its business of cleaning up its operations and looks set to join its peers in times ahead.

Cholamandalam Investment & Finance Co. (CIFCO), the financial services arm of the Murugappa group, was set up in 1978 with the primary objective of offering asset finance through leasing and hire purchase to corporates and then to retail customers. It has since evolved itself into a large, composite financial services organization that operates from over 350 branches across India with AUM of over Rs.10000 crore. Today, CIFCO is a pan-Indian, composite financial services provider that offers vehicle finance (new and used HCVs, LCVs, SCVs, MLCVs, MUVs, tractors, and cars and 3 wheelers), business finance, home equity loans, stock broking and distribution of financial products to its customers. It comprises the parent company, CIFCO, and its subsidiaries Cholamandalam Distribution Services Limited (CDSL) and Cholamandalam Securities Limited (CSec).

In 1997, CIFCO entered into a JV with Cazenove Fund Management Limited of U.K and launched its MF business in India. CIFCO held a 51% stake and Cazenove the balance 49%. This venture lasted for 4 years when CIFCO opted to look for a bigger international player in this area and bought out Cazenove’s 49% stake. It was the renamed as Chola AMC.

In Jan '06, Singapore-based DBS Bank (the largest in Singapore then) bought equity shares of CIFCO @150/share from the Murugappa Group's flagship, Tube Investments (17.4%), public shareholders (20%) through an open offer and subscribing to a preferential allotment of 30 lakh shares. The transaction resulted in DBS Bank and the Murugappa Group having equal shareholding of up to 37.5% each in the company. The shareholding of the Murugappa Group in CIFCO was at 55% prior to the deal. While continuing its focus on the core business of vehicle financing, the company entered the retail financing business with new products for personal loans and home equity. CIFCO was then renamed as "Cholamandalam DBS Finance". Under this arrangement, DBS also partnered CIFCO in their existing asset management venture renaming the company as Chola DBS AMC. This carried on the AMC business for a few years, but was unable to establish its credibility in the Indian market, barring a few of its schemes which performed well. L&T Finance which was looking for an entry into this business bought it over and in the process got the license to run an AMC. At a valuation of 1.56% of the AMC’s AUM, of about 3000 crore, this was a steal for L&T Finance and one of the cheapest deals in the MF space. However, it must be noted that Chola DBs AMc was a loss-making entity at this time.

In Jan ’09, the JV went thru a turbulent phase when both partners negotiated with each other to buy the other out. Finally in April ’10, the Singapore-based DBS Bank sold its entire 37.48 per cent stake in the company Cholamandalam DBS Finance to the Murugappa Group holding companies, Tube Investments of India and New Ambadi Estates. Following this, the company was again renamed to its original name i.e. CIFCO and is thus now a subsidiary of Tube Investments.

A few months back, in March ’12, Multiples Private Equity (floated by the former ICICI Venture CEO, Ms Renuka Ramnath) acquired 5% of the total equity share of the company through preferential allotment. Another fund, Creador (floated by a former managing director at ChrysCapital) has also invested around 5% here @160/share. Since then the price has steadily climbed to more than 200 currently.

Over the last few quarters, the company has shown strong loan growth, better NIM and lower provisioning and looks set for growth in the coming quarters. While Sundaram Finance trades at a P/B of 2.32 and Shriram at 2, CIFCO is quoting at 1.87. Considering that even M&M Financial Services trades at a P/B of 2.36, there is still scope for at least 20%, if not more, appreciation here, from the current levels.

Diversified businesses

Kothari Products (KP), the flagship company of Kothari group, is best known for its pan masala which is sold under the brand name of Pan Parag, and has over a period of time become a generic name for pan masala. The company was also involved in the business of packaged drinking water under the "yes" brand. In Nov. 2008, the company hived off the activities of manufacturing of pan masala, beverages divisions into a separate legal entity in the name of “Pan Parag India Limited” Redeemable preference shares were issued for this company to the shareholders of KP. These have since been redeemed.

Consequent upon the demerger, KP has focused on business opportunities in the what they consider to be the most buoyant and vibrant sectors of the economy such as real estate, investments and international trading of Exports & Imports. The core concentration of KP is now on these businesses. So in that sense, it is more of a quasi-holding company which not only has its operations in the above businesses, but also holds stake in other businesses of the group.

 Real Estate - The company itself and through its associates and other promoter group companies has substantial investment in the real estate sector in the Commercial, residential, retail, hospitality segments, land and development thereof. The company has a strategic partner in the Sattva (Salarpuria) group. Sattva is one of the leading real estate development group based in Bangalore, which is well known for its “IT Techno Parks” and beautiful residential buildings. The Salarpuria Group has its offices in Bangalore, Delhi, Pune, Jaipur, Hyderabad, Vizag and Kolkatta. Under the joint development with Salarpurias, KP has embarked upon development of mega residential projects in Bangalore and Pune. 

International Trade – KP has ventured into the import-export trade of various products/commodities including agro-based commodities, minerals, metals and petroleum products. Recently the company has also incorporated its foreign subsidiary in Singapore for “General Whole sale Trade (including General Imports & Exports)” in addition to a domestic subsidiary to pursue the business of international trade vigorously and profitably.

The company’s trading items are being exported directly or through merchant exporters to China & Thailand. The company has exported iron ore and is also in the process of exporting of aluminium ingots to Thailand and also planning export of Literite to Bahrain. The company is also planning various minerals and metal products for export. New developments under process are Soya DOC.

FMCG business – This was the core business of KP before the diversification as mentioned above. This business is now housed in its wholly owned subsidiary Pan Parag India Ltd. which is also involved in the business of packaged drinking water under the "yes" brand.

As has been seen in the past, the hullabaloo regarding pan masala ban, due to the recent Maharashtra government ruling, will soon die down. The gutkha and pan masala manufacturers will move court and get this rolled back as they have done twice in the past. After all, cigarettes also fall in a similar category and the courts couldn’t stop their production.

This company has a tiny equity capital of about Rs 6.63 crore. Promoters hold roughly 75% of the equity capital.  As of March ’11 (current years’ results awaited), this company had a cash and bank balance of Rs 36 crore and loans & advances of close to Rs 322 crore. This makes the total liquid assets available with the company at more than Rs 350 crore. Against the liquid assets of Rs 350 crore, this company has a total debt of only 90 crores. This is besides the other investments the company holds in its subsidiaries at book value which in real terms will be worth many times over.

For the year ending March ’12, the company has an EPS of more than 90. This company has been a regular dividend payer, for the last many years it has consistently paid dividends of more than 100% going even up to 160% in some years (this year it was 150% or 15/share). So here we have a company, which has very little debt, a small equity and a very high promoter stake. It is creating huge value for the shareholders, year after year whereas the market price is not going up in the same proportion.

With a book value of nearly 980 crores, it is quoting at a P/BV of less than 0.5 and a P/E of 5.4. It should not be looked at as a pure holding company since it has some operations of its own, and hence should be looked at in that light. So merely applying a discount to BV to arrive at a fair price may not be the correct way since its operational business is not being considered. And real estate as well as trading operations, if managed correctly, have been known to be good money spinners.

Such companies producing tobacco-related products have a market cap which is more than its sales revenues many times over - ITC (8), Godfrey Phillps (nearly 2), VST (nearly 3), KP commands a Market Cap to Sales of just 0.1. The company thus appears grossly undervalued compared to its peers and carries potential to reduce the huge valuation gap which exists currently. At the current price of about Rs 408, this stock is a pure value play. Also, considering its huge reserves vis-à-vis the equity, a bonus could be distinct possibility. However, considering the diverse nature of its businesses most of which are not doing so well (for e.g. real estate and trading due to general consumer environment and volatile exchange rate), it may not soar too much in the current environment. However, under benign conditions, the returns should be good (last July ’11 it was quoting as much as 670).

Niche technology

Astra Microwave Products Ltd (AMP), a Hyderabad-based electronics company was promoted by technocrats B. Malla Reddy, who has worked for over two decades in ISRO, Bangalore, and DRDL, Hyderabad, P. A Chitrakaar, who has worked as a scientist for over 20 years with Defense Electronics Lab, Hyderabad and C Prameelamma, who has had a distinguished career with Electronics R&D Establishment, Bangalore, and the DERL, Hyderabad. It is engaged in designing and manufacturing high value added RF (Radio Frequency) and microwave super components and sub-systems for defense, space and civil communication systems. Its products are widely used in VSAT operations, radars, satellite applications, antennas, etc.  with European Aeronautic Defence and Space Company, Israel Aerospace Industries, Elettronica, Italy's SIAE Microelettronica among its top foreign customers.

AMP operates in very niche and high-tech space with very few listed peers. The biggest listed competitors/peers to it on the Indian exchanges are the PSU BEL, BEML which work as monopolies in the supplying defense equipment to the government. With privatization being allowed in defense procurement recently (as evidenced in MoD officials’ pronouncements in Defexpo India 2012), quite a few private companies are gearing up to enter this field. The major players/groups who have shown interest and are already active in this space are the Mahindras (thru Mahindra Aerospace and Mahindra Systech, both private companies in the group), Larsen & Toubro, Tatas (thru Tata Technologies which has a JV with HAL, a PSU), Pipavva Defence & Offshore Company (also referred as Pipavav DOC which was formerly Pipavav Shipyard), and Kirloskars. The rising defense expenditure in India is throwing up huge opportunities for private sector as they can enter into partnerships with global majors for manufacturing. Shipyards are another area where private sector smells an opportunity. Pipavav DOC (formerly Pipavav Shipyard) has already entered into a JV with Mazgaon Dock, India's biggest defense shipyard for shipbuilding with more than 85% of indigenous defense vessels being built there. With Mazgaon Dock already executing huge orders for the govt., some of it will surely come Pipavav’s way.

As with retail, this sector (defense equipment and services) is more or less out of bounds for the private sector, a scenario which is undergoing winds of change. As with retail, govt. is taking small but steady steps in opening up this sector to private participation realizing that PSUs such as BEL alone may not be able to supply India’s growing needs for this sector. FDI is currently 26% in this sector but private sector is lobbying for this to be increased to 49 (similar to Retail and Insurance). It may be a matter of time when the govt. gives the nod for this keeping all stakeholders happy. The govt. has already decided to issue licenses to Indian and foreign private companies to invest money and to start manufacturing defense equipments. So far, they have given licenses to 24 companies, including Larsen & Toubro, Tata and Mahindra and Mahindra.

AMP is backed by Strategic Ventures Fund (SVF), a PE fund managed by Mauritius-based Frontline Strategy Limited with a 15%. Besides this, other major players who have found Astra to be investment worthy are L&T which has a near 10% stake, Reliance Capital with 5.6% and Skanda Aerospace, a Hyderabad-based company with 7%.

Recently, a few month back, in one of the largest defense offset contracts awarded to a mid-tier Indian firms, AMP has bagged a Rs 310 crore deal from one of its overseas customers, the first time that they have bagged such a large order in their history. Including the new order Astra Microwave will now be executing orders worth approximately Rs 730 crore outsourced by its foreign and domestic customers – DRDO and ISRO. The order will significantly add to the Astra's revenues. India's defense authorities plan to spend Rs 75,000 crore over the next decade to procure new radar systems in a bid to modernize the armed forces with more sophisticated weapon systems. So there is ample scope for companies small and large to scale up their divisions in this area. Once there is a steady stream of work coming in, the bigger companies may well look at sub-contracting some of the work to smaller players like AMP or even outright acquire them if they appear attractive enough with niche skills and inability to scale up on their own. AMP would fit the bill perfectly here. A couple of years back, L&T was looking to increase its stake in AMP by buying some from SVF, but the deal fell thru. Later BEL was also looking to get into AMP which also didn’t materialize.

AMP @44 is currently quoting at a PE of about 10.6.  It has a reasonable low equity of 16 crores with healthy OPM consistently maintained at 25-30% and PAT margin of 12-15%, This year they also gave a bonus of 1:1.

The major risk for AMP would be adverse government policies, but given the strategic nature of their business this should be largely under control. Also, they have their overseas business to fall back on if this were to happen. Considering the healthy demand scenario both domestically and overseas, as well as sound operating metrics, AMP should do well going ahead. Any M&A activity will be a bonus.