How much of success can be attributed to effort and how much to luck has been debated since ages. But the fact that enduring fortune favors the brave, the prepared, the hard worker is undisputed. Unless a person/company is prepared to handle good times, success can at best be fleeting.
Four disparate events happened across the world in the past few years which brought huge stroke of luck for those Indian defence companies which had prepared themselves for this opportunity: –
- The Armenian Azerbaijan war in 2020 which was won by Azerbaijan mainly on the strength of drones changed the way the world looked at the importance of drones and counter drone capabilities.
- Ukraine Russia war is still not settling in favour of Ukraine despite it being gifted, what defence analysts say, enough equipment to win the third world war because of lack of training to use this equipment.
- Hamas was able to shock Israel, one of the most militarily advanced countries in the world, probably because Israel was not vigilant enough.
- Make in India drive by the Government of India in Defence procurement with preference to IDDM (indigenously designed, developed, and manufactured) opened floodgates of orders for domestic companies. Approximately Rs One Lac Crore worth of domestic orders are expected in FY 2023-24 and this figure is only going to go up every year.
Indian companies slogging for years doing R&D in the fields of drones, counter drone systems, simulator equipment to train soldiers, surveillance systems etc are beneficiaries of these Rs One Lac Crore per annum (and growing) orders. Plus, as these companies achieve global credibility, defence exports are also exploding. They have already gone up 10x from @ 1900 Cr in FY2015 to @ 19000 Cr in FY 2023 and will only keep increasing.
One such company listed on the Indian bourses is Zen Technologies. It has been in existence for 30 years doing R&D with 130 patents under its belt but its track record until defence indigenisation drive was forgettable. In nine years between FY 2013 to FY 2022, its revenues only doubled, EBITDA remained flat and PBT fell 50%.
But with the defence indigenization drive, manna started raining. In FY23 its revenues tripled, EBITDA went up 14 times, PBT went up 24 times over last year. Management is guiding for revenues to double in FY24 to around 450 Cr and then double again in FY25 to 900 Cr with EBITDA and PAT margins maintained at 35% and 25% respectively because of the valuable and non-replicable patents/IP it holds. Management goes on to add that it will be disappointed if the company does not achieve 5000 Cr revenues in five years! Icing on the cake is that the company does not require any substantial capex till topline of 2000 Cr since it outsources the manufacturing part to third party vendors using IP provided by Zen.
Zen Technologies claims to be among the leaders in defence simulators, drones, and counter drone systems all of which are ‘must have’ by any country to secure itself considering the events mentioned above. Its expertise can be guesstimated from the fact that exports are contributing around 25% of its order book and the company expects their contribution to reach 50% in a few years.
There are a few risks too. Defence has always been amongst the fastest evolving technologies in the world. What works today may not work tomorrow. Past patents and IP will not sustain growth for Zen, it must continue being at the forefront in R&D. Secondly, its working capital cycle is high which can be a big drag though in FY23 it has improved to 128 days from 225 days in FY22. Management expects the 120-140 days range to continue but any deterioration will be negative.
It could end FY24 with EPS of @ Rs 15 translating to high PE of 50 (at CMP of Rs 750). This is certainly not cheap unless high growth continues with margins maintained. Posterity will tell whether the company flies or not, but its MD Ashok Atluri certainly seems grounded. In an interview with BQ Prime post Q2FY24 results, he attributes success of the company to changed external environment rather than anything special the company has started doing of late to deserve this success.