PIPAVAV DEFENCE & OFFSHORE ENGINEERING LTD : BUY ON DIPS !!!

Scrip Code: 533107 / PIPAVAVDOC

CMP:  Rs. 81.00; Buy at current levels & On DIPS.

Medium to Long Term Target – Rs. 100; STOP LOSS – Rs. 74.50; Market Cap: Rs. 5,598.70 Cr; 52 Week High/Low: Rs. 92.70 / Rs. 50.10

Total Shares: 69,11,98,388 shares; Promoters : 29,95,76,180 shares –45.00 %; Total Public holding : 39,16,22,208 shares – 43.44 %; Book Value: Rs. 24.90; Face Value: Rs. 10.00; EPS: Rs. 1.16; Div:-- % ; P/E: 69.82 times; Ind. P/E: 24.60; EV/EBITDA: 35.48.

Total Debt: 2,020.75 Cr; Enterprise Value: Rs. 7,952.92 Cr.

Pipavav Defence and Offshore Engineering Company Ltd: Pipavav Defence and offshore engineering Company is promoted by SKIL Infrastructure was formerly known as Pipavav Ship Dismantling and Engineering Limited and changed its name to Pipavav Shipyard Limited in April 2005 which again changed to its current name on 29^th September,2011. Pipavav Defence and Offshore Limited were incorporated in 1997 and are based in Mumbai, India. The company engages in the defence ship-building, and construction of offshore oil and gas assets, as well as provision of commercial ship-building and repairs, and heavy engineering services in India. Pipavav is the only private shipyard in India to have license to produce frontline warships from the Govt. of India giving it significant opportunities in the defence space. The company also offers very large crude carriers, suezmax tankers, aframax tankers, capesize bulk carriers, panamax bulk carriers and tankers, handymax and handysize bulk carriers and tankers, and product and chemical tankers; and specialized vessels, such as LNG carriers, LPG carriers, reefers, containerships, offshore support vessels, ferries, and dredgers. It also provides offshore platforms, which include rigs, jackets, and single buoy mooring systems; naval vessels; and ship repair services, such as refit/dry docking, a-float repair, and conversions. Pipavav Defence & Offshore Engineering Limited is the largest shipyard in India and the 5th largest in the world in terms of its size (400000 dwt). Pipavav’s dry dock capacity is larger than top 5 yards in India put together. The Company has two units, one Special Economic Zone (SEZ) unit spread over around 95 hectares of Land and another Export Oriented Unit (EOU) Unit spread over around 103.92 hectares of Land. The Company is engaged in the Pipavav Shipyard project. Pipavav Shipyard is a shipbuilding, ship repair and offshore fabrication complex being constructed by the Company at Pipavav in the State of Gujarat, India. The complex is spread over an aggregate area of 198.92 hectares (approximately 491.53 acres), comprising a SEZ unit spread over 95 hectares (approximately 234.75 acres) and an EOU spread over 103.92 hectares (approximately 256.79 acres). The Pipavav Shipyard is situated on the west coast of India on the Dubai-Singapore sea route. The company is compared with ABG Shipyard Limited locally and globally with Boustead Heavy Industries Corporation Berhad and Coastal Contracts Bhd.

Investment Rationale:

India is set to spend Rs. 60,000 Cr over the next five years on improving its military infrastructure. Due to the 'Buy Indian, Make Indian' policy put in place by the Ministry Of Defence, a large part of this sum will go to domestic companies. Even in case of imports, there is an offset clause that benefits domestic companies. For any defense contract for capital purchases of over $60 million (Rs.324 Cr), the foreign vendor is required to allocate 30 % of the contract value to Indian players, primarily in the defense, internal security and civil aerospace sectors. According to the Ministry of Defense (MOD), there could be an offset opportunity of $15 billion over the next five years this also envisages a greater role for the private sector, which should benefit established players like PIPAVAV & it enjoys first mover advantage and best-in-class infrastructure in the ship-building segment. It operates the second largest ship-building capacity in the world. PIPAVAV uses modular construction technology, with two 600MT Goliath cranes, which enables it to reduce the construction and delivery time of vessels. Further, it enjoys strong strategic partnerships with several international players, which should aid robust warship order booking in the near future. MOD's growing stress on indigenization and its Mazgaon JV should boost order intake. PIPAVAV's current capacity stands at $1.7 billion (in terms of revenue potential) are likely, to shoot up to $2.5 billion once the second dry dock becomes operational by 2014. The private sector defence business is at a nascent stage in India & with the various government initiatives encouraging indigenization and private sector participation, it is believed that the defense orders offers immense opportunity to private sector players. PIPAVAV is well placed ahead of the curve to exploit this opportunity in the next few years with its global-sized assets and best-in-class tie-ups. Also, PIPAVAV offers the only credible large-size exposure for investors to India's defence business.

Outlook and Valuation:

India imports 70 % - 75 % of its defence requirement from the foreign nations. The government aims to reduce its dependence on imports by encouraging indigenization, with the introduction of the ‘Buy Indian, Make Indian’ category in its defence procurement policy. The increasing stress on indigenization is also the result of several bitter experiences that India has had in sourcing defence equipment from overseas. For instance, India had once placed an order for a Scorpion submarine with France. The order was executed with a delay of four years and the eventual cost was four times its original cost. Similarly, the Indian Navy’s order for a Gorshkov Class Aircraft Carrier witnessed a price escalation of 3x. Such experiences led Defence Ministry to initiate the policy of ‘Buy Indian, Make Indian’. The government has also suitably modified its policies to allow greater participation by domestic private sector companies. The Ministry Of Defence (MOD) has directed public sector companies to enter into partnerships with private players that have the requisite capabilities and foreign collaborations. For instance, the MOD has decided to liquidate the piling orders of government shipyards to private players like PIPAVAV and L&T. PIPAVAV operates the second largest shipbuilding capacity in the world, capable of constructing vessels up to 400,000DWT. Hyundai Heavy, the largest shipbuilder has a total capacity of 10,00,000 DWT. PIPAVAV intends to become the world's largest shipbuilding company after completing the conversion of its second wet dock facility to a dry dock. It has a shipbuilding, ship repair and offshore fabrication complex spread over 750 acres with 720 meters of sea front and 685 meters of outfit quay, including two Goliath cranes of 600 tons each, which service the dry dock and the adjoining pre-erection berth, enabling PIPAVAV to handle up to 1,200 tons of pre-outfitted ship blocks. A host of other technologically advanced infrastructure makes PIPAVAV one of the most modern shipyards in the world. Any new private player wishing to enter this sector would need at least 8 to 10 years to set up such a kind of facility as compared to PIPAVAV. The Land acquisition, required environment clearances, construction, license procurement and technology tie-ups can take an average of 10 years to the new player who wishes to enter this sector. This gives an established player like PIPAVAV an added advantage. PIPAVAV uses modular construction technology, which enables it to reduce the construction and delivery time of vessels, as it is able to simultaneously work on different orders. It has a separate shipbuilding facility, which breaks down a complete ship into separate blocks for construction, which include cutting, forming, blasting, painting, steel stacking, treatment and welding. The dock is used to only assemble mega blocks with the help of two installed Goliath cranes. PIPAVAV is well placed/ahead of the curve to exploit the massive opportunity that India's defence sector offers in the next few years. It has globalsized assets and best-in-class tie-ups. Also, PIPAVAV offers the only credible large-size exposure for investors to invest into Indian defence sector. Hence, the Fair value for PIPAVAV DEFENCE, based on replacement cost method comes at Rs. 6,700 Cr which translates in to Rs.100/share. The company can post an EPS of Rs.0.8 for FY12 and Rs.1.2 for FY13E. The Board meeting will be held on 30th May 2012 to consider and approve the audited financial results of PIPAVAV DEFENCE & OFFSHORE ENGINEERING LTD for the year ended 31st March 2012.

KEY FINANCIALS	FY10	FY11	FY12E	FY13E
SALES (Rs. Crs)	629.40	860.00	1,820.00	2,460.00
NET PROFIT (Rs. Crs)	-48.20	40.00	50.00	80.00
EPS (Rs.)	0.00	0.60	0.80	1.20
PE (x)	0.00	127.90	95.50	62.70
P/BV (x)	3.20	2.90	2.60	2.30
EV/EBITDA (x)	00.00	43.70	18.20	12.80
ROE (%)	00.00	2.30	2.90	3.90
ROCE (%)	0.00	4.90	7.70	9.10

I would buy PIPAVAV DEFENCE & OFFSHORE ENGINEERING LTD with a price target of Rs. 100 for Medium to Long term. As I always say, I am a long term believer in markets & I do respect the markets and will keep a strict stop loss of 8 % or Rs. 74.50 on every purchase.

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