Sell Mazagon Dock Shipbuilders for Target price Rs 600: ICICI Securities

Margins improve, but order inflow is still a concern

Mazagon Dock Shipbuilders’ (MDL) Q4FY23 performance was 50% ahead of our estimates mainly on higher-than-expected revenue. Key points: 1) Revenue grew 49% YoY (14.5% QoQ) to Rs20.8bn mainly led by the commissioning of 5th submarine (under P75 programme); 2) EBITDA margin was 10.1% YoY (Q3FY23: 16.3%) owing to higher cost of material consumed; 3) orderbook at Mar’23 end was Rs385bn, likely to get executed by FY27. Going ahead, we perceive peak execution through to FY25E based on the current orderbook visibility. However, long gestation period implies free cashflow is likely to decline FY25E onwards with the unwinding of contract liability, resulting in cash depletion. Our TP on DCF-based valuation methodology remains unchanged at Rs600. Maintain SELL on the stock. Repeat orders of P-17A frigates or P15B destroyers are a key risk to our thesis.

 Performance exceeds estimates. MDL’s Q4FY23 EBITDA of Rs2.1bn (up 172% YoY) exceeded consensus estimates by a wide margin of 50% mainly led by the commissioning of 5 th Scorpene class submarine – Vagir on, 23 Jan’23. Key points: 1) Gross margin fell to 29.3% mainly due to higher cost of materials consumed as 6 th submarine and two remaining destroyers enter the equipment fitting phase; 2) manpower cost also declined to 10.1% of revenue (Q3FY23: 10.9%) owing to cost efficiencies; and 3) EBITDA margin was 10.1% (Q3FY23: 16.3%) tracking lower gross margin. During Q4FY23 earnings call, management indicated EBITDA in FY23 was aided by refund of Rs1.74bn (22% of reported FY23 EBITDA) of liquidated damages (LD) by the Indian Navy pertaining to second submarine delivered earlier. Going ahead, management expects the current orderbook to exhaust by FY27 with peak revenue recognition in FY25. For FY24, management expects revenue growth of 10-12% YoY and EBITDA margin to remain at similar level as FY23 – sans the impact of LD refund.

 Lack of orderbook visibility is a key risk. While we expect robust revenue growth until FY25, we believe earnings growth is likely to recede owing to an uncertain order pipeline. In Q4FY23 earnings call, management mentioned bids for P-75I programme are likely to be submitted by 01 Aug’23 with evaluation of bids taking another 18 months. For FY24, management indicated possible order inflow of Rs42bn along with Medium Refit and Life Certification (MRLC) of a submarine spread over 3-4 years. Besides, there is no clarity on the timeline of repeat orders for destroyers.

 Outlook: Unfavourable risk-reward. MDSL’s lack of order visibility offsets its near-term robust revenue estimate. As a result, we perceive unfavourable risk-reward at CMP. We maintain SELL on MDSL stock with an unchanged TP of Rs600 (based on DCF methodology).