Paras Defence & Space Technologies IPO: Information analysis

Based in Mumbai, Paras Defence and Space Technologies designs, develops, manufactures and tests products related to defence and space engineering. Incorporated in 2009, it has emerged as a major player in all product segments, including defence electronics, defence optics, EMP (electromagnetic pulse) hardening and heavy engineering. Unlike its competitors, it is involved in manufacturing products in all product segments. It is the sole manufacturer of critical-imaging systems in India. Besides, it is the only player involved in EMP protection on a turnkey basis. Under this, it builds machines and sells them as a whole rather than in parts.

The company's product portfolio comprises defence and space optics (infrared lenses, large-size optics and optical domes), defence electronics (rugged control system and rugged displays for defence applications), EMP solutions (EMP racks, EMP cabinets, shielded doors and onsite installation) and heavy engineering (flow-formed tubes, titanium structures and heavy dynamic structures with built-in optimisation). The company generates around 80 per cent of its revenues from defence-related products and 20 per cent from space-related products. However, since the company has a wide range of products, the contribution of these products to the total revenue keeps changing. Its optics segment generated 45.3 per cent of revenue, heavy engineering generated 26.4 per cent and defence electronics and EMP solutions combinedly generated 28.3 per cent of the total revenue in FY21. Exports accounted for around 15 per cent of the revenue and it is expected to grow in the future.

India has been witnessing geopolitical tensions across its borders with China, Pakistan and Afghanistan. This has resulted in the government initiating the modernisation of defence equipment faster than ever before. Also, in line with the Atmanirbhar Bharat programme, the government is reducing its dependence on imported defence materials and has already allocated $9.48 billion for domestic procurement, which will help the company in the future.

Strengths
1) It is one of the leading IDDM (indigenously designed, developed and manufactured) companies. IDDM companies take care of everything in-house, right from designing products to delivering products to customers without any outsourcing.
2) The company has a unique nanotechnology machining centre in Navi Mumbai, which makes it a leading provider of optics. Also, it is the only Indian company to have design capability for space-optics and opto mechanical assemblies.
3) It is the only company to provide all four major products, comprising defence electronics, defence optics, EMP hardening and heavy-engineering capabilities in the industry.
4) The company already had an order book for Rs 305 crore for various products as on June 30, 2021.
5) Given growing geopolitical tensions, the Atmanirbhar Bharat move in the defence sector and the increasing interest in space exploration, the company's future potential seems bright.

Weaknesses
1) The company majorly depends on government contracts. If there is any change in priority or reduction in the allocation for defence and space, the company's business may face the brunt. Any delay or inconsistency in payments from the government may harm its cash flow.
2) It mostly undertakes only fixed-price contracts where the amount to be paid is decided beforehand. So, if there is an increase in the material or labour costs, the company cannot recover the costs from its clients.
3) Around 60 per cent of the company's revenue comes from the top five customers. If any adverse situation arises that affects its top five customers, it will put a dent in the revenue.
4) Being involved in the defence and space sector, the company has to adhere to strict quality regulations and various other regulations. If clients find the company's products unsatisfactory, not only current contracts but even future contracts will be cancelled.
5) The company requires huge working capital. In 2021, its working-capital requirement was around 112 per cent of its total revenues.

IPO questions

The company/business

1) Are the company's earnings before tax more than Rs 50 crore in the last 12 months?
No, the company's earnings before tax for FY21 was Rs 22.6 crore.

2) Will the company be able to scale up its business?
Yes, the company is a leader in defence optics and also the only company to deliver products in all the major segments. It has also planned to enter the commercial space in the future. Given its capital-expenditure plans, it can scale up its business.

3) Does the company have recognisable brand/s, truly valued by its customers?
Yes. When it comes to defence contracts, the company is a preferred partner, owing to its quality and variety of product offerings.

4) Does the company have high repeat customer usage?
Yes, the company has been offering its services to the public-sector undertakings, including Bharat Electronics, Hindustan Aeronautics and private-sector companies, including TCS and Solar Industries India, for years.

5) Does the company have a credible moat?
Yes, the company is a leader in defence optics and the only entity having design capabilities for space optics. It also offers a wide range of defence-related products in all the major segments, unlike its competitors.

6) Is the company sufficiently robust to major regulatory or geopolitical risks?
Yes, the company does not have major exposure to the international market and it has also adhered to all the regulatory requirements so far.

7) Is the business of the company immune from easy replication by new players?
Yes, the company is immune to new entrants. It exists in an industry that is highly regulated and requires brand recognition from customers.

8) Is the company's product able to withstand being easily substituted or outdated?
Yes, the company's products are predominantly being used in the defence and space-exploration sectors. The use and demand for its products will only increase, owing to the increasing interest in space exploration and modernisation in the defence sector.

9) Are the customers of the company devoid of significant bargaining power?
No, one of its major customers is the Government of India and government contracts can be won only through tenders. The company that quotes the least amount of money for production wins the contract. Besides, its customers' ability to cancel the contract if any criterion is not met gives them a huge advantage over the company.

10) Are the suppliers of the company devoid of significant bargaining power?
Yes, the company gets its materials from various domestic and foreign suppliers. Owing to this diversification, suppliers do not have any bargaining power.

11) Is the level of competition the company faces relatively low?
Yes, this industry has a relatively low number of competitors and the company is a leader among them.

Management

12) Do any of the company's founders still hold at least a 5 per cent stake in the company? Or do promoters totally hold more than a 25 per cent stake in the company?
Yes, its Chairman Mr Sharad Virji Shah will hold a stake of 22 per cent in the company post issue and the promoter group will hold a stake of 59.7 per cent post issue.

13) Do the top three managers have more than 15 years of combined leadership at the company?
Yes, its Chairman Mr Sharad Virji Shah and Managing Director Mr Munjal Sharad Shah have been with the company since its inception and also have more than two decades of experience.

14) Is the management trustworthy? Is it transparent in its disclosures, which are consistent with SEBI guidelines?
Yes, we have no reason to believe otherwise.

15) Is the company free of litigation in court or with the regulator that casts doubts on the intention of the management?
No, the company has 12 cases regarding tax claims against it but it does not cast any doubt on the management's intention.

16) Is the company's accounting policy stable?
Yes, we have no reason to believe otherwise.

17) Is the company free of promoter pledging of its shares?
Yes, the promoter's shares are free of pledging.

Financials

18) Did the company generate a current and three-year average return on equity of more than 15 per cent and a return on capital of more than 18 per cent?
No, the company generated a return on equity of 9.12 per cent for FY21 and 13.07 per cent on a three-year average. It generated a return on capital employed of 12.11 per cent for FY21 and 13.57 on a three-year average.

19) Was the company's operating cash flow positive during the three years?
No, the company posted a positive operating cash flow for FY21 but a negative operating cash flow for FY20 and FY19.

20) Did the company increase its revenue by 10 per cent CAGR in the last three years?
No, the company's three-year revenue CAGR has been -3.7 per cent.

21) Is the company's net debt-to-equity ratio less than one or is its interest coverage ratio more than two?
Yes, the company's net debt-to-equity ratio stood at 0.62 and the interest-coverage ratio stood at 2.82 as of FY21.

22) Is the company free from reliance on huge working capital for day-to-day affairs?
No, the company relies on heavy working capital and it plans to use a part of its IPO proceeds to fund its working-capital requirements. In FY21, the company's working-capital requirement was 112.8 per cent of the total revenues.

23) Can the company run its business without relying on external funding in the next three years?
Yes, as the company plans to use the proceeds of the issue for capital expenditure and working-capital requirements, it won't need any external funding in the next three years.

24) Have the company's short-term borrowings remained stable or declined (not increased by greater than 15 per cent)?
No, the company's short-term borrowings increased by 13.02 per cent in FY21 when compared to FY20 and increased by 79.39 per cent when compared to FY19.

25) Is the company free from meaningful contingent liabilities?
No, the company had a contingent liability of Rs 27.7 crore as of FY21, which was more than 13 per cent of its equity.

Stock/valuations

26) Does the stock offer an operating-earnings yield of more than 8 per cent on its enterprise value?
No, it will offer an operating-earnings yield of just 2.2 per cent over its enterprise value.

27) Is the stock's price-to-earnings less than its peers' median level?
No, the company's stock would trade at a P/E of 43.2, higher than its peer's median level of 19.4.

28) Is the stock's price-to-book value less than its peers' median level?
No, the stock would trade at a P/B of 3.92, higher than its peer's median level of 3.8.

Disclaimer: The authors may be an applicant in this Initial Public Offering.