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Public sector stocks are often recognised for their dividends but not necessarily for their wealth creation. However, in recent years, some of these companies have defied this trend, and Hindustan Aeronautics is a notable example.
Over the past five years, Hindustan Aeronautics (HAL) has witnessed an impressive annual share price growth of 34 per cent, in contrast to Sensex's 12 per cent growth. The bulk of this growth has occurred in the last year, thanks to consistent improvements in its fundamentals and favourable sectoral conditions. In this article, we delve into the factors behind HAL's remarkable growth.
What is HAL's core business?
HAL operates within the aerospace and defence (A&D) industry. Its activities encompass the design, development, manufacturing, repair, and upgrading of defence aircraft and helicopters for the Indian Defence Force. Additionally, HAL collaborates with ISRO on certain space programs. It is evident that the primary clientele of the company are the Indian defence services.
While HAL's revenue growth has been on the lower side, it has experienced explosive profit growth and strengthened its balance sheet. The key to this growth has been a focus on efficiency and profitability, rather than solely concentrating on the top line.
Changing fortunes
HAL's financials have improved significantly over last five years
| FY23 | FY22 | FY21 | FY20 | 3Y growth (% pa) | |
|---|---|---|---|---|---|
| Revenue (Rs cr) | 26927 | 24620 | 22882 | 21445 | 7.9 |
| Operating profit (Rs cr) | 4901 | 4305 | 4186 | 3916 | 7.8 |
| Operating profit margin (%) | 18.2 | 17.5 | 18.3 | 18.3 | |
| PAT (Rs cr) | 5828 | 5080 | 3246 | 2883 | 26.4 |
| ROE (%) | 27.2 | 29.3 | 22.6 | 22.7 |
A generous allocation to the defence sector
The defence sector has received a substantial portion of the government's union budget. In FY23, the government allocated Rs 5.9 lakh crore for the defence sector, a number that has steadily increased in recent years. Since FY19, the allocation for defence has grown at an annual rate of 8.3 per cent. Furthermore, there has been an increased emphasis on domestic manufacturing. These factors have provided HAL with a favourable environment for growth within this sector.
Enhanced efficiency
Until a few years ago, despite its leadership position, HAL struggled operationally. In 2019, it reported negative cash flow from operations for three consecutive years and a cash conversion cycle exceeding 400 days. Consequently, it had to rely on short-term borrowings to meet its working capital requirements, worsening its financial situation.
However, the management has since taken active steps to address these issues. They have not only improved inventory turnover but also adjusted their business model. As a result, the cash conversion cycle has improved, and the company has managed to reduce its debt burden. In FY23, HAL achieved its lowest cash conversion cycle in several years and is nearly debt-free.
A stark improvement in efficiency of HAL
| FY23 | FY22 | FY21 | FY20 | FY19 | |
|---|---|---|---|---|---|
| CFO (Rs cr) | 8830 | 10173 | 15117 | 1527 | -7700 |
| Total debt (Rs cr) | 49 | 47 | 51 | 5927 | 4157 |
| Inventories (Rs cr) | 12149 | 14347 | 16373 | 19346 | 19664 |
| Trade recievables (Rs cr) | 4719 | 4642 | 5668 | 11235 | 12458 |
| Cash conversion cycle (days) | 140 | 219 | 319 | 404 | 442 |
Heightened profitability
As mentioned earlier, a strategic adjustment to its business model has not only resolved liquidity issues but has also bolstered profitability. HAL shifted its focus towards the service side of the business, evident in reduced production volumes. The number of new aircraft produced dropped from 41 in FY19 to 22, while new engines decreased from 102 to 51. Consequently, revenue growth has been somewhat subdued.
To compensate, this focus on the service side has enabled HAL to enhance its margins, resulting in improved profitability. Operating margins expanded, and net margins doubled since FY18.
Future prospects
Management expresses confidence that the recent growth trend will continue in the future. HAL has embarked on several new projects, including entry into the civil aircraft segment and the establishment of a manufacturing plant for ISRO rocket engines. To achieve these goals, the company has planned capital expenditure for capacity expansion, including the ongoing helicopter project in Tumakuru.
However, it is crucial to bear in mind that HAL remains a public sector undertaking (PSU), and investors are advised to exercise caution. The company's reliance on the government for revenue continues to be a noteworthy consideration. Although the cash conversion cycle has improved, 140 days still represents a relatively extended duration. Therefore, we recommend that investors conduct thorough due diligence and take these factors into account when considering investments in HAL.
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