IPO: Azad Engineering

Azad Engineering, a precision forged and machined components manufacturer, is launching its IPO (initial public offering) on December 20, 2023. Below is a breakdown of the company's strengths, weaknesses and growth prospects to help investors make an informed decision.

In a nutshell

• Quality: The company's three-year average ROE and ROCE are 14.1 and 17 per cent, respectively.
  
• Growth: Its revenue grew by 43.2 per cent annually, while profit after tax (PAT) fell by 14.2 per cent between FY21 and FY23.
  
• Valuation: The stock is valued at a P/E and P/B of 365.6 and 6.6 times, respectively, compared to its peers' median and average of 62.2 and 9.5 times.
  
• Overview: The growth of the energy and defence industries should help the company scale up. In addition, the 'Make in India' initiative should provide new expansion opportunities. However, the highly competitive nature of the industry poses a threat. Also, its business is cyclical and sensitive to macro factors.

About Azad Engineering

The company manufactures complex and highly engineered precision forged and machined instruments and supplies these components to OEMs (original equipment manufacturers). Some of its key products include 3D rotating airfoil/blade portions of turbine engines, critical components for gas, nuclear and thermal turbines used in industrial applications, energy generation, defence, civil aircraft and spaceships. Over 72 per cent of the company's revenue comes from selling airfoils/blades to the energy sector.

At present, Azad Engineering has three revenue verticals:

• Energy (87 per cent of FY23 revenue)
  
• Aerospace and defence (9 per cent)
  
• Scap and others (4 per cent)

Strengths of Azad Engineering

• Long-standing client relationships: The top five customers have been associated with the company for over 10 years. Some of its reputed clients include General Electric, Honeywell International, Mitsubishi Heavy Industries, Siemens Energy, Eaton Aerospace and MAN Energy Solutions.
  
• High entry barriers: It caters to industries with significant entry barriers due to stringent quality requirements.

Weaknesses of Azad Engineering

• Client concentration: The top five customers accounted for 63.1 per cent of FY23 revenue; the largest customer contributed 32.9 per cent.
  
• Lack of bargaining power: It sources most of its raw materials from limited suppliers. It secured 42.6 per cent of its raw materials from a single supplier in the six months ending September 30, 2023.
  
• Highly competitive business: The company faces high competition from manufacturers both in India and globally.
  
• High finance cost: Its finance cost totalled Rs 52 crore (17.4 per cent of total debt) in FY23, up 284.7 per cent from Rs 14 crore (6.9 per cent of total debt) in FY22.

Risk report

Company and business

• Are Azad Engineering's earnings before tax more than Rs 50 crore in the last 12 months?
  No. Its earnings before tax for FY23 was Rs 13 crore.
• Will Azad Engineering be able to scale up its business?
  Growth in India's defence and energy sector and the government's 'Make in India' initiative are expected to help the company scale up its operations.
• Does Azad Engineering have recognisable brands with client stickiness?
  Yes. It is difficult for its client to switch to other suppliers, ensuring client stickiness.
• Does the company have a credible moat?
  No. It faces significant competition from both Indian and international players in China, Europe, the US and Japan.

Management

• Do any of the company's founders still hold at least a 5 per cent stake? Or do promoters have over a 25 per cent stake in the company?
  Yes. Post IPO, the promoters' stake will increase to 65.9 per cent.
• Do the top three managers have over 15 years of combined leadership at Happy Forgings?
  Yes. Rakesh Chopdar, Chairman and CEO, has been with the company since 2003.
• Is the management trustworthy? Is it transparent in its disclosures, which are consistent with SEBI guidelines?
  Yes. There is no information to suggest otherwise.
• Is the company's accounting policy stable?
  Yes. There is no information to suggest otherwise.
• Is Azad Engineering free of promoter pledging of its shares?
  Yes, the company is free of promoters pledging its shares.

Financials

• Did the company generate a current and three-year average return on equity (ROE) of more than 15 per cent and a return on capital employed (ROCE) of more than 18 per cent?
  No. Its three-year average ROE and ROCE are 14.1 and 17 per cent, respectively. Its ROE and ROCE were 4.2 and 14.9 per cent, respectively, in FY23.
• Was the company's operating cash flow positive during the last three years?
  No. It generated negative cash flows from operations in FY23.
• Is the company's net debt-to-equity ratio less than one?
  No. Its net debt-to-equity ratio stood at 1.4 times as of September 2023.
• Is Azad Engineering free from reliance on significant working capital for day-to-day affairs?
  No. The business has high working capital requirements. Its cash conversion cycle stood at 204.2 days as of September 30, 2023.
• Can the company operate its business without relying on external funding in the next three years?
  No. The company's cash flows have not been consistent in the past. Besides, it has high debt levels and is highly capital-intensive.
• Is Azad Engineering free from meaningful contingent liabilities?
  No. As of September 30, 2023, contingent liabilities as a percentage of equity stood at around 37.2 per cent.

Valuations

• Does the stock offer an operating earnings yield of more than 8 per cent on its enterprise value?
  No. The stock offers an earning yield of 1.9 per cent.
• Is the stock's price-to-earnings less than its peers' median level?
  No. It is valued at a price-to-earnings ratio of 365.6 times compared to peers' median level of 62.2 times.
• Is the stock's price-to-book value less than its peers' average level?
  Yes. It is valued at a price-to-book ratio of 6.6 times compared to the peers' average of 9.5 times.

Disclaimer: This is not a stock recommendation. Do your due diligence before investing.

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