The good news in Garden Reach Shipbuilders IPO under-subscription
Taking refuge in the company’s strong order book and prospects, the government sought to force through Garden Reach’s share sale process. But with the bitter experience of HAL still fresh, investors ignored the defence shipbuilder
State-run Garden Reach Shipbuilders and Engineers Ltd has extended its initial public offering (IPO) to 1 October, as the issue was under-subscribed. It was due to close on 26 September. The news of weak demand for the IPO came on a day when shares of another state-run defence firm, Bharat Electronics Ltd (BEL) rallied 10%. BEL shares gained as its management allayed investor concerns on the impact of new pricing policy which caps margins of orders received on a nomination basis. The BEL stock lost about 2% on Thursday.
Such contracts are those which are awarded by the government to state-owned companies through a cost-plus framework. The government spells out the product and service requirements, and the companies are asked to come up with price quotations.
The two contradictory events highlight investor discrimination among state-owned defence companies, which is a good sign. Given the recent meltdown in the broader markets and increased risk aversion, investors are cautious. Yet, taking refuge in the company’s strong order book and prospects, the government sought to force through Garden Reach’s share sale process. But with the bitter experience of Hindustan Aeronautics Ltd still fresh—it lost a fourth of its value from its March listing—investors ignored the defence shipbuilder.
To be sure, Cochin Shipyard Ltd—which is also into shipbuilding—listed at a premium, though it lost steam in the recent correction. But the company has a sizeable ship-repair business that is not only cushioning it from the lumpy nature of shipbuilding but is also providing earnings growth. Garden Reach, on the other hand, derives an overwhelming majority of its revenue from shipbuilding, contributing 94% of revenue in FY18 compared with 73.5% at Cochin Shipyard.
This high dependence on shipbuilding has not only led to volatile financial performance at Garden Reach in the past but is also clouding the earnings outlook. “Timelines in defence shipbuilding range from 23 to 66 months. Accordingly, revenue and profit recognition is very lumpy in nature. The same is also highlighted in the performance of the company in the past 10 years,” ICICI Securities Ltd said in a note on Garden Reach.
Despite its chequered financial performance, the initial share sale of Garden Reach was priced at a premium compared with Cochin Shipyard. “At the higher price band of ₹118, the offer is valued at 15.6x P/E on FY18 basis (post dilution) as compared to its closely listed peer Cochin Shipyard which trades at 13.4x,” Centrum Broking Ltd said in a review note on the IPO.
For some, the allure of state-run defence companies is the guaranteed flow of orders. But as experience in the recent past has shown, this notion is increasingly being tested.
Decisions on contracts continue to see delays. According to a Business Standard report, a decision on a sizeable order for which Garden Reach is favourably placed has been delayed. Also, the government’s decision to officially cap margins on orders awarded on nomination basis is ill-timed, especially when it is seeking to sell shares in companies such as Garden Reach.
While the timing of the government actions are not helpful, investors are rightly discriminating among defence stocks. Companies such as BEL, which are better placed to deal with policy changes, are being preferred while others are getting the cold shoulder.
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