DCX Systems is one of leading Indian manufacture of electronic sub-systems and cable harnesses in defence and aerospace sector.Operations of the company are classified as 1) system integration; 2) cable and wire harness assemblies; and 3) kitting.  In FY2022, about 85.3% of the revenue came from system integration, 2.7% from cable and wire harness assemblies and 12% from kitting.

In addition, the company also undertakes certain job work services including assembly and testing of materials that have been supplied directly by its customers.System integration is in areas of radar systems, sensors, electronic warfare, missiles, and communication systems. Its strength in system integration includes manufacturing of complex microwave modules and sub-systems such as transmit receiver modules, receiver subsystems, and antennas used in military applications, space technology and aerospace.

The company manufactures a comprehensive array of cables and wire harnesses assemblies such as radio frequency cables, co-axial, mixed signal, power, and data cables for a variety of uses including communication systems, sensors, surveillance systems, missile systems, military armored vehicles, and other electronic warfare systems for the aerospace and defence industries as per its customers’ requirements.

Kitting comprises supply and assembly ready kits of electronic and electro-mechanical parts. It undertakes all aspects of procurement including sourcing components from suppliers approved by its customer along with a ‘Certificate of Compliance’ for traceability, controlled storage of moisture sensitive devices to ensure that customers receive complete assembly-ready kits when required when they are needed for production.

Since commencing operations in 2011, the company has become a preferred Indian offset partner for foreign original equipment manufacturers (OEMs) for executing aerospace and defence manufacturing projects. 

Its manufacturing facility is located at the Hi-Tech Defence and Aerospace Park SEZ in Bengaluru, Karnataka. The facility, spread over an area of 30,000 square feet, is geared for complete in-house environmental and electrical testing and wire processing. The location of its facility is in the same city as some of its key domestic customers including Bharat Electronics, Alpha Design Technologies Private Limited, Alpha Elsec Defence and Aerospace Systems Private Limited, and Centum Adeno India Private Limited, ensuring shorter delivery time.

As of June 30, 2022, it had 26 customers in Israel, United States, Korea, and India. These included certain Fortune 500 companies, multinational corporations, and start-ups. Its customers include domestic and international OEMs, and private companies and public sector undertakings in India across different sectors, ranging from defence and aerospace to space ventures and railways. It has a mix of domestic and international customers. Certain key customers areEltaSystems,  Israel Aerospace Industries’ System Missiles and Space Division, Bharat Electronics, Astra Rafael Comsys Private Limited, Alpha-Elsec Defense and Aerospace Systems Private Limited, Alpha Design Technologies Private Limited, Astra Microwave Products Limited, Kalyani Rafael Advanced Systems Private Limited, SFO Technologies Private Limited, and DCX-Chol Enterprises Inc.

It holdsmany key certifications including AS-9100:2016 certification for quality management systems for aviation, space and defense products manufacturing, and defenceindustrial license from the Ministry of Commerce and Industry, Government of India, for the manufacture of defence subsystems including microwave components, modules for radar and electronic warfare subsystems, microwave submodules, for command and guidance units for missile subsystems only. It also adheres to global standards and have obtained various global certifications.

These certifications ensure that its processes comply with customer specific, industry specific, statutory health and safety, as well as environmental and social and governance requirements. Certain of these standards also require it to undergo audits. Its global certifications help to serve its customers’ stringent quality specifications and assists in new customer acquisition.

The issue

The issue comprises both fresh issue of equity shares by the company and offer for sale by promoter selling shareholders. Fresh issue involves issue of equity shares aggregating upto Rs 400 crore. Offer for sale involves selling of equity shares aggregating upto Rs 100 crore [Rs 50 crore each by NCBG Holdings INC and VNG Technology, the two promoter selling shareholders]. 

On post issue expanded equity, the holding of promoter selling shareholders will decline to 32.96% from about 44.32% in pre issue equity capital.

Object of the Issue

Of the net proceeds from the fresh issue, about Rs 110 crore will be use for repayment of debt, Rs 160 crore for funding working capital requirements of the company, and Rs 44.883 crore for investment in Raneal Advanced Systems (RASPL), the wholly owned subsidiary of the company to fund its capital expenditure.  RASPL will be setting up a manufacturing facility for EMS, which will have facilities for design, development, manufacturing, qualification and life cycle support of high reliability electronic and electro–mechanical systems used in aerospace and defence, medical electronics and industrial electronics application.

Strength

The order book end June 2022 was strong at Rs 2563.634 crore [of which 94.8% were system integration orders, 0.53% cable & wire harness, and 4.68% kitting]to beexecuted in FY 2023 to FY 2025.

About 87% of the FY2022 consolidated revenue came from offset and 13% from non-offset. Similarly, exports accounted for 55.73% of FY2022 consolidated revenue and 44.27% from domestic. Major exports of the company are to Israel and significantly to North America as well as Korea. 

The company is a preferred IOP for foreign OEMs for executing defence manufacturing projects. It undertakes build-to-print system integration and manufactures cable and wire harness assemblies for both domestic and international OEMs. It is also one of the largest IOP for the Israel-based IAI Group [ELTA Systems and Israel Aerospace Industries’ System Missiles and Space Division], Israel, for the Indian defence market to manufacture of electronic sub-systems, and for cable and wire harness assemblies.

Operating in a growing Indian landscape for defence and aerospace services. The Indian aerospace and defence sectorsare poised to attain a value of US$ 70 billion by CY2030. Recent initiatives like increase in foreign direct investment (FDI) in the Indian defence sector from the current 49% to 74% under the automatic route is anticipated to be a key driver and growth opportunity for the market.

The Defence Research and Development Organization has announced the indigenous development of roughly 108 systems and sub-systems which is expected to generate demand for cables and connectors across the Indian defence environment. The Indian government has also banned approximately 101 items within the defence-based imports segment and introduced the third positive indigenization list that bans the import of 780 LRU/components.

These initiatives are expected to boost indigenous manufacturing within India. The instating of defence industry corridors across Uttar Pradesh and Tamil Nadu is also poised to improve the market growth dynamics by broadening the opportunities offered to the private sector.   All of these, in turn, serve as an opportunity for the company to capitalize on the expected growth in this space.

The manufacturing facility is in a Special economic zone (SEZ), thus, giving several fiscal incentives and other benefits for special economic zone developers and their customers, including exemptions from income tax and duties.

Weakness

 Dependent on certain select customers for majority of its revenue, with top customer accounting for 55.62% of FY2022 consolidated revenue,the top 3 customers accounting for 80.55% of the revenue, and the top 10 customers accounting for 99.71% of revenue.  So, any reduction/loss of business or profitability from its top customers will impact the financial performance of the company.

Any changes in the offset defence policy or a decline or re-prioritization of funding in the Indian defence budget or delays in the budget process could adversely affect the growth of the company. 

Significant shortages of or delay or disruption in the supply of raw materials especially the primary RMs such as electronic assemblies, PCB assemblies, integrated circuits, and connectors could affect the performance of the company. 

Does not own the brand name DCX and does not pay any royalty or other fees to DCX Chol (one of the group companies owning the brand) for the use of the DCX trademark.

Had negative cash flows from operating activities in FY2022.

DCX Chol, one of the group companies, was proposed to be debarred (NPD) for product quality deficiency and defaults in delivery of products by the Defence Logistics Agency of USA on June 17, 2021.

Valuation

Consolidated sales for FY2022 stood at Rs 1102.27 crore. With OPM standing at 6.1%, operating profit was Rs 66.99 crore and net profit was Rs 65.61 crore. 

 For the quarter ended June 2022, consolidated net profit was Rs 5.57 crore on sales of Rs 213.25 crore.  As there are no consolidated figures for Q1FY2022, consolidated TTM numbers could not be calculated.   Similarly, for companies catering to the defence and space, revenue and profit will be backended, resulting in strong H2. Thus, annualization of Q1FY2023 numbers will not be appropriate.

The consolidated EPS for FY2022 on expanded post issue equity based at the upper price is Rs 6.8 and, thus, the PE works out to 30.4 times of its upper price band of offer price. 

In comparison, companies catering to the defence and space segments such as Data Patterns, Paras Defence, and Astra Microwave are quoting at TTM PE of 73.7, 93.1 and 70.7 times of their FY2022 EPS. Bharat Electronics, which is major player and aggregator/client for smaller defence players, was available at a PE of 32.8 times.

The price to book value for the company stood at 3.9 times compared to 12.1 times for Data Patterns, 6.2 times for BEL, 6.7 times for Paras Defence, and 4.5 times for Astra Microwave.