Azad Engineering is a key manufacturer of qualified product lines supplying to global original equipment manufacturers (OEMs) in the energy, aerospace and defence, and oil and gas industries. The products the company manufactures are highly engineered, complex, mission and life critical high precision forged and machined components.

Products of the company include 3D rotating airfoil and blade portions of turbine engines and other critical components for gas, nuclear and thermal turbines used in industrial applications or energy generation; and defence and civil aircrafts and spaceships.

In the energy industry, the companysupplies precision, forged and machined components for energy turbines (which are used in industries and power plants with different fuel types such as gas, nuclear and coal).It produces high-precision rotating and stationary 3D airfoils and blades, special machined parts, and combustion component assemblies for land-based turbines with applications in industrial and energy plants using different fuel types such as nuclear, hydrogen, natural gas and thermal.

The company’s aerospace and defence products include airfoils and blades and components for engines, auxiliary power units (APUs), hydraulics, actuating systems, flight controls, fuel, and inerting sections of commercial and defence aircrafts and spacecrafts, among other defence systems and various critical components for missiles. It has supplied critical components to major commercial aircraft manufacturers such as B737, B737 Max, B747, B777, B777X, A320, A350, A355, A350 XWB, and Gulfstream G550 and is currently in discussions for supply of components for new engine platforms to various kinds of aircraft manufacturers.

For the oil and gas industry, the company manufactures components of drilling rigs such as drill bits and other critical components that are used in drilling equipment and are part of exploration and production phase.

Airfoils and bladesare the major revenue generator for the company currently. These are the most critical 3D rotating and stationary parts of a turbine in the compression section. To sustain the high pressure, airfoils and blades are made up of super alloys and manufactured with a unique process designed by the company.

In FY2023 and H1FY2024, of the total revenue, the energy industry contributed 87.03% [airfoils and blades 78.68% andnon-airfoils 8.35%] and 88.75% [airfoils and blades 72% and non-airfoils 16.75%], respectively. The aerospace and defence contributed 8.95% [airgeneration systems 1.37%,hydraulics 2.99%, and balance others] and 8.62% [airgeneration systems 3.22%,hydraulics 2.21%, and balance others], respectively.

Customers of the company include global OEMs across the energy, aerospace and defence, and oil and gas industries such as General Electric, Honeywell International, Mitsubishi Heavy Industries, Siemens Energy, Eaton Aerospace, and MAN Energy Solutions SE. The company receives purchase orders pursuant to RFQs and RFPs; LTAs and LTCs (of 3-10 years); and tenders.

Most of its revenues are derived from exports to global OEMs, backed by long-term contracts. In H1FY2024 and FY2023, of the total revenue about 89.69% and 80.38% was from contracts with customers located outside India. Since its inception, the company has been supplying components to the USA, China, Europe, Middle East, and Japan. Thus, it is a key link in the global supply chain for OEMs.

The company has four advanced manufacturing facilities in Hyderabad, Telangana, India, capable of producing high precision forged and machined components, with a total manufacturing area of 20,000 square metres. Further, the company has two manufacturing facilities in the pipeline at TunikiBollaram village in Siddipet district, Telangana, and Mangampet village, Sangareddy district, Telangana, with a total manufacturing area of 94,898.78 square metres and 74,866.84 square metres, respectively. The construction and development of these proposed manufacturing facilities are intended to be funded from internal accruals. The upcoming manufacturing facility at Tuniki Bollaram village in Siddipet district, Telangana, is proposed to have dedicated and exclusive manufacturing setups for its customers. The company plans to initially introduce this exclusive manufacturing setup for production of critical and complex components such as airfoils and blades and other special machined parts for gas and thermal turbines for Mitsubishi Heavy Industries, one of its long-standing customers.

The company manufactures complex and highly engineered precision forged and machined components that are mission and lifecritical. Hence, some of its products have a zero parts per million defects requirement.

As of September 30, 2023, the company had approximately 45 qualified manufacturing processes and 1,400 qualified parts and components.

The demand for such precision, forged and machined components is driven by requirements relating to energy turbines (industrial, gas, nuclear and coal), and aircraft (commercial and military) among others.

The Issue

The offer comprises of Fresh Issue of equity shares aggregating to Rs 240 crore and Offer for Sale (OFS) of equity shares aggregating to Rs 500 crore. The OFS component of the issue comprises sale of equity shares worth Rs 204.965 crore by Rakesh Chopdar (Promoter), Rs 260.851 crore worth of shares by Piramal Structured Credit Opportunities Fund (investor selling shareholder) and Rs 34.184 crore worth of shares by DMI Finance (the other selling shareholder). Post-issue, both ISS and OSS will have nil or negligible % of stake in the company at the upper band of the offer price.

Objects of the Issue

Of the net proceeds from the fresh issue, the company intends to use Rs 60.395 crore towards funding capital expenditure; Rs 138.188 crore towards repayment and prepaymentin part or full of certain borrowings; and balance towards general corporate purposes.

As on September 30, 2023, the aggregate outstanding borrowings (except for the PSCOF CCDs) were Rs 154.228 crore (including bank guarantee amounting to Rs 0.592 crore).

Strength

A diversified product range across energy, aerospace and defence, and oil and gas industries.

Qualified and established supplier of highly complex forged and machined products and life critical components to global OEMs operating in highly regulated industries such as energy, aerospace and defence. The company has proven manufacturing capability, having delivered 3.09 million units between Fiscal 2009 to Fiscal 2023 at an overall level.

Airfoils and blades and other products are designed to operate at extreme conditions and require a multi-level safety protocol as such engine products are life critical. Considering that the costs are very high in the energy and aerospace and defence industries, given the stringent quality checks and certifications that are required to qualify as a supplier, there are significant entry barriers, which makes finding a manufacturing partner a lengthy process of many years for OEMs.

Supplies to OEMs with high global market penetration. Moreover, supplies components to five of the key manufacturers in the turbine manufacturing industry. Its customers together control approximately 70% of the gas turbine market globally. Similarly, supplies components to six of the key manufacturers in the aerospace and defence industries and to one of the global manufacturers in the drilling equipment manufacturing industry.

Enjoys long-term relationships with high customer stickiness and a high percentage of repeat business.

Advanced manufacturing facilities, with a diverse range of products and solutions. The focus is on innovation and cost competitiveness.

Weakness

The Top 5 and 10 customers accounted for 63.11% and 79.76% and 60.84% and 79.71% of the revenue of the company for FY2023 and H1FY2024, respectively, reflecting significant client concentration. Thus, loss of business from any client will have an adverse impact on the business of the company.

The markets in which its customers operate are characterized by rapidly changing technology, evolving industry standards and demands for features, and continual product innovation. So, any disruptions in the industry can adversely impact the business of the company.

Statutory auditors of the company have indicated certain matters in their report on the audited financial statements of thecompany for FYs 2023, 2022 and 2021 in accordance with the Companies (Auditor’s Report) Order, 2003.

For the two newpipeline projects, a request for five acres of land at Mangampet Village is yet to be allotted by TSIIC. There is no reply for project extension of two years, without levying any penalties, from the date of allotment of additional land from TSIIC. While the company has placed some purchase orders and has incurred infrastructure expenses on theTunikiBollaram plant (one of two new projects), it is still in the process of placing firm orders for capex to be incurred at the Mangampet plant.

The energy industry projects capex, especially thermal capacity, is cyclical in nature and faces strong challenge with increased investment in renewable such as solar and wind, globally.

Fluctuation in annual operating margin.

Valuation

Consolidated revenue for the fiscal ended March 2023 was up 29% to Rs 251.68 crore. But with 330 bps contraction in operating profit margin to 28.7%, operating profit was up 16% to Rs 72.28 crore. However, net profit was down by 71% to Rs 8.47 crore, hit largely by higher interest and depreciation.

For the half year ended Sep 2023, consolidated revenue was Rs 158.75 crore. With OPM standing at 33.1%, OP was Rs 52.53 crore. Finally, net profit was Rs 26.89 crore.

Consolidated EPS for FY2023 at the upper price band stood at Rs 1.4 and that works out to a PE of 366 times. PE on annualized H1FY2024 EPS of 9.1 worksout to 57.6 times.

In comparison, Triveni Turbines quotes at a PE of 74.4 times of its FY2023 EPS. MTAR Technologies, Paras Defence, Dynamatic Technologies and DCX Systems quote at a PE of 68.8 times, 80.8 times, 70.5 times and 48.4 times, respectively.