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Review By Dilip Davda on December 16, 2023

•    AEL is a niche player in life critical components and is most preferred partner.
•    The company posted steady growth in its top line for the reported periods. 
•    Declined bottom line for FY23 attributed to one-time adjustments and amortization.
•    Based on FY24 annualized earnings, the issue appears fully priced. 
•    Investors may park funds for the medium to long term rewards.

ABOUT COMPANY:
Azad Engineering Ltd. (AEL) is one of the key manufacturers of qualified product supplying to global original equipment manufacturers ("OEMs") in the energy, aerospace and defence, and oil and gas industries, manufacturing highly engineered, complex and mission and life-critical components (Source: EY Report). It manufactures complex and highly engineered precision forged and machined components that are mission and life-critical and hence, some of its products have a "zero parts per million" defects requirement (Source: EY Report). 

The company competes with manufacturers from China, Europe, USA and Japan (Source: EY Report). Its customers include global OEMs across the energy, aerospace and defence, and oil and gas industries such as General Electric, Honeywell International Inc., Mitsubishi Heavy Industries, Ltd., Siemens Energy, Eaton Aerospace and MAN Energy Solutions SE.

AEL's components have been supplied to countries such as USA, China, Europe, Middle East, and Japan since inception (Source: EY Report). Accordingly, it is a key link in the global supply chain for OEMs (Source: EY Report). AEL is one of the fastest growing manufacturers (in terms of revenue growth for the period between Financial Years 2020 - 2023) with one of the highest EBITDA margins among the key players for machined components for the key industries serviced by it (Source: EY Report). Its vision is to revolutionize the global precision manufacturing industry and disrupt the industries in which it operates in with cutting-edge technology while contributing towards India's evolving manufacturing ecosystem.

Company's products include 3D rotating airfoil/ blade portions of turbine engines and other critical components for (a) gas, nuclear and thermal turbines used in industrial applications or energy generation, and (b) defence and civil aircrafts and spaceships. The demand for such precision, forged and machined components is driven by requirements relating to energy turbines (industrial, gas, nuclear and coal), aircrafts (commercial and military), amongst others (Source: EY Report). Airfoils/ blades are one of the most critical 3D rotating and stationary parts of a turbine in the compression section. To sustain the high pressure, airfoils/ blades are made up of exotic/ super alloys and manufactured with a unique process designed by AEL.

In the energy industry, it produces high-precision rotating and stationary 3D airfoils/ 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. For the oil and gas industry, it 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.

It has in-house capabilities and proficiency in engineering, design, tooling, material development coupled with a range of finishing and assembly operations focused on continuous improvements to manufacturing and quality processes. AEL's process design capabilities and several years of experience of manufacturing life and mission critical portions of turbine engines enable it to develop high quality and cost-effective solutions for the demanding applications of global OEMs, which differentiates us from our global competitors. It is a technology-driven and innovative company with manufacturing facilities and high-quality products meeting global standards.

The qualification process imposed by OEMs is characterized by a significant entry barrier due to a lengthy and stringent qualification process. The vendors are required to go through separate qualification processes for each component that they supply. The qualification process for a new vendor is stringent and includes multiple steps (such as assessment and audit of technical capabilities of the vendor, vendor registration, evaluation and test of the product qualifications). This entire process is time intensive and often takes more than 15 months to qualify as a supplier during which the vendor is evaluated by the OEM. The vendors also need to institute quality and tracking procedures for all products that are supplied which demands a higher order quality control. (Source: EY Report).

The components manufactured by AEL are critical for the functioning of, inter alia, energy applications (nuclear, gas, oil and thermal) and worldwide air travel (military and civil). Considering that the company manufactures life-critical and mission-critical components, the margin for error is zero in its manufacturing process for some of components, which it adheres to by way of strong quality control systems. Airfoils/ 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 (Source: EY Report). AEL believes that it would ideally take 15-20 years for a new player in industry to reach the position the company currently occupy in the market. As of September 30, 2023, it had 1300 employees on its payroll and additional force of 248 contract workers.

ISSUE DETAILS/CAPITAL HISTORY:
The company is coming out with its maiden combo book building route IPO of Rs. 740 cr. (14122138 shares at the upper cap) consisting Rs. 240 cr. fresh equity shares (4580153 shares at the upper cap), and an Offer for Sale of Rs. 500 cr. (9541985 shares at the upper cap). It has announced a price band of Rs. 499 - Rs. 524 per share of Rs. 2 each. The issue opens for subscription on December 20, 2023, and will close on December 22, 2023. The minimum application to be made is of 28 shares and in multiples thereon, thereafter. Post allotment, shares will be listed on BSE and NSE. The issue constitutes 23.89% of the post-IPO paid-up capital of the company. From the net proceeds of the fresh equity issue, it will utilize Rs. 60.40 cr. for capital expenditure, Rs. 138.19 cr. for repayment/prepayment of certain borrowings, and the rest for general corporate purposes. 

The company has reserved shares worth Rs. 4.00 cr. for eligible employees and from the rest, it has allocated not more than 50% for QIBs, not less than 15% for HNIs and not less than 35% for Retail investors. 

The joint Book Running Lead Managers (BRLMs) for this issue are Axis Capital Ltd., ICICI Securities Ltd., SBI Capital Markets Ltd. and Anand Rathi Securities Ltd. while KFin Technologies Ltd. is the registrar of the issue. 

Having issued initial equity shares at par value, the company issued further equity shares in the price range of Rs. 200 - Rs. 1204.60 (on the basis of Rs. 2 FV) between March 2009 and December 2023.  It has also issued bonus shares in the ratio of 5 for 1 in September 2023.The average cost of acquisition of shares by the promoters/selling stakeholders is Rs. 0.34, Rs. 267.03, and Rs. 321.41 per share. 

Post-IPO, its current paid-up equity capital of Rs. 10.91 cr. will stand enhanced to Rs. 11.82 cr. Based on the upper cap of IPO price band, the company is looking for a market cap of Rs. 3097.52 cr. 

FINANCIAL PERFORMANCE:
On the financial performance front, for the last three fiscals, the company has (on a consolidated basis) posted a total income/net profit of Rs. 125.03 cr. / Rs. 11.50 cr. (FY21), Rs. 199.26 cr. / Rs. 29.46 cr. (FY22), and Rs. 261.52 cr. / Rs. 8.47 cr. (FY23). For H1 of FY24 ended on September 30, 2023, it earned a net profit of Rs. 26.89 cr. on a total income of Rs. 169.54 cr. The sudden fall in bottom line for FY23 is attributed to one-time adjustments and special provisioning of few accounting norms. H1 of FY24 is indicative of likely trends going forward as the company is ready with all things in place and its meter is down. It is having major thrust on aviation segment in coming years and that will change its revenue mix. 

For the last three fiscals, the company reported an average EPS of Rs. 3.48, and an average RoNW of 12.68%. The issue is priced at a P/BV of 11.46 based on its NAV of Rs. 45.74 as of September 30, 2023, and at a P/BV of 4.94 based on its post-IPO NAV of Rs. 106.01 per share (at upper cap). 

If we attribute annualized FY24 earnings to post-IPO fully diluted paid-up equity capital of the company, then the asking price is at a P/E of 57.58. Thus the issue appears fully priced, but considering bright prospects ahead, it's a worthy bet. 

For the reported periods, the company posted a PAT margins of 9.37% (FY21), 15.15% (FY22), 3.37% (FY23), 16.94% (H1-FY24), and RoCE margins of 12.09%, 16.95%,12.99%, 9.63% respectively. 

DIVIDEND POLICY:
The company has not paid any dividends for the reported periods of the offer document. It has adopted a dividend policy in September 2023, based on its financial performance and future prospects. 

COMPARISON WITH LISTED PEERS:
As per offer document, the company has shown MTAR Techno, Paras Defence, Dynamatic Techno and Triveni Turbine as their listed peers. They are trading at a P/E of 66.94, 81.46, 90.11, and 76.34 (as of December 15, 2023). However, they are not comparable on an apple-to-apple basis. 

MERCHANT BANKER'S TRACK RECORD:
The four BRLMs associated with the offer have handled 80 public issues in the past three fiscals, out of which 24 issues closed below the IPO price on listing date. 

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