Stock Call. Why Midhani stock is a good buy

The newly introduced Defence Acquisition Procedure 2020, which came into effect from October 1, 2020, focusess significantly on boosting indigenous production.

This bodes well for comapnies such as Mishra Dhatu Nigam (Midhani) in the long run.

Midhani is a PSU catering to the needs of India’s strategic sectors such as defence, space, atomic energy and aeronautics by supplying critical materials and alloys. The niche segment that the entity operates in, its ability to deliver customised products and good financials (low debt, strong operating margin) favour the company.

At the current market price of ₹198, the stock is valued at about 21 times its expected earnings for FY21. While many PSUs trade at lower valuations, Midhani is a niche player. The stock price is at 20 per cent discount to peak levels witnessed pre-Covid, though long-term business prospects remain green.

At this level, it is a good buying opportunity for investors with a three-to-four-year time horizon.

Sanguine prospects

Midhani, established in 1973, is a leading manufacturer of special steel, super alloys and titanium alloys. These products can withstand high stress, temperature and corrosion and are mostly used in aerospace, defence and nuclear power plants. The company derived nearly 55 per cent of the revenues from the aerospace segment in FY20, with ISRO being the major customer.

The increasing demand in the aerospace industry for light materials due to stringent emission norms and increasing fuel efficiency is one of the critical drivers for the alloys market going ahead. Midhani will be a beneficiary of this.

The import share in the aerospace segment is much higher. Currently, about 70 per cent of these raw materials required for aerospace manufacturing is imported into India, giving enough room for import substitution for niche players like Midhani.

Defence, energy and other segments contributed 26 per cent, 13 per cent and 6 per cent, respectively, to revenue last year.

Currently, India domestically produces only 45-50 per cent of defence products it uses, and the rest is imported.

The recently announced Defence Acquisition Procedure 2020, focussing on Atmanirbhar Bharat and Make in India initiatives, is an opportunity for domestic players. The Ministry of Defence’s (MoD) recent embargo on imports of 101 items to boost indigenisation of defence production is also a positive to domestic manufacturers.

Also, the Defence Production Policy of 2018 (DPP-2018) aims to place India among the top five global aerospace and defence manufacturers, with annual export target of $5 billion by 2025.

Though the target seems stretched at this point of time, any initiatives in this direction will likely better the prospects of the company.

Expansion plans

Currently, Midhani has only one manufacturing unit in Hyderabad, generating revenue of ₹700-770 crore in the last few years. Now, it is in the process of setting up two more facilities — an armour plant at Rohtak, Haryana, and aluminium alloy plant at Nellore, Andhra Pradesh.

The bullet-proof armour plant is in its final stages of commissioning and is expected to come into operation by the end of this financial year.

And the contribution from the plant in the first year of operation is likely to be ₹50-60 crore. The management believes that the domestic demand for armours is expected to be robust, going ahead, with little competition in India.

The Nellore plant is in joint venture with the National Aluminium Company (NALCO), for manufacturing of high-end aluminium alloy products at an estimated capital expenditure of ₹4,500 crore. Being value-added products, they are expected to bring in good margins. Currently, the company has negligible debt. Despite taking debt for capex requirements, its debt-equity ratio stood at healthy 0.14 times in FY20.

Profitability

While the growth in revenue has been tepid, in the last three years to FY20, net profit climbed up at a CAGR of 8.14 per cent to ₹ 159.73 crore.

During the same period, the operating profit margins improved from 24 per cent in FY17 to 27.7 per cent in FY20.

This is because, as per the management, the company has been focussing more on high-margin, value-added products (aerospace and defence) despite the volume requirement being lower. Going ahead, this trend is expected to continue.

The first-quarter performance of the company in FY21 was impacted due to disruption in production activities for about 45 days. It recorded sales of nearly ₹113.49 crore (down 14.11 per cent y-o-y) and net loss of ₹0.91 crore as against a net profit of about ₹23 crore for the period ending June 2019.

The company restarted operations from May 20, 2020, and as of now, is close to normalcy.

The revenue for FY21 is expected to be ₹800 crore, which is about 12.35 per cent higher than what was recorded in FY20.

As on July 15, 2020, the company has an order book of about ₹1,732 crore, more than twice the revenue recorded in FY20.

Being a CPSE, the company is required to pay a minimum annual dividend of 30 per cent of profit after tax or 5 per cent of the net worth, whichever is higher.

In the last couple of years, the dividend yield has been 1.2- 1.5 times.

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