PIPAVAV DEFENCE AND OFFSHORE ENGINEERING COMPANY LTD

October 21, 2011

BSE Code: 533107 NSE Code: PIPAVAVDOC Reuters Code: PIPA.NS Market Data Rating CMP (`) Target (`) Potential Upside (%) Duration 52 week H/L (`) All time High (`) Decline from 52WH (%) Rise from 52WL (%) Beta Mkt. Cap (` bn) Enterprise Val (` bn) Fiscal Year Ended FY10A Revenue (`mn) Net Profit(`mn) Share Capital EPS (`) PE (x) P/BV (x) EV/EBITDA (x) ROCE (%) ROE (%) 6,293.8 6,306.0 6,658.0 -0.1 -123.0 3.3 -1.3 -2.7 FY11A 8,676.1 6,980.6 6,658.0 1.4 129.5 3.3 42.8 3.2 2.6 FY12E 15,617.0 11,717.8 7,164.0 2.4 73.9 3.0 17.6 7.8 4.1 FY13E 30,453.1 22,303.3 7,164.0 4.6 26.1 2.7 10.1 13.5 10.4 Bloomberg Code: PIPV:IN

Pipavav Defence and Offshore Engineering Company Ltd (PDOECL) is the largest shipyard in India and among the 5th largest in the world in terms of its size (400000 dwt). Promoted by SKIL Infrastructure, PDOECLs dry dock capacity is larger than top 5 yards in India put together. PDOECL is the only private shipyard in India to have license to produce frontline warships from the Govt. of India giving it significant opportunities in the defence space. With worldclass infrastructure, PDOECL stands at the forefront to capitalize on increased opportunities provided in the defence.

BUY
85

135
~59
Long Term 96/61 96 11 39 0.51 56.6 72.3

Investors Rationale

PDOECL is situated on the west coast of India on the Dubai-Singapore

sea route, approx. 150 nautical miles from Mumbai, one of the busiest international maritime ports in India. It is also close to the offshore oil fields on the western coast of India as well as in the Middle East, thus suited to tap the offshore construction market. Hence, proximity to the Pipavav Port enables them to benefit from the ports infrastructure facilities.

The Indian Navy has huge acquisition plans with requirements of more
than 100 ships of different types including submarines in the next two decades. The Indian Coast Guard would also need about 160 ships over next seven years. The company has been declared as the successful bidder for construction of five Offshore Patrol vessels for Indian Navy with order value of approx. `29.75 billion.

The company is exploring itself to cater the demand of heavy

engineering sector which has huge potential through extending its product range with use of its engineering infrastructure. It is also in talks with some reputed players in this segment.

One Year Price Chart

100 20,000 15,000 10,000 May-11 Feb-11 Mar-11 Nov-10 Dec-10 Aug-11 Sep-11 Apr-11 Oct-10 Jun-11 Jan-11 Jul-11 90 80 70 60 50

PDOECL has a robust order book of around $1.5 billion, which offers
good revenue visibility. Around half the order book comprises export orders, 42% comes from defence and the remaining are offshore orders. With the continuous inflow of high value orders across all the geographies in both defence and offshore space, we expect the total order book of PDOECL to grow more than four- fold to ~$6-7billion by the end of FY12.

With well-built infrastructure, and technological bliss, PDOECL is

Promoters Institutional General Public Others

SENSEX

PDOECL

expected to mark its progressive journey from FY12 onwards with the successful establishment of all the growth pillars. With billion dollar investment in developing world-class heavy engineering infrastructure with attached dry dock, PDOECL stands at the forefront of private sector companies ready to capitalize on increased opportunities in the global defence sector.

Shareholding Pattern

Jun11 45.0% 20.1% 6.5% 28.4%

Mar11 45.0% 19.5% 6.8% 28.7%

Diff. 0.60 (0.30) (0.30)

Joins hands with Airbus SAS of France, marking its foray into the aviation business
PDOECL has joined hands with Airbus SAS of France to jointly develop aircraft maintenance, repair and overhaul (MRO) unit in India, with an initial investment of `4900 million ($100 million). PDOECL will hold a 51% in the Joint venture while EADS will pick up 26% equity in the project and may further increase its stake to 49%. The MRO facilities and associated infrastructure, the first of its kind in the country, is likely to be used for civilian and military applications. The company also intends to add a spare parts and logistics unit to the MRO facility and induct a technical partner for effective operations. Though PDOECL is yet to decide the location for the MRO unit, it has shortlisted five places for the purpose, viz Cochin International Airport in Kerala, old Bangalore international airport, a small airport site in Maharashtra and two other sites near private airports The deal will help PDOECL to position itself in the aerospace sector as it expects $500 million a year in revenue from the business, over the next five-six years. With rapid growth in the Indias aviation sector, the MRO market in the country is expected to generate ~$1.06 billion revenues by 2015. MRO service requirements in the country are expected to grow annually at a compounded rate of 13.5% in the same period. Low labour costs in India at around $30-35 per man hour, compared with $55-60 in South-East Asia and the Middle East and even higher in the US and Europe also makes India a lucrative destination among its peers for MRO service.

Increased focus on exports to add order book growth

PDOECL is betting higher to increase its export reach to geographies like Indonesia, Southeast Asia, Latin America and Africa. The company is also optimistic of earning high value defence contracts worth ~$3 billion from foreign countries which share friendly relations with India in FY12. Presently, the private shipbuilding giant of the country has a total order book of around $1.5 billion, of which $710 million comprises of export orders, $110 million offshore orders and around $600 million in the defence segment. Under its initiative to boost its total order book to ~$6-7 billion by the end of FY12, the company has also signed major proptocal with a company under the Russian ministry of defence for a potential contract of ~$2 billion. The expected clearance of its joint venture with MDL will also add other $650 million domestic orders to its total order book, making the achievement of expected order book feasible.

Total order book to grow more than four-fold

4,500 4,000 3,500 3,000 `million 2,500 2,000 1,500 1,000 500 0 FY11 Domestic orders 790 710

4,000

3,000

FY12E Export orders

Multiple strategic initiatives to fuel up growth

In order to augment the future growth in the defence segment, the company is planning to acquire 51% stake in Bangalore-based ship design engineering and consulting firm, Conceptia Software Technologies Pvt. Ltd. Conceptia has expertise in preparation of detailed designs and 3D modeling for Ships and offshore oil & gas assets and has a subsidiary in Singapore for marketing its services and products in Asia Pacific region. The proposed acquisition is likely to bring synergy and integration which will enhance the growth of both the companies in defence as well as in offshore oil & gas sector. Beside, PDOECL already had strategic tie-ups with foreign partners including SAAB Dynamics, Northrop Grumman and UKs Babcock Group for defence production. Earlier, in April this year, the firm got the go-ahead from the Foreign Investment Promotion Board (FIPB) to build warships, thus making it eligible to bid for multi-billion dollar defence contracts along with foreign partners. With regard to this, the firm has signed a protocol with a company controlled by the Russian ministry of defence for a potential contract of about $2 billion. Moreover, the company converting its existing wet basin into a dry dock facility to enhance manufacturing facilities for the defence sector, for which they are raising long term loans of upto `13 billion out of that `10 billion has been approved by lenders.

PDOECL stays MoDs best choice for building warships

PDOECL has emerged as the first private sector company to get a license from Government of India to build submarines and warships and has bagged its first large order valued at `29.75 billon for the design and construction of five warships viz. Naval Offshore Patrol Vessels (NOPVs) for the Indian Navy. For this purpose, the company has formed an equal joint venture with state-run Mazagon Dock Ltd (MDL) to implement part of the existing orders of MDL, which amount to `1 billion ($21.69 billion) and also bid for future defence contracts in India PDOECL has the capacity to build a dozen submarines and warships at a given time due to their modular configuration and has already invested over $1 billion in the up-gradation of its facility. Apart from carrying out work for the Navy, the JV will also look at export orders from "friendly countries. The company is in dialogue with the governments of six friendly nations to build their warships at our world class defence focused infrastructure in India. However, joint venture confronts a hold from the Ministry of Defence (MOD) until the formulation of a new policy on warship-building JVs following a flurry of protests from the other three of PDOECLs rivals Larsen & Toubro, ABG Shipyard, and Bharati Shipyard, complaining lack of transparency and non-discloser of the evaluation criteria. Though the defence ministry has cleared state-owned MDL of all charges in selecting PDOECL as its partner for a joint venture, the hold stays on all new warship projects for the Indian Navy until a formal policy is formulated. Considering factors like PDOECLs geographical nearness to MDL on the west coast and its possession of a dry dock for constructing large warships that matches MDLs method of building in a dry dock, PDOECL has the likelihood of emerging as the most appropriate choice, even in case of any re-evaluation. Beside, PDOECLs bid was also the most aggressive. Contemplating a JV with a paid up capital of `500 million, PDOECL volunteered to contribute `490 million, with MDL contributing `10 million. MoD and MDL also strongly defends PDOECLs selection, arguing that its location and facilities make it the best choice for partnership with MDL.

Q1FY12 income jumps on additional earnings from the delivery of Panamax vessels
During Q1FY12, PDOECLs income from operations inclined by 92% to `3.38 billion as completion of orders of Panamax vessels led to booking of additional revenue. PDOECL maintained its operational productivity through efficient steel cutting, helping its OPM to increase by 1266 bps to 19.7% and cause the operating profit to rise by 438% to `666.3 million. Among other financial charges, other income decreased by 48% to `65.7 million. Interest increased by 88% to `430.4 million while depreciation increased by 52% to `179.3 million. The PBT and PAT has seen a turnaround, which stood at `122.3 million and `79.4 million respectively. The improved capacity utilizations and developing efficient processes led to an increase in profitability.

Income growth pegged at CAGR ~ 69% during FY10-FY13

35,000 30,000 25,000 20,000 `million 19.5 25.0

26.8 30453.1

30.0 25.0 20.0 15.0

15617.0

15,000 10,000 8676.1 6293.8 437.1 5,000 0 -5,000

2166.1

10.0 5.0 0.0

-0.2 -460.2 FY10

FY11 Net Profit

FY12E

765.9

FY13E EBIDTA Margin %

-5.0

Net Sales

PDOECL to see additional revenue booking with its Oct delivery of a break bulk carrier
Indias largest shipyard at the Gulf of Cambay in Gujarat on the West coast, PDOECL has a robust order book, having signed many million dollar contracts with overseas ship owners, Indian state run organizations as well as the Indian Navy. With its developed Comprehensive and holistic heavy engineering and integrated defence infrastructure base, the company is all set to make a series of ship deliveries. The first ship, a 75,000 tonner break bulk carrier, built for Norwegian ship owners is ready for delivery by the end of October 2011. Another vessel is also getting ready for delivery and should be handed over soon thereafter. The company has also signed a contract with the Indian Defence Ministry to the tune of $ 660 million for the design and construction of naval gunboats for the Indian Navy. In addition, PDOECL is in the process of adding another dry dock adjacent to the existing facility on the south western coast of Gujarat, at a cost of around $230 million.

PDOECL banks high on superior infrastructure

PDOECL is the largest shipyard in terms of capacity in India and is a strong contender for defence orders going forward, considering that the company has got a warship production licence from the Indian government. India needed an infrastructure to manufacture the warships of tomorrow, conceptualised with the next hundred years in mind. PDOECL has bridge the gap with the development of its world-class infrastructure to boast of. The infrastructure that PDOECL has built is not only massive in terms of the sheer size, but it is developed as a complete and holistic heavy engineering and integrated defence infrastructure base that ensures that it is not just the biggest, but one of the most integrated and best in technology as well. PDOECL owns one of the largest dry docks in the world measuring 662 x 65 sq. mtrs and is planning to build a new dry dock, which too will be amongst the largest in the world. The company constructs vessels based on modular technology, which helps in efficient shipbuilding at faster pace. This method of ship building reduces production time and enables simultaneous production of multiple ships. The state-of-the-art engineering complex builds the blocks which are then assembled at the land berths in mega blocks. The company also enjoys locational advantage on the western coastline, spread across 782 acres of land. Technological tie-ups with various global defence giants would also boost PDOECLs ability to deliver high quality ships with superior technology.

Growth Strategy
With well-built infrastructure, developed global standards in capabilities, technology and size, PDOECL is expected to mark the progress from FY12 onwards after the establishment of all the growth pillars. After the successful accomplishment of the delivery of two Panamax bulk carriers for the Golden Ocean group in June this year, the company is on the verge of delivering another vessel in October, sharpening its competitive edge in the execution front. Going further, the order book is expected to grow multi-fold on the back of increasing defence demand, greater demand for offshore assets, and the significant need for repair for vessels visiting/ passing through Indian waters. The company is also well-poised with modern heavy engineering facilities to undertake both civil and non-civil heavy engineering projects, whether be the construction of civil nuclear reactors or land based heavy defence machinery such as tanks. With offshore activities shifting to deeper waters and increasing demand from the naval sector, Indian industry will undergo a dynamic change in the coming years. Having invested in state of the art facilities and having developed a world-class heavy engineering infrastructure with attached dry dock, PDOECL stands at the forefront of private sector companies ready to capitalize on increased opportunities provided in the defence and offshore oil and gas assets space and is set to experience robust growth and profitability going forward.

Strong business model Business Growth Drivers Key Developments

Defence

Increasing focus of the Government of India on indigenization of

defence production-Defence Procurement procedure, Buy Indian, Make Indian.

Received orders worth `29.75 billion for the

construction of 5 NOPVs

Currently bidding for several such projects

and is in talks with governments of six friendly nations for similar orders

Rising E&P expenditures will divert resources towards revival in the

Offshore
offshore industry.

Received contract for the construction of 12

OSV worth ~`5300 million from ONGC Dedicated facilities for the fabrication and revamping of offshore oil rigs.

Redevelopment and modernisation of rigs reaching expiration

period.

Turnaround in the global shipping industry will revive demand for

Commercial Shipbuilding
large dry bulk cargo ships

Indian Government plans to capture 5% of the global market share

for commercial shipbuilding by 2020.

Orders are under execution

Ship Repair & Refit

Global repair market will continue to increase substantially. Segment will capture demand from Indian ships that depends on
domestic shipyards India is likely grow to be major hub for ship repair by 2020.

Capacity to repair VLCCs and OSVs.

Key opportunities in the end-user segments

PDOECL to benefit from Government emphasis to reduce import dependency in defence India imports around 70%-75% of its defence hardware requirements from foreign nations and to encourage Indian companies to produce high tech defence equipments to reduce import dependency, the Indian Government has introduced the Make Indian and Buy Indian category in its Defence Procurement Policy. PDOECL is not only well-positioned to benefit from the Governments emphasis on self reliance in the defence production sector but is also well-equipped among its peers to gain the most. Huge demand in the offshore oil and gas sector In India, the demand for high-end offshore facilities such as drill ships and floating production storage platforms amounts to approximately $20-40 billion. With the oil prices on a rise, the importance of this sector is building up. The increase in the demand for offshore assets would lead to consequential increase in demand of Offshore Supply Vessels (OSVs) required to service them. Furthermore, higher production cost of OSVs in other countries such as Japan may result in diversion of orders to India, consequently creating huge prospects for PDOECL. PDOECL has established itself in this area through its current construction programme of OSVs. Rising demand for naval defence as well as replacement of defence vessels Considering the increasing geo-political challenges and the need for antipiracy operations in the Indian Ocean, Government has recognised the need to build more warships and other military hardware indigenously to rapidly expand the countrys Naval and Coast Guard fleet. A huge replacement/ refurbishment demand for defence vessels has also been witnessed. About 40% of the commercial fleet is more than 20 years old and Indian ship owners are expected to spend approx. $4 billion to replace these during FY 2010-2015. With commissioning o Indias most technologically advanced infrastructure geared for construction/ repair of the most sophisticated warships including aircraft carriers, submarines, landing platform docks, patrol vessels and other naval products, PDOECL stay far ahead of its peers to bank on such lucrative opportunities. PDOECLs distinct advantages as a key solution provider to the Indian naval and offshore shipbuilding

World Class marine

Capable of handling a diversified portfolio mix

World Class Infrastructure

One of the largest dry docks in the world Can accomodate vessels of up to 4,00,000 DWT

engineering infrastructure with high vessel handling capacity

Competitive advantage due to

size of facility and its strategic location

Reputed Strategic Partner

Advanced shipbuilding technology aided by international expertise coupled with a competitive cost structure Associated with reputed strategic partners across the globe, including Europe, in South Korea and Singapore

Strategic partnership across

the globe allows the company to enjoy the benefits of technological advancement and global presence.

Risk factors Though in recent times, PDOECL has turned around to make profits in the last couple of quarters, increasing debt and tardiness in
launching ships could put pressure on profitability.

Despite a robust order book and world-class infrastructure to boast of, PDOECL is yet to prove itself on the execution front given the
companys limited track record in the space.

Though PDOECL has emerged as the first private sector company to get a license from Government of India to build submarines and
warships, the company confronts several macro-economic hurdles like rising input cost, lack of transparent policy and uncertainty in approvals etc.

The Shipping Industry

Global aspirations of economically strong India, with ever increasing geopolitical challenges have made the Indian Government realize the imperative need to strengthen its defence capabilities. The Government through its Defence Procurement Policy (the DPP) is encouraging private players to participate in various defence acquisition programs and to create an indigenous network of suppliers. The opportunities that the DPP presents to the domestic players are vast and domestic companies that meet the necessary demands of the Indian Navy will benefit the most. India sits in a prime position in the Indian Ocean, with over 7,517 kms of coastline. Indian sea trade accounts for approximately 90% of volume and 77% of value of Indias aggregate trade. Maritime interests are crucial for establishing a secure tomorrow, as the economy is dependent on the sea for sectors such as Oil and Gas exploration & production, Commercial trade, etc. Protecting maritime assets is an imperative for the Indian Navy and Coast Guard. The Government is continuously making efforts to ensure naval security in the Indian Ocean, which ultimately will lead to demand for better quality defence vessels. According to the Maritime Agenda 2011, there are currently 27 prominent shipyards in the country, of which 8 are in the public sector. India advanced from 0.1% of the world share of shipbuilding in 2002 to approximately 1.5% in 2010.

Global Scenario
While the global shipbuilding outlook until 2011 looked subdued, it is expected that the commercial shipbuilding industry will turnaround by FY 2012-13. Global trends show a demand for larger vessels as the pursuit of economies of scale drives businesses to demand both bigger and fuel efficient ships. Since ships that can carry larger cargoes translate into lower cost of transport, companies that are able to deliver large vessels will benefit. There is also a demand in niche sectors. For example, increased requirements for dredging have translated into demand for dredgers. Similarly the emergence of LNG as a substitute for coal is resulting in a demand for LNG Carriers. Increased spending on infrastructure and subsea pipelines is resulting in greater demand for Heavy Lift Vessels. Companies like yours capable of manufacturing these specialised vessels would gain from this demand.

Market share of Indian Shipping Industry in global shipbuilding industry

6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% FY11 FY17E

India's market share in the global shipping industry

Outlook
The Indian Government has encouraged indigenization of defence hardware with introduction of the Make Indian and Buy Indian category in its Defence Procurement Policy. It is aimed at promoting production of defence equipment by capable Indian companies. In view of global aspirations of economically strong India, ever increasing geo-political challenges and the need for antipiracy operations in the Indian Ocean, the Indian Navy and Coast Guard are being modernized for safeguarding Indias maritime interests. Moreover, the scope of naval defence is further widened by providing support to maritime neighbours during natural disasters. This will require a massive as well as rapid expansion of Indias Naval and Coast Guard fleet. There is a huge replacement/ refurbishment demand for defence vessels. About 40% of the commercial fleet is more than 20 years old and Indian ship owners are expected to spend approx. $4 billion to replace these during FY 2010-2015. In India, the demand for high-end offshore facilities such as drill ships and floating production storage platforms amounts to approximately $20-40 billion. With the oil prices on a rise, the importance of this sector is building up.

Balance Sheet (Consolidated)

(`million) Share Capital Reserve and surplus Net Worth Loan fund Capital Employed Gross fixed assets Less: accumulated depreciation Net Fixed assets Capital WIP Total Fixed Assets Investment Net Current Assets Capital Deployed FY10A 6,658.0 10,365.0 17,023.0 13,299.0 30,322.0 11,873.0 459.0 11,414.0 14,416.0 25,830.0 77.8 4,414.2 30,322.0 FY11A 6,658.0 10,250.0 16,908.0 20,208.0 37,116.0 17,432.8 978.8 16,454.0 11,350.0 27,804.0 230.0 9,082.0 37,116.0 FY12E 7,164.0 11,568.0 18,732.0 20,963.2 39,695.2 19,338.2 1,793.6 17,544.6 2,200.0 19,744.6 230.0 19,720.5 39,695.1 FY13E 7,164.0 13,734.1 20,898.1 32,674.3 53,572.4 20,238.0 2,687.0 17,551.0 2,200.0 19,751.0 230.0 33,591.4 53,572.4

Profit & Loss Account (Consolidated)

(`million) Operating Income Operating Expenses EBITDA EBITDA Margin (%) Depreciation EBIT EBIT Margins (%) Interest Other Income PBT Tax Net Profit Net Profit Margin (%) FY10A 6,293.8 6,306.0 -12.2 -0.2 377.3 -389.5 -6.2 730.0 675.4 -444.1 16.1 -460.2 -7.3 FY11A 8,676.1 6,980.6 1,695.5 19.5 519.8 1,175.7 13.6 1,190.0 557.3 543.0 105.9 437.1 5.0 FY12E 15,617.0 11,717.8 3,899.2 25.0 814.8 3,084.4 19.8 2,058.9 100.0 1,125.5 359.6 765.9 4.9 FY13E 30,453.1 22,303.3 8,149.8 26.8 893.4 7,256.4 23.8 4,014.0 100.0 3,342.4 1,176.3 2,166.1 7.1

Key Ratios
FY10A EBITDA Margin (%) EBIT Margin (%) NPM (%) ROCE (%) ROE (%) ROA (%) EPS (`) P/E (x) BVPS P/BVPS (x) EV/Operating Income (x) EV/EBITDA (x) -0.2 -6.2 -7.3 -1.3 -2.7 -0.7 -0.1 -123.0 25.6 3.3 10.1 FY11A 19.5 13.6 5.0 3.2 2.6 0.7 1.4 129.5 25.4 3.3 8.4 42.8 FY12E 25.0 19.8 4.9 7.8 4.1 1.2 2.4 73.9 28.1 3.0 4.4 17.6 FY13E 26.8 23.8 7.1 13.5 10.4 3.3 4.6 26.1 31.4 2.7 2.7 10.1

Valuation
PDOECL has a long term strategy to capitalize on the prevailing strong and steady economic growth of India. The companys strategy to cater the Indian defence service, tied with robust order would augur well for the company in ensuring days. The company is on track to become a major defence player in the country. Based on a sound business model with well defined business strategies, the companys balance sheet is expected to register a robust growth in the coming two years. Considering the above aspects, we rate the stock as BUY at the current market price of `85, the stock is expected to attract Premium over other players, even after considering the heavy debt and capital intensive nature of business. At the current market price, the stock is trading at PE of 73.9x on FY12 EPS of `2.4 and 26.1x on FY12E EPS of `4.6.

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