Solar Industries:: Centrum

Defence potential remains exciting despite challenges
Our recent plant visit to Solar’s defence and explosives facility reaffirms our view on
the strong potential for the defence business but revenue monetisation could take
time as it has to cross key hurdles. We were accompanied on our visit by Mr. Subimal
Bhattacharjee (defence expert and Ex-country head, General Dynamics India) who
affirmed the huge potential for the defence business in the long run notwithstanding
the near term bottlenecks and challenges. The company’s core business of explosives
is expected to pick up in H2 after a subdued H1 but we see slower overall growth in
FY14E and revise our estimates marginally. We shift our valuation base to Sep’15E and
revise our target upwards to Rs1140 but downgrade the stock to Hold from Buy earlier
on the back of smart recent stock performance.

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 Setting up of defence facility smooth and impressive: The setting up of defence
facility by Solar has been smooth and the HMX division with 50 tpa capacity has
already started trial runs. The propellants division’s construction is in full swing and
trial run has been brought forward to Jan-Feb’2014 (from July 2014 earlier). Capacity
in the first phase is pegged at 2500 nos (~250tpa) for propellants. Management
expects to derive significant revenue from the defence business in FY15E after getting
approvals for products after trial runs. We estimate sales of 15 tonnes of HMX and 500
nos of propellants in FY15E with total revenue of ~Rs500mn.
 Monetization from defence business after crossing key hurdles: We infer after our
detailed interaction with the management and the defence expert that revenue
monetization from the defence business will involve crossing key hurdles. These
include smooth approvals for production from MoD and CCE, approval of trial run
products by customers (BDL & ODF), quality control and regular order inflow from
customers post product approvals. We expect the company to cross these key hurdles
in the next 12-18 months and then successfully monetize the defence business from
FY16E in a big way depending upon order inflow (which is expected to be strong due
to inherent shortage of supplies).
 Explosives business momentum to return from H2: After a subdued H1(which was
adversely affected by multiple factors), momentum in explosives business is set to
return from H2 backed by higher domestic demand, better exports and higher
revenues from overseas subsidiaries. The company is also setting up four new bulk
plants and creating 20ktpa storage facility for ammonium nitrate to help ease
availability. We revise our EBITDA estimates for FY14E/15E by 3.1%/-1.6%. We expect
revenue growth from core business to remain slow in FY14E (as compared to past 5-
year CAGR) before picking up smartly in FY15-16E.
 Valuation and risks – downgrade to Hold: We move forward our valuation base to
Sep’15 from FY15E earlier and continue to value the stock on the basis of the average
of EV/EBITDA, P/E and DCF. We revise our target price upwards to Rs1140 but
downgrade the stock to Hold from Buy earlier as it has moved closer to our initiating
coverage target price (refer to our report “Blasting to Growth” dated 19th Aug’2013).
Key downside risks are lower growth momentum from explosives business and delay
in defence business revenue. Upside risks are faster than expected growth from all
divisions (particularly defence).