Data Patterns: Driving Defence Innovation from Concept to Deployment

Portfolios Research Smallcase Wealth PMS In the high-stakes game of geopolitical chess, India is making some bold moves! In recent times, India has been in a constant tussle or the so-called territorial disputes with China and Pakistan over the ownership of the Indian states of ‘Kashmir’ and ‘Arunachal Pradesh’ respectively. Think of it this way, India has the second-largest armed forces in the world, that is a lot of boots on the ground and it’s about providing them with quality technology and equipment. This has made the Indian government turn its eyes to defence and aerospace as an industry of strategic importance. As a result, India has been on a shopping spree, being the top importer of defence equipment in the last 5 years to gain technological advances against the likes of China and Pakistan. All these factors cumulatively have led the Indian Government to see the defence and aerospace sector as a focus area for initiatives like the ‘Atma Nirbhar Bharat’ and ‘Make in India’. This has been very clear looking at the increasing amount of money spent by the government on this sector. The budget allocation for the defence industry jumped 13% to INR 5.9 Lakh Crores in FY24 and the same trend continued in FY25, with defence allocation reaching Rs 6.2 Lakh Crores. *Source: Data Patterns’ FY23 Annual Report. Click on the image to enlarge India is aiming to become a major player in the global defence and aerospace market, targeting a turnover of INR 1.75 lakh crore by 2025, including INR 35,000 crore in exports. The country is already on the move, with exports hitting ~Rs 16,000 crore in FY23, a solid Rs 3,000 Cr jump from the year before. Furthermore, India has set a goal to achieve 70% self-sufficiency in weaponry by 2027. Government Initiatives setting the tone right! The Indian government has gone all out to support the sector. Two dedicated Defence Industrial Corridors sprung up in Tamil Nadu and Uttar Pradesh to leverage existing infrastructure and human capital. Both corridors have cumulatively signed 108 memorandums of understanding (MoUs) representing investments worth Rs ~2,400 Cr. Additionally, programs like Innovations for Defence Excellence (iDEX) and the Defence Testing Infrastructure Scheme (DTIS) have been introduced to foster innovation while making sure they are tested for action! Plus, the government is rolling out the red carpet for private companies with the Green Channel Status Policy (GCS), making it easier for them to join the defence production party. Multiple companies in the defence sector are well-placed to benefit from all the Industry tailwinds. However, in an industry dominated by PSUs, there are a few private companies that have been making strides in the industry and the one we are talking about today has been in the business for ~35 years. 35 Years of Innovation in Defence and Aerospace! Data Patterns (India) Ltd , the brainchild of Mr. Srinivasagopalan Rangarajan, who started his journey in 1985 has grown over the past three decades to become a notable player in India’s defence and aerospace industry. The company specializes in designing and manufacturing electronic systems and solutions, with a focus on indigenous development. They offer a range of products that cater to the entire spectrum of defence and aerospace (land, sea, air, and space) platforms.  It has a 100% in-house development and manufacturing capability, with a diversified order book with marquee customers. It has supplied products for LCA-Tejas, Light Utility Helicopter, and BrahMos missile. As of Q3 FY24, Data Patterns has 1,298 employees with more than 865 qualified engineers. More than 150 of them have been associated with the company for 10 years or more. Wide Range of Products As we said, Data Patterns (India) Ltd. stands out in the defence and aerospace electronics sector with its wide diversification of products. Below is an overview of the key product categories in Data Patterns’ portfolio: *Source: Data Patterns’ Q3FY24 Investors Presentation. Click on the image to enlarge Let us now dig deeper and understand what some of their key products are- 1. Radars – They manufacture radar systems for various applications. Surveillance Radar – Detects moving targets. Weather Radar – Cloud and rainfall measurement. Wind Profiler Radar – Determines the direction and intensity of the wind at various altitudes. Tracking radars – Used by satellites to monitor the flight trajectory. Example – PSLV and GSLV of ISRO. BrahMos Missile Seeker – Part of the missile that searches for the target and guides the missile to its target. 2.Electronics Warfare (EW) – These include systems for electronic attack, electronic protection, and electronic support. 3. Avionics Display – It is one of the most important products for the company. These are used in the cockpits of aircraft and helicopters. 4. Automated Test Equipment (ATE) – Used in electronic devices for functionality and performance. Electronic systems on the PSLV and GSLV as well as some satellite sub-systems are tested by ISRO using such ATEs. The diversity of Data Patterns’ product range shows the company’s ability to cater to a wide spectrum of requirements in the defence and aerospace sector. Diverse Revenue Streams Selling the final product is not the only way Data Patterns’ earns its revenues. It has 3 revenue sources – 1) Service:  This revenue source involves providing support and maintenance services for the electronic systems and sub-systems the company designs and manufactures. This is considered to be recurring as clients require ongoing assistance for optimal functioning of the equipment. 2) Development:  Development revenues are mainly earned through the design and development phase of a new product or customizing an already existing product to specific client needs. 3) Production: Production revenue comes from the actual manufacturing and sale of the company’s products. This is directly related to the volume of products that are manufactured and sold by the company. Let us now see which of these sources have contributed the major chunk of Data Patterns’ revenues in recent times. *Source: Data Patterns’ Q3FY24 Investors Presentation. Click on the image to enlarge Clearly, major sources of revenue are development and production whereas service only contributes a small percentage. From the chart above, we can see that the revenues have grown to Rs 337.5 Cr in 9MFY24 from Rs 268.3 Cr in 9MFY23. Notably, the share of development revenue has risen from 31% to 40% during the same period. A higher share of development revenue is a positive sign. It indicates that more projects are in the design and development phase. Once these products get the green light, they move into the production phase, leading to further revenue growth. This suggests a healthy pipeline of future production orders and potential revenue increases for Data Patterns. Dedicated Management  Mr. Rangarajan, the Chairman and Managing Director, alongside Mrs. Rekha Murthy Rangarajan, the Whole-time Director, has been instrumental in shaping the company’s growth and product development over the past three decades. The founding duo has maintained a tight grip on the stake, holding a significant stake of ~46% post-IPO in FY22, which was slightly reduced to around 43% in Q1 FY24 due to a QIP aimed at funding product development. Many of the key personnel have been associated with the company for over two decades. The long tenure of key management personnel and a modest KMP remuneration of 2.5% of profit in FY23, underscore a strong commitment to the company’s success. Data Patterns has demonstrated robust financial health, with an average ROE of 17.7% over the last five years, surpassing the industry average of 16.17%. This indicates efficient capital utilization and value creation for shareholders. With a leadership team that’s in it for the long haul highlights their confidence in the company’s prospects. Their alignment with shareholder interests and the company’s strong financial performance make it a credible player in the defence and aerospace electronics sector. Financials After exploring the multiple tailwinds supporting the growth of the defence and aerospace sector. Let us now dive into the financials of data patterns to see if they align with the positive outlook we’ve discussed. Consistent Track Record *Source: Data Patterns’ Q3FY24 Investors Presentation. Click on the image to enlarge The period of FY19-FY23 tells us that their order book has grown at 40% + CAGR, translating into a healthy revenue growth of ~36% CAGR during the same period. Their EBITDA too has grown significantly from Rs 25.7 Cr in FY19 to Rs 171.8 Cr in FY23 at an impressive CAGR of ~61%. The management expects the growing order book to support revenue growth of 25% + CAGR for the next two years considering the visibility of a healthy order pipeline. A sustainable high margin of ~40% is expected to be maintained as well. Expanding capacity to meet growing demand! In Q3FY24, Data Patterns reported order inflows of Rs 99.1 crore. Below is the detailed breakdown of the company’s order book: *Source: Data Patterns’ Q3FY24 Investors Presentation. Click on the image to enlarge The management of Data Patterns is optimistic about the future, expecting to receive further orders of Rs 600 to Rs 800 crores in the next 2 quarters. To service this growing order book, the company has increased its workforce by 25% in the last fiscal year. As of Q3FY24, Data Patterns has a strong team of 1,298 employees, including over 865 qualified engineers. But wait, there’s more! The company has also commissioned a new manufacturing facility in Q4FY23. Looking ahead, Data Patterns has ambitious plans for further expansion, with a capex of Rs 100+ crores for FY25. *Source: Data Patterns’ Q3FY24 Investors Presentation. Click on the image to enlarge Comparing Data Patterns *Click on the image to enlarge As discussed earlier, most of Data Patterns’ peers are PSUs. In the last 5 years, it has been setting the pace with revenue growth of 36% CAGR which is more than 2x the average of its peers, the nearest rival being Astra Microwave trailing at 29% CAGR. When it comes to EBITDA, it has grown significantly well at 61% CAGR from FY19-23 while the average growth of its peers hovers around 21% CAGR. In terms of return ratios like ROE and ROCE, they are in line with the industry average with HAL leading the pact. Data Patterns’ P/E Ratio is a tad higher at 72 times, compared to the peer average of 62. But hey, let’s not forget that this sector is a playground for PSUs. Is Data Patterns riding the export wave? As we said, India is very keen to transform itself from a net importer to a net exporter of defence products. It’s already on the move with total defence production touching the monumental mark of Rs 1 lakh Cr and defence exports hitting an all-time high of Rs 16,000 Cr in FY23. With products like the Dornier-228, BrahMos Missiles, Akash Missile System, Radars, Simulators, etc., India has expanded its defence footprint to over 85 countries. But, the question remains. Is Data Patterns riding the wave? In FY23, Data Patterns made revenues of Rs 72 Cr through exports which is ~16% of the total revenue. However, this figure has dropped to ~5% in the first 9 months of FY24. When asked, the management said they expect exports to be a major revenue source for them in the next 4-5 years. Currently, they see domestic opportunities as very large and want to focus their capacity on addressing these markets. What is Driving Growth? The funds from the QIP raised in Q4FY23 (Rs 500 Cr) are channeled towards new product developments of existing categories (Radar, Electronic Warfare, Communication systems, Avionics & Satellite Systems). Additionally, The company has its sights on being a major player in contracts worth Rs 2000-3000 Cr in the next 3-4 years. To keep up with the growing order book, they’ve expanded their manufacturing facility and boosted their manpower. Further capex plans of ~Rs100 Cr in FY25. The industry’s tailwinds, like increasing geopolitical tension, higher budget allocation, and supportive government policies, are all playing in their favor. Current Outlook and Valuation Data Patterns showed robust performance in Q3FY24: Revenues grew 25% YoY to Rs 139.5 Cr. EBITDA showed 28% YoY growth to Rs 60 Cr. Gross Margin at 68% and EBITDA Margin at 43%. Strong Balance Sheet, Debt Free Cash, Bank, and Investments– Rs 619.4 Cr Data Patterns’ current Enterprise Value is around ~13,403 Cr. (Market Cap: 14,000 Cr + Debt: 3 Cr – Cash: 600 Cr). In FY23 it posted an EBITDA of ~172 Cr translating into a lofty EV/EBITDA of 77 times as of FY23. As mentioned earlier, its revenues are expected to grow at 25% CAGR over the next two years, while maintaining sustainable EBITDA margins of ~40%. This gives us an estimated revenue of Rs 707 Cr and an EBITDA of Rs 283 Cr bringing the EV/EBITDA to a more descent 47 times as of FY2025E. At first glance, this suggests that EBITDA is set to outpace Enterprise Value, inching towards a more reasonable valuation. While the current valuation might seem steep, it’s a reflection of the high growth potential investors see in Data Patterns. However, it becomes a wait-and-watch game to see whether the management can capitalize on the luring benefits of the industry in the next 2 to 3 years to justify the numbers. What are the risks? High Cash Conversion Cycle The company has a very high cash conversion cycle (275 days in FY23). This means, they always have to maintain strong liquidity to fund their working capital needs. But, the management is optimistic that they can trim it down to ~240 days in the next 2 years. How? Well, the pandemic pressure on inventory days is easing up, and as they ramp up contract executions, the cash will start flowing in faster. Concentrated Revenues  The company is highly dependent on government projects or programs associated with PSUs, with a big chunk of its revenue coming from its top 3 or 4 clients. In FY23, MoD (Ministry of Defence) alone made 31% of its revenues, while DRDO chipped in another 32%. *Click on the image to enlarge The recent stock jump: What’s driving it? To achieve its vision of a self-sufficient defence and aerospace industry, the Indian Government took another bold step last week by relaxing the FDI (Foreign Direct Investment) norms in the space sector. The new norms allow up to 49% FDI in launch vehicles, 74% in satellites, and a whopping 100% in satellite components. As a result, the Singapore sovereign wealth fund, GIC Pvt. Ltd. on account of the Government of Singapore (GOS) and the Monetary Authority of Singapore (MAS) bought a 6.32% stake in Data Patterns for ~650 Cr. This was an open market deal where Florintree Capital Partners divested its entire 10.71% stake in Data Patterns, amounting to nearly Rs 1,100 crore. Meanwhile, Data Patterns stock has been on an up move in the last one month (up 75%). It’s evident that Data Patterns is riding a wave of investor enthusiasm, fueled by India’s strategic policy moves and a vote of confidence from a global investment heavyweight. To Summarize The industry is supported by multiple tailwinds and Data Patterns is strategically positioned to harness these opportunities over the next 2-3 years. Strong balance sheet, Data Patterns stands debt-free with a healthy cash reserve. The company has demonstrated consistent financial growth, with increasing revenues and sustainable high margins. Aim to expand its export revenue in the next 4-5 years, currently focusing on capturing domestic opportunities. While the current valuation is steep due to investor optimism, it’s expected to align with more realistic figures as earnings continue to grow. Data Patterns in part of our Capitalmind Focused Portfolio. So, please consider that we have a bias. Subscribe to the Focused smallcase for access to the full portfolio This post is authored by Sidhanth Paul and reviewed by Krishna Appala, from the team at Capitalmind Research LLP. Disclosure:  Data patterns is part of our Capitalmind Focused Portfolio. This article is intended solely for informational purposes and should not be construed as an investment recommendation. Additional reads: BSE Turnaround story Adding 3 stocks to Focused Portfolio Tata Motors: Is the future green? Divgi TTS: Supplier of transmission systems for Tata Motors