EQUITY RESEARCH: Zen Technologies Ltd.

Zen Technologies Ltd is engaged in the layout, development and manufacture of training simulators. The Company offer its products to police and paramilitary forces, defense force, security forces, govt. departments, including transport, mining, infrastructure and civilian markets. The Company's merchandise are divided into three classes: Land-based Military Simulators, Driving Simulators, and Mining & Special Equipment Simulators. Its products comprises Zen Advanced Weapon Simulator (Zen AWeSim), Zen Small Arms Training Simulator-SL (Zen SATS), Zen Hand Grenade Simulator (Zen HE36S), Zen Driving Training Simulator (Zen DTS), Zen BMP-II Driving Simulator (Zen BMP-II DS), Zen Anti-Tank Guided Missile Simulator (Zen ATGM Sim), Zen Artillery Forward Observer Simulator (Zen ArtyFOS), Zen Driving Simulator (Zen DS) & Zen Automated Driving Simulator (ZEN ADS), Zen Tactical Engagement Simulator (Zen TacSim), and Zen 81mm Mortar Integrated Simulator (Zen 81mm MIS), among others.

Zen Technologies Ltd.

ABOUT

• For the training of defense and security personnel around the world, Zen Technologies Ltd. (ZTL) designs, develops and manufactures cutting-edge combat training solutions. ZTL is the exclusive manufacturer of training base Simulator in India. The company creates driving simulators, live range equipment, anti-drone systems, and land-based military training simulators. To support both individual and group training capacities, ZTL creates more than 40 different Live Fire, Live Instrumented, Virtual, and Constructive training systems.
• The company has dedicated R&D (accredited by the Ministry of Science and Technology, Government of India) and production facilities in Hyderabad, and it has sold more than 1,000 training systems around the world and filed over 130 patent applications. Hyderabad, India serves as the headquarters of ZTL, which also has operations there and in the USA. The company employs 611 people, including 320 contract workers and more than 120 of them work exclusively in R&D services. ZTL has developed excellent R&D skills.

• Zen Technologies Limited was incorporated in 1996. The co. designs develops and manufactures combat training solutions for the training of defense and security forces. It is actively involved in the indigenization of technologies, which are beneficial to Indian armed forces, state police forces, and paramilitary forces.

• Product Portfolio
  1 Training Simulation Equipment: A leader in defense training solutions
  2 Counter-Drone Solutions: Anti-drone systems are used to detect or intercept unwanted drones and unmanned aerial vehicles (UAVs). The system can detect and deactivate drones of any size within a 4-km radius.
  3 Annual Maintenance Contract(AMC): A recurring revenue stream with exceptional
  profitability margins.
• Market Share
  Zen Technologies Ltd. is a leader in manufacturing defense training solutions with over 95% market share in tank simulators. 
• Geographical Split - FY23
  Domestic - 56%
  Overseas - 44%
• Segment Revenue Mix FY23
  Sales of Equipment: 78%
  AMC: 22%
• Subsidiaries
  Co. has 3 subsidiaries as of 31st March 2022 namely, Zen Medical Technologies Private Limited, Zen Technologies USA, Inc, and Unistring Tech Solutions Private Limited. 
• R&D
  Co.’s R&D facility in Hyderabad is recognized by the Ministry of Science and Technology. As of FY23, Co. had filed 110+ patents of which 27 were granted. In FY23, investment in R&D reached an all-time high of nearly ₹19 crores, significantly higher than the average of ~₹14 crores spent in the last 5 years.
  The company developed Anti-Drone system technology and is making further investments in the development of Air Defence Gun Simulators. **
  Investments made in R&D are written off in P&L in the same year**.
• Clientele
  Ministry of Defence, Government of India and its Armed Forces, Security Forces and Paramilitary Forces. 
  In FY22, a single customer contributed to ~46% of the total revenue. 
• Preferential Issue
  During FY22, co. allotted ~40 lakh 10% Compulsorily Convertible Debentures (CCDs) for cash, for an aggregate amount of ~ ₹ 86.5 Cr, which shall be converted into an equal number of Equity Shares of ₹ 1 each within a period of 18 months, on a preferential basis to the general public. It also allotted ~4.7 lakh Convertible Warrants, convertible into 1 equity share of ₹ 1, so as to raise up to ₹ 10 Cr on a preferential basis to the Promoters. 
• Strategic Focus
  The company plans to establish itself as a leader in the development of live and virtual land-based simulators. They also want to dominate the anti-drone market through continuous investment in R&D, and by maintaining strong connections with its customers. Additionally, the company plans to grow its AMC business and aims to expand its presence in the Middle East, Africa, and CIS countries.
• REVENUE STREAMS:

SHAREHOLDING PATTERN

ORDER BOOK:

The order book position of the simulators over the years

The order book position of the ADS over the past two years

Board of Directors

AUG CONCALL SUMMARY

Summary:

Financial Performance:

• Zen Technologies reported a strong performance in Q1 FY '24, with a new record for the company and a significant improvement in the order book position.
• The company has a strong liquidity position with INR 275 crores of cash as of July 2023.
• The EBITDA margins are expected to be sustainable, and the company anticipates strong revenue and profitability growth in the next few years.
• The company's order book is approximately INR 1000 crores, with around INR 340 crores from exports and INR 660 crores from domestic orders.
• Zen Technologies anticipates a net margin of around 25% going forward.
• The company expects significant growth in the next four to five years and is optimistic about the current and next financial year's performance.

Product and Market Focus:

• Zen Technologies is focused on R&D and developing intellectual property to become a dominant force in simulators and anti-drone systems.
• The Indian government's focus on IP ownership and the defense positive list has provided a boost to Zen Technologies, leading to increased demand for their products.
• The company expects a huge acceleration in the procurement of simulators by the Government of India due to the simulation framework and the cost-saving benefits of simulation.
• There is a growing demand for simulators and anti-drone systems globally, with foreign countries showing interest in Zen Technologies' products.
• The market size for simulators is estimated to be around INR 15,000 crores.
• Zen Technologies is fully utilizing its manufacturing capacity for anti-drone systems and has a network of vendors for manufacturing.
• The company's order book is fixed-price orders, with a focus on the Middle East, Africa, and CIS countries for exports.
• The Agnipath Pravesh Yojana initiative by the Indian government has accelerated the procurement of simulators for the armed forces.
• Zen Technologies has a strong position in the anti-drone systems market, with most competitors relying on imported products.
• The company expects to win a majority of the orders in the anti-drone systems market due to its ability to make software and hardware changes to tackle evolving threats.
• In the simulator market, Zen Technologies faces little competition, especially in specialized products like tank simulators and air defense simulators.

Intellectual Property and Competitive Advantage:

• Zen Technologies has filed 110 patents, with 27 already granted, providing a competitive advantage and helping secure orders.
• The company expects to maintain a gross margin of the current level, with some variability based on product mix.
• Zen Technologies has a success rate of around 80% in winning orders.
• The company is open to inorganic acquisitions that align with its existing products and strategy.

Dividend Policy and PLI Schemes:

• Zen Technologies is considering revising its dividend policy to benefit shareholders.
• The company does not foresee any major export bottlenecks due to security reasons.
• Zen Technologies is not currently benefiting from any PLI (Production-Linked Incentive) schemes but is advocating for a PLI scheme for anti-drone systems.

FINANCIALS

Q1FY24 Result Update

• ZTL claimed good performance, solid execution, and several orders won. It reported good performance, obtained numerous orders, had strong executions, and had the highest level of liquidity ever. In Q1FY24, revenue increased by 257.3% YoY to Rs 132.4 crore, driven primarily by strong order execution.
• EBITDA increased to Rs 68.9 crore in Q1FY24 from Rs 10.8 crore in Q1FY23 thanks to the quarter's strong operating income. In comparison to the same quarter last year, net profit increased to Rs 47.1 crore from Rs 7.5 crore. In Q1FY24, the EBITDA margin and PAT margin increased to 52% and 35.6%, respectively.
• As of June 30, 2023, the whole order book was worth Rs 543 crore, or 1.5 times the TTM sales.
• As a result of its dependency on government orders and its operation being based on tenders, ZTL's financial picture has historically been unstable. However, as of FY23, metrics for profitability and return, zero debt, excellent liquidity, and robust debt coverage all appear solid.
• ZTL reported that its revenue CAGR from FY12 to FY23 was 26%. According to our predictions, the company's revenue CAGR from FY23 to FY25E could be around 78%.
• ZTL's net profit has fluctuated over the past ten years; in FY23, it was Rs 42.7 crore compared to Rs 2.2 crore in FY22. We anticipate that the company will record a 98% PAT CAGR from FY23 to FY25E.
• To increase profitability, ZTL has concentrated on cost-control strategies and broad indigenization initiatives. Over the past five years, ZTL has utilized internal accruals to cover its entire working capital requirement. As of July 31, 2023, the company has a good cash and bank balance of roughly Rs 275 crore on a consolidated basis, which is indicative of adequate liquidity.
• As a debt-free business with a strong liquidity profile, ZTL is anticipated to generate enough cash from operations to cover dividend payments and capital expenditures. Additionally, the business continues to spend extensively on R&D at a rate of 12–14% of revenue, which is charged to the P&L account on an annual basis. In the last five years, it has spent 73 crores of rupees on R&D.

Key Updates

Strong order book brings better earning visibility going forward

As of September 5, 2023, the company had unfulfilled orders of Rs 1275 crore (Simulator product: Rs. 590.99 crore; Simulator AMC: Rs. 228.3 crore; and anti-drone systems: Rs. 456.1 crore), up from Rs 543 crore (Simulator product: Rs. 240.2 crore; Simulator AMC: Rs. 145.6 crore; and anti-drone systems: Rs. 157 crore) as of June 30, 2023. An order book is at 4.1 times TTM Sales, which offers sufficient revenue visibility over the next few months. After the first quarter of FY24, the firm reported a healthy order intake of Rs 732 crore, which included both equipment and AMC components, giving it a strong revenue outlook for the following few years. 91%–92% of the order book is based on government nominations, and the remaining 20% is acquired through a bidding process. It obtained a further order for Rs. 227.65 crore from the Ministry of Defense on September 22, 2023. According to the present order pipeline and ZTL's success record of about 80% in gaining orders, order inflow for the remaining portion of FY24 is anticipated to be between Rs 200 and 300 crore. Given its degree of experience, technical prowess, and good track record of execution, the company anticipates being a major beneficiary of the prospective prospects resulting from the government's emphasis on indigenization.

Expectation of huge growth opportunity in AMC business

With more than three decades of experience in providing cutting-edge military training and counter-drone technologies, ZTL has been a market leader. The business produces cutting-edge driving simulators, live range equipment, counter-drone systems, and land-based military training simulators. The global market for military simulation and training is predicted to increase at a 5.6% CAGR between 2022 and 2027, rising from an anticipated US$ 9.2 billion in 2022 to US$ 12.2 billion by 2027E. This buoyancy is the result of rising defense spending globally for the creation of new technology to improve defense effectiveness and military and training capabilities. Simulators and drone/anti-drone systems are projected to be in higher demand as unmanned technologies for defense become more prevalent. In the Indian context, the addressable market for army training simulators is estimated to be worth approximately Rs 15,000 crores. The armed forces spend over Rs 1,000 crores a year on simulators. Agnipath Pravesh Yojna (APY), which was recently announced, might provide young people in the nation with the chance to serve in the armed forces as agnives for a 4-year tour of duty, which could increase demand in the future. One of the biggest players in India's training and ground simulator markets is ZTL. The simulators that ZTL sells come with a 36-month warranty. After the 36-month warranty period has passed, the company receives 10% of the order value as AMCs (Annual Maintenance Contracts). The AMC business eliminates the lumpiness in new equipment orders while simultaneously providing strong margins. The AMC division contributed about 22% of the company's total revenue in FY23. A simulator has a 15-year lifespan and offers a lifetime earning potential of 120% of product sales. According to the current order execution, ZTL's AMC revenue, which is currently at Rs 40 crore, could rise to Rs 70 crore by 2025 and Rs 150 crore by 2027–2028.

Expectation of margin stability

The profitability of ZTL has fluctuated in the past as a result of high input costs and other expenses, particularly R&D costs. Due to strong revenue growth and attempts to reduce costs, its tale has now entered a phase of expansion. The business is upbeat about the performance of the current and next fiscal years and anticipates significant growth in the following four to five years. With minor variation based on product mix, the company anticipates maintaining its existing gross margin. The company predicts robust revenue and profitability growth over the next five years, and the EBITDA margins should be sustainable. Going ahead, the business anticipates reporting a sustainable net margin of about 25%.

KEY RISKS

• Any modifications to the defense forces' purchasing practices or a sizable cut in the defense budget could have an effect on their revenue and order backlog. Additionally, any unfavorable changes in governmental conditions or policies from Defense units may have a long-term negative impact on ZTL's operations.
• Since the defense industry has been opened to the private sector, large private players like Adani Defence and Aerospace, L&T, Bharat Forge, Data Patterns, etc., and PSU players like BEL and BDL, etc. pose a challenge to ZTL's market share.
• ZTL's revenue generation and financial flows are susceptible to delays in project execution or, in some cases, final payment clearing because of the large concentration of orders from the government sector. Going forward, ZTL wants to take advantage of the non-defense commercial opportunity, which includes exports.
•  The majority of the company's simulators are developed in response to detailed client feedback, but there is no assurance that customers would purchase the finished product, placing the company at a high financial risk.
• The common government practice of selecting the vendor with the lowest price could be detrimental to the business. Due to their bigger bandwidth, other suppliers occasionally offer less expensive solutions because their development expenses have already been amortized.
• Any significant capital expenditure financed by debt and/or an extension of the working capital cycle could have an adverse effect on the company's operations and long-term capex plans.

VALUATION

ZTL's order book has been strong; as of September 5, 2023, it was at Rs 1275 crore, or 4.1x TTM revenue. Simulators and anti-drone systems are mostly in charge of this. It received a further order for Rs 227.65 crore from the Ministry of Defence on September 22, 2023. According to the present order pipeline and ZTL's success record of about 80% in securing orders, order inflow is anticipated to be between Rs 200 and Rs 300 crore for the remaining FY24E. Given its degree of experience, technical prowess, and good track record of execution, the company anticipates being a major beneficiary of the prospective prospects resulting from the government's emphasis on indigenization. ZTL anticipates rapid expansion in the subsequent four to five years and aims to meet its aspirational revenue forecast of Rs 1,000 crore during that time frame.

The majority of ZTL's rivals in the anti-drone systems market rely on imported goods, whereas the company is making full use of its anti-drone system production capability and has a network of vendors for manufacturing. Due to its capacity to modify both its software and hardware to address changing threats, the business anticipates capturing the majority of orders in the anti-drone systems industry. Additionally, the Indian government's Agnipath Pravesh Yojana initiative has sped up the purchase of simulators for the armed forces. Military training simulators are thought to have a market worth roughly Rs 15,000 crores. However, ZTL is up against competition in the simulator business, particularly in highly specialized goods like tank simulators and air defense simulators. The assigned target price is 735.

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