INITIAL COVERAGE: Zen Technologies Ltd.

For the training of defence and security forces around the world, Zen Technologies Ltd. (ZTL) designs, develops and manufactures cutting-edge combat training solutions. ZTL is the exclusive manufacturer of training base simulators 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 (recognized 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 112 patent applications. Hyderabad, India serves as the headquarters of ZTL, which also has operations there and in the USA. ZTL has established itself as a market leader in creating training systems for enhancing and assessing combat readiness, having shipped more than 1,000 training systems across the globe.

INDUSTRY UPDATES:

• India's defence sector is crucial to its national security. India has the second-largest army in the world and spends the third most on its armed forces. The Indian defence industry has recently experienced a much-anticipated boom as a result of the Indian Government's desire for self-reliance. The government has proposed a number of plans and projects to expand domestic defence manufacturing capacity and increase defence exports.
• The framework of Simulators in the Armed Forces is a policy document that the government released in September 2021. This document aims to establish the foundation for the three Services and the Indian Coast Guard (ICG) to more effectively and efficiently utilise simulators. The policy framework calls for a comprehensive vision to promote simulation-based training for warriors, leaders, maintainers, administrators, life science specialists, procurement, and finance agencies across all military sectors. This action intends to decrease the use of live equipment while also attaining cost-effectiveness, efficiency, safety, and quick, creative training.
• To promote indigenous design, development, and manufacturing of defence equipment, a new category of capital procurement called "Buy Indian - Indigenously Designed, Developed, and Manufactured (IDDM)" has been developed.
• The Ministry of defensive has also announced three "Positive Indigenization" lists that contain 310 pieces of defensive gear that must be produced domestically rather than imported.

ABOUT COMPANY:

• About: For the training of defence and security forces around the world, Zen Technologies Ltd. (ZTL) designs, develops and manufactures cutting-edge combat training solutions. ZTL is the exclusive manufacturer of training base simulators 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 (recognized 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 112 patent applications. Hyderabad, India serves as the headquarters of ZTL, which also has operations there and in the USA. ZTL has established itself as a market leader in creating training systems for enhancing and assessing combat readiness, having shipped more than 1,000 training systems across the globe.
• Product Portfolio: The Co.’s broad category of products includes - land-based military training simulators, driving simulators, live range equipment, and anti-drone systems. It also has a training platform in Hyderabad, with an integration of its complete product range, that provides a real battle experience.
• Market Share: Zen Technologies Ltd. is a leader in manufacturing defence training solutions with over 95% market share in tank simulators.
• Order Book: As of September 2022, the Co. had a robust order book of ~Rs. 432 Cr. The breakup is as follows - Annual Maintenance Contracts - 34% and Equipment - 66%.
• Subsidiaries: The Co. has 3 subsidiaries as on 31st March 2022 namely, Zen Medical Technologies Private Limited, Zen Technologies USA, Inc, and Unistring Tech Solutions Private Limited.
• R&D: The Co.’s R&D facility in Hyderabad is recognized by the Ministry of Science and Technology, Government of India. Until FY22, the Co. has applied for 110+ patents. In FY22, it invested ~Rs. 14 Cr in R&D activities.
• Clientele: The Co. relentlessly serves the Ministry of Defence, the Government of India and its Armed Forces, Security Forces and Paramilitary Forces. In FY22, a single customer contributed to ~46% of the total revenue.

BUSINESS MODEL:

Training Simulation Equipment

• A leader in defence training solutions.
• Infrequent but large orders with long closing cycles.
• 90% of orders are from repeat customers.

Counter-Drone Solutions

• Anti-drone systems are used to detect and/or intercept unwanted drones and unmanned aerial vehicles (UAVs).
• The system can detect and deactivate drones of any size within a 4-km radius.
• Remote demonstration – getting a positive response.
• Expect big orders in the coming years.

Annual Maintenance Contract

• A recurring revenue stream with exceptional profitability margins
• New simulator sales leading to growth in revenues from AMC
• Growing service revenue from AMC ensures sustainability
• Have already reached about ₹ 40 crores of annual AMC revenues.
• Will soon achieve ₹ 50 crores of AMC annual revenues. 

BUSINESS UPDATES:

• The company's main business is the design, development, and production of training simulators for law enforcement and paramilitary units, the armed forces, security forces, government agencies like transportation, mining, and infrastructure, as well as the general public. The company's products are broken down into three main categories: driving simulators, mining & special equipment simulators, and land-based military simulators. The business serves both the domestic and foreign markets. The company's manufacturing facility is situated in Maheswaram Mandal, Telangana, India, in Hardware Park.
• Over the course of the product lifecycle, AMCs may be able to earn about 120% of the equipment sale value in income. As the number of simulator installations grows, AMC sales will also climb steadily, which will assist to smooth out the company's annual performance.
• ZTL authorised the conversion of up to 4,69,633 convertible warrants issued to promoters and up to 40,64,627 Compulsorily Convertible Debentures ("CCDs") to marquee non-promoter investors into equity shares in May 2023. These were issued in November 2021 and were exchangeable for shares at a price of Rs. 213 per share.
• The purchase of a 51% stake in Unistring Tech Solutions (UTS) was approved by the board of directors of Zen Tech on August 14. Electronic warfare (EW) solutions, advanced communication systems for defence, telemetry systems, and simulators for radar and EW system evaluation are all areas of expertise for UTS. In November 2021, a public sector undertaking in the defence industry awarded Unistring Tech Solutions Private Limited an order of Rs 61 crore. By assuring a laser-like concentration on the development of electronic warfare and counter-drone technology, it was able to achieve this order.
• Additionally, ZTL has a completely owned subsidiary called Zen Technologies US, a marketing firm.

MANAGEMENT COMMENTARY:

Mr Ashok Atluri, CHAIRMAN & MANAGING DIRECTOR said, "I am pleased to provide you with an update on the impressive performance of Zen Technologies Limited for Q4FY23 and the fiscal year 2023. This year has been a strong one, as we achieved our highest-ever revenue. During Q4FY23, we secured multiple new orders worth ₹141.67 crores,
increasing our orders in hand to ~₹473 crores as of March 31st, 2023. We have placed bids for substantial orders and we expect the results to be out by H1FY24. To capitalise on these potential opportunities, we are taking steps to enhance the bandwidth of our key functions, including Supply Chain, Procurement, and Production Planning. We have also
initiated the recruitment of technical and non-technical manpower to support our growth. Our liquidity position is currently at an all-time high, positioning us well to deliver on our ambitious growth plans. We anticipate a few order wins under the Emergency Procurement plan, which will further accelerate our growth. We are also optimistic about the promising prospects of the export market. Our long-term focus is on achieving leadership in several key areas. Our first priority is to establish ourselves as leaders in the development of
both live and virtual land-based simulators. We are also committed to dominating the anti-drone market through continuous investment in research and development, and by maintaining strong connections with our customers. Additionally, we plan to grow our services business by leveraging AMC. Finally, we aim to expand our global presence, with a
particular focus on the Middle East, Africa and CIS countries.

SHAREHOLDING PATTERN:

FINANCIALS:

• ZTL claimed good performance, solid execution, and several orders won. In Q4FY23, revenue increased by 245% YoY to Rs 95.9 crore from Rs 27.8 crore, mostly due to the quarter's strong order execution.
• EBITDA increased to Rs 35.2 crore in Q4FY23 from Rs 4.8 crore in Q4FY22 thanks to the quarter's strong operating income. In comparison to the same quarter last year, net profit increased to Rs 23 crore from Rs 5.1 crore. In Q4FY23, EBITDA and PAT margins increased to 36.7% and 24.4%, respectively.
•  In Q4FY23, the company received orders totalling Rs 141.7 crore. As of March 31, 2023, there were 473 crore rupees in the total order book. It has submitted bids for sizable orders and anticipates hearing back by H1FY24. It is taking steps to broaden the scope of its core operations, such as supply chain, procurement, and production planning, in order to seize these potential prospects. In order to support its expansion, it has also started the hiring of both technical and non-technical personnel.
• As a result of its dependency on government orders and its operation is based on tenders, ZTL's financial picture has historically been unstable. However, as of FY23, metrics for profitability and return, debt-free status, excellent liquidity, and robust debt coverage look solid.
• ZTL recorded a 26% CAGR in revenue over a ten-year period (from FY12 to FY23). According to our predictions, the company's revenue CAGR from FY23 to FY25E could be at 48%.

INVESTMENT RATIONALE:

• Increasing Focus on Simulators

The recently announced Policy Document on Framework of Simulators in the Armed Forces has created significant opportunities for us, as it aims to promote simulation-based training across all military domains. Going forward, The company will be focusing on leveraging this policy framework to offer innovative, cost-effective, and safe training solutions to the Indian Armed Forces.

• Increasing Revenues from AMC

In the next couple of years, the contributions from the AMC stream will cover the fixed operating expenses of the business. This will provide stability and predictability to the business operation. The huge order wins of equipment can then offer huge operating leverage and boost the bottom line. 

• Strong Government Support to Act as Tailwind

The Government's strict implementation timelines and focus on Make in India and Atmanirbhar Bharat has created a favorable environment for the defense industry. This provides a strong tailwind to the company and the recently announced Agnipath Pravesh Yojna (APY) by the Government presents another emerging opportunity for the Company.

• Increasing Focus on International Markets

The keen focus on export markets has resulted in brisk growth in the export footprint. The Company has a strong product and projects pipeline in the export markets of the Middle East, Africa, and CIS countries and expects exports to contribute more than 30% to the top line in the current financial year. Furthermore fast clearances from the Government for exports further act as a tailwind. 

• Simplification of New Drone Rule-2022 and ban on drone imports in India could bring ample opportunity to ZTL

A drone import restriction is intended to encourage the Indian manufacturing sector to quickly adopt new technologies in order to meet the demands of the Indian market along with the notification of these Rules. New laws and guidelines support the ambitious objective of the Indian government to establish India as a hub for drones by 2030.

RISK:

• Any modifications to the defence forces' procurement procedures or a sizable cut in defence spending could have an effect on the company's earnings and order backlog. Furthermore, any unfavourable changes to government regulations or terms for Defence units may have a longer-term negative effect on ZTL's operations.
• The group's operating efficiency is limited by the revenue profile's volatility, which is represented in the period's fluctuating operating profitability, which ranged from 8% to 43%. Over the medium run, improvement and sustainability of the revenue increase will be crucial to watch.
• 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 high financial risk.
• 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 upcoming capex plans.
• The corporation is susceptible to a number of risks because of the ongoing change in the business, geopolitical, and external environments. These risks are dynamic in nature.

ORDER BOOK:

On March 31, 2023, the company had an unfulfilled order book worth Rs 472.8 crore. The order book is currently 2.2 times the operating income for FY23, which offers sufficient revenue visibility over the next few years. In FY23, the company recorded record-high order inflows of Rs. 203 cr, giving it a good view of future income. 91%–92% of the order book is made up of government nominations, and the remaining 20% is acquired through competitive bidding.

VALUATION & ANALYST COMMENT:

·    To increase profitability, ZTL has concentrated on cost-control strategies and broad indigenization initiatives. Over the previous five years, ZTL has used internal accruals to cover its entire working capital requirement. As of March 31, 2023, the company has a robust cash and bank balance of about Rs 170 crore on a combined basis, which adds to its ample 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 keeps up a heavy investment in R&D, charging 12–14% of revenue to the P&L account each year. It invested 73 crores of rupees in R&D five years ago. Provided with the above-mentioned factors, we aim for 450 levels over the next two to three quarters. Currently, it is trading at 79.1 PE [Median PE at 64.1].

SOURCE:

STOCX.

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