Hey. Thank you for sticking around and for the patience that’s got you this far. 

As we delve into the next part of this series on building critical technology prowess,  it’s important to highlight the critical junction India finds itself at. Our previous discussion painted a vivid picture of the vast opportunities and formidable challenges that lie ahead for India in its quest to become a manufacturing powerhouse.

Read the Part-1 Here:

We have seen how the country’s efforts, through initiatives like Make in India and the Production Linked Incentive (PLI) schemes, have sparked life into sectors like Pharmaceuticals, Chemicals, Textiles, Electronics, and Automobiles. The push to establish a Semiconductor ecosystem signals India’s serious intent to play with the big boys in the global supply chain. Yet, despite these strides, there are systemic hurdles that continue to impede our progress, from bureaucratic red tape and archaic labor laws to costly energy tariffs and cumbersome land acquisition processes.

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The stakes have never been higher. Geopolitical dynamics demand that India becomes truly ‘Atma-Nirbhar’ or self-reliant, especially in high-tech and high-value manufacturing. While we acknowledge the challenges, it is equally important to recognize and celebrate the brave pioneers who are forging ahead despite these obstacles.

This brings us to the subject of today’s discussion – an intriguing company that exemplifies this bravery. They are not just assembling gadgets; they are innovating, creating, and pushing the boundaries of what is possible. They stand as a testament to what India can achieve when intent meets innovation.

Azad Engineering : The Alpha

This is the company which  had consciously decided to enter a niche market where it is manufacturing life-critical and project-critical parts. Yes. Life-critical because the products they are into, their every detail can mean the difference between life and death. 

It’s ‘the’ alpha. Though not the only one.  But in this jungle – it is the only one. 

It is Azad Engineering. 

Oh. Before you yell at me, I know it doesn’t manufacture jet engines (yet) nor does it manufacture turbines used in nuclear or thermal power plants. I get it. However, its products play a critical role in each of the below segments.  And we don’t have to be a geopolitical schemer like Henry Kissinger to understand that each of these segments plays a crucial role in ensuring the security of any nation.

Source: Company Website

Rakesh Chopdar, a high school drop-out and first generation entrepreneur, started with just a single CNC machine in 2008 and since then this company has gone on to  manufacture products which are used in Sukhoi and Brahmos. 

Just like the movies, innit? 

Azad Engineering Ltd. supplies precision-forged and machined components, including airfoils/blades and other special machined parts, to the Energy/Oil and Gas, Aerospace and Defense industry. 

And oh. Did you know that Sachin Tendulkar is an early investor in this business? No wonder he is the master blaster. 

Serving power plants or Aircraft manufacturers, Azad’s high-precision, mission-critical components meet a “zero defects” standard, and has made the company a vital link in the global supply chain.

Airfoils, also known as blades, are the curved or flat surfaces on aircraft wings or other structures that help generate lift or propulsion by interacting with the air. And these are highly critical for the performance of a turbine engine.

Fuel efficiency of a turbine is highly dependent on Airfoils and minor deviations in design could lead to significant detrimental impact on fuel consumption.

And mind you, these are the parts never seen in India before Azad and their competition for their  product line is with the US, China, Europe and Japan.

There are companies like Paras Defense, MTAR and others in India who provide components to OEMs but Azad has the highest operating margins and PAT margins of all indicating that their product line is relatively advanced and critical to these OEMs.

Source: Azad Engineering RHP

Business Mix

With north of 85% business coming from exports, Azad is catering to multiple customers across the globe while  having an average relationship for over 10 years with many of their key customers. 

I have clubbed their business into 2 key verticals for simplicity. 

1. Aerospace and Defense

Source: Q4FY24, Investor Presentation

In this segment Azad manufactures precision components critical for civil and military aircraft, including airfoils, valves, housings, and flight control systems. These parts are made from investment castings, forgings, and bar stock, with rigorous machining and testing processes. Additionally, they  produce aerospace fluid distribution parts using advanced forging technology, ensuring performance in extreme conditions. 

Their products undergo stringent qualification processes to meet aerospace standards and are tested using specially designed equipment.

Source: Azad Engineering Website

These goods are used in both new builds and by Maintenance, Repair, and Overhaul (MRO) service providers.

Essentially, a buyer uses Azad’s Indian-made parts directly in engines flying at 30,000-35,000 feet. Any failure could be catastrophic, won’t it? 

Hence, at the cost of repeating, Azad’s products are life-critical.

Azad Engineering Ltd. supplies components to the below mentioned original equipment manufacturers (OEMs) in the Aerospace & Defence segment mentioned below:

• The Boeing Company,
• Airbus SE, 
• Collins Aerospace, 
• Eaton Corporation Plc, 
• GE Aerospace, 
• HAL, 
• Honeywell International Inc., 
• Lockheed Martin Corp., 
• Safran S.A.. 

If you have been following the counter or are a defense nerd, Azad Engineering will manufacture and supply complex components for defense aircraft engines to Rolls-Royce over the next 7 years.

With this, Bharat along with Azad got a foot in the exclusive and closed global supply chain of advanced engine technology. It might just be an air blade but it will give India an opportunity to demonstrate its growing prowess in advanced manufacturing.

Add to it the development of GE aerospace signing an MOU with Hindustan Aeronautics Limited (HAL) in June 2023, to produce GE’s F-414 engines for Tejas Light Combat Aircraft Mk2 in India. This too will further open up opportunities for Azad Engineering Ltd.

2. Energy/Oil and Gas

Source: Q4FY24, Investor Presentation

Airfoils/ blades are one of the most critical three dimensional/3D rotating and stationary parts of a turbine in the compression section. These are used in generation of energy by means of natural gas, nuclear (clean energy) and thermal operations. To sustain the high pressure, airfoils/ blades are made up of exotic/ super alloys and manufactured with a unique process which is designed in-house by Azad.  These are highly engineered and complex parts which have a high entry barrier in terms of qualification and production. Azad also supplies rotors to these turbine OEMs.

Source: Azad Engineering Website

Though the below headline might just seem like any other order-win but the Global Head of GE Vernova visited the site himself to walk-down Azad’s upcoming facility in Hyderabad. This sends a message not only to Azad but to India as well. The world is looking at us. We just need to believe.

Source: LinkedIn, Director- Aerospace & Defence, Govt of Telangana

Interestingly, Azad Engineering Ltd. also supplies components to the biggest players in the oilfield industry. Their products in this segment include drill bits and slips which are used in the drilling equipment and are part of the exploration and production in the oil and gas fields.  Additionally, the company also supplies downhole drilling tools such as reamers.

Azad Engineering Ltd. supplies components to some of the manufacturers of drilling equipment like:

• Schlumberger Limited, 
• Baker Hughes, 
• Halliburton, 
• NOV Inc., 
• RPC Inc.

At an overall level, the company has delivered 3.09 million ‘zero-defect’ units between FY09 to FY23. That says something of the quality of the company.

Though 84% of their revenues come from Energy/Oil Gas Segments and about 13% from Aero & Defense segments, the fascinating story is the 95% growth in the latter’s contribution to Azad’s overall revenue. 

And just as I was writing this blog, a notification alert popped up:

Source: Exchange Filing

The Defence Research and Development Organization’s (DRDO) Gas Turbine Research Establishment (GTRE) had issued a tender for the development and production of 20 Advanced Turbo Gas Generator (ATGG) Engines, including spares, within 30 months. This tender aims to engage Indian industry partners in creating manufacturing, assembly, and integration technologies. 

Source: IDRW

The ATGG, a single-spool turbojet engine with advanced features, is designed for various aerospace applications, including UAVs, drones, and other aircraft. 

Source: Varun K on X/Twitter

And guess what? Azad Engineering has been selected as the sole industry partner, and will deliver the first batch by early 2026. GTRE will provide critical engine components and ready-to-fit parts to support this initiative. 

This collaboration enhances India’s defense manufacturing capabilities, promotes self-reliance, and demonstrates the nation’s growing expertise in advanced engineering and technology. 

Do note that the quantum of this order wouldn’t be huge to move the needle immediately in terms of the order book for Azad or the ’in-limbo’ indigenous jet engine project –  but it is a start for both. 

Azad Engineering: The Financials

I know what you’re thinking, “We get it bro but what’s it to do with investing?” 

Listen here, sir or ma’am , I’ve got a few reasons why we like companies like Azad Engineering that might help you appreciate the potential manufacturing prowess that might come out from India if we decide to get serious about it. 

First off, the quality of the products is crucial – we’re talking zero parts per million defects requirement. That’s right, these products are going into super critical and expensive end use applications, so they better be damn near perfect. And it’s not just about fancy machines, it takes a unique blend of expertise, innovation, quality, and advanced safety controls to make it happen. Plus, you can’t forget about adherence to delivery timelines – nobody wants to get slapped with a penalty for delay in adhering to service and order timelines. 

So this will separate the wheat from the chaff. 

Moreover, with geo-political risks breaking roofs, supplier locations now are closely monitored by OEMs , and India is increasingly being considered a strategic procurement destination. 

Sure. Quality is paramount but we also know that OEMs/Government are in it for the money too so pricing is a big factor too. Everyone wants to save a buck, and Indian players are 20-30% cheaper.  

But don’t think it’s easy to break into this industry. 

The entry barrier is high, thanks to a lengthy qualification process for energy components. It takes 36-48 months to even qualify as a supplier, and that’s not counting the time and resources needed to set up manufacturing infrastructure and facilities. 

And once you’re in, you better be ready to spend a lot of time and money on design, manufacturing, first article inspection (FAI), and testing & certifications.[Also, park this point.] 

The gravity of the situation needs to be understood by the readers. 

Just like the semiconductor industry, the global supply chain in these critical sectors, especially the Aerospace and Defense sector  is more or less controlled by a few set players. Control over the supply chain is critical in this industry since the tolerance for error is non-existent. Ability to ramp to meet the production schedules is also a key requirement for the OEMs and Tier1 players. They prefer suppliers who can provide this consistently. 

Securing a recent long-term contract with Rolls-Royce, in addition to being a critical component supplier to Airbus and Boeing, is no small feat. Azad has muscled its way into a tight knit supply chain of complex component manufacturers for these marquee players. 

Another way to look at this is  given the time invested by OEMs (3-4 years)  in the qualification process, they then become reluctant to switch suppliers as there are high switching costs. They simply don’t switch unless the current suppliers are unable to meet the requirements on quality, cost, or delivery.

Source: Q4FY24, Investor Presentation

Azad Engineering believes that it would take a new entrant in our industry approximately 15-20 years to achieve the market position that they currently hold. It’s a significant head start for any one in the industry to have. 

But wait. Are you scratching your head at the insanely stretched working capital cycle along with negative cash flow generation and thinking “So much for high entry barriers and high switching cost? The bugger is even trading at 140 times TTM earnings.” 

Source: Q4FY24, Investor Presentation

Your concerns are valid but here’s me playing the devil’s advocate. 

Let’s break it down to the specific industries that Azad caters to.

Energy Sector:  Given that Azad Engineering has been present in this segment since the last 15 years, it has a well-established energy business with a cash conversion cycle of approximately 130 to 140 days. This is a result of years of optimization, including streamlining processes and managing working capital efficiently.

Aerospace and Defense, Oil and Gas Sector: Being a recent entrant, these sectors are currently under stringent qualification processes. This poses unique challenges to working capital management for Azad as during the qualification phase, each part and component that are produced are held as inventory until they are approved. (Check Phase 3 below). This results in a temporary inventory buildup, longer lead times,  thus, tying up capital and extending the working capital cycle.

Source: DRHP

Moreover, in order to get their foot in the door, they don’t have much bargaining power against behemoths like Rolls Royce and GE Vernova in terms of the payables. But the belief in the management is that just like a fine whiskey, the relationship between Azad Engineering and their partners will only get smoother with time.

Also, as Azad Engineering indigenizes its raw material procurement, the working capital burden is expected to decrease gradually. Local sourcing can lead to reduced lead times and lower inventory costs, contributing to an improved working capital cycle over time.

The young and dynamic top-team of Azad aims to achieve a blended working capital cycle of 130 to 140 days across all business segments by FY26 and FY27.  

Value Chain and Client Concentration

The manufacturing value chain for Aerospace & Defense (A&D) components consists of four key steps: design, component manufacturing and subassembly of systems, final assembly of specific parts, and post-production services. 

Source: DRHP

The final assembly of aircraft is exclusively carried out by the OEMs such as The Boeing Company and Airbus SE. The final aircraft assembly is only done by OEMs like The Boeing Company and Airbus SE and a tier 1 player does assembly of a particular system. 

On the other hand, a tier 2 supplier primarily supplies subassemblies and components (e.g., blades, fasteners, engine parts etc.) which are then integrated into the final assemblies like that of a propulsions system.

Source: DRHP

One might say that Azad has a client concentration problem. But hey,  GE, Mitsubishi, and Siemens monopolize 70% of the industry, while Boeing and Airbus snatch up a whopping 91% of the aerospace market. Finding new customers? Well, that’s like searching for needles in a haystack.

Azad Engineering has tapped into a market worth over $28 billion-plus, making its presence known across various segments. From airfoils, engine components, hydraulic parts, to flight control parts and air generation systems, Azad Engineering’s product range encompasses a comprehensive array of critical components. Their ability to serve these diverse segments showcases their adaptability and technical prowess. And now with the GTRE order, they have breached the ceiling of just being a Tier-1 component supplier to a system manufacturer and assembler.

In other words, they have ascended the steps of the A&D value chain. 

Source: Q4FY24, Investor Presentation

Conclusion

Azad Engineering operates four advanced manufacturing facilities in Hyderabad, Telangana, India, boasting the capability to produce high precision forged and machined components across approximately 20,000 square meters of total manufacturing space. Additionally, the company has two upcoming manufacturing facilities planned in Telangana, which will be 10x their capacity in the time to come. 

The important thing to note here is that these new facilities are intended to be financed through internal accruals. In light of the negative operating cash flow generation, it will surely be a key monitorable as and when capital is to be employed for these expansions. 

For the first phase of expansion starting FY25, Azad has already set aside Rs. 120 Crore from the IPO proceeds.

The proposed manufacturing facility is expected to feature a dedicated manufacturing / production line catering exclusively to specific customers. 

Initially, the focus will be on producing critical and complex components such as airfoils/blades and other specialized machined parts for gas and thermal turbines and Mitsubishi Heavy Industries, Ltd., a long standing client, is slated to be among the first beneficiaries of this exclusive manufacturing setup.

Azad also intends to augment their facilities by undertaking inorganic acquisitions to enhance their manufacturing facilities and provide value-added services adjacent to their business. Azad has already set-up a subsidiary of a recent acquisition which will help in reducing its dependency on 3rd parties as it will cater to captive requirements while also serving other OEMs. This will again help in reducing the inventory built up.  

The capacity is optimally being utilized at about 80-85% capacity, Azad has over delivered on its topline growth in FY24.  Utilizing the same operating capacity and further optimizing on its efficiency, and with  ~Rs. 3200 Crore order book (Rs. 1700 from A&D and Rs. 1500 from Energy/Oil & Gas) sealed,   the management is confident of delivering a 25-30% of topline growth and ~30-35% EBITDA growth with ~35% OPM in  FY25.

It is evident from the management commentary that the IPO proceeds have helped tremendously in strengthening their balance sheet and its utilization in further capex will result in FY26 to be an inflection point for Azad where they can even outpace their current run-rate of ~30-35% topline growth. Moreover, they plan to  further deleverage their balance sheet in FY25.  

With product mix shifting towards high value added adjacencies and interest cost coming down, we might see an increase in the EPS of the company from FY26 onwards. 

Add into it the matter of  working capital normalizing, Azad’s return on capital will gradually increase sequentially in the time to come. However, a company which is bleeding cash flow at operating level and trading at such high valuations can be optically repulsive to investors and understandably so. 

But a business which is commanding gross margins of 82-87% and has an unconventional knack of only targeting complex and critical products is surely to be looked at with an interest. More so, when the Total Addressable Market is $28bn and growing. Though Azad currently might have only 1% of the wallet share of this market, any incremental increase of 100-200 bps in market share will be a huge topline turner. 

The company in its latest GTRE/DRDO order win said “By entering the production of complete gas turbines, AZAD is set to play a more integral role in India’s defense sector manufacturing capabilities, enhancing self-reliance Prime Minister Shri Narendra Modi Ji’s vision of “Atma Nirbhar Bharat”. Well ,such companies are refreshing, especially as the company and its promoters are young and hungry for nation-building. Celebrate them. 

The world order is changing and global supply chains are in a flux. Bharat needs to seize the moment. It’s now or never. 

Once again, repeating what I said in the Part-I of this series, companies like Azad are showing courage and confidence. It’s about time we started ‘building and manufacturing’ things and not rely on imports. There are second order effects of this which will help us in the long run but none will be as consequential  than what Krishna espouses in Gita. 

PS.  @protosphinx is a huge proponent of manufacturing in India.

Source: X/ @protosphinx