Defence sector firms set for gains as India pushes indigenous manufacturing

Companies like BEL, BDL and HAL have strong order books and are prepping for the export market, say analysts

A strong June quarter performance, expansion of indigenisation list, the potential for higher exports, and valuations are positive triggers for listed defence sector companies. Their stocks were rerated over the last year, with Bharat Electronics (BEL) and Hindustan Aeronautics (HAL) rising 68-72 per cent and Bharat Dynamics (BDL) doubling over this period. Given the triggers, the momentum is expected to continue.

The immediate trigger is the expansion of the list of items the government announced last week domestic companies will manufacture in a move aimed at curbing defence imports. This is sixth list of 780 items comprising components, subsystems and line replacement units. The defence ministry has included 310 platforms/equipment over the last couple of years. These include combat and utility helicopters, combat aircraft, submarines, corvettes, and missile systems.

BEL, the largest listed defence player by market capitalisation, would gain from the indigenisation drive. The company’s order pipeline stands at over Rs 50,000 crore across multiple missile systems. It expects an order inflow of Rs 20,000 crore every year as revenues improve 15 per cent annually for the next three years.

Localisation is expected to help reduce BEL’s import proportion from 35 per cent of raw materials to 15-20 per cent, boosting operating profit margins by 100-200 basis points. Exports are expected to double in FY23 and grow later given the company’s order book of $270 million. JM Financial has a positive view on the company given its order book, margin resilience and strong balance sheet with a five-year return on invested capital of 42 per cent.

Among other beneficiaries is BDL given the company’s focus on the indigenous missile development programme and incremental growth in exports. BDL is the sole supplier of surface-to-air missiles, torpedoes and anti-tank guided missiles to the Indian armed forces and it is expected to benefit from the growth in the missiles and torpedo segment that is slated to reach the $24.5 billion by CY26. Antique Stock Broking expects the company to deliver 27 per cent annual revenue growth and 26 per cent earnings growth over FY22-24 given the Rs 13,000 crore order book and improving execution. BDL expects to finalise orders worth Rs 22,000 crore in two to three years to improve revenue and earnings, said the brokerage.

Analysts believe that in addition to larger PSUs, smaller manufacturers across the value chain across sub-segments will be major gainers. “We remain positive on the indigenization story and are encouraged by rising exports pie. We believe small and medium private defence companies such as Data Patterns, MTAR Technologies, Paras Defence, Astra Microwave, Dynamatic Technologies, Taneja Aerospace would likely emerge as key beneficiaries,” said Harshit Kapadia and Mudit Kabra, of Elara Securities.

A shortage of semiconductors and execution delays affected some defence PSUs in the March quarter. However, ICICI Direct highlights that all defence companies saw a noticeable pick-up in execution in Q1FY23, which led to significant increase in their revenues. BDL, where revenues jumped over 5 times year-on-year (YoY), reported the highest growth among such companies. It was followed by HAL (124 per cent growth YoY) and BEL, Mazagon Dock Shipbuilders and Garden Reach Shipbuilders (80-90 per cent growth).

The stocks have run up quite a bit due to the sector rerating, but valuations are attractive for HAL, BEL and BDL at 16-24 times FY24 earnings estimates, according to ICICI Direct. This is given strong visibility on orders and earnings growth over the next two years.