Defence stocks fly high on strong order books, export potential

Mumbai: Defence stocks rallied on Monday after several public-sector companies from the industry, such as Hindustan Aeronautics (HAL), Bharat Dynamics, Garden Reach Shipbuilders & Engineers and Mishra Dhatu Nigam, started conducting investor outreach programmes normally associated with top-draw banks and technology powerhouses.

Swelling order books from the ministry of defence have caused defence stocks to surge. With comfortable valuations, better outlook on profitability led by a higher indigenization theme, and better operating leverage, analysts are bullish on stocks such as HAL, BEL, Bharat Dynamics, and Garden Reach, among others.

Shares of Hindustan Aeronautics surged 7.4% on Monday, while Garden Reach, Paras Defence, and Bharat Dynamics gained 4% each. Bharat Electronic rose 3%.

"The sector is buzzing on the back of a strong order book, orders from the government, technological advancements and requirements in keeping with the geopolitical environment and export orders," said Ashwin Patil, analyst, LKP Securities. "Valuations, too, seem comfortable. We are bullish on the sector, particularly on BEL due to additional positives like a lean balance sheet, better working capital management, and emphasis on some non-profitable non-defence sectors."

Amid rising demand for indigenization, the defence sector outlook is seen as positive, and analysts expect about ₹5 lakh crore of ordering and tendering opportunities in the defence sector.

"The thrust of the Indian government toward domestic products for developing a self-reliant defence sector will bring greater opportunities for new orders for defense companies," said Rajesh Sinha, analyst of Bonanza Portfolio. "PSU defence stocks are still trading at an attractive valuation, and a healthy pipeline of orders gives more comfort in the longer term for these defence stocks."

Most defence companies have strong revenue visibility with order books at 3-4 times their trailing 12 months' revenues. HAL currently trades at a PE of 19 times FY23 estimated earnings, while Bharat Dynamics trades at 12.2 times. Bharat Electronics and BEML are traded at one year forward PE of 29 times.

The defence ministry approved the sixth positive indigenization list of 780 items, comprising line replacement units, sub-systems, and components, on 28 August 2022 to curtail defence imports further.

According to analysts, most of the defence firms are in a phase of rapid transition towards procuring from domestic players rather than going for indigenization in the wake of Make In India mission, as well as costlier imports. Analysts say that small and medium domestic private companies are major beneficiaries of the indigenization.

"We remain positive on the indigenization story, and companies such as Data Patterns, MTAR Technologies, Paras Defence, Astra Microwave, Dynamatic Technologies, Taneja Aerospace, would likely emerge as key beneficiaries," said Harshit Kapadia, analyst, Elara Capital.