India's defence equipment sector offers significant new opportunities

Though there are some unknowns, Street action suggests big upside

The move towards indigenisation of defence procurement creates new opportunities for India’s military industrial sector. The government of India (GoI) has so far released five lists of items for positive indigenisation – these should be manufactured in India, rather than imported. Each item on these lists represents an opportunity for some local firm.

Apart from the usual list of public sector undertakings (PSUs), which would benefit from this import substitution, there are many listed private sector firms interested in this space. In total, the lists include some 567-odd items plus 18 major platforms such as drones and helicopters (each of which will involve making many parts) to be developed and manufactured indigenously.

Defence procurement budgets are lumpy so year-on-year comparison is hard, but the financial year 2022-23 (FY23) Budget envisages that Rs 84,600 crore of defence goods will be sourced domestically this fiscal. This is around 68 per cent of the total defence capital outlay, compared with 64 per cent in FY22, and 58 per cent in FY21.

The listed PSU beneficiaries of the import substitution policy would include Hindustan Aeronautics (HAL), Bharat Electronics (BEL), BEML, Mazagon Docks, and Garden Reach Shipbuilders. In the private space, there are relatively small firms like Paras Defence, Data Patterns, Astra Microwave, Dynamatic Technologies, Solar Industries, MTAR, Zen Technologies, and of course, giants like L&T, Mahindra Defence Systems or Adani Defence (the latter two are unlisted). The share of private sector defence manufacturers is rising.

Many defence procurements have long gestations, but many smaller items would be recurrent. This will translate to better order books and execution timelines will have to be worked out as this process gets underway. Assessments of working capital needs would also have to be conducted as the market gets a sense of how prompt payment schedules will be. As of now, sentiment has certainly improved across the list of hopeful firms.

After the notification of the first and second lists, contracts for 31 projects worth Rs 53,900 crore were signed by the armed forces. Acceptance of Necessity (AoN) for 83 projects worth Rs 1.77 trillion has been accorded. In addition, cases for orders worth around Rs 2.94 trillion will be processed in the next 5-7 years.

The lumpiness of orders in this sector makes it hard to do the normal year-on-year, or quarter-on-quarter, comparisons of balance sheets. Also the trend in terms of orders is nascent and not easy to collate. It’s a new sector with a single buyer and defence deals have a history of unpredictable delays and reworking. Hence valuations are difficult.

Despite these complications, many investors are betting on a big upside in the sector. If there is a substantial increase in orders and a rise in the number and type of items and platforms being manufactured domestically, the sector should do well. In the last month, several stocks mentioned above have seen double-digit increases in share prices.

For example, Solar Industries is up 25.5 per cent in a month. BEML has done even better (25.8 per cent), HAL is up 21.65 per cent, Mazagaon Docks has risen 21.3 per cent, Dynamatic Technologies is up 20.9 per cent, and Astra Micro (14.8 per cent) and Paras Defence (11 per cent) have also seen double-digit gains.