MTCR bid brings multiple gains for defence firms

They can directly procure high-end equipment; revenue and profitability to get a fillip

On an otherwise lacklustre day of trade, shares of defence companies such as Bharat Electronics (BEL), Reliance Defence, Astra Microwave, Nelco and Walchandnagar Industries rose 5-13 per cent, following the news that India was  admitted as a member of the Missile Technology Control Regime (MTCR). MTCR is a partnership among 35 countries to prevent the proliferation of missile and unmanned aerial vehicle technology.

While the news is more of a sentiment booster for the near term, experts feel it holds strong long-term potential for Indian defence equipment manufacturers. Currently, India’s defence sector is heavily dependent on foreign collaborations even for self-sustenance. With India becoming a member of MTCR, this is set to change. Santosh Yellapu of Angel Broking says Indian companies will now have an option to procure high-end missile technology and surveillance systems directly from vendors. Indian companies, including the state-owned BEL now have to mandatorily collaborate with foreign entities for these procurements.

Export opportunities also open up for Indian manufacturers, also catering to the needs of the domestic market. Therefore, while in the near term companies might continue to partner with their foreign collaborators, in the long run  investment into research and development (R&D), including human resources is set to increase. While this is a positive for the sector, analysts feel return ratios such as return on equity might moderate, given the investment that may be made into research and technology sourcing. However, Yellapu feels the pain is only transitional, as higher realisation from products would expand profit margins and return ratios in the long-run. In fact, over the past few years, as BEL has increased outsourcing of low-yielding products, its operating margins have also expanded noticeably (27.8 per cent in FY16 versus 20.8 per cent in FY13). This will further rise as dependence on foreign collaborations reduce.

  Interestingly, smaller component manufacturers such as Astra Microwave, Nelco, Walchandnagar Industries and Rolta are also attracting investor interest, as BEL is increasing its outsourcing activities. “As the universe of listed entities is increasing in defence, it is positive for the sector as operational transparency would improve,” says an analyst from a domestic brokerage. But for now, BEL remains the best pick in defence, with 15 of the 20 analysts recommending ‘buy’ on the stock.  According to Yellapu, though there are smaller companies, BEL’s leadership position and pure-play defence strategy positions it ahead of the rest. Notably, apart from being government-owned, BEL is debt-free, with cash and bank balance of Rs 7,500 crore as on March 31.