India Playbook 2024 – the India defence equity market story

Note:

1. Simple average is calculated for the above stocks in Defence

2. Note: The calculated Alpha is the difference between BSE500 & Simple Avg

(Source- Bloomberg)

The story
The Interim Budget for 2024 underscores the government's sustained commitment to enhance its defence capabilities. The allocation for the defence capital expenditure outlay has surged significantly, increasing from ~Rs800bn (in FY2014) to Rs1.72 trillion (in 2025BE) over the two terms of the Modi Government. Analysis of the data of past 11 years shows that the government's commitment towards domestic defence manufacturing has intensified over the last couple of years with the overall commitment increasing in absolute terms ~145% in the last 11 years.

Though the defence capital expenditure (capex) experienced a modest 4% CAGR from FY14-19…. India's defence spending exhibited consistent growth during this period, primarily attributed to increased pension disbursements (17% CAGR) and a significant rise in salaries following the implementation of the 7th Pay Commission recommendations. While defence revenue expenditure (including Pension) saw a robust double digit (~13%) CAGR over FY14-19, defence capex witnessed only a modest 4% CAGR.

….. starting from FY20, defence capex gained momentum, doubling its growth to 9% CAGR over FY19-25BE. This upswing can be attributed to capital expenditures on submarines, fighter aircraft, communication systems, helicopters and armoured vehicles.

(Source - Union Budget)

… AtmaNirbhar Bharat - Thrust on indigenization lead to disproportioned growth for the Order book of Indian manufacturers
The current Government has taken several steps to become self-reliant in defence equipment and has opened the door for private sector participation, including strategic partnership with foreign players. The Government has also come out with a defence items list which will be prohibited from imports beyond Dec-27. The key beneficiary of these initiatives will be the domestic players, who are expected to register healthy growth.

The Indian defence sectors can we broadly classified into four major segments a) Aerospace, b) Ship building and shipyard, c) Ammunitions and d) ancillary or part supplier. The sector opened up to private participation in early 2000’s but due to preference given to PSUs, private-sector participation remained negligible until recently. We believe that despite various measures taken by the Government to encourage private participation, PSUs will continue to dominate the sector for at least next 5-10 years. The Government holding in most of the PSUs are more than 70-75%, with competitive intensity, either low or medium. Among defense PSUs, we believe Hindustan Aeronautics, Bharat Dynamics and Bharat Electronics to be key beneficiaries of rise in domestic defence capex, imports reduction/exports ramp-up.

India's aerospace industry has many legs of growth and Hindustan Aeronautics is the key player in the space. In near-term, HAL will witness double digit earnings growth once it start LCA Tejas delivery and in medium/ long term its should see significant growth due to the modernization of the Indian armed forces. The company has a) healthy order book and impressive manufacturing book to bill ratio of 8-9x, b) attractive +20% ROE and c) stable EBITDA margin of 23-25%.

In ammunitions space, Bharat Dynamics (BDL) is India's sole manufacturer of certain missiles like Surface-to-Air Missiles, Anti-Tank Guided Missiles, and torpedoes. It is DRDO's key production agency and it receives steady inflow of orders from them. Exports, which is 7-8% currently, has the potential to grow meaningfully as many of their missiles are approved for exports. The company order book stood at +Rs.200bn (as on Dec-23), implying healthy book to bill ration of >8x.

Bharat Electronics is an experienced market leader in defense electronics. The company has been supplying indigenous defense systems to Indian armed forces in the fields of radar, communication, electronic warfare, weapons and night vision devices, among other systems. The company’s consistent and significant investments in R&D/capex give them competitive edge. The company witnessed significant increase in orders this fiscal year and has an attractive book to bill ratio of +4x.

With favourable government policies and dedicated focus on indigenization, defence companies in India witnessed a substantial increase in government orders from FY2020-24, leading to stock rerating over the past 2-3 years.