With defence stocks being the flavour of the season, Hindustan Aeronautics Ltd’s (HAL) share price has been flying.
The stock has soared 44 percent in the past three months, while year-to-date (YTD), it has gained 105 percent. In the past three years, the scrip has generated 230 percent returns for its investors.
What powered up the stock?
While the promoter, the Union government, divested its stake to 75.15 percent in June 2022 from 89.97 percent in September 2019, foreign and domestic institutional investors (DIIs) have been lapping up the stock.
FIIs have increased their stake to 5.56 percent in June 2022 from nil in September 2019. DIIs hiked their holding in the stock to 15.71 percent in June-end this year, from 8.74 percent in September 2019.
Retail investors are also bullish on the stock. This is evident from the increase in public shareholders’ stake to 3.58 percent in June 2022 from 1.29 percent in September 2019.
Additionally, despite India reportedly being among the five biggest defence spenders in the world, the government’s increased focus on domestic manufacturing, coupled with rising geopolitical tensions across the globe and with China and Pakistan, has jazzed up the outlook for home-grown defence companies. This has also powered up defence stocks.
HAL is one such company that market mavens see as an exciting play on the defence sector.
The Bengaluru-based company is primarily engaged in designing and developing fighter, training, and transport aircraft, and civil and military helicopters.
The company also manufactures special test equipment, aircraft engines, ground-handling equipment, avionics, and accessories.
Government’s thrust to produce locally
The government has already notified three 310 defence items to be procured locally in the next three-five years. These items were notified in the last two years and three lists were issued.
Out of these 310 items, 90 are planned to be indigenised by December 2022 only.
Moreover, the Defence Ministry has also notified two lists, specifying a total of 458 items in the last six months, for indigenisation.
The government has taken several policy initiatives in the past few years under the 'Make-in-India' programme to encourage indigenous design, development and manufacture of defence equipment in the country, thereby reducing import of defence equipment.
The expenditure on defence procurement from foreign sources has been reduced to 36 percent in 2020-21 from 46 percent in 2018-19.
The defence equipment procurement budget was at Rs 1.24 lakh crore for FY23, of which Rs 84,598 crore, or 68 percent, has been kept for purchasing locally produced weapons and systems to boost self-reliance in the sector.
Outlook for domestic defence industry
According to government estimates, contracts worth around Rs 5 lakh crore will be placed for defence platforms, equipment and components in the next five years, ICICI Securities said in a brokerage report.
The domestic defence industry is expected to receive orders worth about Rs 3.5 lakh crore in the next five years, the domestic brokerage house added.
In line with its commitment to fight future wars with indigenous solutions, the Indian Army, over the weekend, invited domestic manufacturers to offer critical defence equipment, such as guns, missiles, drones, counter-drones, and loiter munition, among others, for emergency procurement.
Where does HAL stand?
HAL operates in a space that supports the government in the form of design and development, and also a sector that has high-entry barriers. It enjoys a near monopoly situation in the segment.
HAL is India's only defence aerospace equipment manufacturer and has a large order book of Rs 84,800 crore, boosted by the recently awarded Rs 48,000 crore order to make 83 Light Combat Aircraft (Tejas), said Antique Stock Broking.
Morgan Stanley said India’s aircraft fleet upgrades and expansion plan will create a $60 billion order pipeline for HAL over the next decade. Growth will be further supported by engine upgrades and refuelling and overhaul and services orders, which form two-third of revenues, and exports that constitute 1 percent of revenue now.
Plus, the indigenisation thrust can further boost the order pipeline, with foreign players being required to manufacture locally or with local collaboration, it added.
Success in procuring orders from friendly countries can also significantly boost its growth outlook, the domestic brokerage firm said. Antique Broking has initiated coverage on the stock with a ‘buy’ recommendation and a target price of Rs 3,140, based on 25times its FY24 earnings.
At 12.14 pm, the stock was trading at Rs 2,487.50, up 0.26 percent, on the NSE.
Execution a key challenge
“The fundamentals are healthy with an order book of around Rs 85,000 crore, which is 3.5 times its FY22 revenue and thus earnings visibility is good enough to support the rally,” said Priyam Shah, a wealth manager based out of Mumbai, while cautioning that HAL is a company “that has always has seen execution delays”.
The defence industry has a lot of red tape and orders received do not translate into execution immediately as a lot of approvals and clearances are needed, Shah explained.
“This leads to more inventory and stretched working capital cycles and they drag earnings,” he added.
Another fund manager from a Mumbai-based asset management company also expressed his concern about execution being a key challenge for HAL.
HAL as an investment bet“We believe that the company's stock will re-rate meaningfully due to the strong order backlog with stable margins, and unprecedented order pipeline. Given the multi-year double-digit earnings growth potential and robust return ratio profile of 20-percent plus, we believe that the stock, at 19x its FY24 EPS, is attractively valued,” said Antique Stock Broking in its research report.