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MC Explains | Why shares of defence companies are soaring

Defence companies could be a beneficiary of the Indian government's thrust on domestic manufacturing while geopolitical tensions across the globe could also make the sector an exciting play

September 15, 2022 / 12:04 PM IST
 
 
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The Indian government’s increased focus on the defence sector, with initiatives such as ‘Make in India’ and ‘Atmanirbhar Bharat’, have led to a perception among market participants that companies manufacturing defence equipment will do well.

Indian defence companies are seen spreading their wings wider and are expected to soar even higher. Investors have been lapping up shares of these companies and the exuberance is evident from the stellar rise in their scrips. Here’s a primer on what is triggering the rise in defence stocks.

MC Explains

How have shares of defence companies performed so far in 2022?

Most defence stocks such as Bharat Dynamics, Bharat Electronics, Ashok Leyland and Hindustan Aeronautics have rallied between 34 and 123 percent in 2022, so far.

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Indeed, Hindustan Aeronautics (HAL) has shot up 264 percent in the past three years, while Bharat Dynamics has surged 210 percent. Again, Ashok Leyland and Bharat Electronics have soared 208 and 162 percent, respectively.

HAL and Bharat Dynamics have managed to generate triple-digit returns in 2022 so far, at 112 and 127 percent, respectively. In comparison, Ashok Leyland shares gained a modest 36 percent, while Bharat Electronics has risen 60 percent.

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Why is the market bullish on defence stocks?

Along with the Indian government’s increased focus on the defence sector, the centre’s initiatives, such as ‘Make in India’ and ‘Atmanirbhar Bharat’, have led to a perception among market participants that companies manufacturing defence equipment will do well.

Additionally, tensions with China and Pakistan, coupled with the Russia-Ukraine crisis, are seen boosting the growth outlook of defence companies.

Why and how has the government’s focus increased on the sector?

India is reportedly among the five biggest defence spenders in the world. In the FY23 budget, the government earmarked Rs 1.52 lakh crore as the capital outlay for defence, an 11 percent compounded annual growth over FY20-23. This capital outlay is around 29 percent of the total defence budget of Rs 5.25 lakh crore, as compared with approximately 25 percent in FY20.

The total defence equipment procurement budget was at Rs 1.24 lakh crore for FY23, of which Rs 84,598 crore — 68 percent of the procurement budget — has been kept for purchasing locally produced weapons and systems to boost self-reliance in the sector.

What step has the government taken so far to boost the local defence industry?

Over the last two years, the government has notified three lists totalling 310 defence items that will be procured locally in the next three to five years. Of these 310 items, 90 are planned to be indigenised by December 2022. Moreover, the Defence Ministry has also notified two lists of 458 items in the last six months for indigenisation.

The Indian 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. Expenditure on defence procurement from foreign sources has been reduced to 36 percent in 2020-21 from 46 percent in 2018-19.

So, what exactly are these defence items?

These items include major equipment or platforms such as combat aircraft, submarines, armoured vehicles, lightweight tanks, helicopters, missiles, radars, howitzers, sensors, simulators, torpedoes and unmanned aerial vehicles. Defence items for indigenisation manufacturing include sub-systems, assemblies and components.

What does the government have in store for defence companies?

Per government estimates, around Rs 5 lakh crore in contracts 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 get orders worth about Rs 3.5 lakh crore in the next five years, the domestic brokerage house added.

Which companies stand to benefit?

Hindustan Aeronautics, Bharat Dynamics, Ashok Leyland, Mazagon Dock Shipbuilders and Cochin Shipyard. Further, Bharat Electronics, Data Patterns (India), Garden Reach Shipbuilders and Engineers, Bharat Forge and BEML have the potential to gain from the recent developments.

As of June 2022, Bharat Dynamics’ order book stood at Rs 13,000 crore. Meanwhile, L&T’s order inflows rose 57 percent year-on-year to Rs 41,805 crore in the quarter ended June.

Analysts believe Ashok Leyland, a top supplier of vehicles to the Indian Army, could benefit from the government’s decision to increase sourcing from domestic private players.

The outlook for Mazagon Dock Shipbuilders also seems to have improved. Its order book as of March 31, 2022 was around Rs 46,000 crore.
Dipti Sharma
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