HAL, BEL, Data Patterns: Why is Jefferies bullish on these defence stocks?

Analysts at Jefferies see up to 32% further upside on Data Patterns stock, and up to 18% and 10% for BEL and HAL; owing to global geo-political tensions and India's focus on self-reliance.

Global brokerage firm, Jefferies in its report on India's aerospace and defence electronics related stocks this month, has reiterated its positive view on Bharat Electronics (BEL) and initiated coverage on Hindustan Aeronautics (HAL) and Data Patterns with a 'Buy' rating.

The report states that ongoing global geo-political tensions and India's rising focus on self-reliance has been fueling order flow and revenue growth for Indian firms in the defence space.

Jefferies has raised its price target on BEL from Rs 225 earlier to Rs 260, indicating an upside of up to 18 per cent from present levels. Similarly, it sees a 10 per cent gain on HAL and up to 32 per cent surge on Data Patterns stock.

Here are the two key reasons for Jefferies bullish outlook

Global opportunity: India is among the top -3 defence spenders globally, but still total defence spend in 2022 was just 10 per cent of the US spend and 27 per cent of China. At present, India is the second-largest spender in Asia ex-Japan, it is ahead of China in terms of proportion of GDP (Gross Domestic Production). However, in absolute terms it is less than 1/3rd of China, given China's strong GDP growth of 8 per cent CAGR in the last 20 years as against India's 6 per cent. Going ahead, India's capital defence spend should continue at 7-8 per cent CAGR (Compound Annual Growth Rate) seen in the last decade. Indigenisation focus will drive double-digit growth in domestic defence spend.

Focus on self-reliance: The Indian government has been encouraging domestic manufacturing, and aims to reduce defence imports from 70 per cent to 30 per cent. Further, the government has been discussing increasing exports to 3x, in the last two years, exports have already risen by 2x, and the report factors in 2.5x export growth. India's defence exports rose 16x in FY17-24E to $2 billion; the brokerage expects exports to hit the $7 billion mark by FY30E, in line with the government's target of $29 billion by FY29E.

Data Patterns

The company's in-house technology is its biggest USP. Analysts at Jefferies believe that these three key levers will play out over the next 12-24 months. Firstly, India's defence indigenisation focus is driving double-digit revenue growth. Secondly, visibility on revenues rising 5x in FY24E-30E improving as export pipeline builds out and lastly, working capital intensity reducing with client diversification.

The company's share in defence capital in in uptrend, rising from 0.13 per cent to 0.30 per cent. Superior margin profile ensures 20 per cent + ROCE, while working capital is expected to reduce gradually amid client diversification. 

Data Patterns had raised Rs 500 crore through QIP (Qualified Institutional Placement) route, part of which was capex and product development, and part towards debt repayment.

The target price of Rs 3,545 values Data Patterns at 65x FY26E EPS (Earnings Per Share). Downside risks include obsolescence of company's technology and lack of management bandwidth diversification.

Hindustan Aeronautics

Recent MoUs with technology transfer deals are expected to improve capacity for export orders for India's leader in the airforce defence equipment market. Jefferies believe globally, post Russia-Ukraine conflict, governments are looking to focus on aerial equipment especially Unmanned Combat Aerial vehicles (UAVs) and drones. HAL's joint venture agreements with global stalwarts like GE puts it in a position to transform itself into a leading defence OEM. ROE improvement as earnings trajectory moves will be another driver for stock performance.

Among recent initiatives, HAL has entered into agreements with Safran Helicopter Engines, Safran Aircraft Engines, Airbus, Honeywell, Rolls Royce, Heroux Devtek and GE Aerospace for various products and equipment.

Hindustan Aeronautics' price target of Rs 3,900, values HAL at 35x FY26E EPS. Downside risks include Global OEM tie-ups not giving a material benefit and slowdown at ramping up on the product side.

Bharat Electronics

BEL is the market leader in domestic defense electronics. The company benefits from spending across the army, navy and airforce. Management has maintained its upbeat outlook commentary on recent result calls as the government's defence indigenisation focus continues. FY24E-26E double-digit revenue growth is backed by the strong order book and pipeline. Margin strength gives confidence in profitability sustaining.

The company's order book stands at Rs 76,200 crore, up 52 per cent YoY and provides revenue visibility for FY24E-FY26E. BEL's share in defence capital spend rose to 10 per cent in FY23 vs. 6 per cent in FY14. Analysts believe this could see some acceleration in the medium term as embargo lists come into effect and have factored this into a marginal rise in FY24E-26E revenue growth estimates.

The price target of Rs 260 values BEL at 35x FY26E EPS. Downside risks defence indigenisation push slowing down and cost-control measures not being sustainable, the report stated.