Solid order book, indigenisation to keep defence stocks in demand: Analysts

India's total value of defence production breached Rs 1 trillion-mark in the fiscal year 2022-23 (FY23), up 12 per cent year-on-year (YoY). At the bourses, this has been well reflected in related-stocks from the sector as they gained considerable ground during this period.

Shares of Hindustan Aeronautics (HAL), Mazagon Dock Shipbuilders, MTAR Technologies, Bharat Electronics (BEL), and Bharat Dynamics (BDL) have skyrocketed up to 160 per cent in a year, as against a 14 per cent jump in the S&P BSE Sensex.

This stellar run has also prompted mutual fund houses to bet big on defence names.

According to the Association of Mutual Funds in India (AMFI), diversified equity funds with the highest exposure to defence stocks - Aditya Birla SL Pure Value Fund, IDBI Dividend Yield Fund, HDFC Midcap Opportunities Fund, and Mirae Asset Midcap Fund have delivered up to 27 per cent direct returns in the 1-year time period.

HDFC Mutual Fund, on the other hand, recently launched a dedicated defence-themed new fund offering (NFO) to enable investments in India's defence prowess. The fund aims to invest a minimum of 80 per cent of the corpus in shares of defence and allied sector companies.

Meanwhile, analysts believe that the dream run in the defence related-stocks is not over yet. They expect up to 12-15 per cent upside in selective stocks over the next 12-18 months.

Deepak Jasani, head of retail research at HDFC Securities, for instance, said that since the government's defence allocation increased to 75 per cent in this fiscal year 2023-24 (FY24) versus 68 per cent in FY23, India's defence theme still has more legs on higher revenue visibility. He pegged that opportunities would build further for domestic defence companies if budget allocation in FY25 is increased for the Indian Army.

According to ICICI Securities - Standing Committee of Defence report to Parliament, the capital outlay for the Indian Army might go up to Rs 50,000 crore-Rs 70,000 crore in FY25 to cover up the shortfall of Rs 10,500 in FY22 (due to Covid-19), whereas capital outlay for the Indian Navy is likely to be Rs 92,300 crore in FY25.

Ashwini Shami, Smallcase Manager, EVP and Portfolio Manager at OmniScience Capital, meanwhile, said that since defence companies bagged orders 3-8 times (x) of their current revenue, the significant growth in order books would affect their long-term revenue potential.

As of March 2023, around Rs 44,200 crore worth of orders was reported under the Indian-IDMM (indigenously designed developed and manufactured) category, while capital expenditure through foreign procurement saw a decline of nearly 6 per cent in FY22.

However, post a steep rally across defence names, Deepak Jasani of HDFC Securities warned against possible consolidation in the near-term and suggested investors to selectively buy the dip.

Besides, analysts at ICICI Securities expected domestic defence companies to benefit as contracts worth Rs 1.5 trillion remain to be awarded over the next 2-3 years.

"Based on the recent contracts awarded by the defence ministry and the existing pipeline, we believe Bharat Electronics to be the primary beneficiary. Besides, we see opportunities for Bharat Dynamics as the government’s focus on missile systems would directly benefit the company," they wrote.