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There has been a sharp rise in the share price of listed defence equipment makers since the start of the current calendar year. However, the rally has yet to reflect in the financial performance of these companies.
The combined market capitalisation (m-cap) of six public-sector defence companies is up 45 per cent year-to-date (YTD) and has more than doubled in the past year. In contrast, the combined earnings was up only 15.8 per cent in 2022-23 (FY23).
The six defence stocks in the Business Standard sample ended Tuesday with an m-cap of Rs 2.93 trillion, up 44 per cent from about Rs 2.04 trillion at the end of December 2022 and Rs 1.4 trillion at the end of June 2022.
For comparison, the benchmark S&P BSE Sensex is up 7.8 per cent YTD and up 23.7 per cent since the end of June last year. This makes defence stocks one of the top-performing sectors on the bourses in the past year. The six defence equipment makers in Business Standard’s sample include Hindustan Aeronautics (HAL), Bharat Electronics (BEL), Mazagon Dock Shipbuilders, Bharat Dynamics, Cochin Shipyard, and Garden Reach Shipbuilders & Engineers. Of this, HAL is the biggest, with an m-cap of Rs 1.29 trillion, followed by BEL at Rs 91,774 crore on Thursday.
The rally in defence stocks has been largely driven by valuation rerating rather than faster growth in revenue and profit. The financial performance of these companies in recent quarters suggests a slowdown in revenue and profit.
The combined net sales of these companies was up just 12.2 per cent in FY23, while net profit was up 15.8 per cent in the period. By comparison, net sales was up 14.1 per cent year-on-year (YoY) in 2021-22, while net profit was up 35.8 per cent YoY during the financial year.
This has resulted in a sharp rise in the valuation of defence stocks. The average trailing 12-month price-to-earnings (P/E) multiple of these six defence stocks has nearly doubled in the past year, from 13.6x at the end of June 2022 to 27.1x on Thursday.
As a result, defence stocks are now trading at a premium to the valuation of the benchmark Sensex, compared to a deep discount six months ago. The Sensex stocks ended with a trailing P/E multiple of 25.7x on Thursday, up from 21.6x at the end of June 2022. Some analysts see a bubble in the current sharp rally in defence stocks.
“The recent spike in the share price of defence stocks is part of the big rally in small- and mid-cap stocks. But this is expected to fizzle out soon as the rally is not backed by a corresponding rise in earnings,” says Chokkalingam G, founder, Equinomics Research & Advisory.
According to Chokkalingam, the rally is an opportunity for investors to book profits in these stocks rather than make fresh investments.
“It’s too late and risky to make fresh investments in defence stocks, given their super-high valuation now,” he adds.
Bulls are, however, betting on growth acceleration in the sector, driven by new orders and the technological modernisation of India’s key arms platforms. For instance, the country’s second-biggest equity fund house, HDFC Asset Management Company, launched India’s first defence fund last month.
The HDFC Defence Fund seeks to allow investors to participate in the structural growth potential of India’s defence sector. A dedicated sectoral fund for the defence sector is expected to improve the flow of long-term institutional capital in the sector and consequently support a rally in the sector.
