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Despite a sharp market sell-off on Wednesday, the defence sector showed some strength. The Nifty India Defence Index rose 4% as positive guidance from Defence Secretary Rajesh Kumar Singh, at a recent event, aided investor sentiments.
Singh said that the defence industry is at the threshold of a major expansion drive, as the government plans to relax foreign direct investment policies and industrial licensing procedures. These, he said, will encourage more public-private partnership in advanced manufacturing processes in the industry.
Investors also reacted positively to North Atlantic Treaty Organization (Nato) allies’ plans for increased defence investment, a proactive measure aimed at deterring potential Russian aggression.
“A rise in their (Nato allies’) defence spending can possibly lead to more export opportunities for Indian defence companies,” said Jyoti Gupta, research analyst at Nirmal Bang Institutional Equities.
Also read: Bharat Electronics is riding the defence boom. But is it a long-term bet?
In fact, one of the major players, Bharat Dynamics is already rehashing its existing contracts to enhance its presence in the specialised technology sector within the global defence industry, Gupta wrote in a recent note.
However, she mentioned that the company will likely realise these opportunities over time rather than in the short term. The company rose 4% on Wednesday, even though it currently trades at a 42% premium to its own 5-year historical valuation (average one-year forward P/E ratio of 30).
Defence stocks ended with strong gains, led by Mazagon Dock (11.1%), followed by Garden Reach Shipbuilders & Engineers (11%) and Zen Technologies (10%).
However, the Street had already priced in such favourable effects of the government’s indigenisation push for the domestic defence ecosystem along with enhancements of FDI limit in the sector.
Prices bottoming out
Despite corrections, valuations remain high.
“Most defence stocks currently trade at premiums to their historical valuations, despite steep corrections in the last six months,” noted Gupta. But she also noted that prices for major defence stocks have bottomed out in the recent broader market sell-off.
Also read: Senior officers face a significant change in the Indian Army’s promotion policy
The defence sector has seen significant declines, with the Nifty Defence index currently 36% below its all-time high. Is this a sign of opportunity?
Gupta believes so, stating, “Now is a good time to enter the defence pack. Q4 (March quarter) earnings are expected to be even better which will boost sentiment further and we can see a gradual and sustained rally from here on.”
Q3 offers hope
The recent December quarter results also offer some hope as major players reported impressive double-digit sequential revenue and profit growth, albeit on a low base.
Companies like Hindustan Aeronautics which were saddled with order execution challenges and delays due to global supply chain risks, outperformed Nomura Global Research’s expectations in Q3, the international financial institution noted in a recent report.
Its sales grew 16% sequentially in Q3 and is expected to go up further in Q4 as it plans to deliver its first Light Combat Aircraft Tejas Mk1A in March. However, the company was supposed to start delivering by FY24 but got stalled due to delays in engine deliveries from General Electric.
Also read: Execution hiccups curb order flow excitement for defence stocks
Experts anticipate such supply chain issues to ease from FY26 onwards as they bet on increased inter-governmental cooperation in the defence industry going forward.
The government’s FY26 defence budget of ₹6.81 trillion, a 9.5% boost over the current one, is also likely to swell the order books of defence public sector undertakings in the next fiscal, improving their revenue visibility further.
Hence, ship building companies like Garden Reach Shipbuilders & Engineers and Mazagaon Dock Shipbuilders, which got special attention in the latest budget, are expected to benefit from a robust order pipeline in the medium term. Both these companies posted a 10-12% sequential rise in their net sales in Q3 upon better execution of their existing orders.
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