Top 4 Undervalued Defence Stocks in the Current Market

Defence plays a vital role in protecting a country from internal and external threats.

As a developing economy, India recognises the importance of upgrading its defence capabilities to become self-sufficient.

India has set an ambitious defence export target of Rs 350 billion (bn) by 2024-25, driven by a strong emphasis on indigenising weaponry and systems.

Moreover, India's aim to achieve a turnover of Rs 1.8 trillion in defence manufacturing by 2024-25 highlights the significant growth potential within the sector.

There is no doubt that India's prospects of being a long-term player in global defence manufacturing merits long term investment.

Which is why we have shortlisted some undervalued defence stocks to keep on your watchlist.

Please note that these stocks are filtered using Equitymaster's Powerful Stock Screener.

One important thing... as you would be aware, most defence stocks have already shot up a lot in the past 1 year. Within the sector, there aren't exactly many attractively valued stocks per se which could be termed as undervalued.

However, what gives us comfort to term the below stocks undervalued is the valuation of their arch-rival companies and/or the overall industry average valuations.

#1 Hindustan Aeronautics (HAL)

First on this list is Hindustan Aeronautics (HAL).

I know what you're thinking... how is India's premier defence play undervalued despite a 150% rally in the past 1 year?

Well, shares of HAL have fallen from their peak and they continue to remain under pressure in this current global stock market meltdown.

At the current price of Rs 4,623, HAL shares are trading at a price to earnings (PE) multiple of 40.3x.

This is a sharp correction from its PE of 49x hit last month.

HAL shares are now also trading lower than the industry average PE of 45.4x.

When compared on a price to book (PB) multiple, HAL shares trade at a P/BV ratio of 10.5x compared to the industry average P/BV of 11.3x.

HAL - Historical Valuations

Financial Year	FY20	FY21	FY22	FY23	FY24
PE (x)	6.18	10.25	9.79	15.67	29.2
Price to Book (x)	1.35	2.16	2.57	3.87	7.64
Dividend Yield (%)	6.19	3.02	3.36	2.01	1.05
High PE	10.57	17.63	14.54	15.87	36.7
Low PE	5.58	5.72	9.68	9.95	15.56

Data Source: Ace Equity

The recent decline in HAL's share price can be attributed to profit booking by investors and the stock's high valuations.

After a remarkable performance and substantial price appreciation, many investors decided to lock in their gains. This profit booking is a common occurrence, especially after significant upward movements in share prices.

Another factor contributing to HAL's recent share price decline is the selling activity by foreign institutional investors (FIIs).

FIIs have reduced their stake in HAL, which triggered a downward trajectory in the stock price.

At the end of December 2023 quarter, FIIs held a 12.9% stake in HAL, but by the end of June 2024 quarter, this stake had decreased to 11.7%.

Despite the recent decline in HAL's share price, several factors suggest that this may be only a temporary setback.

The company is aggressively promoting its products globally, especially the Tejas aircraft and the Advanced Light Helicopter (ALH). These efforts could significantly boost its international sales and market presence.

HAL has also partnered with Airbus to establish a maintenance, repair, and overhaul (MRO) facility for the A320 family of aircraft in New Delhi. This MRO hub aims to provide a comprehensive solution for commercial airlines, potentially increasing HAL's revenue streams.

Another strategic move is HAL's collaboration with Israel Aerospace Industries (IAI) to convert civil aircraft into multi-mission tanker aircraft. This partnership is expected to enhance HAL's revenue and profitability by tapping into new business segments.

Similarly, HAL's tie-up with Safran, a French aircraft engine manufacturer, to develop a sales and support ecosystem for helicopter engines in India, promises to fortify its market position.

HAL's order backlog stands at Rs 940 bn which is three times its FY24 revenue. To meet this demand, the company is expanding its manufacturing capacity for both aircraft and helicopters.

A new facility for helicopter manufacturing is being set up in Tumkur, while a facility for Tejas aircraft manufacturing is under construction in Nashik, expected to be operational by October 2024.

The company's fundamentals remain robust. HAL is debt-free and enjoys high return ratios around 25%.

#2 Bharat Electronics

Next on the list is Bharat Electronics.

Similar to HAL, the stock of Bharat Electronics has fallen from its peak price of Rs 340.

It currently, trades at Rs 289 with a PE multiple of 50.1x.

While a PE of 50x is of course not ideally called undervalued, it's lower compared to the peak of 61x it hit last month in July.

Moreover, it's also lower than the industry PE of 61.3x.

On the P/BV front, Bharat Electronics trades a PB ratio of 12.4x compared to the industry average of 7.7x and 5-year average of 4.5x.

Bharat Electronics Historical Valuations

Financial Year	FY20	FY21	FY22	FY23
PE (x)	9.93	14.52	21.42	23.89
Price to Book (x)	1.8	2.76	4.18	5.14
Dividend Yield (%)	3.77	3.2	2.13	1.85
High PE	19.19	20.97	24.77	30.1
Low PE	9.93	7.98	14.15	20.37

Data Source: Ace Equity

Interestingly, Bharat Electronics is the only Indian defence stock to be listed for over a decade. The company's valuations have moved up from an average of around 25x to around 60x in just two years (2022 to 2024). That too after a wait of 18 years.

As of June 2024, Bharat Electronics boasts of an order book value of Rs 760 bn, which includes an export order book of US$ 407 million (Rs 339.9 bn).

Key export products included transmit and receive (TR) modules, compact multi-purpose advanced stabilisation systems (COMPASS), radar and EW systems, medical electronics, and communication equipment.

The company has a market share of 12% in the overall defence market and a market share of nearly 60% in the highly specialised defence electronics segment.

This also makes Bharat Electronics one of the biggest beneficiaries of the Indian government's decision to put defence items under import embargo as a part of Aatmanirbhar Bharat.

Established in 1954 in association with CSF France, the company is now a government aerospace and defence company. The government of India holds a 51.1% stake in the company.

The company heavily relies on the Indian defence sector, constituting about 87% of its revenue.

Further, its pipeline of fresh orders remains healthy, supported by the government's growing capital budget allocation and continued focus on rolling out reforms to increase India's defence product manufacturing capability and gradually reduce imports.

For more details, see the Bharat Electronics company fact sheet and quarterly results.

#3 Mazagon Dock Shipbuilders

Next on the list is Mazagon Dock Shipbuilders.

Shares of Mazagon Dock currently trade at Rs 4,671, having fallen from the peak of Rs 5,860 touched not long ago.

This fall has taken the company's PE multiple down to 49x compared to the peak of 59x touched last month.

It's also lower than the industry average of 62.5x.

The PE ratios of Mazagon's peers - Cochin Shipyard and Garden Reach Shipbuilders - are a bit high at around 85.7x and 78.8x, respectively.

Coming to price to book value, Mazagon Dock trades at a P/BV multiple of 15.5x, only slightly higher than the industry average of 14.2x.

Mazagon Dock Historical Valuations

Financial Year	FY20	FY21	FY22	FY23
PE (x)	0	8.34	7.91	11.96
Price to Book (x)	0	1.25	1.25	2.81
Dividend Yield (%)	-	3.41	3.64	2.41
High PE	-	14.27	10.76	22.68
Low PE	-	8.34	6.42	6.76

Data Source: Ace Equity

As of June 2024, the company has an outstanding order book of Rs 385.6 bn. This makes it India's largest shipbuilder, both in terms of revenue and order book.

This strong position is largely due to its unique role in the Indian defence sector, specialising in building conventional submarines and destroyers for the Indian Navy.

It has been tasked with manufacturing some of the Indian Navy's most ambitious programmes, including its Scorpene class of submarines and the Visakhapatnam and Kolkata class destroyers.

It is currently awaiting approval from the Indian government for a submarine project worth Rs 200 bn for manufacturing three more submarines, the first of which was inducted in 2017, which is further set to bolster its order book.

From starting a small shipbuilding dock to manufacturing submarines, Mazagon Dock has established itself as a warship giant in India.

The company, owned primarily by the Indian government, makes everything from cargo vessels to offshore platforms and destroyers, frigates, corvettes and submarines.

With the shipbuilding scheme likely to be extended beyond 2026, Mazagon Dock stands as the biggest beneficiary as it beats the biggest peers on revenue growth, profit growth, and many more metrics.

For more details, see the Mazagon Dock Shipbuilder company fact sheet and quarterly results.

#4 Axiscades Technologies

Next on the list is Axiscades Technologies.

The company is present across engineering design services and has been serving various verticals like aerospace, defence, heavy engineering, automobile and industrial products.

With acquisition of several companies, the company has successfully entered into system integration activities focused on the defence sector involving hardware and product design, development and deployment.

Shares of the company currently trade at Rs 516 compared to its 52-week low of Rs 433. It has fallen around 23% in 2024 so far.

At the current price, the company trades at a PE multiple of 64x, compared to the industry average of 32x.

On the price to book value front though, the company looks largely undervalued. It trades at a PB multiple of 3.6x compared to the industry average of 8.1x.

Axiscades Historical Valuations

Financial Year	FY20	FY21	FY22	FY23
PE (x)	3.53	0	21.68	0
Price to Book (x)	0.33	0.51	1.5	3.15
Dividend Yield (%)	0	0	0	0
High PE	373.42	43.27	451.18	188.32
Low PE	0	0	0	0

Data Source: Ace Equity

In financial year 2024, the company's revenue grew by 17% despite several challenges.

It also turned profitable by posting a net profit of Rs 334 million against a loss of Rs 48 million last year.

By FY26, the company is targeting to reach a net profit of Rs 1.8 bn as the defence theme picks more momentum and as the company bags more orders.

Finance costs have been a big cause of concern for Axiscades. In FY24 finance costs increased owing to the heavy debt. For tackling this problem, the company is looking at various measures and how it can reduce debt.

In one of management discussion, they mentioned that Axiscades plans to reduce debt by almost Rs 500 million which ultimately will bring down finance costs.

Moreover, the company is expecting big potential of Rs 30 bn from its drone business over the next five years.

The company is expecting orders from Air Force, Navy, and Home Guard Security Service for its drone business.

To know more, check out Axiscades Technologies financial factsheet.

Snapshot of Undervalued Defence Stocks

Here's a snapshot of the above companies on Equitymaster's powerful stock screener.

Please note that these parameters can be changed accordingly and filtered as per the user's needs.

In Conclusion

While growth prospects look promising, the stock market is a tricky place. Top defence sector stocks, like other sectors, are influenced by economic conditions and market fluctuations.

You need to look out for a fundamentally strong defence company to make the most of the current opportunity.

Get started by using Equitymaster's stock screener to filter the best defence stocks in India.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...