Modi's Big Move Could Boost these 5 Defence Stocks

To corporatise the defence sector, the Ministry of Defence (MoD) has dissolved the Ordnance Factory Board (OFB) with effect from 1 October 2021. This is the PSU that supplies arms and ammunition to the armed forces.

The board's 41 ordnance factories, the first of which is more than 300 years old, will now be a part of seven new defence public sector undertakings (DPSUs). They will be structured as corporate entities.

The idea behind the creation of these DPSUs is to give them autonomy and help them improve accountability and efficiency.

The armed forces had from time to time raised concerns about the delay in production and the quality of equipment produced by the factories under the OFB.

With the new structure, there will be an improvement on both counts. It will also give India's defence sector a new lease of life.

This step is in sync with the government's goal to make India a dominant player in the defence equipment space.

Already, several steps have been taken and companies are starting to make the most of it.

We take this opportunity to discuss 5 defence stocks at the forefront of the 'defence' megatrend.

#1 Bharat Electronics

Bharat Electronics is an Indian Government-owned aerospace and defence electronics company.

The company primarily manufactures advanced electronic products for ground and aerospace applications.

Given the company's execution track record, it's set to benefit from the government's rising expenditure on the defence sector. It derives most of its revenues from Ministry of Defence (MoD) contracts.

During the financial year 2021, BEL achieved a turnover of about Rs 135 bn against a turnover of Rs 126 bn in 2020 in spite of the challenges posed by the Covid-19 pandemic.

The company's order book as of 1 April 2021 stood at Rs 530 bn. In 2021, it has secured significant orders worth Rs 150 bn.

The recent import embargo imposed by the government also bodes well for the company.

The company's management has highlighted that 692 of its items have been uploaded on the Ministry of Defence indigenisation portal. EOIs (Expression of Interest) for 69 items have also been published.

BEL is providing test facilities to private vendors apart from participating in the process. The company's revenue has seen a growth of 13% CAGR since the government's indigenisation effort began in 2015.

#2 Bharat Forge

Bharat Forge is among the leading forging companies in India involved in a variety of segments such as defence, power, oil & gas, and automobiles.

The company is in a sweet spot now because of the cyclical recovery in its core business segments.

For the financial year 2022, Bharat Forge plans to increase its investments in the defence domain as it has a strong order book.

The company is looking to acquire 175 acres in an industrial park near Pune for Rs 2.4 bn which will house new factories for its defence and electric mobility business divisions.

These new assets will manufacture speciality vehicles, certain systems and aggregates that go into artillery guns and an assembly plant which will also house a testing facility.

The company has also recently announced plans to join the country's electric vehicle (EV) revolution to produce electric two-and three-wheelers through its associate company, Maharashtra-based Tork Motors.

The first model is expected to be available in 2022. With this partnership, the company is strongly positioned to capitalise on opportunities in both defence and electric vehicles.

#3 Hindustan Aeronautics

Hindustan Aeronautics (HAL) is an Indian state-owned aerospace and defence company. It's one of the oldest and largest aerospace and defence manufacturers in the world.

It was established with the aim of manufacturing aircrafts in India. In 1941, the Indian government became one of its shareholders and acquired the company completely in 1942.

The state-owned company is known for manufacturing some very competitive aircraft and helicopters, including 'Light Combat Aircraft', 'Chetak', and 'Cheetah'.

In 2020, HAL announced an ambitious project of developing a 10-12 tonne attack helicopter by 2027, touted to be India's answer to America's Apache helicopter, which is manufactured by Boeing.

The company faces limited competition from the private sector as it has an almost 100% market share in aerospace manufacturing.

The market leader's stock has rallied 58% in 2021 so far on triggers of large deal wins.

Recently, the company signed a US$716 m deal with GE Aviation for the supply of engines. The stock's inclusion in the futures and options segment also fuelled the rally this year.

#4 Cochin Shipyard

Cochin Shipyard is the largest shipbuilding and maintenance facility in India. The company builds platform supply vessels and double-hulled oil tankers.

Even though it's registered as a commercial shipyard, it derives 80% of its revenues from building and repairing defence ships. It derives the remaining 20% from commercial shipbuilding and ship repair.

CSL is a unique player to ride the potential in India's defence manufacturing space. Its towering performance in a difficult sector lends it fundamental merit.

CSL is one of the most profitable companies in the industry (including private shipyards) and is a consistent dividend payer. This makes the PSU one of the safest bets to ride the defence megatrend.

For the June 2021 quarter, the company reported a marginal decline in revenue as its operations were negatively impacted due to the second wave of the pandemic.

The company continued to work on a reduced time scale for a significant period of the first quarter which affected its results.

However, the company is gearing up to bring its top-line back to pre-pandemic levels by executing orders in all three major business categories.

The company's current order book size stands at Rs 120 bn, which includes private, government, and navy shipbuilding and ship repairs. Its orders are all in the execution phase.

#5 Bharat Dynamics

Bharat Dynamics (BDL) is one of India's manufacturers of ammunition and missile systems. It was founded in 1970 to be a manufacturing base for guided weapon systems.

BDL is poised to enter new avenues of manufacturing, covering a wide range of weapon systems such as surface to air missiles and air defence systems making it a defence equipment manufacturer.

Recently, the company announced it would set up an environmental testing facility at its Visakhapatnam unit. It will consist of a vibration testing facility, thermal chamber, and walking chamber for a whole torpedo.

The environmental test facility will be the first of its kind in the country and will contribute towards the realisation of 'Atmanirbharta' in the defence sector.

The facility, once operational, will enhance BDL's capability in the testing infrastructure for torpedoes and underwater weapons.

For the financial year 2022, the company has a strong order book and good earnings visibility.

In its latest quarterly results, BDL's revenues saw a three-fold jump.

Its current order book is around Rs 83 bn, which is 4x its annual revenue. Orders, which were delayed, are now expected to be finalised soon. The company is expecting Rs 130 bn worth of orders in the current fiscal.

Co-head of Research at Equitymaster, Tanushree Banerjee, keeps a close watch on stocks in the defence space. As per Tanushree, defence will be a big wealth-creating opportunity.

Back in June 2020, she recorded a video about India's best defence stocks.

Tune in to the video below to find out more.

Should you include defence stocks in your portfolio?

Here are a few reasons why stocks from the defence pack offer a good opportunity to investors.

1. The China-India standoff is not resolved. In fact, it's possibly a long-term concern and India will need to be prepared accordingly. There will be a requirement for defence ammunition. Hence, the demand for these companies will be strong.

2. The Government's 'Atmanirbhar' nudge is another area that is creating an opportunity for the sector. The armed forces will rely increasingly on indigenous suppliers.

In the recent import ban list notified on 31 May 2021, 108 items have been put in the import ban list. This means they need to be mandatorily sourced from indigenous suppliers.

3. Operating profit levels are gradually rising for the above companies after the weak first quarter of the financial year 2021. The order book for these companies is full. Some of these companies such as Bharat Dynamics are purely debt-free companies.

Defence sector stocks are somewhat buffered from industry-related losses because they are almost certainly going to have government projects at any given time.

While this certainly is a good thing, one must view defence stocks with the same amount of caution as one would view other stocks. Sustained research must not be compromised despite the positive odds.

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