Top 5 Defence Stocks to Watch Out in Nifty's Run-up to 40,000

The Nifty 50 index has grown significantly in 2023, from around 17,000 to over 20,000. It has shown remarkable resilience and growth and remains determined to reach the coveted 40,000 milestone in the long run.

This journey to 40,000 could unfold at a fast pace, and investors looking to partake can consider some of the top defence stocks from the index or that can be a part of the index in the future.

Defence stocks in India are growing in importance, driven by government emphasis on modernisation, increased spending, and the "Make in India" initiative. Defence exports have surged to around Rs 160 bn in FY23, a tenfold increase since 2016-17.

However, today's largest blue-chip companies are not pre-destined to hoover up all the benefits. A new set of emerging blue-chip contenders could potentially join the Nifty 50 and contribute to its journey toward 40,000.

#1 Larsen & Toubro (L&T)

At the top of our list is the country's engineering major, Larsen & Toubro.

L&T is committed to leading the defence revolution in India by playing a significant role in the sector.

It offers a wide range of products, including ships, submarines, land combat vehicles, radar systems and PSLV rockets.

Presently, L&T's defence segment is a small part of the whole, bringing in around 2-3% of the total group revenues in the projects and manufacturing segment. However, the company stands out as a significant player in the Indian private defence industry.

What sets it apart is the company's extensive expertise in ship and submarine construction, given that the Indian defence segment plans to procure numerous modern ships and submarines for the Navy.

This segment is expected to grow on a strong footing amongst other expanding businesses of the company.

Between 2019-2023, the company's sales and net profit have grown at a 5-year compounded annual growth rate (CAGR) of 9% and 8%, respectively. The returns have been strong, with the Return on Equity (RoE) and Return on Capital Employed (RoCE) averaging over 12% and 13.3%.

Larsen & Toubro Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	11.76%	8.10%	-5.51%	15.05%	15.70%
Operating Profit Margin (%)	18.42%	18.67%	20.00%	17.18%	16.49%
Net Profit Margin (%)	7.15%	6.99%	3.43%	6.57%	6.89%
Return on Capital Employed(%)	13.29%	12.49%	9.97%	11.61%	12.98%
Return on Equity(%)	16.58%	15.84%	6.58%	13.07%	14.78%

Data Source: Ace Equity

L&T has deleveraged its balance sheet in the past five years. The debt-to-equity ratio has fallen from 1.2x in the financial year 2019 to 0.7x in 2023.

The interest coverage ratio has also been rangebound at 2.8 times over the same period. These healthy financial parameters give L&T the financial flexibility to invest in new projects.

To know more about the company, check out its factsheet and latest quarterly results.

#2 Bharat Forge

Next on our list is Bharat Forge.

Bharat Forge is a global provider of high-performance, innovative, safety & critical components and solutions to various industrial sectors, including automotive, railways, power, defence, construction & mining, aerospace, marine, and oil & gas.

The company has been diversifying from its core operations, building a strong defence portfolio. It has consistently invested in cutting-edge facilities that house world-class products, capabilities and facilities.

Consequently, all of their defence products have been internally designed and developed, with full ownership of the intellectual property.

This independence from partnerships and joint ventures has been a catalyst for business expansion, with over 80% of its revenue coming from exports.

It has also made Bharat Forge a renowned aircraft compressor and turbine manufacturer and one of the best aircraft fan blade manufacturers in the country.

Presently, the company is expanding its global footprint further. It is in talks with at least ten to twelve countries, (including the US), for the export of artillery guns, armoured and protective vehicles, and components.

Bharat Forge Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	22.07%	-20.55%	-21.09%	64.56%	22.83%
Operating Profit Margin (%)	22.18%	16.11%	16.27%	20.99%	14.99%
Net Profit Margin (%)	10.18%	4.34%	-2.00%	10.22%	3.93%
Return on Capital Employed(%)	19.94%	6.67%	0.82%	13.61%	8.75%
Return on Equity (%)	20.59%	6.59%	-2.39%	17.97%	7.66%

Data Source: Ace Equity

Between 2019-2023, the sales have grown at a CAGR of 9%. The returns have been rangebound, with the RoCE and RoE averaging at over 9.9% and 10%, respectively.

In FY23, the debt-to-equity was at 1x with an interest coverage of 3.8x.

To know more about the company, check out its factsheet and latest quarterly results.

#3 Bharat Electronics

Third on the list is Bharat Electronics.

A government entity, Bharat Electronics is a primary provider of radar, communication and electronic warfare equipment to the Indian armed forces.

Their product portfolio is quite diverse, encompassing defence and non-defence products such as software and electronic manufacturing services.

In addition to serving the domestic market, the company also exports its goods to various nations, such as Botswana, Indonesia, Sri Lanka, Russia, the United States, and South Africa.

Bharat Electronics has established multiple growth drivers by developing a robust infrastructure, fostering strong relationships with government entities and venturing into non-defence sectors to create new avenues for expansion.

The company reported a current order book of Rs 687 bn, which is more than three times its order book for FY23.

Bharat Electronics Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	14.06%	7.43%	7.25%	9.53%	15.91%
Operating Profit Margin (%)	24.51%	22.04%	23.66%	23.25%	24.64%
Net Profit Margin (%)	15.19%	13.82%	14.66%	15.31%	16.58%
Return on Capital Employed(%)	30.50%	25.73%	27.92%	27.20%	30.15%
Return on Equity (%)	21.45%	18.59%	19.59%	20.17%	22.49%

Data Source: Ace Equity

Between 2019-23, the company's sales and net profit grew at a 5-year CAGR of 10.7% and 15.8%, respectively.

The 5-year average RoCE and RoE stood at 28.7% and 20%, respectively. The consistent expansion in operating margin comes from an increasing level of indigenisation and a strong channel of local supply chains.

To know more about the company, check out its factsheet and latest quarterly results.

#4 Hindustan Aeronautics

Fourth on the list is Hindustan Aeronautics.

Hindustan Aeronautics is a play on the growing strength & modernisation of India's air defence. Its significant presence is evident, with approximately 80% of the defence force's fleet being supplied or serviced by the company.

The company has been advancing its technologies, evidenced by the development of more sophisticated platforms. What's even more exciting is that it has successfully transitioned from manufacturing products through licensed production to establishing a range of homegrown designs.

This places the aerospace giant in a sweet spot to capitalise on the long-term, sustainable demand created by the government's commitment to procuring indigenous defence aircraft.

Hindustan Aeronautics Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	5.72%	6.66%	6.89%	10.18%	11.69%
Operating Profit Margin (%)	24.62%	24.30%	24.92%	26.00%	31.03%
Net Profit Margin (%)	11.64%	13.44%	14.18%	20.63%	21.64%
Return on Capital Employed(%)	29.28%	24.50%	26.26%	30.37%	30.59%
Return on Equity (%)	21.57%	22.76%	22.64%	29.25%	27.18%

Data Source: Ace Equity

The defence PSU maintains a healthy order book and is reporting consistently higher profitability through scaling up operations and leveraging its capabilities.

At Rs 822 bn, Hindustan Aeronautic's outstanding order book is three times its trailing twelve-month revenues.

The company's sales have been growing smoothly. Between 2019-23, the sales and net profit have grown at a 5-year CAGR of 8% and 24%, respectively. The returns have been admirable, reporting a 5-year average RoCE and RoE of 28% and 24%, respectively.

To know more about the company, check out its factsheet and latest quarterly results.

#5 Cochin Shipyard

Last on our list is Cochin Shipyard.

The company holds a prominent position in the construction and maintenance of a wide range of maritime vessels, encompassing tankers, product carriers, bulk carriers, passenger ships, and defence vessels.

It stands as the sole shipyard in India capable of constructing vessels with a deadweight tonnage (DWT) of up to 110,000 and repairing vessels of up to 125,000 DWT.

In addition to its work in defence shipbuilding, the company has diversified its product line by venturing into inland and coastal shipping, the fishing industry as well as the cruise and ferry market.

Over the years, the company has built its expertise in defence vessels. Progressing from bulk carriers, the company is credited with building smaller, technologically advanced ships, including Platform Supply Vessels and Anchor Handling Tug Supply Vessels.

Recently, the company achieved a significant milestone by constructing India's first indigenous aircraft carrier, INS Vikrant, delivered in the previous financial year.

Going forward, the company enjoys strong revenue visibility as its order book currently stands at close to Rs 210 billion (bn). This is an almost whopping 10x its FY23 revenues of around Rs 23 bn.

Cochin Shipyard Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	25.44%	14.91%	-17.94%	14.75%	-25.54%
Operating Profit Margin (%)	26.88%	27.95%	32.41%	27.89%	19.82%
Net Profit Margin (%)	16.11%	18.47%	21.59%	17.67%	12.89%
Return on Capital Employed(%)	22.34%	24.87%	21.65%	18.88%	10.17%
Return on Equity (%)	14.51%	17.93%	15.69%	13.39%	6.91%

Data Source: Ace Equity

Between 2019-2023, the company's sales and net profit have been stable, with the net profit falling a little.

In the FY23, the company experienced a decline in revenue due to a weakened order book. This decline was primarily attributed to concerns stemming from the pandemic.

Orders began to flow in towards the end of FY22; however, due to the time required to fulfill these orders, the company couldn't recognize the corresponding revenue in FY23.

The 5-year average RoCE and RoE stood at 19.5% and 13.6%, respectively.

To know more about the company, check out its factsheet and latest quarterly results.

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