Where to Find a Multibagger Defence Stock

Editor's note: Defence stocks are hot right now in the market. But which defence stock is a good buy? Where should investors look? In this editorial, Equitymaster's co-head of research, Tanushree Banerjee, has the answer. Read on...

Mughal Emperor Babur is popularly credited with introducing canons in the Battle of Panipat in 1526. He had then decisively used gunpowder firearms and field artillery to defeat the much larger army of Ibrahim Lodhi.

In fact, the canons rendered the fortitude of forts useless. Forts that had safeguarded kingdoms for hundreds of years fell prey to the might of the canons.

Over the centuries, countries that invested in ever evolving defence technologies, managed to outlast wars, invasions and border conflicts.

It is foolish to assume that only the handful government owned defence entities can do it all to make the best defence technologies available to India. Or that the PSU can handle every element of the defence supply chain.

In the financial year 2022, Indian defence exports touched a record high of Rs 130 bn. 70% of it came from the private sector. Further, there was a substantial increase in exports to the US, the Philippines, West Asia, and Africa.

The target is to triple the size of India's defence exports by 2025.

In 2018, when I wrote about Bharat Forge making a big shift from auto ancillary to defence, few believed it to be true.

Here is what I wrote...

• The company has defence joint venture with three companies, two from Israel and one with Swedish defence major SAAB.
  
  Bharat Forge will look at more companies to partner to expand its footprint. On the aerospace front the company is looking to get into the supply chain of HAL and domestic aerospace companies, and start looking at building systems and sub-systems. It expects to be the frontrunner in these businesses in about five years.
  
  With the resilience that the company has shown in the past, and given its management's foresight for being future proof, Bharat Forge is certainly a stock to own for the long term.

The stock languished for three years before taking off in 2020.

Over the past decade, Bharat Forge has focused on platform development, metallurgy and material science as well as embedded electronics.

With these efforts, the company has positioned itself as a product supplier and not just a component supplier.In the defence vertical, Bharat Forge's offerings include artillery business (towered and mounted guns), vehicle business (protected vehicles), and armoured vehicles for defence segment.

Meanwhile, Solar Industries is the modern-day equivalent of a canon ball maker. It is one of the world's leading manufactures bulk explosives, packaged explosives and initiating systems, which find applications in the mining, infrastructure, and construction industries.

But over the past five years the company has pivoted its business model to focus on the defence supply chain.

The company has orders for making propellants for the Akash missile, a medium-range surface-to-air missile, and the Pinaka, a multiple rocket launcher, as well as for pyrotechnics, which helps initiate the explosion, and igniters, which provide the spark for the ammunition.

In July 2022, Solar Industries became the first indigenous supplier of boosters for the Brahmos missiles, a medium-range missile that can be fired from submarines, ships, aircraft or land.

At L&T, a team that once worked under the guidance of Dr Abdul Kalam, leads the defence efforts. L&T's team is working on artificial intelligence (AI), Internet of Things (IoT), virtual reality (VR), augmented reality (AR), geo-spatial technology, and cyber security for India's defence forces.

L&T's defence business took the path of digitalisation almost over a decade before anyone was even talking of digital. To add to that, there was strong technical collaboration too.

For instance, L&T's partner in the manufacture of the gun systems is Hanwha Land Systems, South Korea's largest defence conglomerate. Hanwha is the largest producer of tracked self-propelled guns globally, with over 1,000 pieces in service with various armies. The guns produced by L&T-Hanwha have been modified to suit Indian requirements. It has greater than 50% indigenous content.

Also, there is sufficient capacity in the offing. L&T has concurrently built a whole new manufacturing complex at its Hazira premises for the manufacture of these gun systems. It includes state-of-the-art test tracks to qualify mobility of every gun system produced here.

So, private sector companies like Bharat Forge, Solar Industries and L&T that have transformed themselves into key players of the defence supply chain are to watch out for.

Their ability to specialise in technical innovation are the crucial spokes in the wheel of India's defence evolution.

Over time, there will be barely any PSU monopolies in Indian defence sector.

The companies offering defence products are temporarily expected to have higher working capital too. This is due to the nature of payments in the defence sector.

Do not speculate on short-term order wins or quarterly performances of the defence segment. However, the massive transformation of India's defence industry is now inevitable.

Ignore this megatrend at your own risk.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)