Why I'm Bullish on India's Junior Defence Stocks

Dec 5, 2023

Why I'm Bullish on India's Junior Defence Stocks

In January 2022, Philippines signed a deal to buy three batteries of the BrahMos missile. The missile is the first such armament developed jointly by India and Russia.

The deal was India's first significant defence export.

The missiles are manufactured by Brahmos Aerospace in India.

After this, several other nations in Southeast Asia have expressed interest in buying the missile, including Vietnam and Thailand.

Now it is important to understand that electronics form 40% of the defence aircrafts and missiles.

So, while the public sector defence giants may grab the limelight, a relatively smaller entity, contributing to Brahmos Fire Control system for both land and airborne missiles, deserves as much attention.

The company's manufacturing facility consists of a 100,000 square feet factory built on 5.75 acres of land in Chennai.

The factory has facilities for design, manufacturing, qualification and life cycle support of high reliability electronic systems used in defence and aerospace applications.

The company I am referring to is Data Patterns.

The company is not a startup. It has been around for two decades.

The name Data Patterns, however, did not ring a bell for most investors looking to ride the defence megatrend in India, even a few years back. Until the BrahMos story came to the fore.

It was in November of 2002 when S Rangarajan, Chairman and Managing Director of Data Patterns, got a call from Sivathanu Pillai's office.

The latter, then chief of India's BrahMos missile programme and Chief Controller, R&D, in DRDO (Defence Research and Development Organisation) planned to visit Data Patterns' office on a Sunday.

Pillai had heard about Data Patterns' (DP) technical expertise from the Indian Space Research Organisation (ISRO), to which it was supplying to.

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He wanted to see for himself. He was especially keen to check if an electronics systems supplier to the aerospace industry had the product capability to compete in a tender with the likes of Tatas, L&T, and Bharat Electronics.

The rest, as they say, is history.

Data Patterns developed an indigenous electronics input for which Brahmos Aerospace was paying its Russian supplier three times what it paid Data Patterns.

So, producing few electronics products indigenously dramatically reduced the cost of the missile.

Today, Data Patterns is a vertically integrated defence and aerospace electronics solutions provider. It caters to the indigenously developed defence products industry.

The company has proven in-house design and development capabilities. Plus, it has experience of more than three decades in the defence and aerospace electronics.

The reason I call Data Patterns a junior Defence stock is because it is unlike most frontline defence companies in India specialise in few areas.

The junior defence stocks aid their larger peers by catering to multiple needs.

For instance, unlike large defence giants catering to specialised defence equipment, Data Patterns caters to the entire spectrum of defence and aerospace platforms like space, air, land, and sea.

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It has design capabilities across the entire spectrum of strategic defence and aerospace electronics solutions.

This includes processors, power, radio frequencies and microwave, embedded software and firmware, and mechanical engineering.

Data Pattern's electronic solutions are developed by specialist teams working on all layers of software.

The company's design and development capabilities have allowed it to develop complete systems as well as sub-systems for various strategic defence and aerospace electronics solutions.

These systems have found applications on various platforms and programmes such as the Tejas Light Combat Aircraft, the Light Utility Helicopter, BrahMos missile programme, precision approach radars, and various communications intelligence and electronic intelligence systems.

Not surprisingly, Data Patterns' order book has doubled over the past three years.

Increase in order book was mainly due to repeat production contracts for products already developed and accepted by the customers.

The company expects the order book to keep compounding at nearly 30% per annum based on potential repeat contracts.

Geopolitical Conflicts - Future of Defence Stocks

Ever since the Russia-Ukraine war broke out in 2022, defence companies globally have seen an increase in stock prices.

The Russia-Ukraine war has led to complicated geopolitical consequences in Europe, and the EU member countries fear that the conflict might engulf the entire region.

As a result, the countries in Europe have increased their defence spending to fortify their military capabilities.

The Russian invasion has rocked the global markets, and the aerospace and defence companies' stock prices increased due to the increase in defence spending.

The Israel-Hamas conflict has only added to the clamour for defence supplies.

Several countries are planning to increase their defence budget. Countries such as Germany and Japan having already announced a rise in their defence budget.

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Germany's defence budget will now make up to 2% of its GDP from the earlier 1.5%. Japan's defence expenditure will reach 1% of its GDP.

The increase in spending would take time to materialise into orders for defence companies. But the defence stocks have gained considerably due to the US and its allies' supply of arms and ammunition to Ukraine.

India's need for indigenous defence supplies was felt earlier during the Kargil war. But the constant threat from China and recent geopolitical events have stoked the urgency.

Amid increasingly shifting geopolitical realities, it is even more crucial for India to be self-reliant in technologically relevant defence systems today.

India does have large public sector defence entities with research capabilities at DRDO and ISRO. But their supplies were often imported.

So, home grown defence electronics and technology companies like Data Patterns will always be critical vendors to India's frontline defence stocks in a significant way.

Such junior defence stocks in India are likely to stay on investor radar.

Warm regards,

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

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