Defence Sector Growth Outlook Makes A Case For Costlier Stocks
Union Defence Minister Rajnath Singh's recent comments on defence exports triggered a rally in related stocks. But for how long? We do a deep dive.
Shares of Indian defence companies rallied this week after Union Defence Minister Rajnath Singh pledged to increase sectoral exports to Rs 50,000 crore by FY29.
The minister also said the government will continue to modernise the armed forces, setting ambitious goals that are expected to generate big business opportunities for domestic manufacturers.
Defence stocks have returned gains ranging between 46% and 233% so far this year, according to NDTV Profit calculations.
Thus, investors must evaluate if the growth in terms of order visibility and profit support the valuation and the rally witnessed so far.
Current Valuations Vs Historical Average
Several defence stocks show significant increase in their price-to-earnings ratio for FY25 as compared with their historical average.
Hindustan Aeronautics Ltd., with a P/E ratio of 50 times for FY25E as per Bloomberg, is more than double its three-year average of 19.56 times. Similarly, Solar Industries Ltd., Mazagon Dock Shipbuilders Ltd., and Garden Reach Shipbuilders and Engineers Ltd. all have P/E ratio higher than their historical average.
This trend may be justified by the sector's growth prospects. "We expect the share of defence capital outlay to increase to 37% of total defence budget in FY30F," said Nomura in its India Defence note. "This implies cumulative capital outlay of $186 billion over FY24F-30F (versus cumulative FY18-24F: $93 billion)."
Valuation And Growth Outlook
Overall, the comparison suggests a potential fall in valuations for some stocks like HAL, while others like Bharat Dynamics Ltd. might see the metric remain high or even increase.
"We expect HAL’s premium valuations to sustain as value opportunity of Rs 4.4 lakh crore over the next eight years provides growth visibility," said Nomura in its India Defence Note released in May.
In terms of other stocks like Bharat Electronics Ltd., the note said, "Valuation-wise, BEL enjoys a premium largely due to the structural shift in India’s defence sector, which has translated into higher robust inflows, earnings conviction, and improved visibility on order inflows over the next 7-8 years."
