India's Defence Sector: A Promising Investment Opportunity

Industry Overview

India's defence sector is experiencing significant growth, driven by the government's efforts to strengthen international alliances and boost defence exports. With domestic defence expenditure expected to double between FY2024-30E and a projected annual growth rate of 13% from FY2023-30E, the sector offers attractive investment opportunities. India's defence exports have surged, positioning the country as a major supplier to global markets, particularly in the Middle East. The government's reforms, including the Strategic Partnership Model, import embargo, and liberalized FDI policy, further support the sector's growth.

Investment Thesis

India's defence sector presents a compelling investment opportunity, underpinned by several key factors:

1. Robust Defence Expenditure: India's ambition to position itself among the global defence spending elite is reflected in the projected 13% annual growth from FY2023-30E, with an expected expenditure of $100-120 billion over the next decade, despite its current expenditure being a fraction of the United States and China.
2. Surging Defence Exports: India's defence exports have witnessed a remarkable 16-fold increase to $3 bn from FY17-24E, with expectations to reach $7 bn by FY30E. This positions India as a significant supplier to global markets, particularly in the Middle East, which represent 33% of global arms imports.
3. Redefining Global Defence Trade Dynamics: As the global defence trade amounted to $32 bn in 2022, with India accounting for a substantial 9%, the nation's defence import strategy has been recalibrated towards greater self-sufficiency. This strategic pivot is set against declining imports from traditional powerhouses like China and a surge from Israel, underscoring a global realignment in defence trade patterns.
4. Government Reforms: The Strategic Partnership Model, import embargo, indigenization lists, liberalized FDI policy, and development of defence corridors create a conducive environment for domestic defence manufacturing and foreign investment. Under the Strategic Partnership (SP) model, some of the foreign ship-builders shortlisted were Naval Group-DCNS (France), Rosoboronexport (Russia), ThyssenKrupp Marine Systems (Germany), Navantia (Spain) and Daewoo (South Korea). A phased import embargo on 928 defence items and a positive indigenization list detailing 4,666 items for Defence Public Sector Undertakings further accelerates the domestic sourcing of defence components. The increase in the cap for Foreign Direct Investment (FDI) in the defence sector to 74% through the automatic route stands as a testament to India's openness to foreign participation and investment.

Key Listed Players in the Defence Sector

1. Bharat Dynamics Ltd (BDL): Commanding a formidable position with an order book standing at INR 20,000 cr. as of January 2024, BDL is set to fulfil these orders within the next 4-5 years. Dominating over 55% of India's guided missile and torpedo market, which is projected to reach $25 bn by FY2026, BDL's robust growth trajectory seems certain.
2. Bharat Electronics Ltd: Established in 1954, BEL has been at the forefront of designing and manufacturing advanced electronic components for defence services, alongside other governmental agencies. With order inflows of INR 32,700 cr. in Q3FY24 and a FY2023 order book INR 77,000 cr., BEL should experience strong growth as these large orders convert to billings over the next few years.
3. Hindustan Aeronautics Limited Ltd (HAL): India's largest defence PSU, HAL clocked INR 26,975 CR in FY2023. HAL is renowned for its comprehensive range of aerospace products and services. Its strategic importance is underscored by a robust order book of INR 1.08 trillion, a testament to HAL's integral role in advancing India's air defence capabilities through indigenous platforms like Tejas and AMCA.
4. Mazagon Dock Shipbuilders Ltd (MDSL): Transitioning from a humble ship repair entity to a leading shipyard, MDSL's specialization in corvettes, destroyers, and submarines is impressive. With a healthy order backlog of INR 41,400 cr. as of March 2024, MDSL is instrumental in augmenting India's naval strength.
5. Astra Microwave Products Ltd (AMPL): It is the market leader in the design and production of microwave processors, radio frequency systems, microwave-based components, and subsystems for the Defence, Telecommunications, and Space industries. AMPL's significant order flow of Rs INR 250 cr. in Q3FY24, alongside a backlog worth INR 1,500 cr. as of FY2023, positions it as a cornerstone in defence, telecom, and space sectors, with a promising outlook on an Rs INR 8,000 cr. opportunity pipeline.
6. Paras Defence and Space Technologies Ltd (PDSTL): Specializing in IDDM solutions across diverse defence and space domains, PDSTL's monopoly in submarine-grade optronic periscopes and its pioneering role in the drone and anti-drone markets underscore its strategic value. With anticipated revenue growth of 12% for FY2025 from an expected INR 273 cr. in revenue for FY2024, PDSTL is poised for significant expansion.
7. Data Patterns Ltd: It is one of the only vertically integrated defence and aerospace electronics solutions providers. Demonstrating a remarkable order book growth, Data Patterns stands out with its diversified portfolio catering to defence stalwarts like MoD, BrahMos, DRDO, ISRO, and HAL. The company's management anticipates maintaining its current revenue growth rate of ~30%, gross margins of 60-65%, and an EBITDA margin of ~40%. The expected inflow of new orders, ranging between INR 600 to 700 cr.

Conclusion

As India strides forward on this path of strategic and defence empowerment, it's clear that the nation is not just participating in the global defence arena but is set to become a key player in the space. While risks and challenges exist, the long-term outlook for the Indian defence sector remains positive, presenting a promising opportunity for investors seeking exposure to this strategic industry.