Investors' Guide To Defence Stocks After Recent Run-Up | Open Interest

Defence stocks have been through a run-up. A gauge for the sector is trading at a premium. The order timelines remain stretched. But there can be a chance for investors to partake in the space.Hello! It's a new week, and we're here with the latest edition of 'Open Interest'. Today we are looking at the erstwhile market darlings — defence stocks. While they have cooled down since their stellar run in December, there still is a chance to pick up stocks in the sector. You just need to know what to look for.Without further ado, let's jump right in:But before we do, you can subscribe to our daily and weekly newsletters here..Defence stocks have seen correction since mid-December on the back of fears of a slowdown in the order flows and future earnings growth. The Nifty India Defence Index corrected 27% from Dec. 17, 2024, to February-end, before climbing 20% in March alone.The defence gauge at its peak in December had a forward price-to-earnings ratio of 64 times and fell to a low of 32 times at February-end. The Nifty India Defence Index is now trading at a P/E ratio of 38 times, a premium to the 10-year average for the index of 25 times..So, are the defence stocks on a roll once again?The defence play is a factor of faster Defence Acquisition Council approval conversions and higher domestic allocation of future requirements.The Budget for 2025-26 increased the capital outlay to Rs 1.80 lakh crore from the Rs 1.59 lakh crore earmarked till March 2025. The latter figure was reduced from Rs 1.72 lakh crore budgeted at the beginning of the year on account of delay in orders due to Lok Sabha elections. This decline in allocation disappointed the street, but even then the DAC has approved procurement proposals worth Rs 2.2 lakh crore in the current budget year. This, however, is shy of defence acquisitions worth Rs 3.6 lakh crore in the fiscal to March 2024..To be clear, the Defence Acquisition council approves the Acceptances of Necessity (AoN) for armed forces' requirements, which is then taken to the Cabinet Committee of Security for final approval before the order is rolled out. The AoN period itself can take up to two-three years. Thereafter, further approvals take another 48–60 months. In short, it takes about 60–72 months before an armed forces requirement is finalised.In the last five budget years, the DAC has approved proposals worth Rs 10.18 lakh crore. DAC orders take multiple years before they reach the final approval by the Cabinet Committee on Security, and they turn out to be multi-year orders to be delivered as per schedule which may vary over two–six years. A large part of these orders is now flowing to domestic public and private companies due to the import curb list of the Defence Ministry that encourages domestic manufacturing of military hardware.Case in point, the latest Cabinet approval for ATAGs – Advanced Towed Artillery Gun System – has taken over 10 years before the order could be given to two private sector companies – Bharat Forge Ltd. and Tata Aerospace and Defence Ltd. DAC had approved the AoN in 2017. Defence Research and Development Organisation began collaboration on this indigenous project in 2014 with the defence divisions of Kalyani Group and Tata Sons.The upcoming Budget year has higher allocation for other equipment and the recent Rs 7,000-crore approval for ATAGs will be part of this budget but again this needs to be delivered over the next five years.India's capital allocation for defence is growing at a slow pace from Rs 1.54 lakh crore in FY24 to revised estimate of Rs 1.59 lakh crore in FY25 and Rs 1.80 lakh crore budgeted in FY26.With over Rs 10.18 lakh crore DAC approvals in place in the last five years, the fuller utilisation of defence capital outlay is expected to rise in the coming years provided the AoN translate into orders. The industry would be happy if the AoN conversion to orders got reduced to six months from two years. And that is being too optimistic, the private sector would say!There are two positive aspects. First, the total share of domestic procurement has seen a phenomenal improvement from 54% in FY19 to 75% in recent years and is expected to improve further. Second, the DAC has approved guidelines for compressing timeline at various stages of capital acquisition, enabling faster, more effective, and efficient procurement by reducing the requirement to procurement timeline to six months from earlier two years..India has allocated over RS 48,000 crore for aerospace and aviation engines in the next fiscal. This is followed by the next big requirement of Rs 63,000 crore for other equipment. Naval fleet orders will get Rs 24,390 crore and construction work will get Rs 11,450 crore.The Budget also has Rs 15,000 crore on R&D, i.e., 8.3% of the total defence capital outlay. Many of the private and public sector companies will have access to this as DRDO collaborates with the private sector for future projects.As DAC approvals gradually get converted into orders, there is a likelihood of Rs 5–7 lakh crore of additional order conversions in the next two to three years. This augurs well for the domestic companies, but it is a long-term play.Valuations for defence stocks rose on expectation of rising order inflows. But for a sector that is dependent on the government budget, the growth for domestic companies will come from export markets and conversion of DAC approvals to Cabinet approvals which gets reflected in annual capital outlay for the defence sector.Therefore, investors should look closely where the capital allocation is being provided in the budget to select stocks in this sector.Before we bid you adieu, here are some of the stories we are reading at NDTV Profit:1. Is it finally time to buy? Market veteran CK Narayan chalks out the road ahead in the backdrop of the rising markets last week. 2. Trump’s ‘Big One’ on tariffs has emerging market on edge.3. How pushback against Elon Musk has ballooned into 'Tesla Takedown', Mohammed Uzair Shaikh writes.4. 'SAIL' has the highest number of 'sell' ratings among peers. Read Mihika Barve's piece to know why.5. From the blooming world of AI, OpenAI has found links between ChatGPT use and loneliness. Read here.

Investors' Guide To Defence Stocks After Recent Run-Up | Open Interest

Which defence stocks are on a roll once again? Depends on the where the capital allocation for the sector has been made.

NDTV Profit

NDTV Profit

Follow Us

DOWNLOAD THE APP