The Indian defence sector is going through a major transformational phase as the government looks committed to reducing imports and increasing indigenisation of various key defence platforms, systems and associated equipment required for these platforms.
Should you buy defence stocks? The emphasis is on modernisation, surge in manufacturing to give impetus to growth
Defence production in FY 2021-22 stood at Rs. 92,708 crore (US$ 11.85 billion). The Indian government has set the defence production target at US$ 25.00 billion by 2025 (including US$ 5 billion from exports by 2025). The government is taking several initiatives to encourage domestic manufacturing and reduce its external dependence for defence procurement.
In January 2021, Defence Research and Development Organisation (DRDO) announced that it will support at least 30 start-ups every year to develop innovative products for Indian defence forces. The government announced measures under the ‘Make in India’ initiative, including raising foreign direct investment (FDI) limit from 49% to 74% via the automatic route; this resulted in significant FDI inflows in the defence and aerospace sector.
Bolstered growth due to Government actions
The share of imports, which is about ~35% of the total defence procurement budget, has come down in the last two to three years. It is likely to reduce further in coming years as the government continues to focus on allocating more budget to DRDO for indigenous development of new generation & modernised equipment, sign large scale orders for these equipment/platforms with defence PSUs and encourage more domestic private players, MSMEs and startups for manufacturing key components, which India used to import from countries.
Indian defence production value
India’s defence manufacturing sector recorded increased production to US$ 11.85 billion in FY22 from US$ 10.9 billion in FY21. Defence production by PSUs stood at Rs. 55,066 crore (US$ 7.09 billion) in FY 2021-22 registering a growth of 12.36% YoY.
The country plans to spend US$ 130.00 billion on military modernisation in the next five years and is also achieving self-reliance in defence production. The Government of India opened the defence industry for private sector participation to provide impetus to indigenous manufacturing.
The Ministry of Defence (MoD) has notified 310 major equipment/platforms in the last two years through three separate lists, which included combat aircraft, trainer aircraft, combat helicopters, utility helicopters, submarines, next generation corvettes, tank engines, MRSAM system, vessels, torpedoes, etc. These platforms are planned to be indigenised progressively till 2027.
All defence companies were in line with the execution, which led to significant increase of in their revenues (highest growth being witnessed in Bharat Dynamics (BDL) where revenues jumped over 5x followed by 124% growth by Hindustan Aeronautics (HAL) and 80-90% growth seen in Bharat Electronics (BEL), Mazagon Dock Shipbuilders (MDL) and Garden Reach Shipbuilders (GRSE).
Defence exports have seen a rapid uptick
To boost the domestic defence sector manufacturing, the Ministry of Defence, in December 2020, approved the export of indigenously developed surface-to-air Akash missile system and set up a panel to ensure faster approvals for acquisition proposals by various countries.
With an emphasis on promoting defence exports from the country, India Pavilion at Aero India 2021 - Bengaluru will showcase a range of indigenously developed helicopters. In October 2020, India and the UAE have agreed to take their defence cooperation further through joint production and mutual trade. This move is expected to boost domestic defence exports and achieve defence export targets worth US$ 5 billion in the next five years.
Recent improvements in defence sector
In June 2022, the Ministry of Defence approved the procurement of military equipment and platforms worth ₹76,390 crore (US$ 9.84 billion) from domestic industries. In June 2022, Ministry of Defence signed a deal for the Astra Mk 1 Beyond Visual Range (BVR) AAM and associated equipment, at a cost of Rs. 2,971 crore (US$ 382.79 million).
To promote private industry, MSMEs and start-ups in defence production ecosystem, the Ministry of Defence has allocated 25% of domestic capital procurement/ acquisition Budget, amounting to Rs. 21,149.47 crore (US$ 2.72 billion), for domestic private industry in FY 2022-23.
Under Mission Raksha Gyan Shakti, 1348 Intellectual Property Rights (IPRs) (until April 2022) have been granted/registered by the Indian Patent office. The government has established two Defence Industrial Corridors (DICs) in the country, one in Uttar Pradesh called the Uttar Pradesh Defence Industrial Corridor (UPDIC) and the other in Tamil Nadu called the Tamil Nadu Defence Industrial Corridor (TNDIC), with the goal of attracting ₹10,000 crore (US$ 1.31 billion) in investment in each.
The projects under the scheme will be given up to 75% government funding in the form of ‘Grant-in-Aid’. The remaining 25% of the project cost will be borne by a Special Purpose Vehicle (SPV) comprising members from Indian private entities and state governments.
The healthy pipeline of orders and mission gives more comfort in terms of long-term earnings growth for companies like BDL, HAL & BEL. Balance sheet of these defence companies looks better with zero debt and working capital support from MoD.
Shuchi Nahar is a Certified Research Analyst. She can be found on Twitter at @shuchi_nahar
Note: This article is for informational purposes only. Please speak to a SEBI-registered investment advisor before making any investment relatedinvestment-related decision.