Defending The Defence Stocks — And Why You Should Buy

In these days of cross-border terrorism infiltrating even in our drawing-rooms through discussions, geo-political tensions finding space in the arguments over hot cups of tea, defence stocks have yet again hogged the limelight. Whether the hovering tension along the Line of Control will lead to a full-fledged war or not, war to by defence companies’ stocks at a lower price have kicked off among retail investors. In DSIJ, we believe to bring you the latest on the recent happenings always so that you stay abreast with the developments around you and take right decisions when it comes to investing your money in right instruments—this piece of exhaustive research is brought to let you know if this is the right time to buy defence stocks and also identify the perfect matches.

Why 

On the wake of consistently increasing expenses of the government on procurement of materials and equipments related to defending the country, we find this sector has enormous opportunity to shine further. Also now that the government has opened the door for private players to take part in the tenders related to defence procurement, high time we keep our ears and eyes on this sector.

Going with the statistics, the Department of Industrial Policy and Promotion has so far issued 319 industrial licenses covering 190 companies till January, 2016 for manufacture of a wide range of defence items to private companies. As many as 50 licensed companies have so far reported commencement of their production. After opening up of the defence sector for Indian private sector participation, so far 34 Foreign Direct Investment proposals and joint ventures have been approved by defence sector for manufacturing various defence equipments, both in public and private sector. FDI amounting to Rs 24.84 crores has been received by the defence sector from April 2000 to September 2015.

India opened up the defence sector allowing foreign companies to own as much as 100 per cent equity in the local defence sector through the government approval route in cases where it is likely to result in access to modern technology.

Consequently, the role of private sector has shifted from that of supplier of raw material, components, sub-systems to the one of becoming partners in the manufacture of complete advanced equipment systems to cater the growing needs of defence.

Where is the money

There are more chances that in the union budget of 2017-18 the per cent allocation in the sector may increase.This step, once taken, will inevitably strengthen the position of the private players engaged in this sector.

What’s brewing now

Premier Explosives has bagged an order worth Rs 27.79 crore from Bharat Dynamics for supply of booster grains. The company manufactures the entire range of explosives and accessories for the civil requirement. The company is the first manufacturer in India to deploy totally indigenous technology in this sector. On the other hand, Solar Industries has bagged an order from Singareni Collieries for the supply of 163911.20 MT explosives worth Rs 434.44 crores for the financial year ended 2016-17 and 2017-18. In March 2016, Himachal Futuristic Communication, a leading integrated solutions provider entered the defence segment. The company has been granted license for a range of products which includes electronic fuses, electro optical devices and communication equipment along with permits for assembling electronic warfare systems, radar and the design, development and manufacturing of aircrafts, including helicopters. 

The number-game

We identified 12 listed companies and worked exhaustively on their numbers and business prospects. We have excluded L&T, Mahindra & Mahindra as it may not be correct to analyse their financials as they have their separate defence subsidiaries through which they operate. The total consolidated gross sales of these 12 companies stands at Rs 21512 crores and the PAT for the year ended March 2016 stands at Rs 945.70 crores.The top line is largely dominated by Bharat Electronics, Bharat Forge and BEML which contribute 71 per cent of total gross sales. BEML which is Asia's second-largest manufacturer of earth moving equipment and has control over 70 per cent of India's market in that sector, is the largest profit churner amongst these 12 companies.

Multi-Baggers 

Top three performers in the last six months

Conclusion

In March 2016, Defence Minister, Manohar Parrikar cleared the much-awaited Defence Procurement Policy 2016. This policy has replaced Defence Procurement Policy, 2013. The Policy has given a wider assistance to the companies operating in the defence sector. Under the old Defence Procurement Policy, 80 per cent of the cost of designing and developing indigenous equipment was reimbursed but under the new policy, Indian government will be reimbursing 90 per cent of the development cost. On the other hand, there is greater assurance for the companies operating in defence industry to recover their costs. If after successfully developing a prototype, the vendor does not get an order within 24 months, his 10 per cent expenditure will be refunded. The sector has just opened up for the private players and therefore we will have to wait to arrive at the segmental revenue derived by private companies from their manufacturing of defence related activities. With the opening up of defence sector for the private players, new private companies will emerge in the upcoming years. However, it is the right time to invest in companies which have exposure to the defence or will soon have the exposure in the sector as the industry will grow in leaps and bounds.

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Our Recommendations

Bharat Forge

Bharat Forge Limited is a global provider of high performance, innovative, safety and critical components & solutions to various industrial sectors including automotive, railways, power, construction and mining, aerospace, marine and oil & gas.

The gross sales of Bharat Forge in the financial year ended March 2016 stands at Rs 7840.15 crores which has increased by 1 per cent. However, the PBIT of the company stands at Rs 1128.56 crores which has decreased by 10 per cent YoY. PAT stands at Rs 647.02 crores which has decreased by 15 per cent as compared to previous year. However, the balance sheet of the company is quite strong. Reserve and surplus stands at Rs 3529.19 crores which has increased by 4 per cent YoY. Total net worth has also increased by 4 per cent, but the interesting part the investments have grown by 62 per cent. The Q1FY17 profit stands at 122.06 crores and PATM stands at 12.75 per cent. Net sales in this quarter stands at 888.76 crores which is down by 20 per cent YoY.

With a strong market cap of Rs 20813.48 crores, Bharat Forge maintains a healthy dividend payout ratio of 23.75 per cent. The trailing-twelve-month P/E of the company stands at Rs 33.59 which is very close the industry P/E of 37.81. Adjusted EPS of Bharat Forge stands at Rs 26.97 and maintains a dividend yield of 0.84 per cent. You can bank on this company and go for a buy at this stage.

Premier Explosives

Premier Explosives is one of the major companies manufacturing entire range of explosives and accessories for  civil requirement. The company is the first manufacturer in India to deploy totally indigenous technology. It has bagged an order worth Rs 27.79 crore from Bharat Dynamics for supply of booster grains. The order is to be executed before June 30, 2017.

The financial numbers of the company are quite strong. In the financial year ended March 2016, Premier Explosives’ PAT stands at Rs 5.68 crores which has increased by 7 per cent as compared to its previous financial year. PBITDT has increased by 36 per cent and stands at Rs 18.17 crores. Total income of the Premier Explosives stands at Rs 189.02 crores which has increased by 23 per cent. Reserve and surplus of the company has grown by 7 per cent and stands at Rs 56.39 crores

In Q1FY17, PAT stands at Rs 1.75 crores. In Q1FY16, the company posted a net loss of Rs 1.4 crores. Net sales of Premier Explosives stands at Rs 184.99 crores which has increased by 25.75 per cent YoY.

Premier has a market cap of Rs 334.46 crores and maintains a healthy dividend payout ratio of 28.70 per cent. Premier Explosive has given a ROE of 12.60 per cent in the last three years. The trailing-twelve-month P/E stands at 34.89 which is quite healthy as compared to the industry P/E of 29.43. This can be a good buy considering the company’s impressive numbers and also happening in this sector. 
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NILESH PANPALIYA
CFO,SOLAR INDUSTRIES

Ans.After the recent surgical strikes, the country has realised that there is huge requirement for ammunition for the army. The statements from the Defence Minister and the Prime Minister who have asked the private sector to gear up which has given a lot of boost sectoral players who have their operations in defence. The sentiment is good and the investment in the sector is picking up and even now with the defence ministry is showing a lot of confidence with placing the order with the private players which is likely to benefit the defence stocks like solar industries.

Looking at the budget allocation in the Indian defence Industry, one could easily observe that the budget allocation has constantly increasing in the sector. Your comments?

Ans.The budget has been increasing and there is enough room we feel that as the economy grow stronger and stronger and as we continue to buy peace and to do that we must strengthen the ammunition base in the country. Till date we wore totally depended on imports but today with the initiative by the Government wherein they plan to ensure that the private sector comes out and helps the defence in manufacturing we will see more allocation of defence related work to the private players.

Ans.Earlier the challenge was the sector should be opened to private players once it opened the challenge was obtain valid licence. On the other hand, there are companies which are in the sector for the last 15 years which is also a prime challenge for the companies which have been just issued licence. Validation process, getting TOT, getting the product certification takes a long time which is normal in defence. Going ahead all the companies will benefit but in the nascent stage all private companies are facing the same problem. Two things which we all are trying to take it to the Government is that give us the level playing field with the ordinance factory and consider the capacity of the private sector participants before placing orders for import. Everyone is facing the same challenge but we all are hopeful that we will be getting huge orders from the next fiscal and the day is not far where the large numbers of defence orders will be held by the private players.

Rohit Natarajan,
Analyst - Institutional Equities, IDBI Capital Markets Services

Till 2001, defence production in India was reserved strictly under public sector. The role of private sector, however, was to supply of raw materials, semifinished products, parts- components to these defense public sector undertaking and ordnance factories. Thereby, given the lack of state-of—art technology in Indian public sector space, the major weapons/equipment were either imported or built under Transfer-of-technology (ToT) from Original Equipment Maanufacturers (OEM).

With more than 70 per cent imports, India remained a top importer of defence products. Now Ministry of Defence plans to spend $120bn in next five years. However, ministry wants the domestic share to improve from 30 per cent to 70 per cent. This would mean, for the domestic kitty, $84bn is up for grabs.

Thereby, going by the situation, we can argue that major naval programs can dole out Rs. 3.2 tn opportunities till 2025. And thereby, the demands for aircraft carrier, land platform dock, Frigate, submarines, corvettes, Mine couture measure vessels, landing craft units and fast attack crafts–theoretically remains on cards.