Guardians of Security: Unveiling the Defense Sector's Dominance

 


Defence has been one of the most talked about sectors since Shri Narendra Modi came into power in 2014 and announced Atmanirbhar Bharat & Make in India. It came more into talks since the first indigenisation list was announced by Ministry of Defence (MoD) in August, 2020 which comprised of 101 items. The second list came in May, 2021 comprising of 108 items. The third one with another 101 items came in April, 2022. And the fourth list was announced with another 101 items in Defence Expo, 2022 which was conducted in December, 2022. Indigenisation means the action or process of bringing something under the control, dominance, or influence of the people native to an area. All these lists will promote Make in India & Atmanirbhar Bharat.

This has increased the exports. India's defence exports have grown eightfold in the last six years -- from Rs. 1521 crore in 2016-17 to Rs. 12,815 crore in 2021-22 out of which 70% exports were contributed for by the private sector. This number in 2022-23 has reached Rs. 16000 crore which is a 23 fold increase from 2013-14.

Looking at the above data, it made me want to look at the listed Defence space. I made a watch list of all the companies and came up with about 17 companies ranging from the Market Cap of 200 crores to 336000 crores which would include a few large caps like Larsen & Toubro, Hindustan Aeronautics and Bharat Electronics which are sure shot bets and are performing very well since Covid in 2020.

My eye was caught by the other Midcap/Small Cap/Micro cap companies. By Microcaps, I would usually refer to companies which have a market cap less than 1000 cr (There is no definition given by AMFI for Micro caps. This is my personal definition). The Midcap Space includes two names Bharat Forge and Solar Industries. The Small Cap space includes Mazagon Dock, Bharat Dynamics, Data Patterns, Cochin Shipyard, BEML Ltd., MTAR Technologies, Mishrat Dhatu Nigam, Astra Microwave Products, Zen Technologies & Paras Defence. The Microcap Space includes two names Taneja Aerospace & Krishna Defence with a Market Cap of 429 and 211 crores respectively as of June, 2023.

Before looking at their fundamentals, it made more sense to look at their current valuations as defence has been the most liked sector since 2020 and the sector overall has given great returns in the last 3 years. There has been a lot of frenzy about the sector and the stock prices have given a straight up move. I thought of comparing the PEG Ratio rather than the PE ratio as it provides more insight into the stock’s valuation as future earnings growth is also factored in.


A lower PEG ratio favours a stock to be undervalued especially below 1. MTAR Tech, Taneja Aerospace & HAL show PEG ratio lower than 1 but MTAR Tech has a P/E of 56 which doesn’t fulfil my criteria of investing in companies with a P/E below 50. Based on PEG Ratio, Taneja Aerospace would be a good company to look at and then maybe invest in but obviously after it passes most of my criteria from the The Equity Checklist. Taneja Aerospace has a good promoter holding of 51% and ROE and ROCE of 10.4% and 15.4% respectively.

A negative PEG can result from either negative earnings (losses), or a negative estimated growth rate. Either case suggests that a company may be in trouble. Cochin Shipyard, BDL and Bharat Forge have a negative PEG ratio with BDL and Bharat Forge having a P/E ratio higher than 50.

Companies with no PEG ratio mentioned might have been recently listed companies. Mazagon Dock, Solar Industries and BEL are still a little overvalued (PEG ratio above 1 but below 2) but as the P/E Ratios are below 50, it definitely qualifies for a Fundamental Check. Promoter Holdings of all 3 companies is above 50 and ROE/ROCE are in double digits. 

There are a few risk factors in this sector. There is heavy dependence on government orders for the same. Exports are a part of the revenue but not a huge one. Also, there is this question of if Modi Government doesn't win the 2024 elections, will these formal policies announced by him still continue or not. 

The sector is very hyped and an investor needs to be very selective with the stocks as well as what time you invest in. A cool off period is definitely a requirement to invest in these stocks. 

Hope this helps investors better analyze companies!!!!

None of the above are a buy recommendation whatsoever!

Happy Investing!!! 

References:

https://economictimes.indiatimes.com/news/defence/percentage-of-capital-expenditure-on-import-by-armed-forces-on-decline-in-last-3-yrs-govt-data/articleshow/93217994.cms?from=mdr

https://www.mod.gov.in/sites/default/files/PM-announces-fourth-positive-indigenisation-list.pdf

https://www.businesstoday.in/latest/economy/story/indias-defence-exports-skyrocket-to-all-time-high-surpassing-rs-16000-crore-in-fy-2022-23-383563-2023-05-31#:~:text=India's%20defence%20exports%20have%20reached,twenty%2Dthree%2Dfold%20increase.

https://www.investopedia.com/terms/p/pegratio.asp#:~:text=In%20general%2C%20a%20good%20PEG,suggesting%20a%20stock%20is%20overvalued.


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