PSU defence stocks to watch: An ‘atmanirbhar’ defence sector stands to benefit these govt firms most

August 27, 2020 10:03 AM

India has a volatile border on the Eastern and Western fronts and also has a long coastline to guard its maritime interests.

The defence ministry has set a goal of a turnover of USD 25 billion (Rs 1.87 lakh crore) in defence manufacturing in the next five years.

By Rusmik Oza

India has a volatile border on the Eastern and Western fronts and also has a long coastline to guard its maritime interests. In addition, there is this constant muscle flexing by a vastly modernized People’s Liberation Army of China (PLA). This makes it imperative and urgent to achieve modernisation and self-reliance in defence production. While the country has made major strides in space technology, a sore point is its high dependence on imports of defence equipment. This not just results in a loss of foreign exchange but also exposes the country to the vagaries of the foreign vendor for spares and maintenance.

Given this, and the potential for exports and job creation that the sector offers, the government has come out with various measures to drive indigenisation of the defence sector. The time has come for Indian companies which have been focussing on defence manufacturing to see bigger orders come through. High Fiscal deficit has led to a sober budget for defence spending in the last few years. However with border escalation with neighbours we can expect higher spending and procurement in the defence sector. 

Among the key measures include raising the sectoral cap of foreign direct investment (FDI) (automatic approval) from the existing 49% to 74%, creating a negative list for the import of defence equipment in India, a separate capital budget for indigenous weapons procurement, and corporatisation of the Ordnance Factory Board (OFB) and reforming the defence procurement.

We look at the implications and opportunities of these measures

  • The increase in FDI limits could aid in attracting foreign funds and transfer of technology know-how by defence-oriented companies headquartered abroad with subsidiaries in India.

  • To boost domestic participation in the defence sector, the negative list introduced could potentially result in estimated generation of orders worth Rs 4 lakh crore for Indian companies within the next seven years. Among the major items identified for domestic production are wheeled armoured fighting vehicles (AFVs) with the army expected to order units valued at over Rs 5,000 crore. The navy will order six conventional submarines under its Project 75I valued at Rs 42,000 crore, a process for which is underway. The air force will order 123 of the LCA MK 1A fighter jets in the next few years that will cost over Rs 85,000 crore. In addition, the defence ministry has earmarked a part of its capital acquisition budget only for purchases from the domestic sector — starting with Rs 52,000 crore this year that will progressively increase in the upcoming budgets.
  • The defence ministry has set a goal of a turnover of USD 25 billion (Rs 1.87 lakh crore) in defence manufacturing in the next five years that included an export target of USD 5 billion (Rs 37,500 crore) worth of military hardware. Defence products exports will contribute to strengthening diplomatic and economic partnerships and simultaneously lead to enhanced military cooperation.

  • The OFBs have been missing their production targets (achieved targets for only 49% of items) and have high overhead costs. Corporatisation can lead to greater competitiveness and effective management of the OFB units. Apart from this, the government has released the “Defence Acquisition Procedure” (DAP) 2020, which is aimed at twin objectives of simplifying the procedure and boosting indigenous procurement of defence equipment.

There are hardly any large defence stocks in the private sector. Few of the larger private sector players who have JV/Tie-ups for defence manufacturing are L&T, Bharat Forge, M&M, Tata Motors. However, defence as a segment is very minuscule in the overall consolidated revenue of these companies. Some of the listed PSU companies that are purely focussed on defence segment like Bharat Electronics, Hindustan Aeronautics & Bharat Dynamics stand to gain.

(Rusmik Oza is the Executive Vice President and Head of Fundamental Research at Kotak Securities. The views expressed are the author’s own. Financial Express Online does not bear any responsibility for their investment advice. Please consult your investment advisor before investing.)

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