Execution hiccups curb order-flow excitement for defence stocks

A pickup in defence approvals and orders, which were in the slow lane for much of FY25, improves the medium-term revenue visibility of defence public sector undertakings (D-PSU). However, the execution of existing orders remains a major challenge for most of these companies. Hence, a continued focuson order inflows, which typically leads to a sentimental uptick in stocks,might lead investors to miss the wood for the trees.

Defence capital spending fell 20% year-on-year in H1FY25, but activity is expected to pick up in Q4FY25 with multiple large-ticket orders lined-up for finalization such as Sukhoi engines and SU-30 MKI, Antique Stock Broking Ltd said in a report on 27 December. For FY25, the Defence Acquisition Council (DAC) has approved the acceptance of necessities worth ₹1.7 trillion till December.

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Despite an almost six-fold jump in the last couple of years to its all-time high of 8,302.03 in July 2024, the Nifty India Defence index is down almost 25% currently. The Street seems to have already priced in suchfavourable effects of the government’sindigenization push forthe domestic defence ecosystem along with enhancements of FDI limit in the sector. Plus, lofty valuations of most defence stocks havegrossly underestimated the risks from execution hiccups, rise in raw material costs, competitive pressures and cash flow generation. A key concern is that most D-PSUs remain saddled with order execution challenges and delays due to global supply chain risks.

For instance, the recent order for 12 Su-30MKI fighter jets is likely to swell HAL’s order book by ₹13,500 crore. But HAL is currently struggling to deliver its past orders of TejasMK1Alight combat aircraft. Since HAL imports the aircraft’s engines from US-based General Electric Co (GE), it has been exposed to global supply chain disruptions that have delayed the production of those engines. GE is now likely to deliver them by March, instead of the initial delivery timeline of September to November. This is feared to adversely impact FY25 revenue growth estimates of HAL.Bharat Dynamics Ltd and Cochin Shipyard Ltd are among the others who are also witnessing some execution hurdles.

Also Read: Supply delay drags Hindustan Aeronautics’s near-term growth prospects

Indigenisation push

Despite the government’s indigenisation push since FY21, India continues to import technology, design and core components of its aircraft, submarines and weapons. Theinvolvement of foreign parties stretches the orderapproval to the execution process, while exposure tosupply chain bottlenecks often delays the operations further for domestic players. Moreover, government spending on research and development, a key tool to reduce the country’s dependency on such crucial imports,remains chronically low compared to its procurement, salary, and pension expenditures.

Nonetheless, current levels ofindigenisationpush are expected to aid the earnings of both public and private defence companies.“While the order for 12 nos. Su-30MKI and 100 nos. K-9 Vajras benefits HAL and L&T directly, we believe larger defence ecosystems are likely to benefit as indigenisation level is likely at >60% for both of them,” an ICICI Securities Ltd report on 14 December said.

BEL will likely benefit from fresh demand for radars and electronic warfare systems from the latest round of orders. Astra Microwave Products Ltd, PTC Industries Ltd and Solar Industries India Ltd could see a trickle-down effect.

However, defence companies’ current pace of execution, and hence a subsequent bump in their topline and bottomline, remains a key trigger of any potential upside in their stock prices, Harshit Kapadia, executive vice president of institutional equity research at Elara Capital told Mint.

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