India's defence sector a $138bn opportunity; HAL, BEL top buys: Nomura

India’s defence sector presents an ordering opportunity worth $138 billion between fiscal years 2023-24 (FY24) and FY32, said a latest note by Nomura, which has initiated coverage on two defence-related players – Hindustan Aeronautics (HAL) and Bharat Electronics (BEL) – with a ‘buy’ rating.

The research and broking house sees an upside potential of 28 per cent and 32 per cent, respectively in these two stocks from the current levels.

India's defence sector, Nomura said, is witnessing significant growth driven by increasing defence budgets, modernisation efforts, and the government's emphasis on indigenous manufacturing through initiatives like "Make in India."

"India's strategic location in the geopolitically significant South Asian region makes defence a priority area for national security as it continues to strengthen its defence capabilities to address regional security challenges.

"Our bottom-up analysis presents an ordering opportunity worth $138 billion over FY24-32F for defence manufacturing and production," wrote Umesh Raut and Tanay Rasal of Nomura in the recent report.

Most frontline defence-related stocks, meanwhile, have done well at the bourses with Nibe Defence and Aerospace Limited (NIBE) surging 135 per cent thus far in calendar year 2024 (CY24).

NIBE is involved in the production of structures, sub-assemblies, and assemblies of mobile weapon launchers.

It also manufactures structural systems, such as Modular Bridge for the Indian Army, and engineering systems tailored for naval applications.

Data Patterns (India), HAL, BEL, and Bharat Dynamics are some of the other defence-related stocks that have gained up to 50 per cent thus far in CY24, ACE Equity data shows.

In comparison, the S&P BSE Sensex has moved up 1.7 per cent.

Military spends

The total military expenditure globally surged to $2,443 billion in CY23, rising 6.8 per cent year-on-year (Y-o-Y), according to reports, which is the steepest YoY increase since CY09.

A notable development, the Nomura report said, is that this spending has risen across all five geographical regions – Europe, Asia and Oceania, Americas, the Middle East, and Africa – defined by Stockholm International Peace Research Institute (SIPRI), a trend not seen since CY09.

The five biggest spenders in CY23 were the United States (US), China, Russia, India and Saudi Arabia, which together accounted for 61 per cent of world military spending in CY23, according SIPRI.

The surge in military spend in India, Nomura said, was primarily driven by rising personnel and operations costs, which accounted for nearly 78 per cent of total military budget.

In comparison, capital outlays for military procurement remained relatively stable, comprising around 22 per cent of the budget in CY23.

“A significant portion of these military outlay (75 per cent), was directed towards equipment produced domestically.

"This represents the highest level ever and marks an increase from 68 per cent in CY22.

"Overall, we expect the share of defence capital outlay to increase to 37 per cent of total defence budget in FY30F (FY24RE: 26 per cent).'

"This implies cumulative capital outlay of $186 billion over FY24F-30F versus cumulative spend in FY18-24F at $93 billion,” wrote Raut and Rasal of Nomura.

Why buy HAL, BEL?

In this backdrop, Nomura remains bullish on HAL for its strong moat in fighter aircraft and helicopters, and significant capability upgrade that provides basis for development of indigenous engine program; and BEL for its increased visibility on order inflows, conviction on margins delivery and expansion in returns ratios.

Nomura expects HAL's revenue, Ebitda, and PAT to register respective compounded annual growth rate (CAGRs) of 14 per cent, 11 per cent and 23 per cent over FY23-26F.

They value HAL at 38x (implied PE of 32-43x based on DCF) FY26 earnings, with a target price of Rs 4,750 apiece.

BEL, on the other hand, Nomura said, is poised to demonstrate revenue, Ebitda, and PAT CAGRs of 16 per cent, 18 per cent, and 22 per cent, respectively, over FY23-FY26F, underpinned by a strong order backlog of Rs 760 billion.

“We value BEL at 40x FY26F earnings per share (EPS), with a target price of Rs 300 reflecting improved visibility, a strong competitive moat, and a well-established presence in significant defence contracts.

"We anticipate that BEL's premium valuations will endure, supported by enhanced visibility on the platform side, healthy return ratios, and a resilient margin profile,” the Nomura report said.

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