Want to bet on defence? Harshit Kapadia on 3 ways to do it

Time of India

13-05-2025

Harshit Kapadia
, VP,
Elara Securities India
,
says the defence sector offers three investment avenues: PSUs like
HAL
and BEL, shipbuilding, and private companies. Currently, PSUs benefit from order flow due to their integration capabilities. However, private defence firms like
Data Patterns
,
Zen Technologies
, and Astra Microwave are poised for disproportionate growth with increasing indigenization, alongside larger players like L&T and Bharat Forge. Drones have become a big part of modern warfare and there is a lot of potential into drone manufacturing as well as anti-drone systems. But they are mostly imported and defence drones are from unlisted entities.
Let us understand defence. There are two ways to look at capital goods and defence. Drones were used in this attack. Does that make the rest of the defence industry redundant or for the rest of the defence industry in India and rest of the world there is a warning sign now that you need to build, you need to build fast, and you need to perhaps keep everything future ready now?
Harshit Kapadia:
No, it would not make the other equipment redundant. It just tells you that modern warfare has changed a lot and right now drones are the in thing and so is a counter drone system which is also used to detect this system. So, both are of an equivalent number and in terms of markets, I have shown this, both not just our war or our conflict, I would rather put it that way, the other two wars have also shown that. Hence we are also prepping up our drones manufacturing. There are more than 300 plus companies in India who are manufacturing drones in India of various variety from a small use, it may be non-defence use to a defence use. So, both the Indian defence companies, foreign companies are all here in India who are into this drone manufacturing and so is the counter drone system as well.
Can you identify some companies where you think this entire drone effect could be a big driving factor for future earnings? Within listed space, which are the companies that have direct or indirect presence in the drone segment and defence drone because there are civilian drones also? Idea Forge gets 96% from civilian drones, so frankly it is not relevant.
Harshit Kapadia:
So, no major player in the listed space is into defence drones, although everybody claims to be on the defence drone side. One name you already mentioned there are companies like Paras Defence also is into defence plus non-defence drones. Zen Technologies has recently launched a defence drone according to them, but nothing has been supplied as of yet. So, most of the drones that we see which are used by the Indian armed forces are largely imported and there are defence drones, but most of them are from the unlisted entities where they are buying in, so that is what we understand.
As an investor, what is a better way to own defence companies? Is it via the government owned companies or could it be a better strategy to have a mix of private names as well? Everything from Bharat Forge to M&M, many of these private businesses as well do have a defence component and company.
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Harshit Kapadia:
The defence can be played in three ways. One is your largecap defence PSUs which is HAL, BEL, Bharat Dynamics; then there are ship building company that is another way to play it; then there is a small and private defence companies like Zen, Data Patterns, Astra, Paras more names and then there are large defence private sector companies some of which you already mentioned like Bharat Forge,
Solar Industries
, L&T so this is a three bucket in which I would want to put.
Now what we think right now it is the time for PSUs because lot of orders are going towards this PSUs because they are the ones who are integrating most of the technology, but let us say 5 or 10 years down the line we see the private defence sectors rising disproportionately as we are looking at indigenisation, we are looking at components being manufactured for some of the integrated project which PSUs are getting into.
So a lot of beneficiaries would come from small and private defence companies and in this concurrent time even the large players will also see a rise as they also get into much more integrated modes like L&T and Bharat Forge. So, in the small and private space what we like is Data Patterns. Zen Technologies, Astra Microwave are some of the companies that we like within the small. So, you can play this in three ways.
When it comes to the defence and the kind of technologies that we have, do you believe that we have a larger scope to grow our share of export as well because well, of course, export has seen a good growth of almost 12% in the year on by, already at an all-time high level, but how much more headroom do you believe we have still to grow our exports?
Harshit Kapadia:
So, our target was to touch close to $5 billion in terms of exports by FY25, but probably in a few years down the line we should be able to even breach this number. Now, lot of events which have happened in the last few days have created a lot of impulse in the global media on our indigenised products.
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So, some of them may see the light of the day. Some are already in the conversation with a lot of countries where it is BrahMos, where it is Akash, whether it is those kinds of systems. Even in terms of helicopters and aircraft the discussions are ongoing. We had seen some success in some missile related products.
Now with this current Indo-Pak thing, conflict, a lot of indigenous system was used and this may see on a broader aspect, will entice interest much more significantly from smaller countries like Southeast Asian countries, Middle East countries, and African countries, some Latin American countries as well. So, we should see even much more multi-fold growth in exports from here on.
What is the right way to look at defence stocks and their valuations? Is it PE, is it order book because the order books are very different from let us say an infra company's order book or auto company order book because these are orders which come initially and then executed over years. I mean, HAL told me that it takes about 8-9 years to make one plane, so the order book reflects a large number, but execution takes 7, 8, and 10 years sometimes.
Harshit Kapadia:
Yes, the execution timelines are very stretched. This would be true mainly for ship building companies. So, every company has a different strength. So, if we are looking at missiles, the order conversion time is somewhere between two to three years. For somebody like
Bharat Electronics
, they have orders which can be converted from six months going up to three to four years.
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For HAL, it would be from four years to even seven years. Ship building companies would be somewhere from six years to ten years. So, every company has to be played in a very different way. You cannot just pinpoint one company. But if you are looking at earnings growth momentum will be highest, then it would be somewhere where the execution cycle is the lowest and some company sitting in an order book of close to 5x or 10x of the sales. I am talking about Bharat Dynamics. So, there the order conversion time is only two to three years.
They have an order book of around Rs 20,000 crore as on March 25. When it comes to HAL, we will see more revenue growth execution pickup. So, they had issues in terms of supply chain. Hence, they may not be able to execute it. But from here on FY26 going up to let us say next two to three years we see double digit both earnings as well as revenue growth momentum for HAL. For Bharat Electronics, the growth momentum would be upwards of 20% is what we understand as far as these three names are concerned.
Given the fact that for now and for the year gone by the India defence budget is fixed at 6.8 lakh crores. Help us understand what you are pencilling in with respect to this number because in a special situation like this, is there a possibility that the government can actually go ahead and increase its spending in any way.
Harshit Kapadia:
Yes, there is a separate report which is coming from standing committee where it highlights that if and when the armed forces require additional amount because of any situation or if there is a certain buying requirement which has come, they can go to the ministry and they can increase the budget per se and they can increase the amount which they want, any of the armed forces, so there is a scope there.
If the need be, then our armed forces will go and increase the budget, out of this Rs 6 .8 lakh crores which you mentioned, the appropriate amount which is for the equipment buying or for the defence capital goods is 1.8 lakh crore as far as FY26 is concerned.
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