Enough Ammunition In The Defence Sector For Steady Growth!

Enough Ammunition In The Defence Sector For Steady Growth! 

The defence sector is often considered as a sector which is yet to reach its true potential in India, in spite of abundant opportunities. Nikita Singh explains how the growth momentum is in place for the defence sector. 

Defence sector is one sector which was never in the top list of investors only a few years ago. But things have changed recently since the launch of 'Make in India' campaign. The defence sector is buzzing with new policy decisions and investors' expression of interest in several projects. 

India has the third largest armed force in the world and 60 per cent of its defencerelated requirements are met by imports. One can only imagine the huge size of opportunity for import substitution when one realises the fact that the allocation for defence in the Union budget is USD 34.53 billion approx. Further, an interesting aspect of the defence budget is the fact that 31.1 per cent of the budget is spent on capital acquisitions. 

As of now, the opening of the defence sector for private sector participation has allowed foreign original equipment manufacturers to enter into strategic partnerships with Indian companies, not only to tap the domestic market opportunities but also to cater to the global markets. This will be a win-win situation for India as it not only attracts foreign investments, but it will also help boost exports. 

Adequate steps have been taken by the current government via its offset policy to ensure that an eco-system of suppliers is built up domestically. After many years, investors are now eyeing a favourable government policy that promises to promote self-reliance, indigenisation, technological upgradation and economies of scale. 

GROWTH DRIVERS 

The amendments made in the Defence Procurement Procedure (DPP) in 2016 provides the much-needed impetus to local defence manufacturing. To encourage indigenous design, development and manufacturing of defence equipment – buy Indian -IDDM (Indigenously Designed, Developed and Manufactured) policy will encourage indigenous design, development and manufacturing of defence equipment. Today, there is more clarity on the definition of indigenous content and it provides investors more confidence while investing in the sector. Provision for maintenance TOT (transfer of technology) to Indian industry partners and the provisions to allow foreign OEM (original equipment manufacturer) to select Indian production agency augurs well for the private companies active in the defence sector in India. 

Companies such as Bharat Electronics, which is a leader in defence electronics in India with more than 55 per cent market share, are expected to be major beneficiaries in the coming year. Mahindra and Mahindra, Godrej, Bharat Forge, Tata group and L&T are some of the private group that have strong defence capabilities. 

INCENTIVES FOR THE SECTOR 

There is tax incentive for the sector as well as state-specific special incentive packages are doled out for mega projects. 

There are incentives for defence exports in the form of export promotion of capital goods scheme, duty remission scheme and incentives as per ‘Merchandise Exports from India Scheme (MEIS)’ under the new foreign trade policy. The foreign trade policy provides guidelines for engaging with Indian missions/embassies abroad for export promotion. Options are offered for export financing through line of credit and the new foreign trade policy promotes better use of offset policy. 

CONCLUSION 

The defence sector will continue to remain in the limelight in the coming years as the government intends to promote the industry. The opportunity is huge for the private sector in India to tap and the latest policies are framed in such a way so as to promote indigenous domestic defence industry. But on the ground, the situation is not rosy though for the private companies as it may take time for the policies and budget outlay to translate into earnings for these companies. However, the momentum is in the right direction and investors can carefully look at the sector for investing opportunities.  

Haresh Mehta, Chief Institutional Trader, First Global 

If we look at the global defence spending in the year 2018, it is expected to reach highest levels and would record growth at around 3.3 per cent, which would be the fastest growth rate in a decade. However, India ranks fourth since last two years in defence spending, after the US, China, and Russia. India's budget allocation on defence spending is 57% for the army, 22% for air force, 14% for navy and 6% for DRDO

Looking at the current stock prices in this sector, many of the companies are trading at P/E multiples of 45 to 60. Currently, many companies from this sector had planned to do capex for expansion and innovation of modern technology. However, the stock prices had ran up and the stocks became overpriced before the execution of plans. Hence, make me neutral at these levels. I feel one should avoid these stocks in the current scenario and wait for a reasonable correction in the stock prices. 

Anita Gandhi, Whole Time Director, Arihant Capital Markets 

The private sector in India has less than 5% (which is about Rs5,000 crore annually) share of direct orders from the Ministry of Defence for manufacturing and is gradually moving towards 10% in tandem with the 'Make In India' initiative. At present, The government has raised the cap on FDI in defence from 26% to 49%. The FDI can be increased to 74% through the approval route if the technology being brought in is needed by India. 

With the exchange rate variation protection while bidding for contracts, the currency risk for the players in the sector is expected to reduce. Higher licensing requirement from 20% to almost 80% for the end-user will ensure safety provisions. The government is also working on various measures to attract more private players in the segment. 

For the defence industry, in the upcoming Union Budget 2018 , we expect more allocation to defence deals, more focus on military modernisation and more involvement of private players 

Indian companies are allowed for tie-ups with a foreign original equipment manufacturer (OEM) for transfer of technology (ToT) under ‘Buy & Make (Indian)’ category.

Defence Stocks Performance 

walchandnagar industries, a heavy engineering products and engineering procurement and construction major, has soared over 60 per cent. The company supplies components for nuclear submarine, missiles and other defence equipments. Bharat Forge, the world's largest forging company, has also jumped by over 50 per cent since February 1, 2017. The company received its maiden order from Ministry of Defence in August last year to supply 1050 dual technology detection equipment worth Rs2.02 billion. The order is to be executed within two years. Ashok Leyland, the largest supplier of logistics vehicles to the Indian Army, has also risen by over 36 per cent since the last budget. Tata Power’s strategic engineering division (SED) division designs, develops and produces strategic defence systems and is a prime contractor to the Ministry of Defence for indigenous defence production. The stock has soared 22 per cent in the period under consideration. Recently, the Indian Navy has also entered into a contract with Tata Power SED in November 2017 under the 'Buy and Make' category. 

Navratna defence PSU Bharat Electronics Ltd (BEL) has more than Rs2500 crore worth R&D programmes lined up for the next two years. The company stock has gawined by over 27 per cent since budget and expects radars, missile systems, communication and network-centric systems, tank electronics, gun upgrades, electro-optic systems and electronic warfare and avionics system to drive growth going forward. However, Reliance Naval and Engineering turned out to be an exception. The defence shipyard was floundering amidst high debt and the company's stock price declined by over 6