India’s defence manufacturing sector stands at an interesting point. Policy intent is strong, budgets are rising, and domestic production is expanding. Market participants who watch the BDL share price are often reacting to missile and weapons orders, while those following the Bharat Electronics share price tend to respond to electronics and systems contracts. Beneath both lie larger forces that will determine how the sector evolves over the coming decade, and this article examines them calmly and without hype.
The Growing Defence Budget and Its Composition
Within the Union Budget, a large amount is allocated to defence. This is split between revenue expenditure (salaries/pensions/running costs) and capital expenditure (new kit). From a manufacturer perspective, capital expenditure is key, and consistently increasing capital spending indicates ongoing demand for new platforms, weapons and electronics.
Positive is that there has been an increase in capital spending awarded to local companies in recent years. This provides a boost to both public and private manufacturers. However, investors should keep an eye on how much is actually being spent, as some money can go unspent.
Indigenisation Lists
The government have released a list of items that cannot be imported by the armed forces. Hundreds of items have been put onto these lists, meaning there is a captive market for local companies and an incentive for private investment.
This will start to filter through over time. Once an item has been added to the list, there will be a period of time before the procurement bodies will place orders, trial and award contracts. Companies that already have an approved product will benefit quickest; however, others still in development may take years. Investors should understand the position of their product so they know when they may see revenues.
Private Sector Involvement
More private companies (large conglomerates and nimble startups) are getting involved in defence manufacturing. This brings new investment, nimble engineers and new technologies (drones, AI, advanced materials etc). This increases the ecosystem and provides more choice for the armed forces.
This provides increased competition in some areas for the public sector units. However, many PSUs are using private companies to manufacture components, joint ventures and shared facilities. Overall this may increase the size of the industry in a more efficient manner. However, margins may be impacted at a company level within some areas.
Technology
Ultimately self-reliance comes down to technology. Whilst it is great to manufacture kit on licence, having your own design and IP provides a long-term advantage. There is increased collaboration between government labs, top engineering institutes and research centres within industry. Technology is being transferred more smoothly to manufacturing partners.
Investors should look at the amount being spent on research as a % of revenue. How many products have been designed internally and how quickly they are going from prototype to product. Companies who can move this quickly will have stronger moats.
Exports
The government have set ambitious export targets and made licensing easier. Indian manufactured components (artillery, radars, missiles) are gaining interest from friendly countries looking for reliable and cost-effective solutions.
Exports can provide a good diversification and economies of scale. However, they will take a while to get off the ground. It takes time to turn interest into orders and there is a lot of complexity with each deal. Realistically, exports are a slow lever.
Potential Issues
There are a few issues that can cause delays. Orders can take a long time to come through and any delays to trials/approvals can cause delays to revenues. Many manufacturers rely on imported electronic components and specialist materials. There can also be a shortage of skilled manpower within niche engineering areas. Finally, delays to payments from customers can cause cashflow issues.
Fast price movements can cause valuation issues. If prices are moving too quickly ahead of earnings then any little disappointment can cause a correction.
How to Invest
Overall, it makes sense to be positive about this long-term trend but be disciplined on what you pay and how big a position you take. Keep an eye on order inflow, budget spend, new policies and how well companies are performing. Try to favour companies with strong balance sheets, solid products and clear management.
