Top 4 Undervalued Defense Stocks to Watch in the Current Market

The defense sector is crucial for safeguarding a nation against internal and external threats. As a rapidly developing economy, India places significant emphasis on enhancing its defense capabilities to achieve self-reliance. The country has set a target to export defense goods worth Rs 350 billion by 2024-25, underscoring its commitment to indigenizing its defense production. Additionally, India aims to achieve a turnover of Rs 1.8 trillion in defense manufacturing by the same year, indicating substantial growth potential in this sector. Given these factors, long-term investments in India’s defense manufacturing sector appear promising.

In light of this, we have identified several undervalued defense stocks that warrant attention. These stocks have been filtered using Equitymaster’s Powerful Stock Screener. It’s important to note that many defense stocks have seen significant price increases over the past year. Within this sector, there are few stocks that can be termed attractively valued. However, the stocks listed below appear undervalued when compared to their industry peers and overall industry averages.

1 Hindustan Aeronautics (HAL)

Hindustan Aeronautics (HAL) stands out as India’s leading defense player. Despite a 150% rally over the past year, HAL shares have experienced a decline from their peak, trading at Rs 4,623 with a PE multiple of 40.3x, down from 49x last month. This PE is also below the industry average of 45.4x. When assessed on a price-to-book (PB) basis, HAL’s P/BV ratio of 10.5x is lower than the industry average of 11.3x.

The recent drop In HAL’s share price is attributed to profit booking and selling activity by foreign institutional investors (FIIs). FIIs reduced their stake in HAL from 12.9% in December 2023 to 11.7% in June 2024. Despite this, several factors suggest that HAL’s decline may be temporary. The company is actively promoting its products globally, including the Tejas aircraft and the Advanced Light Helicopter (ALH), which could boost international sales.

HAL has also partnered with Airbus to establish a maintenance, repair, and overhaul (MRO) facility for the A320 family of aircraft in New Delhi, and collaborated with Israel Aerospace Industries (IAI) to convert civil aircraft into multi-mission tanker aircraft. Additionally, HAL’s tie-up with Safran, a French aircraft engine manufacturer, to develop a sales and support ecosystem for helicopter engines in India, is set to strengthen its market position.

HAL’s order backlog stands at Rs 940 billion, three times its FY24 revenue. The company is expanding its manufacturing capacity, with new facilities for helicopter manufacturing in Tumkur and Tejas aircraft manufacturing in Nashik, expected to be operational by October 2024. HAL remains debt-free with high return ratios around 25%.

2 Bharat Electronics

Bharat Electronics, similar to HAL, has seen its stock price fall from a peak of Rs 340 to Rs 289, with a PE multiple of 50.1x, down from a peak of 61x. This PE is also lower than the industry average of 61.3x. On the PB front, Bharat Electronics trades at a PB ratio of 12.4x, compared to the industry average of 7.7x and a five-year average of 4.5x.

Bharat Electronics boasts an order book value of Rs 760 billion as of June 2024, including an export order book of US$ 407 million (Rs 339.9 billion). Key export products include TR modules, COMPASS, radar and EW systems, medical electronics, and communication equipment. The company holds a market share of 12% in the overall defense market and nearly 60% in the specialized defense electronics segment. The Indian government holds a 51.1% stake in Bharat Electronics, and about 87% of its revenue is derived from the Indian defense sector.

3 Mazagon Dock Shipbuilders

Mazagon Dock Shipbuilders currently trades at Rs 4,671, down from a peak of Rs 5,860. This has reduced the company’s PE multiple to 49x, lower than the industry average of 62.5x. Mazagon Dock’s peers, Cochin Shipyard and Garden Reach Shipbuilders, have higher PE ratios of around 85.7x and 78.8x, respectively. On a PB basis, Mazagon Dock trades at a P/BV multiple of 15.5x, slightly higher than the industry average of 14.2x.

With an outstanding order book of Rs 385.6 billion as of June 2024, Mazagon Dock is India’s largest shipbuilder in terms of revenue and order book. The company specializes in building conventional submarines and destroyers for the Indian Navy. It is awaiting government approval for a Rs 200 billion submarine project, which would further bolster its order book. Mazagon Dock has established itself as a key player in the Indian defense sector, manufacturing a wide range of vessels and submarines.

4 Axiscades Technologies

Axiscades Technologies, present in engineering design services across various verticals, including aerospace, defense, heavy engineering, automobile, and industrial products, trades at Rs 516, down from its 52-week low of Rs 433. The company’s PE multiple is 64x, compared to the industry average of 32x. On a PB basis, Axiscades trades at a PB multiple of 3.6x, lower than the Industry average of 8.1x.

In FY24, Axiscades’ revenue grew by 17%, and the company turned profitable with a net profit of Rs 334 million, compared to a loss of Rs 48 million the previous year. The company aims to achieve a net profit of Rs 1.8 billion by FY26. Finance costs have been a concern, but Axiscades plans to reduce its debt by Rs 500 million. The company also sees significant potential in its drone business, expecting orders worth Rs 30 billion over the next five years.

In conclusion, While the growth prospects for the defense sector are promising, the stock market remains volatile. Investors should focus on fundamentally strong defense companies to capitalize on current opportunities.