Railways and Defence: Which stocks can handle the booming Indian stock market?

Defence stocks have seen a significant uptrend in recent years, bolstered by the government's push for indigenisation. (Image: Pixabay)
Defence stocks have seen a significant uptrend in recent years, bolstered by the government's push for indigenisation. (Image: Pixabay)

Summary

  • How are railway stocks and defence stocks shaping up this year? Find out

Two sectors that have emerged as top wealth creators in the stock market over the last year are defence and railways.

Defence stocks have seen a significant uptrend in recent years, bolstered by the government's push for indigenisation. Railway stocks, on the other hand, received a major lift from the 2023 Union Budget, which prioritized sectoral spending.

Despite the substantial rise in these stocks, investors are keenly watching for opportunities. But which railway and defence stocks are poised to continue their growth trajectory in 2024 and beyond?

So which railway and defence stocks could continue to shine in 2024 and beyond?

Let’s find out.

Why defence stocks are rising

India is among the top five nations globally in terms of defence spending, with its budget for fiscal year 2023-34 (FY24) standing at $74 billion, a substantial portion of the GDP. The government's emphasis on domestic manufacturing of defence equipment creates a conducive environment for growth in defence stocks.

The modernisation of the Indian military fuels demand for defence products and services, opening growth avenues for various defence companies. However, investors should tread cautiously, as the defence sector's performance is as much influenced by economic and market conditions as by government policies.

You need to look out for fundamentally strong defence companies to make the most of this opportunity. Picking the wrong stocks can result in major losses.

For those looking to invest in defence stocks, Equitymaster's co-head of research, Tanushree Banerjee, highlights three critical factors:

Ratio of sales to orderbook: Execution is key to the potential of defence companies' wealth creating ability. Hence while bulging order books are great, you must keep a watch on whether the order book is converting to sales as planned.

Ratio of receivables to sales: Defence behemoths were never a part of StockSelect recommendations until 2018.

The reason? The stocks never met my safety criteria due to the massive backlog in payment receipts from the government. The receivables to sales ratios were always high. Without comfort on cashflows I didn't find them investment worthy.

Defence behemoths like Bharat Electronics and Hindustan Aeronautics had a massive fall in their receivable days since 2018. And this is when the stocks came in my radar.

But going forward too it would be important to evaluate the stocks based on this critical criterion.

Asset turnover ratio: When you look for defence stocks, you need not go only for companies with the biggest capex plans or the largest order book. Rather you should look at businesses that have the fastest conversion of assets to sales.

Why railway stocks are rising

Following the last Union Budget, the railway sector became a significant focus area, with a record allocation of 2.4 trillion aimed at laying 100,000 km of new track over the next 20-25 years. This marked a turning point for the sector, previously hindered by regulatory ambiguities.

The stock market took note, especially after the introduction of a production-linked incentive (PLI) scheme for train component makers. This, along with the green mobility scheme and several rail projects, underscores the government's commitment to enhancing India's railway infrastructure.

As the sector gears up for substantial growth, selecting the right stocks is crucial. 

Equitymaster's Rahul Shah says:

If India must grow at 8-9% on a consistent basis, we need to invest in all kinds of infrastructure, including rail. And if rail infrastructure is given a massive push, sector companies will be among the prime beneficiaries.

As per estimates, the country is well on its way to construct more national highways and rail lines in the decade between 2015-2025 than it has cumulatively done between 1950 and 2015.

Huge capex announcements have already been made and more are in the offing. In fact, quarterly results for these stocks are already sending out feelers about the good times ahead.

Now here are two defence stocks and two railway stocks for your watchlist:

#1 Hindustan Aeronautics

Hindustan Aeronautics Ltd (HAL) manufactures and maintains aircraft and helicopters for the Indian Airforce, Indian Army, ISRO, Indian Navy, and Indian Coast Guard, among others.

The Indian defence sector has surpassed 1 trillion in total value of defence production.

The compnay was at the forefront, taking on as many orders as it could which resulted in a substantial rise in its revenue. Its order book hit $10 billion at the end of 2023.

It has also set up a 2.1 bn integrated cryogenic engine manufacturing facility (ICMF) that would cater to the entire rocket engine production under one roof for ISRO. This will eventually result in higher profits for the company.

HAL also completed a stock split in September 2023 where it issued shares in the ratio of 1:2.

Since 2008, it has declared regular dividends. In fiscal year 2023, the company declared a final dividend of 55 per share, with a dividend payout ratio of 31.5%. The five-year average dividend payout ratio stands at 33.8%.

#2 Solar Industries

The company is a leading manufacturer of bulk explosives, packaged explosives and initiating systems, which find use in several industries, including mining, infrastructure, and construction.

In 2010, it also ventured into defence and started manufacturing propellants for missiles and rockets, warheads and warhead explosives.

Solar Industries is one of the largest players in the explosives industry with a 24% market share and also the first private player to manufacture explosives such as RDX, HMX, and TNT for the defence sector.

The company has 34 manufacturing plants in India and six plants abroad, with a capacity to produce over 4.5 million (m) metric tonnes of explosives per annum.

Solar Industries also manufactured six Pinaka Rockets, which the Indian Army has inducted.

The company also ventured into manufacturing space launch vehicles by partnering with ISRO and Skyroot Aerospace.

Solar Industries is developing an array of drones for ammunition delivery to bring a new capability to the Indian armed forces. It also successfully demonstrated its prototypes of weaponised hexacopter drones and loitering munitions and became the first Indian firm to do so.

The company has high growth plans. It plans to establish three more manufacturing facilities in Australia, Thailand, and Indonesia to grow its international operations.

Solar Industries is also heavily investing in capex to grow its defence portfolio and plans to invest around 7.5 billion in the financial year 2024.

This, along with the Make in India initiative, provides revenue visibility for the company in the medium term.

The company's revenue and net profit have grown at a CAGR (compound annual growth rate) of 22.9% and 24%, respectively. This is primarily due to the growing share of defence in the revenue mix and internal manufacturing of key raw materials.

The company's order book is strong at nearly 27 bn of which defence orders are over 10 bn. In October 2023 the company received its biggest-ever orders worth 18.53 bn from state-owned Coal India Ltd for the supply of bulk explosives.

#3 IRFC

Indian Railway Finance Corp (IRFC) is engaged in the business of borrowing funds from the financial markets to finance the acquisition/creation of assets which are then leased out to the Indian Railways or any entity under the ministry of railways.

The company generates revenue from lease income. Its sole objective is to raise money from the debt capital markets to part-finance the plan outlay of Indian Railways. The funds are used for acquisition of new rolling stock assets to be leased to the Indian Railways to build railway infrastructure.

With substantial investments from the Indian government directed towards the railway domain, the outlook for IRFC appears promising.

The railway sector in India sets to flourish at an impressive compound annual growth rate (CAGR) of 7.5% between 2022 and 2027. This growth trajectory is set to fuel IRFC's financial prospects, riding on the increasing demand for funding in this expanding sector.

IRFC plans to diversify its financing portfolio in future. This evolution will encompass new dimensions of railway projects, notably dedicated freight corridors, high-speed rail initiatives, and the development of smart railways.

On 28 July 2023, IRFC entered a Memorandum of Understanding (MoU) with RITES. The objective is to establish a framework for collaborative efforts to enhance IRFC's involvement in extending financial support to Railway-associated projects.

#4 RVNL

Rail Vikas Nigam Ltd (RVNL) is the construction arm of the Ministry of Railways for project implementation and transportation infrastructure development.

It was incorporated in 2003 to meet the country's surging infrastructural requirements and to implement projects on a fast-track basis. It is a category-I Miniratna public sector undertaking (PSU) under the administrative control of the Indian Ministry of Railways.

RVNL undertakes and executes project development, financing, and implementation of rail related infrastructure. Hence, the shift in the government’s focus to improve Indian railways' condition improves growth opportunities for the company.

The company has received a letter of agreement from the Ministry of Railways for the manufacturing and maintenance of Vande Bharat train sets, including the upgrade of the government manufacturing units and train-set depots.

The agreement involved a quantity of 200 train sets, with a cost per set of 1,200 m. No wonder even any piece of news about development of Vande Bharat trains is having a material impact on RVNL share price.

RVNL in consortium with Siemens India, emerged as the lowest bidder (L1) for Mumbai Metro line 2B of Mumbai Metropolitan Region Development Authority (MMRDA). The project is estimated to cost around 3.8 bn.

The same consortium has bagged two separate orders from Gujarat Metro Rail Corporation. The orders are for Surat Metro Phase 1 (over 40 km covering 38 stations and 2 depots) and Ahmedabad Metro Phase 2 (over 28 km covering 23 stations and 1 depot).

RVNL has now started participating in tenders of other countries as well. The experience of around two decades in India of being one of the lead execution agencies for railway projects would help the company to evaluate, bid and execute projects in other countries.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com

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