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Top 4 stocks supplying critical components to the defence sector

With growing geopolitical tensions, countries have increased their defence spending, and India has focussed on indigenisation and encouraged defence production in the country.
With growing geopolitical tensions, countries have increased their defence spending, and India has focussed on indigenisation and encouraged defence production in the country.

Summary

  • The defence industry relies on a diverse range of suppliers to manufacture products. These four are the top companies supplying to defence companies.

The Indian defence sector registered an impressive growth of 12% year-on-year in the financial year ended March 2023.

Strong order books led by increased government spending on defence and high exports contributed to this growth.

However, this wasn’t the case ten years back.

Although defence companies had good financials, they were run by the government, where profit wasn't the primary motive, and export opportunities were almost nil. Moreover, many companies were plagued with corruption and scams.

However, the defence space has undergone many changes in the last few years. With growing geopolitical tensions, countries increased their defence spending, and India focussed on indigenisation and encouraged defence production in the country.

It also focused on exports, which fuelled the growth of the defence companies.

Hence, the defence space is considered a good opportunity that investors can capitalise on.

However, it’s not just the pure defence stocks that are benefitting from the current trend of high defence spending. Companies that supply to the defence sector are also prime beneficiaries.

With growing order books, the companies that supply components to these defence firms are vital for their growth.

Hence, one can consider these stocks to be a kind of derivative of the main defence companies when scouting for opportunities in the defence space.

We have shortlisted four such companies.

Take a look.

#1 Solar Industries

First on the list is 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 thirty-four 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.

For the financial year 2023, 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 (bn) in the financial year 2024.

Coming to its financials, 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 stood strong at 29 bn as of 31 March 2023. This, along with the Make in India initiative, provides revenue visibility for the company in the medium term.

#2 Premier Explosives

Second on the list is Premier Explosives.

As the name suggests, the company manufactures industrial explosives, detonators, propellants, pyros, and countermeasures.

It is the only Indian company to export fully assembled rocket motors.

The company also undertakes the operation and maintenance of solid propellant plants at the Sriharikota centre of ISRO and the solid fuel complex at Jagdalpur for DRDO.

It has successfully developed and manufactured propellants for various rockets like Pinaka, missiles such as Astra and Akash, and strategic missiles such as Agni and Veda.

Premier Explosives has also developed strap-on-motors for satellite launch vehicles.

Some of its clients include DRDO, Bharat Electronics, ISRO, and Coal India. The company has recently obtained a license from the Chief Controller of Explosives for the production of solid propellant. It has already received orders to manufacture solid propellants for ISRO, DRDO, and L&T.

The company is investing heavily in research and development (R&D) for its defence portfolio and has several products under development, such as 70 mm rockets, air-glide bombs, ammonium perchlorate, HTPB & CL20, and pyrogen igniters for missile programs.

It has also collaborated with Gulbarga University, IIT Madras, and BITS Pilani for research in high-energy materials.

Coming to its financial performance, its revenue has grown at a CAGR of 9.7% in the last three years. It reported a net profit of 70 m against a loss of 110 m three years ago.

Recently, it received a licence, which will help the company save on transportation costs and store ammonium nitrate in bulk at its facilities, which is an important raw material for the company.

As of 30 June 2023, the company's order book stood at 11 bn, which is 5.5 times the financial year 2023's revenue. This shows that the company has good revenue visibility in the medium term.

#3 Avantel Soft

Next on the list is Avantel Soft.

The company is engaged in developing customised solutions for Indian National Satellite (INSAT) based communication services for military applications.

It also develops wireless defence electronics, radar systems, and software applications for the defence and aerospace sectors.

Avantel Soft has an established market presence in the electronics and telecom equipment business. This has enabled it to establish long-standing relations with its customers. Its customers include the Indian army, railways, air force, ISRO, DRDO, Boeing, and L&T.

The company's in-house R&D facility, which is recognised by the Department of Scientific and Industrial Research (DSIR), Ministry of Science and Technology, Government of India, is why it stands out from its peers.

It also spent close to 77 m in the financial year 2023 for R&D. For the financial year 2024, the company has taken up the design and development of software-defined radios (SDR) in high frequency (HF), very high frequency (VHF), and ultra-high frequency (UHF) for marine and land-based solutions.

It is also designing air defence radars for the Indian Army.

All this shows that the company is geared up to make the most of the current Make in India initiative.

Coming to its financials, in the last five years, the revenue has grown at a CAGR of 21.6%, driven by a strong order book. The net profit also grew by a CAGR of 23.1%.

Going forward, the company’s established relationships with its customers and strong order book will drive its growth in the medium term.

#4 MTAR Technologies

Last on the list is MTAR Technologies.

Established in 1970, it is a manufacturing company that has precision engineering capabilities to build nuclear and pressurised water reactors, aerospace engines, and many other critical components and assemblies.

Its product portfolio includes fuel machining heads, drive mechanisms, water-lubricated bearings, liquid propulsion rocket engines, cryogenic engines, and high-precision sheet metal.

Its products find use in nuclear, space, defence, and aerospace industries. Some of the company’s clients include ISRO, Rafael, Elbit, DRDO, BHEL, Bharat Dynamics, and Indira Gandhi Centre for Atomic Research.

MTAR contributed to several notable missions in India. In India’s recent Chandrayaan-3 mission, the company supplied core parts of the rocket engines and core pumps of cryogenic engines required for the take-off.

Its products were also used in India's Aditya L1 mission, and it is also supplying grid fin for the Gaganyaan mission.

In August 2023, the company received the much-awaited 'Defence Industrial Licence' for the production of various mechanical and electronic subsystems in the defence sector.

This will help the company fasten its own defence product line and bid for major defence projects in the country.

MTAR Technologies has huge capex plans. It is planning to set up manufacturing units in Europe and the US. This will take the total manufacturing facility count from seven to nine.

In the last five years, the company’s revenue has grown at a CAGR of 26.1%, driven by strong growth across all segments. The net profit also grew at a CAGR of 21.4%.

As of June 2023, the company's order book stood at 10.8 bn, of which 500 m worth of orders were received in the first quarter itself. Further, it is expecting orders worth 12 bn during the year.

The company expects revenue to grow between 45-50% for FY24, with strong revenue growth expected over the coming three quarters.

Should you invest in companies supplying to defence?

The next ten years are considered a golden period for the defence sector.

With nations across the world increasing their defence spending, the government has increased defence spending to increase defence manufacturing and boost defence exports in the country.

All this means the defence sector is poised for growth, which implies that the companies that supply to the defence sector will also enjoy a slice of this growth.

However, it is important that you do your due diligence before investing in these companies. Remember to treat these companies with the same caution as you do with other companies.

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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