HAL, Data Patterns and BEL: Jefferies sees up to 45% potential upsides on 3 defence stocks

Hindustan Aeronautics Ltd (HAL), Data Patterns and Bharat Electronics Ltd (BEL) are Jefferies' three top picks from the defence sector. The foreign brokerage has 'Buy' rating on the three stocks, with its target prices suggesting up to 45 per cent potential upsides. Global geo-political tensions and India’s rising focus on self-reliance is fuelling order flow and revenue growth for domestic defence companies, Jefferies said while noting that the government is looking at building country-to-country relations to promote exports, which is icing on the cake. A two times growth in domestic defence spend over FY24E-30 should continue to drive stock upside, it said.

Data Patterns | Target price: Rs 3,545

Data Patterns is a leading private sector player in defence and aerospace electronic solutions. Jefferies expects revenues for Data Patterns should rise nearly 5 times in FY24E-30E, as indigenisation and export pipeline benefits the company. The return on equity (ROE) improvement and reducing working capital intensity are the other drivers. It initiated coverage on the stock with a 'Buy' rating and suggested 45 per cent upside (price target at Rs 3,545).  Key risks includes obsolescence of technology and a lack of management bandwidth.

Hindustan Aeronautics | Target price: Rs 3,900

A total of 55-70 per cent of Hindustan Aeronautics’ (HAL) revenue is service income linked to past product sales and recurring. Product business should rise faster as the government is encouraging domestic aircraft manufacturing, Jefferies said.

"GE tie-up shows potential of moving up in the OEM status among global defence companies. Medium-term 22 per cent EPS CAGR visibility in FY24E-30E is a key driver of our 18 per cent upside with PT of Rs 3,900," Jefferies said. Global OEM tie-ups not giving a material benefit and slow at ramp up on product side are seen as key risks for the stock.

Bharat Electronics | Target price: Rs 260

Jefferies said Bharat Electronics is a market leader in domestic defence electronics, with 70-75 per cent of its revenues coming from the navy and army and the balance from air-force. With zero debt and comfortable working capital position, it is well-placed to benefit from the defence opportunity, Jefferies said.

India defence exports

Jefferies said India’s defence exports rose 16 times in FY17-24E to $3 billion. We believe this should rise further to $7 billion by FY30E and is directionally in-line with the government target of achieving $6 billion by FY29E.

Some of the major export destinations for defence products have been Italy, Egypt, UAE, Bhutan, Ethiopia, Saudi Arabia among other countries. Middle East (ME) accounts for 33 per cent of global arm imports at $11 billion and offers opportunity for India. Qatar and Saudi account for 52 per cent of ME imports.

In terms of imports, India is the number-two importer of defence equipment, accounting for 9 per cent of arms imports. "We believe India’s capital defence spend should continue at the 7-8 per cent CAGR seen in the last decade. Indigenisation focus will drive double-digit growth in domestic defence spend," Jefferies said.