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Valuations in the defense sector are currently high, trading at 50-60x P/E for FY25, but the market anticipates long-term growth driven by strong government support. Defense stocks have been surging, reflecting investor expectations of increased allocations for defense capital expenditure and a continued emphasis on domestic armament production. The interim budget announced in February increased the defense budget for the current financial year to ₹6.21 lakh crore, with ₹1.7 lakh crore allocated for capex. With improved government finances, investors are hopeful for a further increase in defense spending.
Earlier this month, the Ministry of Defence reported the highest-ever growth in indigenous defense production, reaching ₹1.26 lakh crore in FY24, a 17% increase from the previous year. Over the past 7-8 years, significant defense reforms have been implemented to reduce component imports, create a robust domestic vendor base, and promote exports. Efforts include mandating foreign players to set up manufacturing in India, transferring technology, and developing homegrown technology through DRDO. Domestic companies, especially small and micro private firms, are experiencing rapid growth by collaborating with DRDO and manufacturing import substitute products. Larger OEMs and private sector giants like Tata and Mahindra Defence are also growing, albeit at a slower pace than smaller firms.
The interim budget allocated the highest share to the Ministry of Defence, with 27.67% for capital expenditure, 14.82% for revenue expenditure, 30.68% for pay and allowances, 22.72% for pensions, and 4.11% for civil organizations under MoD. Currently, defense spending is around 1.9 to 2 percent of GDP, but the industry advocates for increasing CapEx to 3-4 percent, or even 5 percent, to accelerate modernization.
Historically, defense sector valuations ranged from 10-20 times earnings but have risen due to government policies like the import ban. Major defense companies have robust order books, but execution remains a critical factor. While near-term valuations are high, the long-term outlook is positive. Companies like Cochin Shipyard, BEML, and Astra Microwave Products have strong order books but face execution timeline challenges. Post-budget announcements, valuations are expected to correct. Companies like HAL, Bharat Electronics, and BEML, with significant defense portfolios, are poised to benefit from continued budget allocations and order inflows, providing a positive long-term outlook for the sector.