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19% increase in FY21 revised capital expenditure

Key takeaway from defence capital expenditure (FY22) in Budget 2021 was~18.8% increase in FY21RE vis-à-vis FY21BE. Major contributor is Navy (40% + increase), followed by Indian Airforce (27% + increase) – Table 2. Army budget during the same period is nearly flat (+ 2.5%) with 14% increase seen in construction. FY22BE is largely similar to FY21RE; however, while Army witnessed 10% increase, Navy and IAF witnessed 11% and 3% reduction, respectively. Biggest increase in Army’s budget (FY22BE over FY21RE) comes in the form of other equipment highlighting the possible increase in artillery, missiles, rockets (Pinaka), ammunitions. Increase in Army’s other equipment budget is beneficial for Solar Industries (SOIL). Space expenditure has witnessed a reduction of 31% (FY21 RE vs FY21BE) and signals a shift in execution mix of Midhani towards defence in the coming year.

* FY21 (RE) budget has increased 18.8% over FY21 (BE) – the same level of expenditure has been maintained in FY22 (budgeted). Naval budget witnessed 40% higher FY21 (RE) vis-à-vis (BE). We suppose major component of naval increases are i) aircraft and aero engine (P81 surveillance aircrafts, leasing out of predator drones, some allocation for recent approvals of 10 Naval shipborne unamend aerial systems for Rs13bn), ii) other equipment (missiles, electronic warfare – Samyukta Systems) and iii) Naval fleets (submarines, fighters, frigates – mostly accruing to Garden Reach, Cochin, Mazagon). We maintain BUY on Garden Reach. Second largest contributor to the increased RE has been airforce with 27%+ increase. The major component of IAF increase is other equipment budget (FY21 BE saw a sharp decline YoY which has been revived up). we believe that one of the major items has been induction of S400. Further, induction of various missiles including Brahmos, AESA radar induction for Tejas, Su-30MKI is ongoing.

* Increasing share of defence capital expenditure in overall defence budget. What impresses us more is the utilisation of funds within the overall defence budget space. Share of capital expenditure in the overall budget has gone up from ~24% in FY21 BE to ~28% in FY22 BE, whereas share of pensions have declined from 28% to 24% during the same period. This allows 18.7% YoY increase in capital budget (FY22 BE from FY21BE), while overall defence budget is up by only 1.4%.

* Other equipment outlay continues to increase, allowing the much needed headroom for players like Bharat Electronics. Total other equipment outlay (Army + Navy + Airforce) has increased 52% (FY22 BE from FY21 BE) to Rs535bn. While the share of IAF has increased during the same from 34% to 46% (mainly due to induction and import of S400 we believe), not allowing commensurate gains to large OEMs like BEL, the increased budgetary allocation paves way for increased opportunity for BEL. While BEL’s expected FY21E topline formed > 33% of FY21BE for other equipment last year, FY22E expected topline forms only 25% of FY22BE.

* Space budget resets in FY21. Budget for space has reduced significantly with FY21 (RE) declining by 31% over FY21 (BEFY22BE space expenditure is down 2% YoY while budgeted capital expenditure for space research is down 6% YoY. The same reflects in (Midhani) the management guidance of increasing defence contribution to topline as space expenditure takes a breather.

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