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Expect fireworks in Q4 as indigenization up

Expect ordering flow to rise sharply in Q4FY25 for the Defence sector given that defence capex is set to be met in FY25. Allocation to domestic companies stands at 75% of the total budgeted defence capex, with the Navy’s budget up 18% YoY in FY25BE. Also, engine woes for Hindustan Aeronautics (HNAL IN) may end soon as General Electric (GE) will supply F-404 engines in March. Inflows for HNAL may jump by INR 1.2tn in FY26E. Cumulative acceptance of necessity (AoN) in the ~past 2.75 years (at INR 8.3tn) has exceeded that in the past decade (INR 5.4tn in FY13-22) by a sharp 53%. So, expect a multifold jump in contract awarding in the next 2-3 years. We remain positive on India’s defence story. Our top picks in the space are HNAL (Buy; TP INR 5,465), Bharat Electronics (BHE IN, Buy, TP INR 345), Bharat Dynamics (BDL IN, Accumulate, TP INR 1,300 and Garden Reach Shipbuilders & Engineers (GRSE IN, Accumulate, TP INR 1,660).

Expect fireworks in Q4; cumulative domestic AoN in past 2.75 years beat past decade’s level by 1.5x:

Per Ministry of Defence (MoD), the actual defence capex stands at INR 1.7tn in FY25 versus INR 1.72tn in FY25BE, given that the share of defence spend in April-October at 36% was lower by 700bps YoY. So, expect large order inflows to be announced in Q4FY25, including imports of Rafale-M (USD 4bn) and MQ-9B drones (USD 3bn) along with domestic orders for next-generation Corvettes (INR 360bn). In FY23, MoD awarded INR 600bn inflows on a single day (29 March 2023). Also, domestic AoN approved through FY23-December 2024 is cumulatively INR 8.3tn. Domestic AoN approved through FY13-22 was INR 5.4tn. So, cumulative AoN in the ~past 2.75 years exceeded that in the past decade (FY13-22) by a staggering 53%.

Contract awarding to jump multifold in the next 2-3 years:

Cumulative domestic contracts awarded in FY13-22 stood at INR 3.1tn (INR 1.1tn in FY13-17; INR 2tn in FY18- 22). Awarded divided by approval ratio stood at 77% in FY18-22 versus 39% in FY13-17. Domestic AoN approved jumped by 3.5x in FY19 to INR 1.2tn and contract awarded up by 59%/46% in FY20/21, respectively. Cumulative domestic AoN was INR 8.3tn in FY23- December 2024. So, expect a multifold jump in contract awarding in the next 2-3 years.

Supply chain woes to end for HNAL in March:

GE has promised to deliver F404 engines for LCA Mk 1A by March to HNAL, per a standing committee. The delay was due to disrupted global supply chain post Covid. Post the resolution of this concern, HNAL plans to manufacture 24nos and 30nos LCA MK 1A (capacity as on date is 24nos). An agreement to be signed between HNAL and GE in Q4FY25 to co-produce F-414 engines for LCA Mk II. Based on the orderbook data, HNAL may receive INR 1.2tn inflows in FY26 (97nos of LCA Tejas Mk 1A, 156nos of LCH Prachand and Su-30 upgrade).

India’s defence imports drop by 1,100bps to 28% in FY24:

India’s defence import posted a CAGR of just 3.6% in FY15-24 to INR 357bn in FY24. Import, as a percentage of total procurement, declined by 1,100bps to 28% in FY24 from 39% in FY15. In the past decade, imports by the Army decelerated at a CAGR of 9% and by the Navy at a CAGR of 1%. But imports by the Air Force posted a CAGR of 7%. Through FY15-24, average imports by the Airforce stood at 58% (past three years’ average 54%), by the Navy at 26% (past three years’ average 31%) and by the Army at 15% (past three years’ average 15%)

We remain positive on India's defence story.

(set to unfold in the next decade), led by indigenization and exports. We prefer HNAL (Buy; TP INR 5,465) and BHE (Buy; TP INR 345). We raise BDL’s TP by 6% to INR 1,300, on 39x (from 37x) September FY26E P/E, given the prospects of strong execution from H2. However, we revise BDL to Accumulate from Buy as the stock has outperformed the Nifty by 18% in the past three months. We raise GRSE’s SoTP-TP by 11% to INR 1,660, raising the value of core shipbuilding to INR 1,429 on 34x (from 30x) given improved order pipeline, with the order for next generation Corvettes expected soon. In the private defence space, we prefer Zen Technologies, Data Pattern and Astra Microwave (all Not Rated).

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