The Russia-Ukraine conflict, other than keeping people hooked on to the news, has also kept defence officials across the globe busy. The global defence budget touched an all-time high with several countries stepping up on their spend.
India wasn’t behind on this trend with its expenditure ranking third highest in the world. It has grown 33% in the last 10 years. The fascinating part has been that 68% of the capital outlays in the military budget were earmarked for acquisition of domestically produced arms.
This has sent defence stocks flying this year, while the markets have been choppy. A star amongst them has been HAL (Hindustan Aeronautics Limited) - the oldest and largest manufacturer of military aircrafts and helicopters.
Since we added it in our Monopolies portfolio, the stock has been up 70%. And here’s why the streak may continue:
1. HAL is of strategic importance to the Indian defence forces - it is the sole supplier of aircrafts, helicopters and avionics.
2. Defence spend has been accelerating. The Indian defence budget grew by 10% YoY, compared to the average growth over 10 years of 8.4%
3. The Government has been increasingly focused on indigenisation with Make in India and Atama Nirbhar Bharat - this bodes well for HAL’s future growth
4. HAL has an order book of Rs. 1 lakh crore, which translates to 3.5x of revenue. The order book for HAL was seen declining. However, the recently awarded order of 83 LCA (Tejas) in February 2021 has reversed the trend
5. The order book’s conversion to deliveries, and revenues will begin in 2024 - providing visibility for continued strength in revenue growth in the future. The LCA contract account for half the current order book, and will boost revenues by 10-12% per annum FY25 onwards
6. With the growing order book, HAL is setting up new manufacturing plants in Bengaluru (aircrafts) and Tumakuru (helicopters), that intend to boost production in 2022-23:
from 8 aircrafts a year to 16
from 15 helicopters a year to 30
7. An additional order of Sukhoi Su30s is also likely to be won
8. Exports are turning out to be a big potential opportunity. Several countries have shown interest in HAL’s Tejas. Moreover, ASEAN countries too have been looking at HAL for military platforms
9. India plans to add 550 new aircrafts and 300 helicopters over the next two decades - opening up at US$ 50 billion plus opportunity for HAL
10. With revenue growth of 12% expected over FY21-26, EBIDTA margins in the range of 22-24%, and net profit growth of 14%, HAL’s financial performance is expected to be superior, and bound by high visibility
In short, here’s why HAL can continue to perform exceptionally well as a company, and as a stock:
Fulfilment of biggest order ever
Multi-decade opportunity because of higher defence budgets, and increased domestic production
Strong balance sheet
Reasonable valuations given the opportunity, growth and visibility