In recent years, the defense sector has been a remarkable performer in the stock market, with defense stocks providing impressive returns for investors. Following a surge that began in 2020 and gained traction during the 2023 market upswing, these stocks have been buoyed by increasing defense budgets, the Make-in-India initiative, and a burgeoning export market. For instance, an investment of ₹1 lakh in select defense stocks back in 2020 would now be valued at an astounding ₹14 lakh, showcasing a phenomenal 14x return in just over five years. However, after a significant rise, these stocks are now experiencing a pullback, prompting investors to reconsider their positions amidst escalating geopolitical tensions.

Hindustan Aeronautics: A Major Player in Defense

Hindustan Aeronautics Limited (HAL) stands as the largest defense public sector unit in India, boasting Maharatna status. This prestigious designation underscores its importance within the national defense framework and highlights the challenges newcomers face in entering this space.

HAL is renowned for its comprehensive capabilities in designing, producing, and maintaining an array of military aircraft and engines. The company prides itself on its commitment to domestic research and innovation, often forming partnerships for technology transfer when necessary.

• Production Milestones: HAL has successfully manufactured over 4,200 aircraft and 5,200 engines, including 17 indigenous designs. Additionally, they have conducted repairs on 11,000 aircraft and 33,000 engines.

HAL also plays a critical role in providing repair and overhaul services to various branches of the Indian Armed Forces.

Financial Performance: A Closer Look

Over the past five years, HAL has witnessed substantial financial growth. The company’s revenue has increased at a 9% CAGR, reaching ₹304 billion in FY24, while profits surged at a remarkable 26% CAGR, amounting to ₹76 billion. This impressive growth can be attributed to improved operational efficiencies and margins.

In the first three quarters of FY25, HAL’s revenue jumped by 11% year-over-year to ₹173 billion, benefiting from heightened production and repair services. The net profit soared by 32%, totaling ₹43.6 billion, aided by a 20% reduction in depreciation expenses and an extraordinary gain of ₹45 billion.

HAL’s contracts often include variable pricing agreements with the Indian Air Force, Army, and Navy, which mitigate risks associated with foreign exchange fluctuations and raw material price hikes. Investors have seen a 17x return from HAL over the last five years.

Robust Order Book and Future Outlook

HAL’s order book remains strong, valued at ₹1.3 lakh crore as of Q3FY25, with upcoming projects in helicopter and aircraft production. This order book translates to a book-to-bill ratio of about 4x, promising a healthy revenue stream over the next four years.

• Future Contracts: Anticipated orders worth ₹1.33 lakh crore for items like 156 Light Combat Helicopters and 97 Light Combat Aircraft-Mk1A are expected within 3-6 months. The company is also poised to receive additional orders for 60 Utility Helicopters and 43 Advanced Light Helicopters, valued at ₹250-300 billion over the next 18-24 months.

However, the successful execution of these contracts is essential. Any delays could lead to increased costs and impact profitability. Nonetheless, HAL’s long-standing client relationships and the government’s emphasis on domestic manufacturing position it well for future growth.

Bharat Electronics: Leading in Defense Electronics

Bharat Electronics Limited (BEL) also plays a pivotal role in India’s defense landscape, with the government holding a 51.14% stake as of December 2024. Like HAL, BEL is crucial for supplying advanced defense electronics to the Indian military.

With a strong commitment to research and development, investing 6-7% of its annual revenue, BEL has established a competitive edge through the creation of next-gen products.

Impressive Financial Metrics

In FY24, BEL’s revenue surged by 15% to ₹202.7 billion, driven by effective order execution. The net profit also saw a 30% rise to ₹39.9 billion, thanks to a margin improvement of 1.9 percentage points to 24.8%. The company’s move towards greater indigenization has further enhanced profitability.

• Revenue Breakdown: Approximately 81% of BEL’s revenue is sourced from the Indian defense sector, although efforts are underway to diversify. The revenue share from civilian and export markets grew from 11% in FY23 to 17% in FY24.

BEL has delivered a remarkable 15x return over the last five years.

A Promising Future

In the first nine months of FY25, BEL’s revenue increased by 25%, reaching ₹146.2 billion, with operating margins at 27.5%. The company anticipates robust revenue growth in FY25, driven by a strong order book valued at ₹711 billion, translating to a 3x book-to-bill ratio.

Looking ahead, BEL expects to secure contracts worth ₹250 billion from the Indian Army and ₹150 billion from the Navy in FY26. The company is also exploring opportunities in network security, data centers, and border protection to further reduce revenue concentration.

Conclusion: Navigating the Future

Both HAL and BEL are well-positioned to benefit from rising government expenditure, a focus on indigenization, and solid order pipelines. While current valuations reflect a degree of optimism, the significant order books and expected contracts provide substantial revenue visibility. Investors should remain vigilant regarding execution timelines and margin sustainability, especially in light of potential slowdowns in order flow.

As geopolitical tensions continue to rise, the defense sector’s importance and growth potential make it a compelling area for investment consideration. However, prospective investors should always consult with a financial advisor to tailor decisions to their unique investment goals and risk tolerance.