Defence stocks, which experienced a remarkable rally following the COVID-19 crash, have recently faced a significant correction. This sharp decline—over 50% from their recent highs—has left investors concerned. Several factors have contributed to this fall, including high valuations, lower-than-expected budget allocations, and slower order inflows. However, despite these challenges, the long-term outlook for the sector remains positive, given the government’s commitment to self-reliance in defence production and strong capital expenditure plans by key companies.
The Rise and Fall of Defence Stocks
Defence stocks became a major focus of investors after the market crash in March 2020. Companies like Garden Reach Shipbuilders and Engineers (GRSE), Hindustan Aeronautics Ltd (HAL), Cochin Shipyard, Bharat Dynamics (BDL), and Mazagon Dock Shipbuilders saw massive gains, rallying more than 2,000% from their COVID-19 lows. However, after such an extraordinary rise, these stocks have now corrected sharply, leading to significant wealth erosion for investors.
Lofty Valuations: A Key Reason for the Decline
One of the main reasons for the correction in defence stocks has been their excessively high valuations. Many of these stocks were trading at price-to-earnings (P/E) ratios of over 80x, significantly above the industry average of 40x trailing twelve months (TTM) earnings. Such stretched valuations made these stocks unattractive to new investors, especially when future growth expectations were already priced in.
Despite the recent fall, many of these stocks still trade above their historical valuation averages, suggesting that further downside may be possible. The sharp rise in stock prices was supported by strong earnings growth, with major defence companies reporting compound annual growth rates (CAGR) of 24-30% in net profits over the past three years. However, much of this expected future growth had already been factored into stock prices, leading to a less favorable risk-to-reward ratio.
Lower-Than-Expected Budget Allocation
The Union Budget 2025, while offering tax relief for the middle-income class, did not provide any significant boost for the defence sector. The total allocation for defence was ₹6.81 lakh crore, representing a 9.6% increase from the previous year. However, this fell short of market expectations as the government shifted its focus towards boosting consumption rather than capital expenditure. This underwhelming allocation dampened investor sentiment in the sector.
Slower Order Inflows in H2FY25
Another major factor behind the recent correction in defence stocks has been the slowdown in order inflows. The second half of FY25 saw lower order inflows compared to the same period in FY24. For instance, H2FY24 witnessed order inflows of ₹22,000 crore to ₹25,000 crore for companies like BDL, BEL, HAL, and Mishra Dhatu Nigam. However, in H2FY25, order inflows dropped to ₹18,000 crore to ₹20,000 crore.
BEL, the second-largest defence company by order book, received orders worth ₹11,000 crore in 9MFY25—far below its management guidance of ₹25,000 crore. Furthermore, industry reports suggest that capital expenditure execution for H2FY25 stood at just 36% of the total budget estimates, compared to 44% a year ago. This slowdown in execution contributed to lower order inflows, adding to investor concerns.
What Lies Ahead?
Despite recent setbacks, the outlook for the defence sector remains strong. Defence company management teams have expressed confidence in a rebound, expecting substantial order inflows by the end of FY25. HAL, India’s leading aerospace and defence manufacturer, projects its order book to exceed ₹1,20,000 crore by FY25 and anticipates additional orders worth ₹1,70,000 crore over the next 18 months. Similarly, BEL remains optimistic about securing orders worth ₹25,000 crore in FY25.
The Indian government’s push for self-reliance in defence manufacturing and strong capital expenditure plans by leading companies continue to provide a solid foundation for the sector. While near-term volatility may persist, long-term investors with a focus on fundamentals may find attractive opportunities in select defence stocks.
Conclusion
The sharp correction in defence stocks was driven by high valuations, lower-than-expected budget allocations, and weaker order inflows. However, the sector’s long-term growth story remains intact, supported by government initiatives and strong order pipelines. Investors should carefully assess valuations and order book visibility before making investment decisions, keeping an eye on potential opportunities in this strategically important sector.
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