NEW DELHI: Defence stocks, one of the most demanded assets in the multi-year bull run in recent years, have come under selling pressure, with most components falling 20-30% from their July 2024 highs as the latest reported earnings are unable to justify their sky-soaring valuations.
Market analysts believe that the short-term party may be over due to disappointing earnings and valuations run over and above its fundamentals.
“The peaked-out valuations were a matter of concern as the price-to-earnings multiple of many defence companies started trading higher when compared to the five-year average earnings multiple and Q1 disappointing earnings added fuel to the corrections,” said Prashanth Tapse, senior vice president (Research), Mehta Equities.
Tapse added that the room is still open for some more price corrections based on fundamental theories. He, however, also said long-term investors need not worry as the outlook remains optimistic considering the government’s focus on defence as a strategic sector for domestic needs as well as focus on export opportunities.
Following a thrust on localisation, increased budgetary allocation, growing domestic order and expansion in global markets, shares of defence companies generated superlative returns for the investors. However, the first quarter earnings of these companies have failed to impress the investors. For example, Hindustan Aeronautics shares have surged 1,375% in the last 5 years while Bharat Electronics Ltd rallied nearly 800%.
“The recent rally in defence stocks has lost steam, with corrections of 20-30% from July highs. The key issue is high valuations amid a slowdown in India’s defence spending, which rose only 4.7% in FY25,” said Ajit Mishra – senior vice president, Research, Religare Broking. Mishra stated that to justify current high valuations, companies must deliver on both growth and execution, secure significant international orders and ensure flawless execution, as any missteps could seriously affect profitability.
“Defense stocks have experienced a remarkable surge over the past two years, pushing them into an extremely overbought territory. Although conditions have improved in recent months, there are still certain areas, such as BHEL, BEL, Cochin Shipyard, and Garden Reach Shipbuilders & Engineers, that could see further retracement,” said Mishra.
Meanwhile, ICICI Securities on August 16 stated that Mazagon Dock Shipbuilders and Garden Reach Shipbuilders shares may decline 77% and 73%. ICICI Securities increased its price target on Mazagon Dock to Rs 1,165 and for Garden Reach Shipbuilders; the brokerage has given a price target of Rs 515.
Mehta said that high valuation can be the only reason for short-term sector underperformance. He added that domestic defence companies would get high benefits from the Made in India and Make for the World theme.