How are defence stocks performing in India? A sector-wide analysis

Defence stocks in India are mostly R&D focused, and the sector is well supported by the government financially. This makes defence stocks a good choice for investors, despite the short-term pitfalls. Read on to understand how defence stocks have fared in the recent past, and what is in store for them in the future.

Overview of the Indian defence sector

India is among the world's top military spenders, with a defence budget of ₹6.81 lakh crore for FY2025, which is a 9.5% rise over the last year. The Atmanirbhar Bharat initiative and its target to record a $26 billion turnover in aerospace and defence production by 2025 have generated huge growth opportunities for Indian defence firms.

Key highlights of the sector include them modernisation of old equipment and a goal to reach $5 billion worth of defence exports by 2025.

There is also a greater emphasis on indigenous production under the Make in India initiative. Adaptation of the latest technologies like artificial intelligence (AI), drones, and cybersecurity solutions is also critical.

Performance of defence stocks in India

During the last year, the industry yielded a strong return of about 39.17%. Since its peak in mid-2024, the index has corrected more than 25%, with a few stocks going down by over 40%.

The correction is due to apprehensions related to execution delays and margin pressures. And less-than-expected order inflows during H2FY25 relative to H2FY24. High valuations that had already priced in future earnings growth also doesn’t help.

Despite these short-term challenges, analysts remain optimistic about the long-term growth potential due to strong government backing and increasing global demand for Indian defence products. Below are some key trends:

Factors driving performance

1. Government policies

The Indian government has been instrumental in shaping the defence sector's trajectory:

• Relaxed FDI norms (up to 74% via automatic route) have attracted foreign investments.
  

• Policies like "Make in India" prioritise domestic manufacturing, reducing reliance on imports.
  

• Long-term contracts and public-private partnerships provide stability for companies involved in strategic projects.
  

2. Budget allocations

The consistent increase in India's defence budget highlights its commitment to modernisation. Capital expenditure allocation for FY2025 stands at ₹1.8 lakh crore (~$20.76 billion), focusing on indigenous production of advanced military equipment like drones and light combat aircraft. However, analysts note that while overall spending has increased, specific allocations for modernization have grown at a slower pace than expected.

3. Export opportunities

• Bharat Electronics and Hindustan Aeronautics have secured export orders from Europe, benefiting from increased NATO spending amid geopolitical tensions.

• India's competitive pricing and growing reputation as an exporter position it well for further growth.

4. Technological advancements

Companies investing in AI, cybersecurity, drones, and electronic warfare systems are likely to maintain a competitive edge. For instance, Data Patterns' focus on R&D has enabled it to capture market share in high-tech segments like avionics and satellite systems.

Challenges facing defence stocks

1. Execution delays- Prolonged timelines for large-scale projects can impact revenue realisation.

2. Geopolitical risks- Border tensions with China and Pakistan create uncertainty around demand cycles.

3. Budget constraints- While budgets are increasing, they may not always meet industry expectations or address immediate needs.

4. Stock valuations- After years of strong performance post-COVID-19 crash, many stocks are now trading at high valuations relative to historical averages.

Investment outlook: Why invest in defence stocks?

1. Stable demand- Defence is a non-discretionary sector with consistent demand driven by national security needs.

2. Government support- Policies like "Make in India" ensure long-term growth prospects.

3. Export potential- Increasing global recognition of Indian defence products boosts revenue streams.

Key considerations for investors

• Financial health (revenue growth, profitability)
• Order book size and execution capabilities
• Alignment with government policies (e.g., indigenisation efforts)
• Technological innovation and R&D intensity

Conclusion

Leading players are still poised to gain from government programs, technology growth, and export orders. For risk-sanguine investors prepared to stomach the sector's intrinsic risks—geopolitical risks and delay in execution—rewards may be quite attractive in the next few years.