Defence stocks, once crowned as multibaggers, are now facing a slowdown in their bullish momentum. Earlier this month, some of the top stocks in the sector saw a decline of over 20 per cent. Does this signal a temporary breather or an end to the rally?
Defence has become one of the most talked-about sectors lately, be it in the start-up space or new policy schemes. For markets, the sector has been a standout performer with multiple stocks delivering multibagger returns. But recently, the wind seems to have taken a different direction. Earlier this month, many of the top stocks in the space witnessed a sharp decline from their 52-week highs.
Earlier this month, shares of Hindustan Aeronautics (HAL), Mazagon Dock, Bharat Electronics and BEML have plummeted over 20 per cent. While it's true that the broader market also witnessed a sharp decline during this period owing to global bearish sentiment, it later regained momentum. However, many defense stocks are still struggling despite the market's recovery.
For instance, Cochin Shipyard has dropped by more than 26 per cent from its 52-week high on the National Stock Exchange.
Shares of Garden Reach Shipbuilders and Data Patterns followed the trail and witnessed a 33 per cent and 16 per cent decline, respectively from their 52-week highs.
A major shock came when ICICI Securities projected a 77 per cent downside for Mazagon Dock (shipbuilding company), which has delivered over 140 per cent returns in the past year.
What's Behind the Recent Slump?
"The recent decline in defense stocks can be attributed to a combination of profit booking, overextended valuations and macroeconomic concerns. After a strong rally earlier in the year, many investors saw an opportunity to lock in gains, particularly as the valuations in the sector became stretched," said Narinder Wadhwa MD and CEO, SKI capital.
Valuations have long been a concern in the sector. A recent report by Kotak Institutional Equities, titled 'Faith, Froth and Fundamentals,' pointed out that defence space is among those sectors that has significantly outperformed the market during the past 12-15 months.
Majority of the top 20 aerospace and defence companies have a price-to-earnings (P/E) ratio higher than 50. Nearly one-third of these companies have P/E ratios in triple digits, as per Capitaline.
Stretched valuations became even more apparent last month when HDFC Defence fund announced it would stop accepting new registrations for SIPs and lumpsums.
Another fund in this space, Motilal Oswal Nifty Defence Fund has been largely underperforming. The mutual fund has remained in the negative territory since its launch.
"While the initial euphoria surrounding defense stocks was fueled by solid fundamentals, including strong government support and increased defense spending, it’s possible that some of the rapid gains were driven by speculative enthusiasm rather than long-term fundamentals," Wadhwa added.
Losing shine or just a breather
Market hype is often followed by profit bookings as investors run to flock out their investments. For defence, this seems largely true as major stocks like Paras Defence, Bharat Dynamics and Solar industries quickly went on to become multibaggers before declining sharply on the bourses.
Meanwhile, shares of companies like Cochin Shipyard and Garden Reach went on to deliver 200 per cent returns on just year-to-date basis. Analysts believe that the recent declines might set the stage for new rallies, as short-term corrections are natural after run-up. This often allows fundamentals to catch up with the lofty valuations.
"The ongoing government backing, through the Atmanirbhar Bharat initiative and other supportive policies, coupled with the rising demand for local defence production is likely to sustain the sector's growth, making short-term fluctuation opportunities for long-term investors," said Kripashankar Maurya, AVP-Research, Choice Equity Broking Pvt Ltd.
As for now, the sector is seeing a rather muted movement as markets remain range-bound. Benchmark indices have largely been in the consolidated phase for the last few days with investors struggling to find fresh triggers for the next rally.
What should investors do?
While volatility continues to dominate the larger market sentiment, the defence space might follow the broader trajectory. As per analysts, defense stocks continue to experience fluctuations as the market digests recent gains and adjusts to the broader economic environment.
"However, the long-term outlook remains positive, underpinned by consistent government support, increasing defense expenditures, and the push for self-reliance in defense manufacturing," said Wadhwa.
Sectoral-wise, the industry continues to be on a stronger path. The government increased its defense budget to Rs 6.22 lakh crore, up from last year's Rs 5.94 lakh crore. This rise in spending along with the push for self-reliance in defense manufacturing, is expected to boost the sector even further.
With increasing geopolitical tensions, India has no alternative but to support and expand its domestic defence industry, ensuring a steady demand for locally produced platforms and driving future growth in the sector, said Maurya.