Railways and Defence: Which Stocks Can Handle the Booming Indian Stock Market?

Two sectors that have been among the top wealth creators in the stock market over the last year: Defence and railways.

While defence stocks have been running up for the last few years ever since the government's indigenisation push, railway stock got a huge boost after the 2023 Union Budget prioritised spending to this sector.

Investors have high hopes from these stocks but they have already risen quite a lot.

So which railway and defence stocks could continue to shine in 2024 and beyond?

Let's find out...

Why Defence Stocks are Rising

India's defence spending ranks among the top five globally. With recent increases in India's defence spending, it wouldn't be surprising if India breaks into the top 3.

At US$ 74 billion in FY24, defence spending represents a significant portion of the country's GDP.

The government's focus on promoting domestic defence equipment manufacturing offers a favourable environment for defence stocks to thrive.

The Indian military is undergoing modernisation, driving demand for defence products and services. This increased demand provides growth opportunities for many kinds of defence companies in India.

That being said, it's important for investors to understand that investing in the best defence stocks to buy in India is tricky. You see defence sector stocks are influenced by economic conditions and market fluctuations, as much as there are influenced by the government's decisions.

You need to look out for fundamentally strong defence companies to make the most of this opportunity. Picking the wrong stocks can result in major losses.

Here're are three points highlighted by Tanushree Banerjee, co-head of research at Equitymaster, that you should look at when considering how to invest in defence stocks.

• • Ratio of sales to orderbook: Execution is key to the potential of defence companies' wealth creating ability. Hence while bulging order books are great, you must keep a watch on whether the order book is converting to sales as planned.
  • Ratio of receivables to sales: Defence behemoths were never a part of StockSelect recommendations until 2018.
    
    The reason? The stocks never met my safety criteria due to the massive backlog in payment receipts from the government. The receivables to sales ratios were always high. Without comfort on cashflows I didn't find them investment worthy.
    
    Defence behemoths like Bharat Electronics and Hindustan Aeronautics had a massive fall in their receivable days since 2018. And this is when the stocks came in my radar.
    
    But going forward too it would be important to evaluate the stocks based on this critical criterion.
  • Asset turnover ratio: When you look for defence stocks, you need not go only for companies with the biggest capex plans or the largest order book. Rather you could also consider business that have the fastest conversion of assets to sales.

  Why Railway Stocks are Rising

  In the Union Budget last year, the railway sector was the biggest beneficiary. A record Rs 2.4 trillion (tn) was allocated for the Indian railways. Part of the funds will be used for the railways' ambitious plan to lay about 100,000 km of new track over the next 20-25 years.

  Improving India's railway infrastructure has always remained a priority but never before has the government shown such serious interest. The regulatory environment lacked clarity before. But this has now changed... and the stock market has noticed.

  The sector got a huge boost after reports emerged that Indian government will introduce a production-linked incentive (PLI) scheme for train component makers. This serious effort is part of the country's effort to attract foreign manufacturing firms and reduce dependence on imports.

  The government has also approved the Rs 576.13 billion (bn) green mobility scheme, seven multitracking rail projects worth Rs 325 bn to add 2,339 km of track, and an upskilling and concessional credit scheme worth Rs 130 bn.

  It's important to select the stocks within the sector very carefully as not all companies stand to benefit.

  First here's what Rahul Shah, co-head of research had to say about railway stocks...

  If India must grow at 8-9% on a consistent basis, we need to invest in all kinds of infrastructure, including rail. And if rail infrastructure is given a massive push, sector companies will be among the prime beneficiaries.
  
  As per estimates, the country is well on its way to construct more national highways and rail lines in the decade between 2015-2025 than it has cumulatively done between 1950 and 2015.
  
  Huge capex announcements have already been made and more are in the offing. In fact, quarterly results for these stocks are already sending out feelers about the good times ahead.

  Now here are two defence stocks and two railway stocks for your watchlist...

  #1 Hindustan Aeronautics

  Hindustan Aeronautics manufactures and maintains aircraft and helicopters for the Indian Airforce, Indian Army, ISRO, Indian Navy, and Indian Coast Guard, among others.

  In a groundbreaking milestone, the Indian defence sector scaled new heights, surpassing a significant milestone of Rs 1 trillion in the total value of defence production.

  The company was at the forefront, taking on as many orders as it could which resulted in a substantial spike in revenue. Its order book hit US$ 10 billion at the end of 2023.

  It has also set up a Rs 2.1 bn Integrated Cryogenic Engine Manufacturing Facility (ICMF) that would cater to the entire rocket engine production under one roof for ISRO. This will eventually result in higher profits for the company.

  HAL also completed a stock split in September 2023 where it issued shares in the ratio of 1:2.

  Since 2008, the company has declared regular dividends. In the financial year 2023, the company declared a final dividend of Rs 55 per share, with a dividend payout ratio of 31.5%. The five-year average dividend payout ratio stands at 33.8%.

  To know more, check out Hindustan Aeronautics company fact sheet and latest quarterly results.

  #2 Solar Industries

  The company is a leading manufacturer of bulk explosives, packaged explosives and initiating systems, which find use in several industries, including mining, infrastructure, and construction.

  In 2010, it also ventured into defence and started manufacturing propellants for missiles and rockets, warheads and warhead explosives.

  Solar Industries is one of the largest players in the explosives industry with a 24% market share and also the first private player to manufacture explosives such as RDX, HMX, and TNT for the defence sector.

  The company has thirty-four manufacturing plants in India and six plants abroad, with a capacity to produce over 4.5 million (m) metric tonnes of explosives per annum.

  Solar Industries also manufactured six Pinaka Rockets, which the Indian Army has inducted.

  The company also ventured into manufacturing space launch vehicles by partnering with ISRO and Skyroot Aerospace.

  Solar Industries is developing an array of drones for ammunition delivery to bring a new capability to the Indian armed forces. It also successfully demonstrated its prototypes of weaponised hexacopter drones and loitering munitions and became the first Indian firm to do so.

  The company has high growth plans. It plans to establish three more manufacturing facilities in Australia, Thailand, and Indonesia to grow its international operations.

  Solar Industries is also heavily investing in capex to grow its defence portfolio and plans to invest around Rs 7.5 billion (bn) in the financial year 2024.

  This, along with the Make in India initiative, provides revenue visibility for the company in the medium term.

  Coming to its financials, the company's revenue and net profit have grown at a CAGR (compound annual growth rate) of 22.9% and 24%, respectively. This is primarily due to the growing share of defence in the revenue mix and internal manufacturing of key raw materials.

  The company's order book is strong at nearly Rs 27 bn of which defence orders are over Rs 10 bn. In October 2023 the company received its biggest-ever orders worth Rs 18.53 bn from state-owned Coal India Ltd for the supply of bulk explosives.

  To know more, check out Solar Industries' financial factsheet and latest quarterly results.

  #3 IRFC

  If you are considering railway stocks, this one is a no brainer for your watchlist.

  Indian Railway Finance Corporation (IRFC) is engaged in the business of borrowing funds from the financial markets to finance the acquisition/creation of assets which are then leased out to the Indian Railways or any entity under the Ministry of Railways.

  The company generates revenue from lease income. Its sole objective is to raise money from the debt capital markets to part-finance the plan outlay of Indian Railways. The funds are used for acquisition of new rolling stock assets to be leased to the Indian Railways to build railway infrastructure.

  With substantial investments from the Indian government directed towards the railway domain, the outlook for IRFC appears promising.

  The railway sector in India sets to flourish at an impressive compound annual growth rate (CAGR) of 7.5% between 2022 and 2027. This growth trajectory is set to fuel IRFC's financial prospects, riding on the increasing demand for funding in this expanding sector.

  IRFC plans to diversify its financing portfolio in future. This evolution will encompass new dimensions of railway projects, notably dedicated freight corridors, high-speed rail initiatives, and the development of smart railways.

  On 28 July 2023, IRFC formally entered into a Memorandum of Understanding (MoU) with RITES. The objective is to establish a framework for collaborative efforts to enhance IRFC's involvement in extending financial support to Railway-associated projects.

  To know more, check out IRFC's financial factsheet and latest quarterly results.

  #4 RVNL

  Rail Vikas Nigam Ltd (RVNL) is the construction arm of the Ministry of Railways for project implementation and transportation infrastructure development.

  It was incorporated in 2003 to meet the country's surging infrastructural requirements and to implement projects on a fast-track basis. It is a category-I Miniratna public sector undertaking (PSU) under the administrative control of the Indian Ministry of Railways.

  RVNL undertakes and executes project development, financing, and implementation of rail related infrastructure. Hence, the shift in the government's focus to improve Indian railways' condition improves growth opportunities for the company.

  The company has received a letter of agreement from the Ministry of Railways for the manufacturing and maintenance of Vande Bharat train sets, including the upgrade of the government manufacturing units and train-set depots.

  The agreement involved a quantity of 200 train sets, with a cost per set of Rs 1,200 m. No wonder even any piece of news about development of Vande Bharat trains is having a material impact on RVNL share price.

  RVNL in consortium with Siemens India, emerged as the lowest bidder (L1) for Mumbai Metro line 2B of Mumbai Metropolitan Region Development Authority (MMRDA). The project is estimated to cost around Rs 3.8 bn.

  The same consortium has bagged two separate orders from Gujarat Metro Rail Corporation. The orders are for Surat Metro Phase 1 (over 40 km covering 38 stations and 2 depots) and Ahmedabad Metro Phase 2 (over 28 km covering 23 stations and 1 depot).

  RVNL has now started participating in tenders of other countries as well. The experience of around two decades in India of being one of the lead execution agencies for railway projects would help the company to evaluate, bid and execute projects in other countries.

  To know more, check out RVNL's company fact sheet and latest quarterly results.

  Happy investing.

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