Defense Stocks: Is Defense Rich? Ravi Dharamshi guides here

“India’s defence industry is just getting started. It would be foolish to ignore it. Around Rs 75,000-80,000 crore defence production is done domestically and this figure will increase to Rs 1,75,000-1,80,000 in the next five years,” Ravi Dharamshi, Chief Information Officer, ValueQuest Investment Advisors.

A lot of time is spent discussing global narratives. Nothing is right, nothing is right, and from here, things just go down. India is a large economy and we cannot turn a blind eye to what is happening around the world. When do we need to realize this?

First, we have to put it in context. India is a small backdrop to the world, both in terms of GDP and market capitalization.

Fifth largest.

The fifth largest is still 3% of the world, so even if we go from 3 to 4, 5, we’re not going to move a needle by a huge amount – it’s still a small thing. We’re also 3% of the world in terms of market cap, so we’re definitely the tail that gets hit hard by global things. But, having said that, at the same time, we also have a small advantage.

A global recession will not necessarily affect local growth. In fact, some level of global caution bodes well for a commodity-consuming country like India. So as long as crude oil and metal prices remain manageable, that’s good for India because India’s domestic cycle is recovering strongly, whether it’s capex, auto CV cycle, real estate cycle, you can see in the credit growth data, the financial leverage cycle just began. So we’ve been deleveraging for the better part of the last decade. Finances, banks and NBFCs are now finally capitalized, they finally have the capital to grow, so I think this is the best combination to get back to domestic growth. So one of the reasons we’ve shown this resilience is because our domestic cycles are colliding with global cycles.

We are on the cusp of a big takeoff, and the world is on the cusp of a big drop. So it’s a countercurrent, but at the same time, I think India will come out unscathed.

So the mix of finance and banking, what are you talking about, is the best way to advance this story?

Cyclical related stocks in the country, whether it’s manufacturing capital goods, engineering, defense, automobiles, auto auxiliary equipment and real estate, obviously financial stocks, when I say financial stocks I mean banks, NBFCs, basically assets A loan company with a good balance sheet. Much of the NPA cycle is behind us. A slight rise in the cost of capital is a marginal challenge, but growth will more than solve it. So these are the areas we focus on and we have adjusted our portfolio to support mainly domestic financials, real estate and defense.

A space that you tracked very carefully, I will come to the pharmaceutical company. The kind of divide you see in the pharma industry, Cipla on the one hand at the pinnacle of life, the recent USFDA approval of Zydus Life, how do you operate now in a space where every company is becoming like a case —A case-by-case special case story?
So you’re absolutely right, it’s not a homogeneous sector. Each company has different drivers, which company is more focused on the biosimilar side, which company is lagging on the USFDA issue, which company may have a large share of the domestic or global market – there are a certain number of these areas. A revival is happening.

But over-reliance on the U.S., especially in the U.S. generic drug market, is a challenge because the negotiating power there has undergone dramatic structural changes. More than 15-20 buyers have been consolidated to just 3 buyers, while the number of suppliers has increased from 15-20 to about 40-50. So, there are only three buyers, there are 50 suppliers, so the power lies with the buyers who are extracting the last cent from manufacturers outside India. Now everyone’s focus is shifting from oral solid generics to biosimilars, inhalers, profit pools that are not yet fully commercialized and generic, and from markets like U.S. generics to emerging and domestic markets.

So, among Indian pharmaceutical companies, who is most likely to take advantage of this specialization?

I’m not going to give you any names, but again I’ll make it clear that inhalers are a lasting chance.

But that’s already exploited, right?

No, we have a big pipeline ahead of us, so in the next five or seven years at least 20-30 drugs will be patented in inhalers, which is a huge opportunity for a company focused on inhalation space. Not only Cipla, others will be joining the club soon, but they have their own woes elsewhere, which is why this hasn’t come up yet. Inhalation is a profit pool, but it’s not easy. The barrier to entry is very high because it’s a combination of a drug and a device, it’s not just a drug. Those pumps and everything you see there are also patented. So, you have to come up with your own device, so it’s not easy to take market share out there. Anyone who manages to make a profit for them will last a long time. So now, it’s a sticky profit pool where you can gain market share. Your valuation may remain elevated for an extended period of time.

You have a great reputation and people call Ravi when anything goes wrong with the pharma company. So, you are now Dr. Ravi of the office?

When I started following the industry, I was as bad as you, or as bad. It is difficult to name the drug.

It’s still…it’s important that you know what’s going to make money.

Yeah, so finally look at the building blocks of any business, if you can figure it out you don’t need to know the semantics of that particular department. You need to know what affects profit and how it moves.

It’s like IT, I’ve been following it for 20 years. I’ve never seen coding, but if someone got the IT trend right, you don’t know how coding is done, I don’t know if it’s Java or C++. I admit. But it’s about identifying the jobs of the Indian IT sector.

That’s it, you don’t need to know the name of the drug or know your own code to really benefit from it.

So, no more Dr. Ravi, never mind, we won’t be talking about pharma anymore.

We are observers. So there is a difference between Sachin Tendulkar’s playing and Harsha Bhogle’s correct comment, so we are Harsha Bhogle. We just need to be sure, we have to understand who is going to play well and then bet.

Defense is ultimately a government-dependent business. It’s a business with different margins than the consumer business. This is a business where you have a commodity cycle and that’s going to play out, the stock has gone up. Does defense have money?

So I think I was talking to one of the leading industrialists in the field recently and what he said I totally agree with him is that the defense industry in India is just getting started. It would be foolish to ignore it, as the stock has been trending higher for the past six months. The opportunity has just opened up. So our defense production domestically is around Rs 75,000-80,000 crore and this figure is being asked to reach Rs 1,75,000-1,80,000 in the next five years, which is domestic production only. If there is an export opportunity increased that is separate. The entire industry could double in five years or less.

What about stocks?

So what valuation do they start with? They are in a single PE. What kind of visibility is available? You can see the next three to five years, maybe there will be quarterly fluctuations because it’s all about execution, but the visibility is that these companies are going to get bigger and bigger. We’re going to have our own Raytheon and Bombardier coming out of this space, so we’re going to have to wait.

What’s the best way to approach the defense, do you stick to the lead, your HAL and BEL, or do you have a little bit, like a rim approach?
At this juncture, there is no choice but to play the defensive PSU, but the good part is that the defensive PSU is in much better shape than some of the other PSUs, and there is a kind of virtual monopoly that will likely last another 8-10 years at’s not like

Suddenly, the sector will open up or the logistics will open up to others. Here, not because of some regulatory requirements, but because the ability to develop aircraft is only HAL, and the ability to develop helicopters is only HAL, so the monopoly of capabilities may remain at least 8-10 years. If yesterday our Air Force commander mentioned that at least 42 squadrons need to be modernized and we have just developed light utility helicopters, then all of this suggests that orders will only go to these companies, it’s a question of when it’s not a question of if. Whether this order is in one year or three years is the only question.

So from Dr. Ravi to Captain Ravi or Admiral Ravi.

No, we’re generalists, what we’re doing is learning as much as possible quickly about the field, and honestly I’m still at the kindergarten level when it comes to understanding defensive space. But I’ve figured out that a lot of money can be made here.

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