Revenue of private sector companies in the defence sector will grow 15-16% this fiscal, similar to last fiscal, supported by a healthy order book of ~Rs 50,000 crore. The growth rides on the government's Atmanirbhar initiative to procure 75% of India's defence requirements from domestic sources.
Encouraged by the opportunity, companies have shifted from low-complexity, offset1-driven export orders to high-margin indigenous production. However, this has stretched working capital cycles, with higher-value orders being subject to more stringent testing and approval norms.
Capital expenditure (capex) is also rising as companies expand capacity to cater to growing demand. However, healthy equity raisings and strong accruals will ensure stable credit profiles.
An analysis of 24 companies, accounting for ~42% of the revenue of private defence industry, indicates as much.
These companies have logged a compound annual growth rate (CAGR) of 26% over the past five years, led by the government's push for indigenisation and rising capital outlays2. Government schemes such as Innovations for Defence Excellence (iDEX), Positive Indigenisation List, Technology Development Fund and Development-cum-Production Partner (DcPP)3 have been supporting the growth momentum.
Says Jayashree Nandakumar, Director, Crisil Ratings, "We expect the revenue of these companies to rise 15-16% to nearly Rs 20,000 crore this fiscal. From offset-fulfilment obligations and sub-assembly (majorly forging) supplies, they are now serving as system integrators. That means they are securing orders in electronic warfare and intelligent systems used in rocket warheads, drones, aerial bomb systems, radars, satellites and surveillance platforms. This shift in their order-book profile, improvement in operational capability and built-in price escalation clauses for key raw materials will underpin continued healthy operating profit margin of 18–19% this fiscal, similar to last fiscal, and up 400 basis points (bps) since fiscal 2020."
High-margin and high-value orders will entail an increase in capex to Rs 1,500-1,600 crore this fiscal, compared with Rs 1,000 crore last fiscal, along with a working capital requirement of Rs 1,600-1,800 crore. Majority of the incremental funding requirement will be met through internal accrual, which remains strong amid healthy margins, thus resulting in limited recourse to external debt.
Says Pallavi Singh, Associate Director, Crisil Ratings, "Besides steady accrual, balance sheets have also benefitted from equity infusions of nearly Rs 3,900 crore over fiscals 2022 to 2025. Hence, the credit profiles of private sector defence companies are expected to remain stable, driven by adequate debt protection metrics. This is reflected in an interest coverage ratio of 4.3–4.5 times and debt to earnings before interest, taxes, depreciation and amortisation (Ebdita) ratio of 2.2–2.3 times this fiscal."
Timely testing and approval are critical for execution efficiencies, particularly for high-margin system integration orders where delays of 5–6 months can occur. For companies assessed by us, a six-month delay in execution could increase the working capital cycle by 35–40 days, compared with the base-case scenario of 240-250 days.
While the Department of Research and Development’s Transfer of Technology provides critical technical knowledge to private manufacturers ensuring products/services adhere to prescribed quality and standards, the ability of companies to adhere to delivery timelines is critical. Risks stemming from changes in defence procurement policies and disruption in supply of critical raw materials also bear watching.
1 Until 2020, 54 offset contracts were inked by the Ministry of Defence while from 2020 till 2025, only 3 contracts were signed
2 Capital outlay is estimated to grow at 10% CAGR over fiscals 2023-2027BE
3 Defence Research and Development Organisation (DRDO) will share 100% technical knowhow, with 0% transfer fees to the manufacturers, have Rs 100 crore corpus to support MSMEs (micro, small and medium enterprises) on funding and provide access to DRDO’s testing facility which will reduce R&D cost, infrastructure cost and will also support quicker complex certifications and faster execution for private sector companies
