Indianivesh Sector Report: Defense and Aerospace

IndiaNivesh | Jan. 3, 2017, midnight

Political Developments:

India, UAE sign 14 pacts including areas like Defense & Security India on Jan 25 signed 14 pacts (including areas Defense & Security) with UAE through a Comprehensive Strategic Partnership (CSP). This development comes when the crown prince Mohammed bin Zayed Al Nahyan was invited as Chief Guest for the Republic parade. A MoU (Memorandum of Understanding) on defense co‐operation was signed covering areas like defense manufacturing, technology transfer. 

Both, India and UAE had their first dialogue on Jan 20, where they elevated their bilateral relationship to ‘Comprehensive strategic partnership’. Both sides were represented by Inter‐ departmental and ministerial delegates, with discussions covering areas like, Energy Security, Renewable Energy, Defense, Electronics & Information Technology and Space.


In addition to 14 pacts signed, UAE (through its Institutional network) decided to invest $75bn in India’s National Investment and Infrastructure Fund.

Our View:

In a Jan 20th meeting, some key agreements were signed, (1) provide offshore patrol vessels and design’s of frigates/corvettes (till now UAE was buying them from USA, Europe), (2) supply Interceptor boats developed by L&T, private players, (3) L&T could bag the project for 100 SPAD guns in partnership with Korean company (we expect project to cost somewhere ~Rs 9‐10 bn). Also, Reliance Defense signed strategic MoU with Emirates Defense Industries Company, a leading UAE based integrated Defense Company. 


We see this development as very positive move, as this is in line with our Defense Minister’s vision to promote India as Defense export hub. Indian Defense Minister had set $2 bn of Defense exports target from India in next 2 years. Growing ties with Mauritius, UAE, Vietnam and Myanmar indicate that Indian Defense system is working towards achievement of $2bn of Defense exports target being set.

Russia allows companiesto directly work with India for supply of spares

Russia has allowed its defense companies to forge ties with Indian defense companies (both, public and private) to supply, service and jointly manufacture spares used by Indian defense forces. Prior to this announcement, India procured >$2bn of spare parts annually from Rosoboronexport for entire Defense platforms and Weapons used by Indian Defense forces.

Our View:

Since 1960s, India has procured multi‐billion dollar of military equipment’s from Russia (a/c’ for >60% of all 3 services' equipment). Current serviceability rate particularly with IAF and IN, is <50%, owing to lack of spares. IN finds it challenging to procure critical spares for its Russian Kilo‐class submarines, warships & aircraft carriers, missiles, electronic warfare control systems, radar communication tools, and navigation systems. IAF finds procurement of spares for HAL manufactured (under license) Sukhoi Su‐30 fighter aircraft tough. Also, IAF and IA Mi‐ series helicopter fleet face shortage of spares. IA faces delays in procurement of spares for T‐ 72, T‐90 tanks; BMP‐2 Infantry Combat Vehicles, Smerch & Grad Multi‐barrel launchers, and Kvadrat, Pechora, Shilka and Tunguska Air defense systems. 


Complaints by Armed Forces departments about delay in readiness of Russian equipments, to switch to other Western countries Armaments and Weapon platforms has forced Russia to open up their spare’s sector to Indian players. This move carries more importance for Russian Defense sector in the backdrop of $54.3bn of Defense projects cleared by DAC since the NDA led government came to power.


Dependency over Rosoboronexport for spare supplies led to issues like, higher costs, lack of standardization and delays (in some cases the delivery time was over 12 months). By opening‐ up the Spares sector for Russian Defense Equipments, we expect (1) Equipment serviceability of Russian fleet to significantly improve, (2) spares cost (on per unit basis) to sharply decline, and (3) PSU’s and smaller unlisted players to benefit from this new development.   


Ukraine targets contracts worth billions from India 

A recent media report highlighted that Ukraine is projecting itself as a cheaper alternative to Russia, and is targeting projects worth $10bn of Indian Defense projects. Some of the projects targeted by Ukraine include: (1) Antonov, Ukrainian Aircraft maker and Reliance.

Defense and Aerospace (RDA) plan to jointly bid for the $6bn Multi‐Role Transport Aircraft (MTA) project, which will be co‐developed by Hindustan Aeronautics Limited (HAL). HAL is yet to release the RFP. Even though exact number of Aircraft’s to be built is not yet know, industry experts predict a requirement of over 300 planes. (2) Ukraine’s SpetsTechnoExport in partnership with RDA expects to bid for the up gradation of over 1,500 BMP‐2/2K Infantry Fighting Vehicles (IFVs). This Indian Army project is expected to somewhere ~$2bn. (3) SpetsTechnoExport in partnership with Punj Lloyd has submitted a proposal to DRDO to upgrade 118 Arjun MK II tanks. Missile‐firing capability is a crucial upgrade in the new tank and Israel Aerospace Industries’ LAHAT missile has failed to meet IA requirements. (4) Ukroboronprom in partnership with RDA is looking to bid for supply of Gas turbines for IN’s New frigates. (5) Ukroboronprom is also in talks with L&T and TATA Advanced Systems to identify partnership areas under government’s ‘Make in India’ initiative. (6) Upgrade 780hp engines with 1,000hp engines for 1,000 T‐72 tanks.

Our View:

India signed a $400mn contract 7 years ago to upgrade IAF’s AN‐32 fleet, which is delayed and running behind the schedule. This coupled with Ukraine’s unstable political environment would force Indian government to cautiously deal with them, especially when Russian players are participating in such bids (Russia enjoys higher influence on Indian Defense than Ukraine).


Industry & Other Developments:

Russia to set‐up MIG‐29 Fighter Jet after sales service centre in India United Aircraft Corporation (UAC) manufacturer of MIG‐29 fighter jets announced that it intends to set‐up an after sales maintenance service centre in India. This service centre would open‐up in 2017.  

Our View:   India currently has approximately 66 MIG‐29 fighter jets. Setting‐up of MIG‐29 service centers would avoid interruptions and delays in maintenance. This would lead to improvement in the serviceability rate of fleet.

Work starts for boosting Brahmos Missile range  

BrahMos missiles, produced jointly by NPO Mashinostroyenia and DRDO, have started works on boosting the missile range by ~300 kms (~185 miles), which is doubling its current range. As part of the works, research has started and it would take 2‐3 years for the final product to be ready. Brahmos Missile based on Russia's P‐800 Oniks (Yakhont) cruise missile, can be launched from Naval vehicles (inc. submarines), Aircraft and land‐based launchers.

Guided Pinaka rocket tested second time successfully

Guided Pinaka rocket was successfully test‐fired for 2 nd time on Jan 23, from launch complex‐ III of the Integrated Test Range (ITR) launch pad at Chandipur. This is a follow‐up to the 1st test, which was successfully conducted on Jan 12, 2017.

Radars, Electro‐optical and Telemetry systems were monitored throughout Pinaka’s flight path. The guided version of Pinaka is developed by ARDE, RCI, and Defense Research and Development Laboratory.

Frigates deal with Russia hits a roadblock

India in Oct‐16 signed an Inter‐Government Agreement (IGA) with Russia to purchase 4 Krivak/ Talwar class Stealth Frigates. The same agreement allows India to procure 2 of them from Russia and remaining 2 to be built in India with Russian assistance. As per commercial offer submitted, Russia quoted ~$990 mn for 2 ships to be imported. Basic structure of these 2 ships is already ready at Yantar shipyard, Russia. Russia has quoted $ 800mn for the construction of ships in India. Also, $51mn is quoted for supply of the project documentation. This project has hit roadblock on cost front and technology transfer part. Hence, DAC has been given approval to (1) initiate negotiations on cost front, and (2) details of local construction along with transfer of technology


CCI clears Reliance‐Dassault JV

Dassault Aviation‐Reliance Group joint venture announced in Oct‐2016 was formed with a
view to execute significant offsets for Rs 580bn Rafale fighter jet deal. This JV plans to build, supply military combat aircraft on "worldwide basis". Reliance AeroStructure incorporated in Apr‐2015 holds 51% stake in this JV, with Dassault Aviation holding the remaining 49%. This JV received its clearance from Competition Commission of India (CCI) on Jan 27, 2017.

The Rafale fighter jet deal entails offset component, money that has to be invested by this JV into the Indian Defense and Aerospace sector in the range of Rs 220‐250bn. While part of offsets will go towards technology acquisition by DRDO under IDDM program (Indigenously Designed, Developed and Manufactured), some of it would go towards setting‐up of the manufacturing base in India. 

In addition to servicing the Rafale deal, this JV would operate with a view to focus on exports in long run. Rafale has worldwide market with orders signed from Egypt for 24 jets worth $5.9bn and 24 jets for Qatar worth $7.05bn. This JV is expected to be operationalised by mid of FY2018 with its main manufacturing unit at Nagpur. The Nagpur plant is likely to be set‐up at 100 acre facility that will integrate supply chain for Rafale fighter jet in India, creating at least 1,500 direct jobs over next 7 years. The offsets would also need a large supplier base of more than 300 vendors to supply the components and parts.

Our View

Reliance Aero was incorporated as step down subsidiary of Reliance Infrastructure (R‐Infra). R‐Infra in the last few quarters has made announcements to exit (partly/completely) its Power Distribution, Cement, Roads & Highways business. Also, during the same period R‐Infra announced JV’s with various foreign players in Defense space. With this JV moving 1‐step closer to manufacturing stage, we expect revenues to start contributing to the financials from later part of FY2018E onwards.

Premier Explosives to produce ejection system for Indigenous Aircraft

Premier Explosives Ltd. (LTD) along with Gulf Oil Corporation Ltd (GOCL) signed agreement with Pune based ARDE and HEMRL of DRDO for production of Canopy Severance System (CSS). CSS is a life saving device in a fighter aircraft which provides smooth passage for pilot in emergency situations by pre‐weakening the cockpit canopy in shortest possible time. As per agreement signed on Jan 20, 2017, both the companies would be first asked to supply 8 sets each in the first phase, on fulfillment of set qualification and functional tests applicable for air borne systems. This new system can be integrated with Tejas, HJT‐36, LCA Trainer and Naval versions and the first HTT‐40 Aircraft. 

The CSS developed has been rated as the fastest ejection system available right now, having completed their trials successfully in London and Moscow.

Our View:

PEL at 3QFY2017‐end reported Order Book of Rs 2.56bn (OB/LTM sales ratio at 1.2x). During 3QFY2017, PEL reported 2 order wins worth Rs 609.7mn. These order wins include, (1) Rs 277.9mn order from Bharat Dynamics Ltd, (2) Rs 331.8mn order from Ministry of Defense. Also in 4QFY2017 PEL has reported the ejection systems project win. These order new wins give improved visibility about the revenue growth prospects of the company.

Top Bets

Bharat Electronics Ltd. (BEL) 


Company Name: BEL

CMP: 1,540

Rating: Buy

Target: 1,916


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