The four Defence and Engineering stocks to buy, according to Jefferies

Brokerage firm Jefferies, in a note on Thursday, June 5, has recommended Hindustan Aeronautics Ltd. (HAL), Siemens Ltd., Larsen & Toubro Ltd. and KEI Industries Ltd. as its top four picks within the engineering and construction space.

Jefferies wrote in its note that the defence order flows increased by 89% year-on-year for stock under its coverage universe. The brokerage also expects operating leverage for most of the defence companies to continue playing out in the current financial year as well.

Power and defence stocks continue to have a high visibility ahead, while the outlook for railways has also improved, according to Jefferies.

Here's a look at its views on its top four stock recommendations:

Hindustan Aeronautics

Jefferies has a bull case price target of ₹7,500 on Hindustan Aeronautics, which implies a 50% upside from current levels. Even its base case target of ₹6,475 implies a 30% upside potential.

For its base case, Jefferies sees a visible order pipeline of up to ₹1.7 lakh crore, which provides enough visibility for medium-term revenues.

For the bull case, defence orders will move at a faster pace with more proposals being cleared and tenders getting floated in the near future. The Make in India program also gathering pace with a higher proportion of domestic orders is also part of the bull case scenario for HAL.

Defence spending facing regulatory roadblocks, ordering process slows down, margin pressure on execution, are some of the key downside risks highlighted by Jefferies for HAL.

Siemens

Jefferies expects shares of Siemens to touch levels of ₹4,500 as part of its bull case target, which is a 36% upside from current levels. Its base case target of ₹3,700 only implies a 12% upside potential.

Exports rising at a faster pace to the parent company, margins crossing previous peak levels, asset turnover improves and India becomes a manufacturing hub for exports to the parent company are some of the key bull case scenarios highlighted by Jefferies for Siemens.

For its base case, Jefferies expects Siemens' Earnings per Share (EPS) to grow at a Compounded Annual Growth Rate (CAGR) of 18% between financial year 2024 - 2027.

A downward surprise in margins, exports to parent fizzling out and debtor days, inventory days and asset turnover not improving are some key downside risks for Siemens.

Larsen & Toubro

Shares of India's largest engineering and infrastructure conglomerate, Larsen & Toubro have gained 9% in the last one month and Jefferies is anticipating another 9% upmove in the stock as part of its base case scenario.

The brokerage's price target of ₹3,965 prices in a Compounded Annual Growth Rate (CAGR) of 18% for L&T's revenue and improving margin trends for its hydrocarbon and heavy engineering segments.

For its bull case target of ₹4,310 though, Jefferies expects a faster recovery in the macro investment cycle, which could lead to a sharp rise in L&T's order flow and consequently its valuations as well. The street has already factored in margin contraction in the Middle East, but that will reverse if better margin orders are received.

Domestic order flows not materialising and a higher than expected margin contraction are some key risks for the stock, according to Jefferies.

KEI Industries

The highest upside potential among the four stocks in Jefferies' bull case scenario is for KEI Industries. The brokerage has a bull case target of ₹5,625 on the stock, which implies a potential upside of 59% from current levels.

For its bull case, Jefferies expects KEI Industries' earnings to compound at a 31% annualised rate over financial year 2025-2027 and margins improve during the same period as retail margins surprise on the upside.

Jefferies has a base case target of ₹4,000 on KEI Industries, which only implies a 13% upside from current levels. Here, the brokerage is pricing in a 25% earnings CAGR over financial year 2025-2027.

Exports and retail share in the overall revenue mix declining is a key risk for KEI, according to Jefferies.