Defense
The author is an analyst for Shinhan Securities. He can be reached at ldh@shinhan.com -- Ed.
1Q23 review: Fixed cost burden from project delays
Korea Aerospace Industries posted sales of KRW568.7bn (-11% YoY) and operating profit of KRW19.4bn (-51% YoY) for 1Q23, falling far short of the consensus estimates by 17% and 56%, respectively. Earnings would have come in line if it were not for shipment delays including the Iraqi project (sales of about KRW120bn) and fixed cost burden (operating loss of about KRW25bn). We believe related sales will be booked from 3Q.
Sales from domestic operations came in at KRW363.5bn (-10% YoY), aircraft exports at KRW27.2bn (-51% YoY), and aircraft parts at KRW174.9bn (-1% YoY). Sales and profits from the Iraqi project should increase once the contract terms are modified in 3Q. Deferred domestic shipments should also be fulfilled in the second half of the year. There were no other notable issues.
Order momentum remains intact for 2023
Sales contribution from export projects will remain low in 2Q. On-time domestic deliveries and a slight rise in aircraft parts sales volume will not be enough to drive up profit. We expect to see visible growth from 3Q with the booking of sales from delivery of 12 FA-50 fighter jets to Poland (4 jets in 3Q, 8 jets in 4Q, sales of KRW800bn in total). The Iraqi project, which has been pushed back due to local issues, should bring in a large profit upon modification of the contract. Domestic shipments that have been put on the back burner due to the export deal with Poland should come to the front.
Order intake in 1Q amounted to KRW1.38tr with the addition of the KRW1.2tr deal signed with Malaysia for the supply of FA-50 jets. The company is likely to win orders worth KRW4.5tr for the full year considering the second round of light armed helicopter production and other domestic orders (KRW2.4tr) and aircraft parts orders (KRW0.8tr).
Heightened expectations for 2024
Although a bit early, we raise our hopes for 2024. Korea Aerospace Industries’ previous share price peak was recorded in 2015, with the market cap briefly topping KRW10tr. It was driven by: 1) launch of the US Air Force’s Advanced Pilot Training (APT) program; 2) high-margin aircraft parts sales (Boeing and Airbus enjoyed strong business on rising demand for low-cost carriers); and 3) order intake for the KF-X development project (roughly KRW8tr). We expect the 2015 rally to be repeated in 2024, given the resumption of the US APT program, margin recovery on aircraft parts, and potential production contract for KF-21 jets (KRW4tr). The company also has a high chance of winning orders from Egypt and the UAE. As for the remaining supply of 36 jets to Poland and 18 jets to Malaysia, it is in discussions to change the sales recognition policy from units-of-delivery to percentage-of-completion method. The switch would guarantee sales for next year, and shares will price in expectations for earnings growth in advance.