The author is an analyst of NH Investment & Securities. He can be reached at email@example.com. -- Ed.
Hanwha Aerospace’s civil business, in addition to its defense business, also enjoyed earnings growth in 4Q19. However, expectations towards 4Q19 defense/ICT earnings appear to have been excessive. In particular, we believe that uncertainties related to USFK stationing costs are in need of resolution.
▶ Impact of USFK defense cost negotiations remains uncertain
In light of expanding uncertainties, we revise down our Hanwha Aerospace earnings estimates and target P/B (from 0.9x to 0.8x). In particular, negotiations regarding United States Forces Korea (USFK) defense costs have the potential to negatively impact the growth of Hanwha Systems. Of note, a seventh negotiation is to take place this week. For Hanwha Aerospace to see a share price recovery, uncertainties related to national defense budget allocation will likely need to be resolved.
▶ 4Q19 results: Expectations for defense/ICT business were excessive
Hanwha Aerospace’s 4Q19 results fell short of the market projection, with sales of W1.6tn (-3.4% y-y) and OP of W34.1bn (35.9% y-y; OPM of 2.2%).
We mainly attribute the sluggish results to weak earnings at Hanwha Systems and Hanwha Defense, the firm’s cash cows. Going forward, earnings improvement at Hanwha Defense is likely to hinge upon the winning of large-scale overseas projects.
▶ Secondary businesses offset sluggishness results at main business
Hanwha Systems and Hanwha Defense, which combined accounted for 55% of the company’s 2019 sales, underperformed expectations in 2019. However, four of Hanwha Aerospace’s other businesses outperformed forecasts, confirming the presence of robust growth potential.
On a non-consolidated basis, Hanwha Aerospace has reduced the scale of its annual losses by around two-thirds and is expected to show earnings recovery at the RSP business. In 2019, Hanwha Techwin’s US sales climbed 23% y-y, benefiting strongly from Chinese spy-chip fears. Meanwhile, Hanwha Power Systems and Hanwha Precision Machinery, two previous loss makers, have turned to profit on the back of restructuring and the acquisition of a machine tool business.