The author is an analyst of Shinhan Investment Corp. He can be reached at firstname.lastname@example.org. -- Ed.
Initiate coverage with BUY rating and target price of KRW12,000
We initiate our coverage on Hanwha Systems with a BUY rating and a target price of KRW12,000. Our target price is based on sum-of-the-parts valuation, with the defense business valued at KRW0.6tr, the information and communications technology (ICT) business at KRW0.6tr, and the company's net cash holdings reaching KRW0.2tr. Investment points are: 1) Korea’s growing defense spend on advanced weapon systems; 2) operational synergy with affiliates; and 3) upbeat outlook for larger dividends and additional M&A opportunities backed by the company's ample cash reserves.
Outlook upbeat on growing advanced weapon demand and synergy with affiliates
Hanwha Systems’ defense sales are forecast to expand at a CAGR of 12.2% from KRW1.1tr in 2019 to KRW1.7tr in 2023, backed by the nation's growing spend on defense buildup. The company’s share in the defense budget for new weapons should increase from 7.0% to 7.4% during the same period.
Hanwha Group’s combined defense sales will likely climb at a CAGR of 9.1% from KRW5.8tr in 2019 to KRW6.9tr in 2021. During the same period, Hanwha Systems’ defense sales should grow at a CAGR of 13%, propelled by the supply of core parts to defense affiliates of the group.
Upbeat on outlook for larger dividends and inorganic growth through M&As
Hanwha Systems plans to use cash assets (KRW308.2bn as of 4Q19) and free cash flow (KRW50bn-60bn per year) to increase dividends and pursue M&A deals for inorganic growth. The company's shares are trading at 2020F PER of 11.4x, remaining undervalued vs. defense (15.0x) and ICT peers (13.4x). With Hanwha Systems to be included in the KOSPI 200 small/mid-cap stock index in March and stable earnings expected for 1Q20, we expect shares to rally.