The author is an analyst of NH Investment & Securities. He can be reached at firstname.lastname@example.org. -- Ed.
Amid the worldwide spread of Covid-19, the global economy continues to plummet. However, due to the nature of the defense industry, for which market size is determined by the scale of national defense expenditure, Covid-19’s impact on defense sector plays should be relatively limited.
Despite expanding macro uncertainties, defense industry share price decline looks excessive
The recent phenomenon of defense industry share prices moving in step with the Kospi represents a novel development. Historically, defense industry beta (relative to the Kospi) has remained within the -1~0 range, with sector share prices holding relatively steady regardless of economic conditions or the stock market environment.
In particular, we note that deterioration in the defense industry share price average (-38.1% YTD) has significantly outpaced the decline of the Kospi (-20.2% YTD) this year. As its business structure should make the defense industry relatively less vulnerable compared to other sectors, we view the recent drop in defense share prices as indicating the severity of current market distortions.
Against this backdrop, we believe that the recent Covid-19-related market plunge is not an accurate reflection of the scale of damage being incurred by individual industries, and that as a result, opportunities to benefit from a rapid rebound may appear once the stock market begins to normalize.
Defense industry insulated from Covid-19 effects; investment attractiveness rising as earnings growth continues
While it is difficult to predict when the Covid-19 crisis will subside or when the market will recover, we positively evaluate the attractiveness of the defense industry for the following reasons:
1) There should be little direct damage from the Covid-19 outbreak;
2) Sector dividend growth is ongoing, and dividend yields will likely surge due to the recent share price plunge;
3) With its long-term growth momentum remaining intact, ongoing industry growth is anticipated.
However, we note that some effects are to be felt at the civil businesses that sector players are operating alongside their defense businesses. Accordingly, we recommend looking at firms with a low portion of civil (especially passenger airplane) business and companies with high captive sales portions.