De­fense shares set to rise

An­a­lysts say low val­u­a­tions, solid fun­da­men­tals, bor­der stand­off, movie are cat­a­lysts

China Daily (Hong Kong) - - BUSINESS - By MENG FANBIN meng­fan­bin@chi­nadaily.com.cn

Shares in high-growth Chi­nese de­fense com­pa­nies whose cur­rent val­u­a­tions are low may be in hot de­mand in the next two to three years, fol­low­ing a grad­ual im­prove­ment in in­dus­try fun­da­men­tals, ex­perts said.

On Aug 5, more than 30 de­fense shares rose 5 per­cent with nine stocks, in­clud­ing Addsino Co Ltd, hit­ting the daily up­per limit, fol­low­ing Sino-In­dian bor­der ten­sions.

The mil­i­tary stand­off “is a cat­a­lyst” for the cur­rent rise in shares, but the de­fense in­dus­try’s “en­doge­nous de­vel­op­ment” has also be­gun, said Wang Zongchao, chief an­a­lyst of de­fense stocks with Hu­atai Se­cu­ri­ties.

“The bor­der is­sue shows that we need a strong mil­i­tary to de­fend our ter­ri­tory and our weapons should be de­vel­oped faster and bet­ter.

“The mil­i­tary-themed Chi­nese ac­tion movie Wolf War­rior 2, which re­ceived much at­ten­tion and pos­i­tive re­views, also tells us that a strong mil­i­tary can safe­guard our con­struc­tion achieve­ments of the Belt and Road Ini­tia­tive.

“De­spite the small pos­si­bil­ity of sub­stan­tial con­flicts (break­ing out), we should con­tinue to fol­low the im­pact on the sec­tor as the sit­u­a­tion changes.”

The de­fense in­dus­try as a whole is un­der­val­ued com­pared to oth­ers’ mar­ket value, Wang said.

The price-to-earn­ings ra­tio of the CSI De­fense In­dex has plunged to 96.78 from its peak of 200 in 2016.

De­fense shares have been plum­met­ing this year with most of them back to their his­tor­i­cal lows.

Shares in Addsino Co Ltd, a com­pany that pro­vides IT so­lu­tions for the de­fense in­dus­try, closed at 9.79 yuan on July 21, this year’s low­est point and down more than 43 per­cent from the Jan 6 peak.

Shares in some high-qual­ity de­fense com­pa­nies are trad­ing low com­pared with their val­u­a­tions ear­lier this year. This sug­gests the de­fense sec­tor in the A-share mar­ket has po­ten­tial for growth, said a re­search re­port from Huashang Fund.

With in­sti­tu­tional re­forms and civil-mil­i­tary in­te­gra­tion pro­gress­ing briskly in China, this year is likely to be the start­ing in­flec­tion point for the de­fense shares’ per­for­mance, which means listed com­pa­nies in the sec­tor are in­vestable, said Gao Song, an an­a­lyst with CITIC Se­cu­ri­ties.

“Of course, the ac­tual move­ment in the share prices is hard to pre­dict as that will be de­ter­mined by the mar­ket’s risk ap­petite, and some spe­cial events and themes. We fore­cast only from the in­dus­try fun­da­men­tals.”

Growth in the de­fense bud­get is ex­pected to bot­tom out next year be­fore re­bound­ing. So, the mil­i­tary sys­tem re­form has been al­ready priced in by the mar­ket, and the fo­cus is on im­prov­ing the sec­tor fun­da­men­tals, ac­cord­ing to a re­search note by China Se­cu­ri­ties.

On July 7, at a con­fer­ence held by the State Ad­min­is­tra­tion of Sci­ence, Tech­nol­ogy and In­dus­try for Na­tional De­fense, China’s 41 de­fense re­search in­sti­tutes an­nounced they have be­gun the process of be­com­ing com­pa­nies or in­de­pen­dent le­gal en­ti­ties.

These re­search or­ga­ni­za­tions have lead­ing-edge tech­nolo­gies in their sec­tors, and strong re­search and de­vel­op­ment ca­pa­bil­i­ties.

Hu­atai an­a­lyst Wang, who fo­cuses on re­search of listed com­pa­nies in the de­fense sec­tor, said: “Putting these in­sti­tutes on a com­mer­cial foot­ing can stim­u­late their vi­tal­ity, and raise their over­all pro­duc­tiv­ity.

“With ad­vanced tech­nolo­gies, the re­search in­sti­tutes will in­crease the prof­itabil­ity and com­pet­i­tive­ness of the al­ready listed de­fense com­pa­nies through cap­i­tal in­fu­sion.

“We have a bullish out­look for the sec­tor in the medi­umto long-term, es­pe­cially in aero­nau­tics and as­tro­nau­tics, as well as high-end equip­ment.

“The con­tin­u­ous surge in de­fense pro­duc­tion this year will last till 2019. Then, we ex­pect to see a large amount of ex­ports of de­fense prod­ucts in the next two years (202021).

“In­vestors should pay much at­ten­tion to the mo­nop­oly-like sit­u­a­tion in the high-end equip­ment seg­ment of the de­fense sec­tor, which is in ur­gent need of a na­tional strat­egy. The Chi­nese govern­ment will likely pur­chase more. In ad­di­tion, re­forms are ex­pected in pric­ing and com­pe­ti­tion mech­a­nisms re­lated to high-end de­fense equip­ment.”

We have a bullish out­look for the sec­tor in the medium- to long-term ...”

chief an­a­lyst of de­fense stocks with Hu­atai Se­cu­ri­ties

AN XIN / FOR CHINA DAILY

In­vestors check stock prices at a bro­ker­age in Fuyang, An­hui province. On Aug 5, more than 30 stocks of de­fense-re­lated, high-growth Chi­nese com­pa­nies rose 5 per­cent, with nine of them hit­ting the daily up­per limit.

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