(HSBC) China Aircraft & Parts : Initiating coverage: Gaining take-off velocity
* Potential reforms should also improve the longer-term outlook and relative sector attractiveness
* Initiate on eight companies: Buy AviChina, JONHON, AVIC Electromechanical and AVICopter
* Significant progress but still substantial potential. China is one of the few
countries to have established a complex aerospace industry. It has reduced its
dependency on foreign designs/suppliers and is now capable of indigenously
developing more advanced 4th generation fighters (J-20 & J-31) as well as mid-sized
commercial passenger planes (C919). The technology gap with international
suppliers across both military and commercial products is rapidly closing, implying
scope for upside as improving competitiveness drives domestic and international
demand.
* Military upgrading to underpin sector growth: The PLA Air Force (PLAAF) is
undergoing rapid modernisation as it replaces aircraft types dating from the
pre-1980s (e.g. J-7 & J-8) with 3rd generation capability (e.g. J-10, J-11 & J-16) and
develops new transporters, bombers and special mission aircraft. We forecast
military aircraft procurement spend to grow at an 18% CAGR over the next five years.
In addition, we see growth upside from various commercial plane developments
especially as the indigenous programmes (e.g. C919) leverage on the strong and
growing domestic demand from the world’s second-largest aircraft market.
* SOE reforms slower than expected but still offer upside: The defence industry
should benefit from the broader SOE reforms. In particular, potential changes to the
standard “cost-plus” pricing model should boost margins, while asset injections into the
listcos and better management incentive schemes should improve industry efficiency
and profitability.
* Sector top picks are AviChina, JONHON, AVIC Electro and AVICopter: All
aircraft manufacturing in China is grouped within AVIC Group. We initiate on eight of
AVIC’s subsidiaries which have majority revenue exposure to defence spending, with
Buy ratings on AviChina (2357 HK, TP HKD8.3), China Aviation Optical-Electrical
Technology (‘JONHON’, 002179 CH, TP RMB52.6), AVIC Electromechanical
(002013 CH, TP RMB30.6) and AVIC Helicopter (‘AVICopter’, 600038 CH, TP
RMB65.9) given growth potential and relative valuations. We view valuations as fair
for AVIC Aircraft (000768 CH, TP RMB27.30), China Avionics Systems (‘AVIC
Avionics’, 600372 CH, TP RMB29.6) and AVIC Aviation Engine (‘AVIC Engine’,
600893 CH, TP RMB51.0) and initiate with Hold ratings. We initiate on Hongdu
Aviation (600316 CH) with Reduce (TP RMB8.9).