20150729-高盛-Three_key_drivers_as_budget,_AVIC_restructuring___reforms_remain_in_focus__Buy_AviChina_48页_1mb

Summary of China: Aerospace & Defense Report

Core Content

This report provides an in-depth analysis of the Chinese aerospace and defense sector, focusing on three key drivers: growing defense budget, AVIC restructuring, and reform policies. It evaluates the current valuations of major listed companies within the sector and provides investment recommendations based on these factors.

Main Drivers and Outlook

• Defense Budget Growth:

  • China's defense budget is expected to grow at 10% p.a. from 2015E to 2020E, reaching US$1trn in total.
  • The official/adjusted defense budget in 2014 was 1.3% / 2.1% of GDP, significantly lower than the 2.8% average of major global peers (3.5% for the US).
  • The report suggests that there is potential for upside due to the low proportion of defense spending relative to GDP and the continued focus on military modernization.

• AVIC Asset Restructuring:

  • AVIC aims to have 80% of its assets listed long-term.
  • Unlisted assets, particularly in the avionics segment, are highly profitable and are expected to be injected into listed companies over the next few years.
  • The avionics segment is highlighted as a key area for M&A accretion and profitability.

• Reform Policies:

  • Pricing reforms are expected to gradually lift margins for final assemblers to match global peers by 2020E.
  • R&D corporatization and airspace reforms are anticipated to take place over 2015E-2017E, with continued low altitude airspace opening as part of the 12th Five Year Plan.

Key Investment Recommendations

Company	Rating	12-m TP	Potential Upside/Downside	Notes
AviChina (2357.HK)	Buy	HK$8.50	38%	Key consolidation platform, 24.6X 2020E P/E
AVIC Avionics (600372.SS)	Buy	RMB37.90	26%	Attractive valuations, potential earnings accretion
AVIC Helicopter (600038.SS)	Buy	RMB71.30	13%	Strong earnings growth, undervalued
AVIC Aviation Engine (600893.SS)	Neutral	RMB52.40	-6%	Fair valuation against returns outlook
Hongdu Aviation (600316.SS)	Sell	RMB22.90	-22%	High valuations, no M&A accretion
AVIC Aircraft (000768.SZ)	Sell	RMB17.80	-49%	Extremely high valuations, not justified by fundamentals

Valuation Analysis

• The report lowers 2015E-17E EPS forecasts by 2% - 15% on average due to limited cost-plus pricing improvements.
• However, it increases 12-month target prices by 20% - 55% based on updated P/B vs. ROE valuation methodology and M&A premium/discount assumptions.
• A cross-check using 2020E P/E exit multiples is performed, comparing China's defense stocks to US defense stocks from 1995-2005.
• The implied 2020E P/E for AviChina is 18X, which is seen as attractive compared to the 20X-30X range for US stocks.
• AVIC Avionics and AVIC Helicopter are also noted to have implied 2020E P/E of 35X and 34X, respectively, suggesting relative value.

Key Points

• AVIC's asset restructuring is a major factor in the valuation of its subsidiaries, with the avionics segment being the most profitable.
• Earnings accretion from asset injections is a key growth driver for AVIC Avionics and AVIC Helicopter.
• The report emphasizes that AviChina is expected to benefit from AVIC's restructuring and is positioned as a key offshore consolidating platform.
• High valuations for AVIC Aircraft and Hongdu Aviation are not supported by fundamentals and are thus Sell recommendations.
• The P/B vs. ROE methodology is used as the primary valuation tool, with exit P/E as a secondary check to assess long-term value.

Conclusion

The report concludes that AviChina and AVIC Avionics are undervalued compared to peers and should be considered as Buy recommendations. AVIC Helicopter is also a Buy due to its strong earnings growth and attractive valuation. AVIC Aviation Engine is Neutral, as it is seen as fairly valued against its returns outlook. AVIC Aircraft and Hongdu Aviation are Sell due to their high valuations that are not justified by current fundamentals. The report highlights the importance of reforms, budget growth, and M&A activity in driving the long-term growth of the Chinese aerospace and defense sector.