At the moment, our strategic focus on military industry can be analyzed from three dimensions: long-term, medium-term and short-term: first, long-term: whether it is the long-term certainty of developing military equipment at the national level or the industrial level, made in China has begun to develop and upgrade to industries such as large aircraft and aeroengine, which will bring huge development opportunities to Chinese military enterprises.
1. Military industry has become the country’s “must choose consumer industry”: the clearest understanding brought by the Russian Ukrainian war is that the world has accelerated the evolution of a major change that has not been seen in a century. The necessity and long-term certainty of developing national defense and military industry under the game of great powers are prominent, and it will exceed the growth rate of GDP in the long run. China’s long-term development goal is to “basically realize the modernization of national defense and army by 2035 and build a world-class army by the middle of this century”. However, at present, there is still a big gap between military equipment and the United States: according to world air force 2022, China’s third-generation and fourth-generation fighters account for about 24% of the U.S. military; According to the data of global firepower and CMPR, China has 2 aircraft carriers, while the United States has 11, 15 nuclear submarines and the United States has 68. There is a long way to go to fill the gap in equipment. As the spokesman of the Ministry of National Defense said, “China’s national defense strength does not match it and does not adapt to China’s international status and security strategic needs”. In order to achieve the goal of building a world-class army in the middle of this century, the proportion of military expenditure in GDP should be in line with that of the United States (according to SIPRI, China and the United States will be 1.75% and 3.74% respectively in 2020). Then it is expected that the growth rate of China’s military expenditure will exceed that of GDP in the next 30 years. The industrial logic behind it is to fill the gap with equipment and continue to iterate with new equipment driven by military confrontation.
2. China’s manufacturing industry has been upgraded to “large aircraft and aeroengine” industry, and the military civilian integration development has brought great development opportunities to military enterprises. Due to the universality of military and civilian technology, military technology is also closely related to strategic emerging industries. Once the overall breakthrough is achieved, it will lead to trillion level civil industries, such as large aircraft, aeroengine, Satellite Internet, all electric propulsion ship and other industries. This is also the direction for China’s manufacturing industry to upgrade to high-end industries and breeds huge market space. For example, for enterprises related to the aero-engine industry, we expect that the “14th five year plan” will usher in the outbreak of military aviation development, the “15th five year plan” will usher in the outbreak of commercial aviation development, and the military civilian integrated development will continue to grow with strong momentum.
Second, medium term: achieve the Centennial goal of building the army in 2027, drive the rapid and large-scale production of weapons and equipment, and focus on missiles, aeroengines, advanced fighters, all electric propulsion ships, UAVs, etc.
1. From the medium-term perspective, the certainty of the rapid growth of the military industry is very prominent. The large advance collection of 2021h1 main engine factory directly locks in the large orders in the next 3-5 years, and the production capacity accelerates, and additional orders can still be added in the future. By 2027, there are two logical supports for the continuous and large-scale volume of equipment. One is that the national defense policy has changed from “steadily promoting the goal of building a strong army” to “building comprehensive combat readiness capacity”. The other is that the main combat equipment has changed from “scientific research and finalization” to “batch production and equipment”. Moreover, comprehensive war preparation means that there is no need to worry about demand. After the release of production capacity, weapons and equipment may meet multiple batches and large quantities
2. Focusing on equipment quality and rapid delivery has always been the core contradiction. There is no need to worry about noise such as “centralized procurement and expanding competition”. The military has issued a series of equipment related documents since 2021, and the military weapons and equipment procurement information network has also issued the notice on the inclusion of market products in the list of electronic components. The market has many concerns about “reducing prices, centralized procurement and expanding competition”. First of all, equipment quality and rapid delivery have always been the core contradiction rather than price reduction. The price is only a step price reduction. If the price is greatly reduced, it will inevitably affect the willingness of the industrial chain to expand production, which is contradictory to the current development of equipment; Secondly, at present, most military products are supplied by single procurement or a few, and there is no centralized procurement; Finally, entering the military industry system requires a complete follow-up research process of “pre research – scientific research – type research”, coupled with a long certification cycle. Therefore, it is difficult to change the supply pattern of military products, and enterprises with core competitiveness do not have to worry about the pattern at all.
Third, short-term: 2022 is the acceleration period of military fundamentals. Demand will accelerate again, and the release of new capacity will drive orders and high performance growth.
1. The delivery of equipment driven by comprehensive war preparation has been continuously advanced, and the release of new production capacity has accelerated the driving fundamentals. In 2021h2, most military enterprises have entered the production capacity bottleneck period, resulting in the slowdown of quarterly profit growth of many enterprises. According to the requirements for comprehensive war preparation put forward in mid-2020, after a one-and-a-half-year production expansion period, 2022 is the release period of new production capacity of the military industry chain, and supply elasticity creates demand elasticity. According to the disclosed related party transactions, it is estimated that the amount of related party transactions of Avic Electromechanical Systems Co.Ltd(002013) / Avic Aviation High-Technology Co.Ltd(600862) / Avic Heavy Machinery Co.Ltd(600765) / Aecc Aero-Engine Control Co.Ltd(000738) goods sold in 2022 will increase by 51.36% / 37.01% / 37.40% / 39.38% respectively compared with the actual value in 2021
2. After significant adjustment at the beginning of 2022, military enterprises have high performance, strong growth certainty and outstanding valuation cost performance. Many military enterprises are expected to have a sustained growth of 30 ~ 40% of their net profit returned to their parent company this year and next year. However, the valuation level of 2022 is only 20 ~ 30xpe. Compared with 2018, the valuation level of many companies is still low, and the valuation cost performance is more prominent.
Fourth, investment strategy: Based on long-term growth, “track + card position” selects military core assets.
Long term growth model of military industry: 1) enterprises that provide products such as underlying materials, chips and core equipment (such as motors) can continuously iterate out new weapons and equipment, military and civilian directions, and can continuously penetrate and train equipment, or platform enterprises can continuously enrich their product lines; 2) The main engine plant, core subsystem or equipment supplier with monopoly product status involves multiple reserve models in the downstream, which brings continuous growth power. Enterprises selected for “track + card position”: in the track of continuous growth, such as engine, military aircraft + UAV, national defense informatization, Beijing Emerging Eastern Aviation Equipment Co.Ltd(002933) etc., choose core assets with high barriers, high growth and good governance structure or improvement.
1. Enterprises with core card positions on the long track: Unigroup Guoxin Microelectronics Co.Ltd(002049) , Fushun Special Steel Co.Ltd(600399) , Xiangtan Electric Manufacturing Co.Ltd(600416) , Hubei Feilihua Quartz Glass Co.Ltd(300395) , Avic Aviation High-Technology Co.Ltd(600862) .
2. For platform enterprises, the product layout is continuously enriched, or the military civilian integrated development opens up growth space: China Zhenhua (Group) Science & Technology Co.Ltd(000733) , Gaona Aero Material Co.Ltd(300034) , Western Superconducting Technologies Co.Ltd(688122) , Avic Jonhon Optronic Technology Co.Ltd(002179) , Avic Heavy Machinery Co.Ltd(600765) , Wuxi Paike New Materials Technology Co.Ltd(605123) , Guizhou Aviation Technical Development Co.Ltd(688239) , Baoji Titanium Industry Co.Ltd(600456) .
3. Military main engine factory or subsystem supplier with monopoly industrial status: Aecc Aviation Power Co Ltd(600893) , Avic Shenyang Aircraft Company Limited(600760) , Aecc Aero-Engine Control Co.Ltd(000738) , Avic Xi’An Aircraft Industry Group Company Ltd(000768) , Jiangxi Hongdu Aviation Industry Co.Ltd(600316) .
4. 2022 is the last year of the three-year action of state-owned enterprises. The reform of state-owned enterprises can be combined: Glarun Technology Co.Ltd(600562) , Eastcompeace Technology Co.Ltd(002017) , Chengdu Spaceon Electronics Co.Ltd(002935) , Shanghai Aerospace Automobile Electromechanical Co.Ltd(600151) , Guizhou Space Appliance Co.Ltd(002025) , China Marine Information Electronics Company Limited(600764) , etc.
Risk tip: the delivery of military industrial chain, the release of production expansion are lower than market expectations, and the rise in the price of bulk raw materials affect the midstream manufacturing profits.
