Aviation Ready to fly high
Korea’s aviation industry offers an attractive long-term investment opportunity We believe Korea’s aircraft and parts industry is well-poised for exceptional long-term Overweight (Maintain) growth, supported by the stable expansion of the global civil aircraft market and the Korean government’s policy support. Domestic parts suppliers should step out of the shadows of Korea Aerospace Industries (KAI) and experience strong growth on their own Industry Report thanks to technological advances. Within a short time span, Korea has evolved into a August 27, 2015 manufacturer of parts, civil aircraft, and military aircraft. We believe the domestic development of civil aircraft will become possible within the next decade, aided by the accumulation of technology from manufacturing advanced fighter jets. Daewoo Securities Co., Ltd. We identify four potential areas of growth for the Korean aviation industry: 1) the [Shipbuilding & Machinery] manufacturing of civil aircraft parts, in which domestic suppliers should gain market share; 2) light-armed helicopters (LAH), light civil helicopters (LCH), and fighter jet (KF-X) Ki-jong Sung development projects, which are expected to commence this year, 3) maintenance, +822-768-3263 repair, and operations (MRO) for civil and military aircraft, and 4) the US next-generation [email protected] trainer program, known as T-X.
Michael Yun KAI (047810 KS/Buy/TP: W143,000): Leader of Korea’s aviation industry +822-768-4169 [email protected] KAI is Korea’s leading aviation company, manufacturing civil aircraft parts (for Boeing and Airbus), as well as military aircraft, such as the T-50 and Surion. The company is also Ho-seung Lee at the center of Korea’s aircraft development projects, planning to develop and produce +822-768-4176 next-generation fighter jets and helicopters. In our view, the company is best positioned [email protected] to benefit from the government’s commitment to fostering the aviation industry. We believe KAI is primed to become a comprehensive aviation company encompassing not [Small Cap] only development and manufacturing but also modification and MRO. Technological Seung-hyeon Park advancements should help the company eventually tap into the development of civil +822-768-4194 aircraft. [email protected] ASTK (067390 KQ/Buy/TP: W49,000): A success story in aircraft parts
ASTK is Korea’s second-largest aircraft parts supplier and is capable of producing civil aircraft fuselages. The company, which currently has an order backlog of W1.1tr, should gain increasing orders from Boeing, Airbus, and Lockheed Martin on the back of rising civil aircraft demand and growing outsourcing of parts production. The acquisition of Orbitech should help the company expand its order book, boost capacity, and reduce costs.
Orbitech (046120 KQ/Buy/TP: W16,000): A combination of growth and stability Orbitech supplies aircraft parts, but also operates a nuclear energy business, which serves as its cash cow. We believe synergies with parent company ASTK will lead to increased orders and cost savings, allowing the aircraft business to swing to a profit in 2015.
Road map of Korean aviation industry
Source: KDB Daewoo Securities
Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.
August 27, 2015 Aviation
CONTENTS
Civil aircraft market outlook 3 1. Market to expand at a CAGR of 5% over the next 20 years 3 2. Market trends: Expansion of global outsourcing 4
Military aircraft market outlook 6 1. Overview of KF-X project 6 2. Status of KF-X project 6 3. Impact of KF-X project 7
LCH/LAH development 8 1. Replacement of aging attack helicopters 8 2. KAI searching for LCH and LAH development partners 8
MRO market 9 1. Civil aircraft MRO market to expand 9 2. MRO business competition to intensify 10
T-X project 11 1. US to replace its jet trainers via the T-X program 11 3. Risks and expectations 11
Korean aviation industry 12 1. Overview 12 2. Domestic aviation industry’s supply chain and recent trend 13 3. Domestic aircraft industry’s history and technological trends 14 4. Overseas technology trends 16
Global peer valuation 19
Korea Aerospace Industries (047810 KS) 22 ASTK (067390 KQ) 29 Orbitech (046120 KQ) 36
KDB Daewoo Securities Research 2 August 27, 2015 Aviation
Civil aircraft market outlook
1. Market to expand at a CAGR of 5% over the next 20 years
According to Boeing, the global civil aircraft market will see demand for 38,050 new aircraft over the next 20 years, with the total value of those new deliveries estimated at US$5.7tr. Notably, airline passenger traffic and cargo traffic are expected to grow at respective CAGRs of 4.9% and 4.7%—higher than the annual average global GDP growth estimate of 3.1%—creating a favorable environment for the civil aircraft market. In addition, we believe that the oil price downtrend will positively affect the market in the medium to long term, as the attendant fall in jet fuel prices should improve the earnings and purchasing power of airlines. (Jet fuel accounts for the highest proportion of airlines’ expenses.)
Of note, small- and medium-sized aircraft (single-aisle and small wide-body) are seeing the fastest demand growth in the global market due to 1) rising emerging market demand, 2) the growing adoption of highly efficient aircraft, and 3) the growth of low-cost carriers (LCCs). Over the next 20 years, the proportion of small- and medium-sized aircraft will likely reach around 70% of the overall civil aircraft market (50% for single-aisle and 22% for small wide-body).
Figure 1. New aircraft and global airline networks Figure 2. Overview of key aircraft market indicators
(%) Average annual growth rate: 2015-2034 6
4.9 5 4.7
4 3.1 3
2
1
0 Global economic growth Passenger traffic Cargo traffic
Source: Boeing, KDB Daewoo Securities Research Source: Boeing, KDB Daewoo Securities Research
Figure 3. Global aircraft market breakdown Figure 4. Civil aircraft market outlook by size
('000 units) 40 2014 2034 Civil aircraft MRO 31 34% 30% 30
[Civil aircraft market] 20,910 units (2013) -> 42,180 units (2033) (2010) 20 W396bn 14
10 6 4 Components/ 2 3 3 3 Combat aircraft 1 1 equipment 12% 0 24% Large wide- Medium wide- Small wide-body Single aisle Regional jets body body
Source: Korea Aerospace Industries Association, KDB Daewoo Securities Research Note: 2013 and 2033 figures refer to total number of aircraft in operation Source: Boeing, KDB Daewoo Securities Research
KDB Daewoo Securities Research 3 August 27, 2015 Aviation
2. Market trends: Expansion of global outsourcing
The aircraft industry environment is oligopolistic and closed. Traditionally, the industry has been dominated by the US and Europe, with Boeing and Airbus, in particular, controlling the global civil aircraft market. And the combined market share of the top 10 makers stands at more than 80%.
However, major aircraft makers are gradually increasing their global outsourcing of sections/parts/materials production, as: 1) Boeing and Airbus currently enjoy order backlogs of more than five years thanks to surging aircraft demand; 2) outsourcing can cut production costs; 3) parts makers are reducing the burden of new aircraft development for aircraft makers via risk- sharing programs; and 4) parts makers have bolstered their competitiveness on the back of defense offset agreements (in which the seller of a product or service agrees to buy products or services from its client as an inducement).
In the past, Boeing outsourced 35-50% of 737 parts production. For the recently developed 787 model, the percentage has increased to 70%. In addition, the company has modified its supply chain by forging partnerships with vendors capable of providing entire integrated sections (similar to modules). Airbus also plans to increase the proportion of non-EU-sourced parts from 31.5% in 2009 to 40% in 2020.
Table 1. Changes in Boeing’s parts outsourcing strategy 737 (past) 787 (current) % of parts outsourcing 35-50% 70% Relationship with parts suppliers Based on conventional supply contracts Strategic partnerships with tier-one vendors Roles of parts suppliers Parts development and production Section development and production No. of parts suppliers Several thousand Around 50 strategic partners Supply contract type Fixed-price contract with delay penalties Risk-sharing partnership Assembly operations 30 days for final assembly Three days (assembly of complete sections) Source: Airway News, KDB Daewoo Securities Research
Figure 5. Boeing 737 supply chain (past) Figure 6. Boeing 787 supply chain (current)
Source: Boeing, KDB Daewoo Securities Research Source: Boeing, KDB Daewoo Securities Research
KDB Daewoo Securities Research 4 August 27, 2015 Aviation
Figure 8. Airbus attempting to raise percentage of non-EU Figure 7. Boeing 787 Dreamliner supply chain overview parts to 40% by 2020
Source: Boeing, KDB Daewoo Securities Research Source: Airbus, KDB Daewoo Securities Research
KDB Daewoo Securities Research 5 August 27, 2015 Aviation
Military aircraft market outlook
1. Overview of KF-X project
The KF-X project is a program that aims to develop an advanced multirole fighter for the Republic of Korea Air Force (ROKAF) based on domestic aerospace technology. The program is targeting production of a 4.5-5G fighter to replace Korea's aging F-4D/E Phantom II and F-5E/F Tiger II aircraft (243 units in total). The government is targeting the introduction of 120 fighter aircraft in 2025. KF-X is Korea’s largest weapons project, bearing total costs of around W30tr (including R&D expenses of W8.7tr).
2. Status of KF-X project
In July 2014, Korea’s Joint Chiefs of Staff decided to equip the KF-X with two engines, pushing back the year of deployment to 2025 and bumping up the total R&D budget from W6.4tr to W8.7tr. The Defense Acquisition Program Administration will assume 60% (W5.2tr) of total development costs, while the Indonesian government will shoulder 20% of the costs under a cooperative agreement with the Korean government. Private firms, including KAI, will bear the remaining 20%.
A 10-year-long feasibility study was completed, and KAI was selected as the preferred bidder in March 2015. As such, the project is currently gaining momentum. Further delays are unlikely, given that authorities will be reluctant to contribute to a potential fighter vacuum, and we expect the KF-X contract to be finalized by the end of this year.
Table 2. Timeline for the KF-X project Date Details 11/02 197th Joint Chiefs of Staff meeting 4/10 Formulated a framework for the project 6/11-12/12. Joint exploratory development study by Korea and Indonesia 3/13-11/13 Outsourced an audit of feasibility study 11/13 8th Aerospace Industry Development Policy Committee meeting Progress 11/13 281st Joint Chiefs of Staff meeting 9/14 Approved basic development plan at a defense project committee meeting 9/14 Signed MOA regarding KF-X technology transfer 10/14 Korean and Indonesian governments signed joint development agreement 12/14 Finalized total project budget 12/14 Announced bidding details 3/15 Selection of preferred bidder Plans 9/15 Contract negotiation and execution Source: Defense Acquisition Program Administration, KDB Daewoo Securities Research
Table 3. KF-X Development costs and expected benefits (Wtr, %) Project Details Value Notes Korean government W5.2tr (60%) Development costs Indonesian government W1.7tr (20%) Companies W1.7tr (20%) KAI likely to invest W0.9tr (10%) KF-X aircraft W9.9tr-13.2tr KF-X Economic benefits Added value from KF-X production W2.8tr-5tr Job creation from KF-X production 45,000-61,000 Aerospace industry W9.5tr Technological benefits Defense industry W17.7tr Other W13.5tr Source: Defense Acquisition Program Administration, KDB Daewoo Securities Research
KDB Daewoo Securities Research 6 August 27, 2015 Aviation
3. Impact of KF-X project
The KF-X fighter project will likely give rise to the following positives: 1) a significant economic contribution, 2) aerospace technology development, and 3) the strengthening of national security.
1) Economic contribution: Excluding R&D costs, roughly W10tr will be invested in mass production and W9tr in fighter operation and management. In light of the government’s export plan, the project is expected to add around W60tr to the economy.
2) Aerospace technology development: We believe that technology transfers from countries with advanced aerospace technologies will give the Korean aerospace industry a chance to take a major leap forward. All in all, the KF-X project is forecast to have positive ripple effects on the aerospace and defense sectors (as well as certain other industries).
3) Strengthening of national security: The domestic development of fighter jets is anticipated to reinforce Korea’s aerial defense and capabilities in joint military operations. And easier operation and maintenance (relative to imported jets) should help increase fighter utilization.
Figure 9. KF-X C103 mock-up Figure 10. KF-X (based on projections)
Source: New Daily, KDB Daewoo Securities Research Source: Kukmin Ilbo, KDB Daewoo Securities Research
Figure 11. Domestic fighter demand trend Figure 12. National defense upgrade costs
(units) Low-end (Wtr) (%) 600 Medium-end 12 Defense upgrade costs (L) 20 High-end YoY growth (R) Number of fighter jets considered 500 10 appropriate 15
400 8 10 300 6 5 200 4
0 100 2
0 0 -5 2008 2013 2018F 2021F 2025F 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: MND, KDB Daewoo Securities Research Source: MND, KDB Daewoo Securities Research
KDB Daewoo Securities Research 7 August 27, 2015 Aviation
LCH/LAH development
1. Replacement of aging attack helicopters
In a 2008 report on armed helicopter deployment plans, the Korea Institute for Defense Analyses (KIDA) advised that the defense ministry should only focus on the development of high-end and low- end models because domestically produced mid-end attack helicopter models based on the Korean Utility Helicopter (KUH) platform could not compete with the equally-sized Apache.
The Joint Chiefs of Staff decided in 2009 to heed KIDA’s advice, with the Korea Institute for Industrial Economics and Trade (KIET) and the Ministry of National Defense (MND) giving assent in 2010. For about one year thereafter, the Agency for Defense Development (ADD) and the Korea Aerospace Research Institute (KARI) led R&D efforts for LAH and LCH, respectively. KAI participated in such efforts as a prototype maker.
2. KAI searching for LCH and LAH development partners
In July 2014, KAI was designated the lead developer for LCH and LAH, and discussions are underway to select foreign partners for development. The company plans to develop an LCH platform by 2020 and an LAH platform by 2022 (based on the LCH platform).
Figure 13. KUH model
Source: KDB Daewoo Securities Research
Figure 14. LAH Figure 15. LCH
Source: KAI, KDB Daewoo Securities Research Source: KAI, KDB Daewoo Securities Research
KDB Daewoo Securities Research 8 August 27, 2015 Aviation
MRO market
1. Civil aircraft MRO market to expand
The aircraft MRO business is largely divided into depot maintenance and performance-based logistics (PBL). Recently, amid LCC-driven expansion of the domestic civil aviation industry, the Korean government has been supporting the growth of aircraft MRO providers. We project the domestic aircraft MRO market to grow to W2.5tr by 2020.
Figure 16. Depot maintenance
Source: KAI, KDB Daewoo Securities Research
Figure 17. KAI’s MRO businesses
Source: KAI, KDB Daewoo Securities Research
KDB Daewoo Securities Research 9 August 27, 2015 Aviation
2. MRO business competition to intensify
On January 19th, the Ministry of Land, Infrastructure and Transport announced a plan to support the growth of the domestic aircraft maintenance industry. This project will provide customized support to establish specialized MRO providers and facilitate the creation of an MRO cluster.
The ministry plans to support a specialized MRO provider that formulates a concrete business plan and settles on a site location after discussions with the local government. Specifically, the ministry will help the MRO provider secure facilities and orders and acquire advanced maintenance technology via defense offset agreements. Over the long term, this project aims to expand the aircraft MRO business by nurturing MRO exporters and jointly sourcing parts.
Regarding bidding for the MRO project, KAI (Sacheon), Asiana Airlines and Boeing (Cheongju), Incheon International Airport (Incheon), and Korean Air (Gimhae) are expected to compete. In addition, Airbus is also likely to create a consortium to participate in the bidding.
We believe the government is unlikely to make a final decision on the project until 2016, as it could generate disputes and controversies (e.g., claims of preferential treatment, etc.)
Figure 18. Status of domestic infrastructure
Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 10 August 27, 2015 Aviation
T-X project
1. US to replace its jet trainers via the T-X program
The T-X program was established to allow the United States Air Force to buy a new two-seat jet trainer for fast-jet training to replace the Northrop T-38 Talon. The bidding is expected to start in 2H16 and finish in 2017. About 350 aircraft (worth US$11bn) are expected to be ordered to replace the T-38. Given that a total of 546 T-38 units are currently in operation, an additional 300 aircraft could be ordered thereafter. As such, the total project value could reach more than W20tr. 2. Competitors
KAI plans to bid for the T-X project with the T-50, which the company has jointly developed with Lockheed Martin. The company’s biggest competitor is a consortium of Boeing and Saab, which plans to develop a new jet trainer for the project. We believe competitors will have no choice but to develop new aircraft, as the T-50 is superior to competitors’ existing jet trainers.
The M-346, which was jointly developed by General Dynamics and Alenia Aermacchi, is considered inappropriate for 5G fighter jet training due to its low (transonic) speed. A prototype developed by Northrop Grumman and Scaled Composites, which is scheduled to begin test flights this year, is emerging as the strongest competitor to the T-50. In addition, BAE Systems’ Hawk Mk.128 and Textron AirLand’s Scorpion are also considered competitors to the T-50.
3. Risks and expectations
Competition to win the T-X project (worth at least W12tr) is expected to be fierce. There is also a possibility that Lockheed Martin might participate in the bid on its own. Lockheed Martin is known to have been developing a new advanced jet trainer since 2010. Although the company has not produced an advanced trainer jet yet, it is likely to have built up knowledge and experience through the joint development and improvement of the T-50 with KAI.
It is worth noting that the US Air Force seems highly likely to award the contract to a US participant. If KAI maintains its partnership with Lockheed Martin and the consortium manages to land the project, it would pave the way for KAI’s accelerated growth, driven by US-bound exports. In an effort to support the KAI-Lockheed Martin consortium, the Korean government selected Lockheed Martin’s F-35 for its next-generation fighter jet acquisition project.
Figure 19. T-38 Figure 20. T-50
Source: Google, KDB Daewoo Securities Research Source: Google, KDB Daewoo Securities Research
KDB Daewoo Securities Research 11 August 27, 2015 Aviation
Korean aviation industry
1. Overview
The aviation industry is engaged in the production, upgrade/modification, and maintenance of aircraft, parts/components, and terrestrial systems. The industry requires comprehensive technologies ranging from machinery to electronic, electric, and materials.
Broadly, the aviation industry can be divided into aircraft production and operation. The aircraft production segment is again divided into parts/materials and finished aircraft, while the operation segment includes MRO and terrestrial support systems.
Classified by use, military aircraft include fighters, surveillance aircraft, and trainers, while civil aircraft include passenger planes and light planes. Classified by propulsion technique, aircraft can be categorized into propeller-driven aircraft and jet planes. They are also classified by type of wings as either fixed-wing (fighters and trainers) or rotary-wing (helicopters) aircraft.
Figure 21. Aviation industry
Source: KDB Daewoo Securities Research
Figure 22. Combat aircraft
Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 12 August 27, 2015 Aviation
2. Domestic aviation industry’s supply chain and recent trend
The aviation industries of North America and Europe have flourished, driven by Boeing and Airbus. As such, these two regions have well-established supply chains, composed of finished aircraft manufacturers, tier-one suppliers, tier-two suppliers, and other partners.
The domestic aviation industry, meanwhile, is only in a nascent stage. Its supply chain, which is still not firmly established, consists of parts suppliers/OEMs, R&D partners, and intermediate/finished goods producers. The industry’s ecosystem has been developing at a slow pace due to 1) the lack of finished aircraft producers, 2) the closed network of major global players, 3) technological challenges and lack of experience, 4) concerns about the potential formation of an oligopoly, and 5) the large capex burden.
Recently, however, the industry’s ecosystem has been improving markedly for several reasons. First, leading players, namely KAI and Korean Air, are seeing increased orders and an expansion in outsourcing. Second, domestic companies have built up technologies and experience. Third, SMEs with strong technological competitiveness, namely ASTK, are rising sharply on the back of strong exports. Lastly, financing conditions have become more favorable thanks to the increase in IPOs.
Figure 23. Domestic aircraft industry supply chain
Source: Korea Aerospace Industries Association, KDB Daewoo Securities Research
Figure 24. Change in domestic aviation industry
Source: Korea Aerospace Industries Association, KDB Daewoo Securities Research
KDB Daewoo Securities Research 13 August 27, 2015 Aviation
3. Domestic aircraft industry’s history and technological trends
The domestic aircraft industry began with the assembly of military aircraft; in the 1980s, for example, Korean Air assembled MD 500 helicopters for Hughes Aircraft Company. Since the mid- 1980s, Korean companies have also been involved in the civil aircraft industry, exporting parts to advanced aircraft makers (through partnerships such as defense offsets and countertrades). In the 2000s, Korean firms began to engage in R&D efforts to develop next-generation aircraft, including medium-altitude UAVs and smart UAVs. Korean firms are also currently preparing to develop attack helicopters.
Korea has acquired a strong competitive edge in production technologies (e.g., airframe design and assembly), and is attempting to sharpen its competitiveness in the aircraft design and development segments, as well. According to industry data, Korea’s civil aircraft production technologies have reached 90% of advanced country levels, while testing and designing technologies have each reached 70%.
Broadly, fixed-wing aircraft include fighter jets, ground-attack aircraft, electronic-warfare aircraft, surveillance aircraft, maritime patrol aircraft, transport aircraft, aerial refueling aircraft, and trainer aircraft. According to industry data, giving a value of 100 to US technology, the level of Korea’s fixed-wing aircraft technology is 73—the 13th highest in the world.
As for rotary-wing aircraft, the completion of Surion (a utility helicopter) made Korea the 11th nation in the world to develop a homegrown helicopter. Korea started developing Surion in June 2006 and shipped the first unit in August 2009, and the aircraft succeeded in its maiden flight in March 2010. With Surion, Korea’s rotary-wing aircraft technology level advanced to 77, the 11th highest in the world. Currently, Korea is engaged in efforts to develop other types of helicopters.
Remote-controlled UAVs are capable of performing dangerous missions. Korea is competitive in both small and large UAV technology, and the level of domestic UAV technology stands at 84, the seventh highest in the world.
Currently, more than 50% of the key requirements for unmanned systems are based on IT technologies. Given Korea’s strong IT capabilities, we expect the domestic development of UAVs to accelerate faster than other areas.
Figure 25. Level of domestic aircraft technology: Strong edge in airframe design and assembly
Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 14 August 27, 2015 Aviation
Figure 26. Level of Korean fixed-wing aircraft technology: 13th in global ranking
100 96 93 91 87 86 86 83 81 79 75 75 73 73 72 65 64 57
Leading industrial Advanced Developed Underdeveloped
Source: Defense Agency of Technology and Quality, KDB Daewoo Securities Research
Figure 27. Level of Korean rotary-wing aircraft technology: 11th in global ranking
100 96 94 91 91 91 84 83 80 78 77 77 75 73 69 69 66 62
Advanced Leading industrial Developed Underdeveloped
Source: Defense Agency of Technology and Quality, KDB Daewoo Securities Research
Figure 28. Level of Korean UAV technology: 7th in global ranking
100 95 93 92 91 87 84 84 84 84 80 75 75 75 72 71 64 56
Leading industrial Advanced Developed Underdeveloped
Source: Defense Agency of Technology and Quality, KDB Daewoo Securities Research
KDB Daewoo Securities Research 15 August 27, 2015 Aviation
4. Overseas technology trends
Recently, the global aircraft industry has been focused on UAVs, environmentally friendly/highly efficient aircraft, high-performance aircraft, and IT convergence systems.
The ultimate goal of developing UAVs is to enable fully autonomous flight. The trend of unmanned systems is spreading beyond military aircraft into the civil aircraft arena. More than 187 companies in 37 countries are participating in UAV projects. Currently, around 400 projects are underway.
The US is striving for the convergence of UAV technology with existing, manned system technology. Israel, meanwhile, is focusing on the diversification, scale, and survivability of UAVs, while France aims to have UAVs replace its Rafale fighters by 2020.
Table 4. Development timeline of UAV technology Period Details Models
1960s-70s - Recorded video during Vietnam War AQM-34 Initial UAV
- Used as decoy and fighter vehicles during Gulf War 1970s-80s Ryan 147 - Improved models (return rate of 90%) used to record Improved UAV Mastiff during Gulf War
Searcher - Low-altitude and short-distance unmanned systems used 1980s-90s Pioneer during Lebanon conflicts and Gulf War UAV systems CL-89 - Real-time spy reconnaissance, Hunter
1990s-2000s - Medium-altitude endurance system emerged during High-performance Afghanistan War Predator UAV - Attack function
- High altitude endurance system 2000s- - Ability to fly for more than 72 hours in the stratosphere Global Hawk Strategic UAV - Private-invested development Smart UAV systems - System integration technology Helios - Real-time communications
Source: Ministry of Trade, Industry and Energy, KDB Daewoo Securities Research
KDB Daewoo Securities Research 16 August 27, 2015 Aviation
The trend toward environmentally friendly and highly efficient aircraft is most evident in the commercial airplane segment (which accounts for over 70% of the global civil aircraft market). Since the 2000s, aircraft manufacturers have been evaluating new aircraft based on their level of operational cost savings. The Boeing B787, for example, with a fuselage and wings made up mostly of carbon-fiber reinforced composites, reduces fuel costs by 20% relative to existing models.
Table 5. Development timeline of green/high-efficiency technology in civil aircraft Period Details Models
1950s-60s - Turbojet engines B707 1G civil aircraft ･ High-speed flying DC-8
- Turbofan engine 1960s-70s B737 ･ Improved economic feasibility 2G civil aircraft DC-9 - Short- to medium-distance flying
B747 1970s-80s - The emergence of large-size aircraft enabled low-cost and A300 3G civil aircraft large-scale transportation DC-10
- Economic recovery following oil shocks 1980s-90s A320 ･ Replacement of old aircraft 4G civil aircraft B757/767 - Low-fuel and low-noise engines; Digital technology
- Growing global demand for transportation; High demand for
direct flights A330/380 ･ High-efficiency mega-sized aircraft; Longer-range 1990s- B777/747A aircraft 5G civil aircraft B787/A350 - Concurrent engineering; Preference for light-weight aircraft B737 Max ･ Simultaneous progress in designing and manufacturing ･ Embracing composite materials Source: Ministry of Trade, Industry and Energy, KDB Daewoo Securities Research
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The US has been the most aggressive in developing high-performance aircraft. Since 1993, the country has developed attack aircraft, including the F-35. The UK, Germany, Italy, and Spain jointly developed the Eurofighter, an attack aircraft that features functions such as mobility, supercruise, and thrust vector control.
Table 6. Development timeline of combat aircraft technology Period Details Models
MiG-17 - Commercialization of hypersonic jets 1945-55 F-86 - Based on avionics 1G combat aircraft Yak-23 - F-104
F-100 - Hypersonic jet 1955-60s F-104, - 1G radar system 2G combat aircraft MiG-21 - Equipped with missiles F-8
F-4, - Improved equipment functions 1960s-70s MirageF.1 - Air-to-air and air-to-ground missiles 3G combat aircraft MiG-23 - Multi-purpose Harrier
- Developed during Cold War Mig-29 1970s-90s - Improved mobility F-14 4G combat aircraft - Precision-guided weapons F-15 - Improved survival rates F-16
Rafale - Super precision-guided weapons 1990s-2000s EFA - Integrated sensor systems 4.5G combat aircraft Su-35 - Limited stealth F/A-18E/F
F-35 - Stealth 2000s- F/A-22 - Mobility, high survival rate 5G combat aircraft PAK FA - Advanced integrated sensor systems Su-47
Source: Ministry of Trade, Industry and Energy, KDB Daewoo Securities Research
KDB Daewoo Securities Research 18 August 27, 2015 Aviation
Global peer valuation
Table 7. Valuation table (Wbn, %, W) Aircraft makers Aircraft parts manufacturers Lockheed China KAI Boeing Airbus Bombardier Avg. ASTK Precision AVIC Zodiac Spirit Avg. Martin Avionics Market cap 8,812 102,188 72,502 61,131 2,258 - 350 37,427 13,016 10,300 8,251 7,813 - 2014 2,280 97,004 48,378 75,018 21,691 - 67 10,851 3,457 5,748 7,497 1,241 - Revenue 2015F 2,952 112,810 53,190 85,586 22,768 - 84 11,769 4,594 6,417 7,897 1,476 - 2016F 3,787 115,448 54,478 87,818 22,833 - 100 12,437 5,543 7,002 8,138 1,717 - 2014 160 7,886 6,078 4,821 931 - -3 2,990 111 700 833 155 - OP 2015F 274 9,625 6,573 5,644 941 - 4 3,106 133 666 1,019 193 - 2016F 350 10,721 7,051 5,716 813 - 15 3,408 181 1,002 1,046 230 - 2014 7.0 8.1 12.6 6.4 4.3 7.7 -4.5 27.6 3.2 12.2 11.1 12.5 10.3 OP 2015F 9.3 8.5 12.4 6.6 4.1 8.2 4.8 26.4 2.9 10.4 12.9 13.1 11.7 margin 2016F 9.2 9.3 12.9 6.5 3.6 8.3 15.0 27.4 3.3 14.3 12.8 13.4 14.4 2014 108 6,166 3,898 3,068 444 - -8 1,908 77 462 584 123 - NP 2015F 205 6,627 4,209 3,567 442 - 2 2,003 92 435 667 144 - 2016F 263 7,322 4,551 3,609 325 - 10 2,205 131 658 671 173 - 2014 14.8 6.3 0.2 -13.9 13.1 4.1 9.3 14.0 22.6 7.3 14.1 10.1 12.9 Revenue 2015F 29.5 16.3 9.9 14.1 5.0 15.0 26.1 5.0 19.4 -5.8 14.2 17.2 12.7 growth 2016F 28.3 2.3 2.4 2.6 0.3 7.2 19.8 10.0 42.2 51.1 0.6 19.7 23.9 2014 1,111 9,014 12,090 3,918 364 - -1,296 13,770 29 1,705 4,006 65 - EPS 2015F 2,122 9,559 13,556 4,632 223 - 179 15,047 37 1,528 4,750 79 - 2016F 2,728 11,158 15,052 4,800 136 - 745 16,885 48 2,329 4,957 97 - 2014 10,568 21,358 16,474 20,256 960 - 3,720 94,966 784 12,752 15,992 569 - BPS 2015F 12,318 12,989 11,840 15,693 532 - 3,600 99,359 918 12,742 20,057 623 - 2016F 14,787 19,669 13,088 18,207 630 - 4,345 106,442 966 14,573 22,666 709 - 2014 81.3 15.2 17.6 18.2 2.6 27.0 - 18.2 155.3 21.0 13.2 65.0 54.5 P/E (x) 2015F 42.6 15.9 17.4 16.7 4.6 19.4 186.5 18.1 127.9 21.7 12.3 57.0 70.6 2016F 33.1 13.6 15.7 16.1 7.4 17.2 44.9 16.2 97.0 14.3 11.8 46.3 38.4 2014 8.6 6.5 13.0 3.5 1.0 6.5 2.3 2.6 5.6 2.8 3.3 7.6 4.1 P/B (x) 2015F 7.3 11.3 19.2 4.8 1.9 8.9 9.3 2.7 5.2 2.6 2.8 7.2 5.0 2016F 6.1 7.5 17.3 4.1 1.6 7.3 7.7 2.5 4.9 2.3 2.5 6.3 4.4 2014 10.7 39.4 73.9 19.3 33.1 35.3 -21.4 27.6 3.2 12.2 11.1 12.5 9.0 ROE (%) 2015F 18.5 64.8 103.0 30.9 72.5 57.9 5.1 26.4 2.9 10.4 12.9 13.1 13.5 2016F 19.9 85.0 124.5 26.5 17.2 54.6 18.7 27.4 3.3 14.3 12.8 13.4 15.9 2014 38.4 9.3 10.0 7.9 6.2 14.4 80.8 11.6 69.7 13.9 7.1 39.3 37.1 EV/ 2015F 24.8 8.6 10.1 6.9 6.9 11.5 55.9 11.8 58.4 14.2 6.7 33.3 30.1 EBITDA 2016F 19.7 7.7 9.4 6.9 7.0 10.1 25.1 10.9 47.2 10.1 6.6 28.6 21.4 2014 3.9 1.0 1.4 0.7 0.1 1.4 0.8 3.2 3.6 1.8 1.0 6.0 2.7 P/S (x) 2015F 3.0 0.9 1.4 0.7 0.1 1.2 0.7 3.1 2.9 1.5 1.0 5.4 2.4 2016F 2.3 0.9 1.3 0.7 0.1 1.1 0.6 2.9 2.4 1.4 1.0 4.6 2.1 Source: Bloomberg, KDB Daewoo Securities
KDB Daewoo Securities Research 19 August 27, 2015 Aviation
Figure 29. Share performance of Boeing Figure 30. Share performance of Airbus
(US$) (EUR) 180 70
160 60
140 50
120 40
100 30 8/14 11/14 2/15 5/15 8/15 8/14 11/14 2/15 5/15 8/15
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 31. Share performance of Lockheed Martin Figure 32. Share performance of Spirit AeroSystems Holdings
(US$) (US$) 220 60
200 50
180 40
160 30 8/14 11/14 2/15 5/15 8/15 8/14 11/14 2/15 5/15 8/15
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 33. Share performance of Triumph Group Figure 34. Share performance of Precision Castparts
(US$) (US$) 80 260
70 240
60 220
50 200
40 180 8/14 11/14 2/15 5/15 8/15 8/14 11/14 2/15 5/15 8/15
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 20 August 27, 2015 Aviation
Figure 35. Share performance of AVIC aircraft Figure 36. Share performance of China Avionics Systems
(RMB) (RMB) 60 60
50 50
40 40
30 30
20 20
10 10
0 0 8/14 11/14 2/15 5/15 8/15 8/14 11/14 2/15 5/15 8/15
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 37. Share performance of KAI Figure 38. Share performance of ASTK
(W) (W) 120,000 40,000
35,000 100,000 30,000 80,000 25,000
60,000 20,000
15,000 40,000 10,000 20,000 5,000
0 0 8/14 11/14 2/15 5/15 8/15 12/14 2/15 4/15 6/15 8/15 Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 39. Share performance of Orbitech Figure 40. Share performance of Hize Aero
(W) 14,000
12,000
10,000
8,000
6,000
4,000
2,000
0 8/14 11/14 2/15 5/15 8/15 Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 21 August 27, 2015 Aviation
Korea Aerospace Industries (047810 KS) Leader of Korea’s aviation industry
Aviation Industry Home-grown fighter jets: From concept to reality
Korea Aerospace Industries (KAI) is Korea’s only manufacturer and developer of aircraft (Initiate) Buy (T-50, Surion, etc.). The company also produces civil aircraft parts for Boeing and Airbus and engages in aircraft upgrades/modification, MRO, training system development, and Target Price (12M, W) 143,000 satellites.
In addition to the LAH and LCH projects, KAI has also been tapped as the preferred Share Price (08/26/15, W) 90,800 bidder for the KF-X development project. The company is essentially tasked with all of Korea’s major civil/military aircraft development and production projects. Expected Return 57% Order backlog to hit record in 2015; Robust growth for the next three years OP (15F, Wbn) 304 For 2015, we expect KAI to win orders of W1.1tr for aircraft, W1.9tr for parts, and W7tr Consensus OP (15F, Wbn) 285 for the KF-X project, bringing total order backlog to W18-19tr. Such strong new orders EPS Growth (15F, %) 109.1 and backlog should keep the company growing at 20% CAGR over the next three years. Market EPS Growth (15F, %) 25.0 P/E (15F, x) 38.1 Other sources of growth Market P/E (15F, x) 10.9 1) MRO business: The MRO market is expected to grow on the back of the increasing KOSPI 1,894.09 entry of low-cost carriers (LCCs). KAI intends to expand its MRO operations to take Market Cap (Wbn) 8,851 advantage of the growth of LCCs and government support. That said, competition is Shares Outstanding (mn) 97 likely to be fierce, with Korean Air and a foreign consortium led by Airbus also battling Free Float (%) 46.0 for a greater share of the market. Foreign Ownership (%) 13.6 Beta (12M) 1.54 2) T-X program and other: For the US Air Force’s next-generation trainer (T-X) program, 52-Week Low 35,450 KAI plans to propose a version of its T-50 trainers together with Lockheed Martin. The T- 52-Week High 103,500 X program will involve supplying around 350 trainers worth up to W11tr, with mass production beginning in 2020. (%) 1M 6M 12M Absolute 0.9 83.1 156.1 Initiate with Buy and TP of W143,000 Relative 9.0 92.6 179.7 We initiate our coverage on KAI with a Buy rating and target price of W143,000. Our 330 KOREA AEROSPACE KOSPI target price is based on a P/E of 30x our 2016F EPS of W3,179, to which we applied a 280 50% premium in light of the company’s high growth potential compared to global peers, 230 as well as the Korean government’s long-term industry support. We see potential for a 180 highly profitable business, with ROE forecast to reach 22.3% in 2016. 130 We believe KAI is well-positioned for long-term growth, as the company is likely to 80 8.14 12.14 4.15 8.15 dominate the development and production of most civil/military aircraft as the unparalleled leader of the domestic aviation industry. In our view, this makes the company a great retirement stock from a medium- and long-term perspective.
FY (Dec.) 12/12 12/13 12/14 12/15F 12/16F 12/17F Revenue (Wbn) 1,535 2,016 2,315 2,848 3,583 4,423 OP (Wbn) 126 125 161 304 398 491 OP margin (%) 8.2 6.2 7.0 10.7 11.1 11.1 NP (Wbn) 74 90 111 232 310 391 EPS (W) 760 924 1,140 2,383 3,179 4,008 ROE (%) 8.6 9.7 11.1 20.4 22.3 22.8 P/E (x) 34.0 31.4 34.9 38.1 28.6 22.7 P/B (x) 2.8 2.9 3.7 7.1 5.8 4.7 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates
KDB Daewoo Securities Research 22 August 27, 2015 Aviation
Company overview
Homegrown fighter jets: From concept to reality
KAI is Korea’s only manufacturer and developer of aircraft (T-50, Surion, etc.). The company also produces civil aircraft parts for Boeing and Airbus and engages in aircraft upgrades/modification, MRO, training system development, and satellites.
In addition to the LAH and LCH projects, KAI has also been tapped as the preferred bidder for the KF-X development project (with an annual development cost of W600- 700bn). The company is essentially tasked with all of Korea’s major civil/military aircraft development and production projects.
Revenue breakdown: 40% for defense, 35% for parts, and 25% for aircraft exports
In 1H15, the defense unit accounted for 37.8% of KAI’s total revenue, followed by parts (36.2%) and aircraft exports (26.0%). Revenue contribution from the defense unit increased sharply on higher T-50 exports. The company’s order backlog stood at around W11.4tr, of which 51% is for parts, 35% for the defense unit, and 14% for aircraft exports. If the KF-X contract is finalized within this year, the company’s total order backlog will likely increase to W18-19tr at the end of the year.
KAI’s largest shareholder is KDB, with a 26.75% stake
KAI’s largest shareholder is the Korea Development Bank (KDB) with a 26.75% stake, followed by Hanwha Techwin and Hyundai Motor Company (10% each), the National Pension Service (7.61%), and DIP Holdings (5.0%). Foreign ownership stood at 14.5% as of August 12th.
Figure 41. Order backlog (based 2Q15) Figure 42. Major shareholders
National defense Korea 19% Development Bank, 27%
Other, 40% Overseas Order backlog business W11.4 tr (aircraft) 15% Parts/MRO Hyundai Motor, 66% 10% Hanhwa NPS, 8% Techwin, 10% DIP Holdings, 5%
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 23 August 27, 2015 Aviation
Orders and order backlog
Order backlog to reach W18-19tr at end-2015
In 1H15, KAI won orders of W1.8tr for parts, W200bn for the defense unit, and W400bn for aircraft exports, bringing its order backlog to W11.4tr.
For 2015, we project the company to receive aircraft export orders (W1.1tr; to Botswana, Turkey, Iraq, etc.) as well as parts orders from Boeing and Airbus (W1.9tr). If the KF-X contract is finalized, its year-end order backlog will likely reach W18-19tr, 80% higher than the level at end-2014 (W11tr).
Lead developer of LCH and LAH
KAI was selected to lead the LCH and LAH development projects in 2014. The company plans to develop an LCH platform by 2020 and then use the LCH platform to develop LAHs by 2022. Once an overseas partner is designated, this project will pick up speed. We estimate overall development costs to reach W600bn, and mass production is planned for 2022.
Figure 43. New orders trend Figure 44. Order backlog trend
(Wtr) (Wtr) 12 20
10 15 8
6 10
4 5 2
0 0 2011 2012 2013 2014 2015F 2011 2012 2013 2014 2015F
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 45. New orders forecast for 2015 Figure 46. Order backlog by business
Parts/MRO 19%
Parts/MRO National Overseas 42% defense business New orders forecast Order backlog forecast 44% (aircraft) W10 tr W18.2tr 11%
National defense 70% Overseas business (aircraft) 14%
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 24 August 27, 2015 Aviation
To enter hyper growth in 2015
We anticipate that 2015 will mark the beginning of a hyper growth phase for KAI, with revenue of W2.85tr (+23% YoY) and operating profit of W303.6bn (+88% YoY). We expect the company’s revenue to grow at a CAGR of 25% through 2017, driven by 1) stable sales at the defense and aircraft units and 2) expansion of aircraft exports. This year, the company will begin exporting T-50 aircraft to Iraq and the Philippines, and KT-1 aircraft to Peru.
Once the company takes KF-X orders in 2015, it should generate around W600-700bn in related annual revenue through 2023. This value is equivalent to more than 20% of the company’s 2015F revenue. Furthermore, the company is likely to generate around W150bn in annual revenue from the KUH project for which it has been selected as a preferred bidder. As such, we expect the company to deliver revenue growth of more than 25%.
Profitability to improve on lower fixed cost burden and the won’s weakness
Backed by robust revenue growth, operating profit will also likely expand sharply thanks to lower fixed cost burden. In particular, T-50 revenue growth is likely to lower the revenue contribution of lower-margin civil aircraft parts. In addition, profitability is expected to improve on the won’s weakness. Of note, given that the won has depreciated by 10% YoY since the beginning of 3Q, operating profit is anticipated to increase sharply during the quarter.
On the non-operating side, interest expenses are likely to increase through 3Q due to borrowings for working capital. However, we believe that borrowings will decrease at the end of the year, as considerable receivables should be collected.
Table 8. Quarterly earnings (Wbn, %) 2014 2015F 3Q15F growth 2014 2015F 2016F 1Q 2Q 3Q 4Q 1Q 2Q 3QF 4QF YoY QoQ Revenue 503 599 517 696 621 679 648 900 25.2 -4.6 2,315 2,848 3,583 Defense 255 324 257 381 241 257 268 453 4.4 4.4 9.4 0.1 50.1 Aircraft 46 106 87 87 167 177 158 190 83.1 -10.4 36.0 112.9 34.8 Parts/MRO 203 169 174 228 214 246 221 257 27.1 -9.8 16.3 21.2 -12.2 Operating profit 29 46 40 47 56 77 71 99 79.4 -8.0 161 304 398 Pretax profit 18 33 42 48 57 74 72 99 69.8 -2.8 140 302 404 Net profit 18 27 34 33 44 57 55 63.6 -3.0 111 232 310 OP margin 5.7 7.7 7.7 6.7 9.1 11.4 11.0 11.0 - - 7.0 10.7 11.1 Net margin 3.5 4.5 6.5 4.7 7.0 8.4 8.5 8.5 - - 4.8 8.2 8.6 Note: All figures are based on consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research
Figure 47. Revenue and OP margin (annual) Figure 48. Revenue and OP margin (quarterly)
(Wbn) (%) (Wbn)Parts/MRO (L) (%) 4,000 Parts/MRO (L) 12 1,000 Overseas business (aircraft) (L) 18 National defense (L) Overseas business (aircraft) (L) OP margin (R) National defense (L) 10 15 OP margin (R) 800 3,000 8 12 600 2,000 6 9 400 4 6 1,000 200 2 3
0 0 0 0 2012 2013 2014 2015F 2016F 1Q12 1Q13 1Q14 1Q15 Source: Company data, KDB Daewoo Securities Research Source: Company data, KDB Daewoo Securities Research
KDB Daewoo Securities Research 25 August 27, 2015 Aviation
Investment recommendation and valuation
Initiate coverage with a Buy rating
We initiate our coverage on KAI with a Buy rating, as:
1) The civil aircraft industry will likely deliver steady growth in the medium to long term.
2) The Korean government is anticipated to invest in and support the military aircraft business over the medium to long term.
3) The company is expected to display steady growth and operating profit on the back of a massive order backlog.
4) Sound cash flow and accumulated technological prowess should maximize the company’s corporate value.
TP of W143,000
We present a target price of W143,000 for KAI. Our target price is based on a P/E of 30x our 2016F EPS of W3,179, to which we applied a 50% premium in light of the company’s high growth potential compared to global peers, as well as the Korean government’s long-term industry support. We see potential for a highly profitable business, with ROE forecast to reach 22.3% in 2016. We think that KAI is a promising investment, as the company can generate solid cash flow in the long term. (See Global Peer Valuation on page 19.)
We believe KAI is well-positioned for long-term growth, as the company is likely to dominate the development and production of most civil/military aircraft as the unparalleled leader of the domestic aviation industry. In our view, this makes the company a great retirement stock from a medium- and long-term perspective. In addition, the outlook is bright for the company’s T-50 exports and civil aircraft parts.
Figure 49. P/E-ROE comparison (2015F) Figure 50. P/B-ROE comparison (2015F)
(P/E, x) (P/B, x) 120 10 AVIC 8 90 China Avionics
6 60 KAI AVIC 4 China Avionics KAI Precision Spirit 30 2 Spirit Zodiac Precision Zodiac (ROE, %) (ROE, %) 0 0 0 5 10 15 20 25 30 0 5 10 15 20 25 30
Source: Bloomberg, KDB Daewoo Securities Research Source: Bloomberg, KDB Daewoo Securities Research
KDB Daewoo Securities Research 26 August 27, 2015 Aviation
Figure 51. Share performances of global aircraft makers
(-1Y=100) 320 KAI Boeing Lockheed Martin Aribus Bombardier 270
220
170
120
70
20 8/14 11/14 2/15 5/15 8/15
Source: KDB Daewoo Securities Research
Figure 52. Share performances of global aircraft parts manufacturers
(-1Y=100) 450 Spirit Triumph Precision 350 AVIC China Avionics KAI 250
150
50 8/14 11/14 2/15 5/15 8/15 Source: KDB Daewoo Securities Research
Figure 53. KAI, KOSPI, and manufacturing index
(-1Y=100) 300 Manufacturing index KOSPI 250 KAI
200
150
100
50
0 8/14 11/14 2/15 5/15
Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 27 August 27, 2015 Aviation
Korea Aerospace Industries (047810 KS/Buy/TP: W143,000)
Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/14 12/15F 12/16F12/17F (Wbn) 12/14 12/15F 12/16F12/17F Revenue 2,315 2,848 3,583 4,423 Current Assets 1,244 1,619 1,882 2,155 Cost of Sales 2,027 2,417 3,028 3,738 Cash and Cash Equivalents 13 212 370 545 Gross Profit 288 431 555 685 AR & Other Receivables 216 199 267 285 SG&A Expenses 127 128 158 195 Inventories 433 480 453464 Operating Profit (Adj) 161 304 398 491 Other Current Assets 582 728 792 861 Operating Profit 161 304 398 491 Non-Current Assets 858 850 819 817 Non-Operating Profit -20 -2 6 18 Investments in Associates 3 4 5 7 Net Financial Income -7 -8 8 18 Property, Plant and Equipment 494 483 474 489 Net Gain from Inv in Associates 0 0 0 0 Intangible Assets 225 222 189 161 Pretax Profit 141 302 404 509 Total Assets 2,101 2,469 2,701 2,972 Income Tax 30 70 94 118 Current Liabilities 543 633 563 496 Profit from Continuing Operations 111 232 310 391 AP & Other Payables 152 161 188 160 Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 103 170 70 0 Net Profit 111 232 310 391 Other Current Liabilities 288 302 305 336 Controlling Interests 111 232 310 391 Non-Current Liabilities 522 591 607 580 Non-Controlling Interests 0 0 0 0 Long-Term Financial Liabilities 261 251 231 181 Total Comprehensive Profit 95 233 310 391 Other Non-Current Liabilities 261 340 376 399 Controlling Interests 95 233 310 391 Total Liabilities 1,065 1,224 1,170 1,075 Non-Controlling Interests 0 0 0 0 Controlling Interests 1,037 1,245 1,531 1,897 EBITDA 250 394 479565 Capital Stock 487 487 487487 FCF (Free Cash Flow) -165 217 320 340 Capital Surplus 128 128 128 128 EBITDA Margin (%) 10.8 13.8 13.4 12.8 Retained Earnings 415 623 909 1,275 Operating Profit Margin (%) 7.0 10.7 11.1 11.1 Non-Controlling Interests 0 0 0 0 Net Profit Margin (%) 4.8 8.1 8.7 8.8 Stockholders' Equity 1,037 1,245 1,531 1,897
Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/14 12/15F 12/16F12/17F 12/14 12/15F 12/16F 12/17F Cash Flows from Op Activities -113 255 360 400 P/E (x) 34.9 38.1 28.6 22.7 Net Profit 111 232 310 391 P/CF (x) 12.6 20.9 18.6 15.7 Non-Cash Income and Expense 196 191 167 174 P/B (x) 3.7 7.1 5.8 4.7 Depreciation 51 52 4845 EV/EBITDA (x) 16.8 22.9 18.215.0 Amortization 38 38 3328 EPS (W) 1,140 2,383 3,1794,008 Others 107 101 86101 CFPS (W) 3,149 4,347 4,8925,791 Chg in Working Capital -389 -83 -31 -64 BPS (W) 10,636 12,773 15,703 19,461 Chg in AR & Other Receivables -198 -11 -56 -17 DPS (W) 250 250 250 250 Chg in Inventories -68 -47 27 -11 Payout ratio (%) 21.9 10.5 7.9 6.2 Chg in AP & Other Payables -159 -5 24 -31 Dividend Yield (%) 0.6 0.3 0.3 0.3 Income Tax Paid -25 -77 -94 -118 Revenue Growth (%) 14.8 23.0 25.8 23.4 Cash Flows from Inv Activities -80 -86 -57 -80 EBITDA Growth (%) 23.2 57.6 21.6 18.0 Chg in PP&E -51 -38 -40 -60 Operating Profit Growth (%) 28.8 88.8 30.9 23.4 Chg in Intangible Assets -54 -35 0 0 EPS Growth (%) 23.4 109.0 33.4 26.1 Chg in Financial Assets 25 -15 -17 -20 Accounts Receivable Turnover (x) 18.4 18.6 20.1 20.6 Others 0 2 00 Inventory Turnover (x) 5.8 6.2 7.7 9.7 Cash Flows from Fin Activities 68 32 -144 -144 Accounts Payable Turnover (x) 15.2 16.4 18.7 23.6 Chg in Financial Liabilities 87 56 -120 -120 ROA (%) 5.4 10.2 12.0 13.8 Chg in Equity 0 0 0 0 ROE (%) 11.1 20.4 22.3 22.8 Dividends Paid -19 -24 -24 -24 ROIC (%) 9.7 15.0 18.7 22.4 Others 0 0 00 Liability to Equity Ratio (%) 102.7 98.3 76.5 56.7 Increase (Decrease) in Cash -125 200 158 175 Current Ratio (%) 229.1 255.8 334.1 434.7 Beginning Balance 138 13 212 370 Net Debt to Equity Ratio (%) 31.8 14.4 -6.9 -21.6 Ending Balance 13 212 370 545 Interest Coverage Ratio (x) 12.1 20.6 33.6 72.3 Source: Company data, KDB Daewoo Securities Research estimates
KDB Daewoo Securities Research 28 August 27, 2015 Aviation
ASTK (067390 KQ) A success story in aircraft parts
Aviation Industry Korea’s second-largest aircraft parts supplier Established in 2002, ASTK is Korea’s second-largest aircraft parts supplier, with Boeing as its biggest client. The company produces stringers, bulkheads, and sections 48 (rear (Initiate) Buy fuselage), and is the only domestic company aside from KAI capable of manufacturing fuselages. Target Price (12M, W) 49,000 To meet increasing demand for single-aisle aircraft in emerging countries, Boeing is ramping up its 737 assembly line and plans to raise its monthly capacity to 52 units per Share Price (08/26/15, W) 29,500 month by 2018. At present, ASTK supplies around five sections 48 for the Boeing 737- 900 every month, but intends to eventually increase its monthly capacity to up to nine. Expected Return 66% Investment points: Ample order backlog, new orders, acquisition synergies
OP (15F, Wbn) 3 We estimate ASTK’s order backlog stood at W1.11tr at end-1H15, the majority of which Consensus OP (15F, Wbn) 3 is for Boeing’s most popular jet, the 737. Given the recent surge in civil aircraft demand EPS Growth (15F, %) - and increased outsourcing of parts production, ASTK should see increasing orders Market EPS Growth (15F, %) 25.0 through customer and product diversification. P/E (15F, x) 253.6 For 2015, we see order backlog rising to W1.5-2tr, driven by additional orders from Market P/E (15F, x) 10.9 Boeing and offset orders from Airbus and Lockheed Martin. Backed by massive order KOSDAQ 667.44 inflows and backlog, we forecast the company to maintain rapid growth of over 20% Market Cap (Wbn) 407 CAGR for the next three years. Shares Outstanding (mn) 14 ASTK’s acquisition of Orbitech should help the company expand its order book, boost Free Float (%) 75.7 capacity, and save costs. ASTK plans to concentrate on large assemblies and fuselages, Foreign Ownership (%) 11.4 while Orbitech will narrow its focus on machinery assembly. ASTK should also see more Beta (12M) 1.10 outsourcing operations following the acquisition, which should prove favorable to 52-Week Low 7,280 margins. The deal is also anticipated to boost ASTK’s production capacity (currently 52-Week High 36,150 W120bn) by roughly W50bn. (%) 1M 6M 12M Initiate with Buy and TP of W49,000 Absolute -17.8 106.3 0.0 Relative -4.4 90.7 0.0 We initiate our coverage on ASTK with a Buy call and target price of W49,000. Our target price is based on a market cap equal to 45% of the lower end of our 2015 order 130 AeroSpace Technology of Korea KOSDAQ backlog forecast (W1.5tr). KAI, the company’s only comparable domestic peer, is 110 currently valued at 45% of our year-end backlog estimate (W20tr). 90 70 On average, global aircraft parts suppliers are trading at a P/E of 71x, P/B of 5x, and 50 EV/EBITDA of 30x, suggesting traditional valuation methods are unsuitable. During good 30 times, the stock prices of aircraft parts suppliers react more sensitively to industry 10 conditions, orders, and margins than to revenue and profit. Looking forward, we 8.14 12.14 4.15 8.15 highlight three investment points: order backlog growth, entry into the offset market, and margin expansion.
FY (Dec.) 12/12 12/13 12/14 12/15F 12/16F 12/17F Revenue (Wbn) 44 61 67 82 102 127 OP (Wbn) 4 -4 -3 3 6 10 OP margin (%) 9.1 -6.6 -4.5 3.7 5.9 7.9 NP (Wbn) 9 -7 -8 2 5 9 EPS (W) 1,639 -888 -630 116 359 656 ROE (%) 72.5 -35.5 -21.4 3.4 9.8 15.7 P/E (x) - - - 253.6 82.1 44.9 P/B (x) - - 2.3 8.5 7.7 6.5 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates
KDB Daewoo Securities Research 29 August 27, 2015 Aviation
Korea’s second-largest aircraft parts supplier
Established in 2002, ASTK is Korea’s second-largest aircraft parts supplier, with Boeing as its biggest client. The company produces stringers, bulkheads, and sections 48 (rear fuselage), and is the only domestic company aside from KAI capable of manufacturing fuselages.
A section 48 (the part of the fuselage on which tail wings are mounted) consists of about 6,400 parts. Spirit AeroSystems had been the exclusive supplier of the Boeing 737’s sections 48, but ASTK won orders in 2013 thanks to surging demand and Boeing’s strategy of increasing outsourcing.
Currently, Boeing’s monthly capacity for the 737 stands at 42 units. To meet increasing demand for single-aisle aircraft in emerging countries, Boeing is ramping up its Boeing 737 assembly line and plans to raise its monthly capacity to 52 units by 2018. At present, ASTK supplies around five sections 48 for the Boeing 737-900 every month, but intends to eventually increase its monthly capacity to up to nine. Currently, sections 48 are the major growth driver for ASTK, contributing to the company’s earnings turnaround in 1H. ASTK’s cumulative section 48 production volume reached the 100 mark in 1H15.
Figure 54. ASTK’s product portfolio Figure 55. Section 48 for the Boeing 737
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 56. Boeing’s monthly production plan for the B737 Figure 57. Civil aircraft market outlook
(units) ('000 units) 80 40 2014 2034 31 60 30 52 47 [Civil aircraft market] 42 20 20,910 units (2013) -> 42,180 units (2033) 40 14
10 20 6 4 3 3 3 1 1 2 0 0 Large wide- Medium wide- Small wide-body Single aisle Regional jets 2014 2017F 2018F body body
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 30 August 27, 2015 Aviation
Ample order backlog and new orders
We estimate ASTK’s order backlog stood at W1.11tr at end-1H15, the majority of which is for Boeing’s most popular jet, the 737. In the aviation industry, after a company is selected as a supplier of parts, it usually continues supplying the parts until the relevant aircraft model is discontinued. Given the recent surge in civil aircraft demand and increased outsourcing of parts production, ASTK should see increasing orders through customer and product diversification.
In our view, ASTK is likely to see a further increase in orders. The company recently won orders for the Boeing 737 MAX, and is expected to receive orders from Triumph Vought, another tier-one supplier for Boeing.
In addition, ASTK will likely make a foray into the military jet offset market in 2H, which has so far been dominated by only a few players in Korea. Recently, Airbus’s A330 MRTT won the Defense Acquisition Program Administration’s (DAPA) future air-to-air refueling and transport aircraft project. As Airbus is believed to have offered an offset deal, ASTK is expected to receive orders from the aircraft company in 2H. In addition, ASTK will also likely be selected as a partner for Lockheed Martin’s offset arrangement in relation to the DAPA’s purchase of the F-35 fighter jets.
Figure 58. ASTK’s order trend Figure 59. ASTK’s order backlog as of 1H15
(US$mn) 500 - Section 48 - B747 after-body assembly 400
- Sec. 48 increment 300 - B737 Max - Bulkhead 200 - Rear spar/ jack screw
100 - B757 MDCD
0 06 07 11 13 14
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 60. ASTK’s main clients Figure 61. New orders expected from Airbus, Lockheed Martin
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 31 August 27, 2015 Aviation
Synergies from Orbitech acquisition
In August, ASTK acquired a 16.6% stake in Orbitech, which specializes in machinery assembly for aircraft parts. Last year, the company formed a technological partnership with ASTK and successfully landed an order from Spirit AeroSystems. The company is now exclusively supplying bulkheads for the Boeing 737-900 via ASTK.
ASTK’s acquisition of Orbitech should help the company expand its order book, boost capacity, and save costs. ASTK plans to concentrate on large assemblies and fuselages, while Orbitech will narrow its focus on machinery assembly. ASTK should also see more outsourcing operations following the acquisition, which should prove favorable to margins. The deal is also anticipated to boost ASTK’s production capacity (currently W120bn) by roughly W50bn.
We forecast Orbitech’s aircraft parts revenue to jump from W2.3bn in 2014 to W11bn in 2015, W22bn in 2016, and W34bn in 2017. As revenue gains momentum, the aircraft parts division should swing from a loss in 2014 to a profit in 2H15, pushing up ASTK’s equity-method gains.
Figure 62. Orbitech’s machine facilities Figure 63. Business strategy of ASTK & Orbitech
Source: KDB Daewoo Securities Research Source: Company data, KDB Daewoo Securities
Figure 64. Orbitech’s aircraft business Figure 65. Change in domestic aviation industry
(Wbn) 40 34
30 Civil aircraft market boom 22 20
11 10
2 1 0 13 14 15F 16F 17F
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 32 August 27, 2015 Aviation
Earnings outlook
ASTK recorded 1H revenue of W36.9bn (+16% YoY), operating profit of W0.7bn (turning to black YoY), and net profit of W0.4bn (turning to black YoY). Earnings growth was driven by: 1) an increase in rear fuselage (section 48) production volume and yield, 2) the won’s depreciation against the dollar, and 3) a decrease in financing expenses.
We believe the company turned an important corner with operating profit returning to black, especially after posting operating losses over the past two years. This was attributable to the company’s investments of over W30bn after taking large-scale orders in 2011. Although profit levels are still modest, the company’s earnings turnaround along with its order backlog of over W1tr and new order momentum should accelerate an improvement in its fundamentals. We expect to see continued growth in both top and bottom lines in 2H.
For the full year, we project ASTK’s revenue at W82.2bn (+23% YoY), operating profit at W2.5bn (turning to black YoY), and net profit at W1.6bn (turning to black YoY). In light of the robust global aviation industry and strong order growth, we believe the company’s margins will rise steadily going forward on the back of a revenue CAGR of 20%
Table 9. ASTK’s quarterly earnings (Wbn,%) 2014 2015F 2014 2015F 2016F 1Q 2Q 3Q 4Q 1Q 2Q 3QF 4QF Revenue 17.4 16.6 16.5 16.0 19.7 19.9 21.5 21.0 66.6 82.2 101.9 QoQ - -5 -0 -3 23 1 8 -2 - - - YoY - - - -13 20 30 32 9 23 24 Operating profit 0.4 -1.5 -0.9 -1.0 0.2 0.5 1.0 0.8 -3.0 2.5 6.1 QoQ - -509 -38 6 TTB 216 80 -13 - - - YoY - - - --53 TTB TTB TTB RR TTB 143 Pretax profit -0.7 -3.5 -1.8 -2.3 0.6 0.1 0.7 0.5 -8.4 1.8 5.2 Net profit -0.7 -3.2 -1.8 -2.2 0.4 -0.0 0.7 0.5 -7.9 1.6 5.0 QoQ - 329 -43 21 TTB RR TTB -19 - - - YoY - - - -TTB RR TTB TTB RR TTB 205 OP margin 2.1 -9.0 -5.6 -6.2 0.9 2.7 4.5 4.0 -4.6 3.1 6.0 Net margin -4.2 -19.0 -10.9 -13.6 2.2 -0.1 3.1 2.5 -11.8 2.0 4.9 Note: All figures are based on consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research
Table 10. ASTK’s annual earnings (Wbn,%) 2012 2013 2014 2015F 2016F 2017F Revenue 44.8 60.9 66.6 82.2 101.9 127.0 YoY 34 36 9 23 24 25 Bulkhead 17.1 18.7 15.4 17.0 21.2 27.5 Section 48 0.4 10.4 18.5 25.6 32.0 39.3 U/L Deck 2.9 5.0 4.9 5.5 6.2 7.0 Stringer 4.4 4.0 3.2 4.0 6.4 9.0 Other 20.0 22.7 24.5 30.2 36.2 44.2 Operating profits 4.1 -4.1 -3.0 2.5 6.1 10.2 YoY 128 TTR RR TTB 143 66 Pretax profit 0.6 -7.2 -8.4 1.8 5.2 10.1 Net profit 0.6 -6.5 -7.9 1.6 5.0 9.1 YoY 124 TTR RR TTB 205 83 OP margin 9.2 -6.8 -4.6 3.1 6.0 8.0 Net margin 1.3 -10.7 -11.8 2.0 4.9 7.1 Revenue portion Bulkhead 38 31 23 21 21 22 Section 48 1 17 28 31 31 31 U/L Deck 7 8 7 7 6 6 Stringer 10 7 5 5 6 7 Other 45 37 37 37 36 35 Source: Company data, KDB Daewoo Securities Research
KDB Daewoo Securities Research 33 August 27, 2015 Aviation
Figure 66. Section 48 monthly production Figure 67. Section 48 sales forecast
(units) (Wbn) 10 50
8.2 39 8 40 6.7 32 6 30 5.3 26
3.9 4 20 19
2.2 10 2 10
0.1 0 0 0 12 13 14 15F 16F 17F 12 13 14 15F 16F 17F
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 68. Revenue breakdown Figure 69. Annual earnings
(Wbn) (%) Bulkhead 150 Revenue (L) 30 23% OP margin (R) 127 Other 120 37% 102 20
90 82 67 10 61 60 45 34 0 25 26 Section 48 30 Stringer 15 28% 9 5% 4 4 4 5 5 U/L Deck 0 -10 7% 02 04 06 08 10 12 14 16F
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 34 August 27, 2015 Aviation
ASTK (067390 KQ/Buy/TP: W49,000)
Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/14 12/15F 12/16F12/17F (Wbn) 12/14 12/15F 12/16F12/17F Revenue 67 82 102127 Current Assets 62 64 76 88 Cost of Sales 65 74 90 110 Cash and Cash Equivalents 14 11 13 15 Gross Profit 2 8 12 17 AR & Other Receivables 20 23 28 33 SG&A Expenses 5 6 6 7 Inventories 27 29 3337 Operating Profit (Adj) -3 3 6 10 Other Current Assets 1 1 2 3 Operating Profit -3 3 6 10 Non-Current Assets 55 55 57 58 Non-Operating Profit -5 -1 -1 0 Investments in Associates 0 0 0 0 Net Financial Income -4 -2 -2 -1 Property, Plant and Equipment 48 50 51 53 Net Gain from Inv in Associates 0 0 1 1 Intangible Assets 4 3 2 1 Pretax Profit -8 2 5 10 Total Assets 117 120 133 146 Income Tax 0 0 0 1 Current Liabilities 58 60 70 75 Profit from Continuing Operations -8 2 5 9 AP & Other Payables 13 17 22 27 Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 43 39 44 42 Net Profit -8 2 5 9 Other Current Liabilities 2 4 4 6 Controlling Interests -8 2 5 9 Non-Current Liabilities 12 11 10 9 Non-Controlling Interests 0 0 0 0 Long-Term Financial Liabilities 8 8 8 8 Total Comprehensive Profit -8 2 5 9 Other Non-Current Liabilities 4 3 2 1 Controlling Interests -8 2 5 9 Total Liabilities 70 72 80 84 Non-Controlling Interests 0 0 0 0 Controlling Interests 47 48 53 62 EBITDA 2 7 1115 Capital Stock 6 6 66 FCF (Free Cash Flow) -7 -4 3 1 Capital Surplus 47 47 47 47 EBITDA Margin (%) 3.0 8.5 10.8 11.8 Retained Earnings -8 -6 -28 Operating Profit Margin (%) -4.5 3.7 5.9 7.9 Non-Controlling Interests 0 0 0 0 Net Profit Margin (%) -11.9 2.4 4.9 7.1 Stockholders' Equity 47 48 53 62
Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/14 12/15F 12/16F12/17F 12/14 12/15F 12/16F 12/17F Cash Flows from Op Activities -2 1 8 6 P/E (x) - 253.6 82.1 44.9 Net Profit -8 2 5 9 P/CF (x) 43.8 50.3 37.4 27.3 Non-Cash Income and Expense 10 6 6 6 P/B (x) 2.3 8.5 7.7 6.5 Depreciation 4 4 44 EV/EBITDA (x) 81.7 60.7 40.829.5 Amortization 1 1 11 EPS (W) -630 116 359656 Others 5 1 11 CFPS (W) 191 587 7891,083 Chg in Working Capital -1 -5 -1 -6 BPS (W) 3,720 3,491 3,850 4,506 Chg in AR & Other Receivables -2 -2 -4 -4 DPS (W) 0 0 0 0 Chg in Inventories -1 -2 -4 -4 Payout ratio (%) 0.0 0.0 0.0 0.0 Chg in AP & Other Payables 2 4 4 5 Dividend Yield (%) 0.0 0.0 0.0 0.0 Income Tax Paid 0 0 0 -1 Revenue Growth (%) 9.8 22.4 24.4 24.5 Cash Flows from Inv Activities -6 -6 -7 -6 EBITDA Growth (%) - 250.0 57.1 36.4 Chg in PP&E -5 -5 -5 -5 Operating Profit Growth (%) - - 100.0 66.7 Chg in Intangible Assets 0 0 0 0 EPS Growth (%) - - 209.5 82.7 Chg in Financial Assets 0 -1 -2 -1 Accounts Receivable Turnover (x) 4.2 4.6 4.9 5.1 Others -1 0 00 Inventory Turnover (x) 2.5 2.9 3.3 3.6 Cash Flows from Fin Activities 21 -4 5 -2 Accounts Payable Turnover (x) 6.5 5.7 5.3 5.3 Chg in Financial Liabilities - - - - ROA (%) -7.3 1.4 3.9 6.5 Chg in Equity 27 0 0 0 ROE (%) -21.4 3.4 9.8 15.7 Dividends Paid 0 0 0 0 ROIC (%) -3.4 2.6 6.6 10.0 Others - - -- Liability to Equity Ratio (%) 151.1 148.7 151.1 135.3 Increase (Decrease) in Cash 13 -3 3 2 Current Ratio (%) 106.3 107.0 109.4 118.3 Beginning Balance 1 14 11 13 Net Debt to Equity Ratio (%) 78.2 74.7 70.9 54.0 Ending Balance 14 11 13 15 Interest Coverage Ratio (x) -0.8 1.5 4.1 7.8 Source: Company data, KDB Daewoo Securities Research estimates
KDB Daewoo Securities Research 35 August 27, 2015 Aviation
Orbitech (046120 KQ) A combination of growth and stability
Aviation Industry An aircraft parts supplier with a stable cash cow
Founded in 1991, Orbitech mainly provided nuclear energy safety services, such as (Initiate) Buy radiation management and in-service inspections (IS), before entering the aircraft parts business in 2013. Last year, the company formed a technological partnership with ASTK Target Price (12M, W) 16,000 and successfully landed an order from Spirit AeroSystems to supply parts for Boeing. In August 2015, Orbitech was acquired by its business partner ASTK. Share Price (08/26/15, W) 9,480 Investment points: ASTK acquisition, aircraft unit turnaround, and cash cow
Expected Return 69% We believe the acquisition by ASTK will generate meaningful synergies. Regarding the aviation business, ASTK plans to concentrate on large assemblies and fuselage orders, OP (15F, Wbn) 1 while Orbitech intends to specialize on machinery assembly as a supplier to its parent Consensus OP (15F, Wbn) 1 company. Orbitech should see steady order growth, backed by ASTK’s export competitiveness. The company should also benefit from profit enhancements via EPS Growth (15F, %) - reductions in indirect costs (development, sales, etc.) and investment efficiency. Market EPS Growth (15F, %) 25.0 P/E (15F, x) 259.0 ASTK has a current order backlog of W1.1tr and is expected to attract strong new Market P/E (15F, x) 10.9 orders over the next couple of years. This should lift Orbitech’s order backlog to W400- KOSDAQ 667.44 500bn from W150bn currently.
Market Cap (Wbn) 103 In the coming years, we forecast Orbitech’s aircraft parts revenue to jump from W2.3bn Shares Outstanding (mn) 11 in 2014 to W11bn in 2015, W22bn in 2016, and W34bn in 2017. Revenue growth should Free Float (%) 80.4 be supported by the increased production of Boeing’s 737, as Orbitech is the exclusive Foreign Ownership (%) 0.4 supplier of bulkheads for ASTK’s section 48. As revenue gains momentum, the aircraft Beta (12M) 1.17 parts division should swing from a loss in 2014 to a profit in 2H15. The company’s other 52-Week Low 1,600 divisions (nuclear energy and ISI), which are licensed businesses with high entry barriers, 52-Week High 11,800 should continue to serve as profitable cash cows. (%) 1M 6M 12M Absolute 9.2 273.2 274.0 Looking ahead to 2016, we expect the company to deliver more meaningful earnings Relative 27.0 245.1 218.4 growth, with revenue of W42bn (+41% YoY), operating profit of W5bn (+259% YoY), and net profit of W4.6bn (+874% YoY).
550 Orbitech KOSDAQ 450 Initiate with Buy and TP of W16,000 350 We initiate our coverage on Orbitech with a Buy recommendation and target price of 250 W16,000. We applied a P/E of 38x, the average multiple of global aircraft suppliers, to 150 our 2016F EPS, and assigned a 20% premium to account for 1) the company’s strong 50 order momentum via ASTK, 2) profitable cash cow business, and 3) above-industry ROE. 8.14 12.14 4.15 8.15 Looking forward, we highlight two investment points: 1) robust new orders from parent
company ASTK, and 2) rapid margin recovery.
FY (Dec.) 12/12 12/13 12/14 12/15F 12/16F 12/17F Revenue (Wbn) 37 15 21 30 42 55 OP (Wbn) 0 -5 -2 1 5 9 OP margin (%) 0.0 -33.3 -9.5 3.3 11.9 16.4 NP (Wbn) 0 -9 -4 0 5 9 EPS (W) 54 -1,142 -472 37 357 660 ROE (%) 1.7 -42.8 -25.0 3.0 21.8 30.7 P/E (x) 62.0 - - 259.0 26.5 14.4 P/B (x) 0.9 1.3 1.1 5.4 4.5 3.4 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates
KDB Daewoo Securities Research 36 August 27, 2015 Aviation
A combination of growth and stability
Founded in 1991, Orbitech mainly provided nuclear energy safety services, such as radiation management and in-service inspections (IS), before entering the aircraft parts business in 2013. The company built an aircraft parts factory in Haman, South Gyeongsang Province, in end-2013. And last year, the company formed a technological partnership with ASTK and successfully landed an order from Spirit AeroSystems to supply parts for Boeing.
Orbitech’s aircraft parts capex has thus far totaled W25bn, which seems a huge investment in light of its 2013 revenue of W14.7bn. The massive capex and initial losses have hurt the company’s financial health, with debt-to-equity ratio and net debt worsening to 228% and W15.2bn, respectively, in end-2014 (vs. 31% and net cash status in end-2012).
However, ASTK acquired a 16.6% stake in Orbitech in August 2015, improving the company’s financial position quickly. On the back of restructuring, improving aircraft business margins, and improving financial position, Orbitech is showing strong growth potential and stability.
Orbitech aims to reach a break-even point in the aircraft business this year by improving process efficiency, saving costs, and directly purchasing raw materials. The nuclear energy safety service unit is acting as a cash cow. We project the company’s debt-to- equity ratio to improve to 50-70%.
Table 11. Company history Year Details 1991 Orbitech established; Started NDT business 2005 Expanded into nuclear power-related businesses (radiation safety management, measurement of personal radiation exposure, etc.) 2010 Listed on KOSDAQ 2013 Advanced into the aircraft precision components market; Built a factory in Haman 2014 Forged a technological partnership with ASTK; Signed a contract to supply aircraft precision components with US-based Spirit 2015 CEO Kim Hee-won of ASTK acquired management control of Orbitech Source: Company data, KDB Daewoo Securities
Figure 70. Aircraft parts factory Figure 71. Aircraft parts pipeline
Source: Company data, KDB Daewoo Securities Source: Company data, KDB Daewoo Securities
KDB Daewoo Securities Research 37 August 27, 2015 Aviation
Expecting synergies with ASTK
We believe the acquisition by ASTK will generate meaningful synergies. Regarding the aviation business, ASTK plans to concentrate on large assemblies and fuselage orders, while Orbitech intends to specialize on machinery assembly as a supplier to its parent company.
Orbitech should see steady order growth, backed by ASTK’s export competitiveness. The company should also benefit from profit enhancements via reductions in indirect costs (development, sales, etc.) and investment efficiency. As for ASTK, acquisition of Orbitech should ensure stable business cooperation (ahead of order growth) and greater price competitiveness. We believe this deal will yield a win-win situation for both companies.
In the coming years, we forecast Orbitech’s aircraft parts revenue to jump from W2.3bn in 2014 to W11bn in 2015, W22bn in 2016, and W34bn in 2017. Revenue growth should be supported by the increased production of Boeing’s 737, as Orbitech is the exclusive supplier of bulkheads for ASTK’s section 48.
As revenue gains momentum, the aircraft parts division should swing from a loss in 2014 to a profit in 2H15. The company’s other divisions (nuclear energy and ISI), which are licensed businesses with high entry barriers, should continue to serve as profitable cash cows.
Figure 72. Business strategy of ASTK & Orbitech Figure 73. Sales breakdown (2014)
Aerospace 11%
ISI 11%
Environment 12%
Nuclear energy 66%
Source: Company data, KDB Daewoo Securities Source: Company data, KDB Daewoo Securities
Figure 74. Aircraft parts business revenue Figure 75. Net debt ratio
(Wbn) (Wbn) (%) 40 20 Net debt (L) 200 34 Net debt ratio (R) 15 150 30 Civil aircraft market boom 10 100 22 20 5 50
11 0 0 10 -5 -50 2 1 0 -10 -100 13 14 15F 16F 17F 00 02 04 06 08 10 12 14
Source: Company data, KDB Daewoo Securities Source: Company data, KDB Daewoo Securities
KDB Daewoo Securities Research 38 August 27, 2015 Aviation
Earnings outlook
In 2Q, Orbitech posted revenue of W7.8bn (+88% YoY), operating profit of W800mn (turning to black YoY), and a net profit of W500mn (turning to black YoY). OP margin reached 10.8%, hitting the highest level since 2010. Improved earnings were driven by: 1) revenue growth at the aircraft unit, 2) a decline in costs associated with restructuring and interest expenses, and 3) recovery of earnings at the nuclear safety service and IS units.
For 2H, we expect to see a temporary decline in nuclear revenue, as a contract with one of two nuclear sites is slated to expire. However, we expect top-line growth to continue, boosted by strong aircraft parts revenue. 2H margins will likely continue to turn around YoY, as the aircraft unit is likely to swing to a profit. Still, the pace of growth is likely to be slow, dragged down by a decline in nuclear safety service revenue.
Looking ahead to 2016, we expect the company to deliver more meaningful earnings growth, with revenue of W42bn (+41% YoY), operating profit of W5bn (+259% YoY), and net profit of W4.6bn (+874% YoY). In particular, the aircraft parts unit is forecast to generate revenue of W22bn (+100% YoY; 52% of overall revenue). In light of robust industry and order-taking, we expect the company to deliver revenue growth (CAGR of 36% over the next three years) and margin improvement.
Table 12. Orbitech’s quarterly earnings (Wbn, %) 2014 2015F 2014 2015F 2016F 1Q 2Q 3Q 4Q 1Q 2Q 3QF 4QF Revenue 4.1 4.2 6.0 6.5 6.2 7.8 8.2 7.5 20.8 29.8 42.0 QoQ 7 0 44 9 -4 26 5 -9 - - - YoY 19 28 43 69 50 88 37 15 41 43 41 Operating profit -0.7 -1.1 -0.3 0.1 -0.3 0.8 0.4 0.4 -2.0 1.4 5.0 QoQ RR RR RR TTB RR TTB -51 9 - - - YoY RR RR RR TTB RR TTB TTB 246 RR TTB 259 Pretax profit -1.2 -2.2 -0.7 -0.9 -0.6 0.6 0.3 0.3 -4.9 0.6 4.8 Net profit -1.2 -2.2 -0.7 0.2 -0.6 0.5 0.3 0.3 -3.8 0.5 4.6 QoQ RR RR RR RR RR TTB -46 14 - - - YoY RR RR RR TTB RR TTB TTB 87 RR TTB 874 OP margin -16.2 -27.0 -5.3 2.0 -4.8 10.8 5.0 6.0 -9.5 4.7 12.0 Net margin -27.8 -52.3 -10.9 2.5 -9.1 6.2 3.2 4.0 -18.3 1.6 10.9 Note: All figures are based on non-consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research
Table 13. Orbitech’s annual earnings (Wbn, %) 2013 2014 2015F 2016F 2017F Revenue 14.7 20.8 29.8 42.0 55.3 YoY -60 41 43 41 32 Power 9.0 13.7 14.2 15.5 16.3 Environment 2.6 2.5 - - - ISI 3.2 2.2 3.1 4.5 5.0 Aircraft parts 1.0 2.3 11.1 22.0 34.0 Operating profits -4.1 -5.2 -2.0 1.4 5.0 YoY RR RR TTB 259 76 Pretax profit -7.2 -7.9 -4.9 0.6 4.8 Net profit -6.5 -9.2 -3.8 0.5 4.6 YoY RR RR TTB 874 85 OP margin -34.9 -9.5 4.7 12.0 16.0 Net margin -62.6 -18.3 1.6 10.9 15.4 Revenue portion Power 57 66 48 37 29 Environment 17 12 0 0 0 ISI 20 11 10 11 9 Aircraft parts6 11 37 52 61 Source: Company data, KDB Daewoo Securities Research
KDB Daewoo Securities Research 39 August 27, 2015 Aviation
Figure 76. Civil aircraft market outlook by size Figure 77. Boeing’s monthly production plan for the B737
('000 units) (units) 40 2014 60 2034 52 31 47 30 42 40 [Civil aircraft market] 20,910 units (2013) -> 42,180 units (2033) 20 14
20 10 6 4 3 3 3 1 1 2 0 Large wide-body Medium wide- Small wide-body Single aisle Regional jets 0 body 2014 2017F 2018F
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
Figure 78. ASTK’s annual earnings Figure 79. ASKT’s section 48 monthly production
(Wbn) (%) (units) 150 Revenue (L) 30 10 OP margin (R) 127 8.2 120 8 20 102 6.7
90 82 6 5.3 67 10 61 3.9 60 4 45 34 0 2.2 30 25 26 2 15 9 4 4 4 5 5 0.1 0 -10 0 02 04 06 08 10 12 14 16F 12 13 14 15F 16F 17F
Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research
KDB Daewoo Securities Research 40 August 27, 2015 Aviation
Orbitech (046120 KQ/Buy/TP: W16,000)
Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/14 12/15F 12/16F12/17F (Wbn) 12/14 12/15F 12/16F12/17F Revenue 21 30 4255 Current Assets 14 19 23 29 Cost of Sales 21 26 34 43 Cash and Cash Equivalents 2 2 2 2 Gross Profit 0 4 8 12 AR & Other Receivables 5 6 8 11 SG&A Expenses 2 2 3 3 Inventories 1 2 34 Operating Profit (Adj) -2 1 5 9 Other Current Assets 6 9 10 12 Operating Profit -2 1 5 9 Non-Current Assets 28 29 31 31 Non-Operating Profit -3 0 0 0 Investments in Associates 0 0 0 0 Net Financial Income -1 -1 0 0 Property, Plant and Equipment 23 24 25 25 Net Gain from Inv in Associates -1 0 0 0 Intangible Assets 2 2 1 1 Pretax Profit -5 1 5 9 Total Assets 42 48 54 60 Income Tax 0 0 0 0 Current Liabilities 9 20 26 23 Profit from Continuing Operations -5 0 5 9 AP & Other Payables 2 2 3 4 Profit from Discontinued Operations 1 0 0 0 Short-Term Financial Liabilities 5 16 21 17 Net Profit -4 0 5 9 Other Current Liabilities 2 2 2 2 Controlling Interests -4 0 5 9 Non-Current Liabilities 20 9 4 5 Non-Controlling Interests 0 0 0 0 Long-Term Financial Liabilities 18 6 1 1 Total Comprehensive Profit -4 0 5 9 Other Non-Current Liabilities 2 3 3 4 Controlling Interests -4 0 5 9 Total Liabilities 29 29 30 28 Non-Controlling Interests 0 0 0 0 Controlling Interests 13 19 23 32 EBITDA 0 4 711 Capital Stock 4 5 55 FCF (Free Cash Flow) 0 9 7 2 Capital Surplus 17 21 21 21 EBITDA Margin (%) 0.0 13.3 16.7 20.0 Retained Earnings -5 -4 09 Operating Profit Margin (%) -9.5 3.3 11.9 16.4 Non-Controlling Interests 0 0 0 0 Net Profit Margin (%) -19.0 0.0 11.9 16.4 Stockholders' Equity 13 19 23 32
Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/14 12/15F 12/16F12/17F 12/14 12/15F 12/16F 12/17F Cash Flows from Op Activities 2 12 10 4 P/E (x) - 259.0 26.5 14.4 Net Profit -4 0 5 9 P/CF (x) 8.7 36.0 16.7 11.0 Non-Cash Income and Expense 6 3 3 3 P/B (x) 1.1 5.4 4.5 3.4 Depreciation 2 2 22 EV/EBITDA (x) 110.5 31.4 15.79.8 Amortization 0 0 00 EPS (W) -472 37 357660 Others 4 1 11 CFPS (W) 259 263 569865 Chg in Working Capital 0 9 3 -7 BPS (W) 2,052 1,746 2,103 2,764 Chg in AR & Other Receivables 1 -1 -2 -2 DPS (W) 0 0 0 0 Chg in Inventories 0 -1 -1 -1 Payout ratio (%) 0.0 0.0 0.0 0.0 Chg in AP & Other Payables -1 0 1 1 Dividend Yield (%) 0.0 0.0 0.0 0.0 Income Tax Paid 0 0 0 0 Revenue Growth (%) 40.0 42.9 40.0 31.0 Cash Flows from Inv Activities -3 -5 -5 -4 EBITDA Growth (%) - - 75.0 57.1 Chg in PP&E -2 -3 -3 -2 Operating Profit Growth (%) - - 400.0 80.0 Chg in Intangible Assets 0 0 0 0 EPS Growth (%) - - 864.9 84.9 Chg in Financial Assets 0 -2 -2 -2 Accounts Receivable Turnover (x) 4.1 6.8 7.0 6.8 Others -1 0 00 Inventory Turnover (x) 26.0 22.1 17.4 16.9 Cash Flows from Fin Activities -1 4 1 -4 Accounts Payable Turnover (x) 15.8 23.1 21.2 19.7 Chg in Financial Liabilities - - - - ROA (%) -8.3 1.0 9.0 15.0 Chg in Equity 0 5 0 0 ROE (%) -25.0 3.0 21.8 30.7 Dividends Paid 0 0 0 0 ROIC (%) -6.3 3.5 13.8 22.2 Others - - -- Liability to Equity Ratio (%) 228.3 156.2 130.2 87.3 Increase (Decrease) in Cash -2 0 0 0 Current Ratio (%) 159.6 94.7 88.6 126.4 Beginning Balance 3 2 2 2 Net Debt to Equity Ratio (%) 118.1 69.4 53.2 21.0 Ending Balance 2 2 2 2 Interest Coverage Ratio (x) -1.5 2.8 25.2 0.0 Source: Company data, KDB Daewoo Securities Research estimates
KDB Daewoo Securities Research 41 August 27, 2015 Aviation
APPENDIX 1
Important Disclosures & Disclaimers 2-Year Rating and Target Price History
Company (Code) Date Rating Target Price Company (Code) Date Rating Target Price KOREA AEROSPACE(047810) 08/26/2015 Buy 143,000 Orbitech(046120) 08/26/2015 Buy 16,000 AeroSpace Technology of 08/26/2015 Buy 49,000 Korea(067390)
(W) KOREA AEROSPACE (W) AeroSpace Technology of Korea (W) Orbitech 200,000 60,000 20,000
50,000 150,000 15,000 40,000
100,000 30,000 10,000
20,000 50,000 5,000 10,000
0 0 0 Aug 13 Aug 14 Aug 15 Aug 13 Aug 14 Aug 15 Aug 13 Aug 14 Aug 15
Stock Ratings Industry Ratings Buy : Relative performance of 20% or greater Overweight : Fundamentals are favorable or improving Trading Buy : Relative performance of 10% or greater, but with volatility Neutral : Fundamentals are steady without any material changes Hold : Relative performance of -10% and 10% Underweight : Fundamentals are unfavorable or worsening Sell : Relative performance of -10% Ratings and Target Price History (Share price (─), Target price (▬), Not covered (■), Buy (▲), Trading Buy (■), Hold (●), Sell (◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst’s estimate of future earnings. * The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions.
Equity Ratings Distribution Buy Trading Buy Hold Sell 72.36% 13.57% 14.07% 0.00% * Based on recommendations in the last 12-months (as of June 30, 2015)
Disclosures As of the publication date, Daewoo Securities Co., Ltd. has participated in issuance of the securities (including DR and IPO) of AeroSpace Technology of Korea Inc., and other than this, Daewoo Securities has no other special interests in the companies covered in this report.
Analyst Certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. Daewoo Securities Co., Ltd. policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. No part of the compensation of the Analysts was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report but, like all employees of Daewoo Securities, the Analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Daewoo Securities Co., Ltd. except as otherwise stated herein.
Disclaimers This report is published by Daewoo Securities Co., Ltd. (“Daewoo”), a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled from sources believed to be reliable and in good faith, but such information has not been independently verified and Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the Korean language. If this report is an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising from the use hereof. This report is for general information purposes only and it is not and should not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws and regulations or subject Daewoo and its affiliates to registration or licensing requirements in any jurisdiction should receive or make any use hereof. Information and opinions contained herein are subject to change without notice and no part of this document may be copied or reproduced in any manner or
KDB Daewoo Securities Research 42 August 27, 2015 Aviation
form or redistributed or published, in whole or in part, without the prior written consent of Daewoo. Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. The price and value of the investments referred to in this report and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur.
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