Soochow: 2024Q3 has reached performance bottom, the defense industry's temporarily weak demand may improve.
14/11/2024
GMT Eight
Soochow released a research report stating that although the performance of the military industry in the first three quarters of 2024 is under pressure, looking ahead to the annual report of 2024, the industry's "performance bottom" is forming. With the gradual issuance of industry orders, the sector's outlook is expected to improve. The reduction in downstream demand is the direct cause of the decline in revenue and profits. The sales gross profit margin continued to decline in the first three quarters of 2024, and ROE was dragged down by turnover rate and net profit margin. The third quarter report may be a signal of the annual "performance bottom", but as the adjustments in the mid-term of the "14th Five-Year Plan" become clearer, and with the reasonable growth of defense budgets, the phase of sluggish demand in the military industry is expected to improve.
Soochow's main points are as follows:
Pressure on the performance of the military industry in the first three quarters of 2024
Affected by multiple factors including personnel adjustments, order delays, and price reductions in the industrial chain, the revenue and net profit attributable to mothers of the military sector both decreased year-on-year. In addition, both gross profit margin and net profit margin of the military industry decreased year-on-year, reflecting a decline in profitability. The increase in inventory size and the rise in accounts receivable and bills also reflect the industry's inventory backlog and pressure on receivables. The performance of sub-industries in the military industry also shows significant differentiation. Among them, maritime equipment achieved positive growth driven by the large-cycle of ships, while ground armaments and military electronics faced significant pressure with a year-on-year decline in net profit attributable to mothers of over 50%. Aerospace equipment remained relatively stable. Despite this, looking ahead to the annual report of 2024, the industry's "performance bottom" is forming, and with the gradual issuance of industry orders, the sector's outlook is expected to improve.
The reduction in downstream demand is the direct cause of the decline in revenue and profits
From the performance of revenue and profits, the military industry encountered significant challenges in the first three quarters of 2024. In the first three quarters of 2024, the total operating income of the military industry decreased to 376.876 billion yuan, with a year-on-year growth rate turning negative for the first time at -4.85%, and net profit attributable to mothers also decreased to 21.383 billion yuan, with a year-on-year growth rate dropping to -2.73%. This change is the result of multiple factors, including personnel adjustments, order delays, and price reductions in the industrial chain, which not only affected the sales and order volume of military enterprises but also led to a double decline in revenue and profits.
In terms of profitability, the sales gross profit margin continued to decline in the first three quarters of 2024, falling to 19.76%, while the sales expense ratio rose to 7.53%. This reflects that in the context of a decrease in operating income, the scale of the company's expenses did not decrease synchronously, especially with research and development expenses accounting for the largest proportion, and the research and development process did not stagnate due to short-term changes in demand. In addition, the ROE (return on equity) was also dragged down by turnover rate and net profit margin, dropping to 3.27% in the first three quarters of 2024. Both total asset turnover and sales net profit margin decreased, and the equity multiplier decreased, leading to a decline in profitability.
The third-quarter report may be a signal of the annual "performance bottom"
Despite facing significant challenges in the first three quarters of 2024, the fundamental logic of the military industry is still determined. With the gradual clarification of the mid-term adjustments in the "14th Five-Year Plan" and the reasonable growth of defense budgets, the phase of sluggish demand in the military industry is expected to improve. At the same time, the continuous placement of new industrial chain capacities has laid the foundation for a new round of bulk procurement. In addition, some listed military companies have shown a high year-on-year growth in single-quarter performance, indicating a sporadic recovery in industry demand, gradually showing signs of recovery. Looking ahead to the whole year, downstream demand in the military industry is expected to gradually transform into substantial contract orders, and it is expected that the fourth quarter military industry performance may show a significant year-on-year and quarter-on-quarter improvement.
Investment recommendations
1) Industry heavyweight main engine plants: AECC Aviation Power (600893.SH), AVIC Shenyang Aircraft (600760.SH), Avic XiAn Aircraft Industry Group (000768.SZ), etc.;
2) Precision guided missile production chain: North Navigation Control Technology (600435.SH), Hubei Feilihua Quartz Glass (300395.SZ), Chengdu M&S Electronics Technology (688311.SH), Beijing Relpow Technology (300593.SZ), etc.;
3) Core suppliers of main battle equipment: Fujian Torch Electron Technology (603678.SH), Gaona Aero Material (300034.SZ), Hubei Feilihua Quartz Glass (300395.SZ), Shaanxi Huaqin Technology Industry (688281.SH), etc.
Risk warning: 1) Industry orders are lower than expected; 2) Progress in the application of new technologies and new products is lower than expected; 3) Intensified industry competition; 4) Increased pressure on military product price reductions.