Aerospace stocks await engine injection

Beijing tipped to announce 145 billion yuan restructuring plan as soon as this week

PUBLISHED : Tuesday, 26 January, 2016, 2:45pm
UPDATED : Tuesday, 26 January, 2016, 3:09pm

With Beijing tipped to announce a 145 billion yuan restructuring plan to form a national aircraft engine company as soon as this week, aerospace manufacturing and defence stocks are poised to benefit from China’s ambition to join the US, Britain, France, Russia and some other parts of the former Soviet Union in the league of independent aircraft engine makers.

The plan, which would involve about 40 entities, including three listed engine-making units of Aviation Industry Corporation of China (Avic), is the latest state-owned enterprise consolidation move from Beijing. It also marks China’s ambition to make a name as not only an aircraft maker after its homegrown Comac C919 jet rolled off the assembly line in November, but also as an aircraft engine maker – a game in which China lags so far behind that the C919 was equipped with a CFM engine, a joint-venture brand from America’s General Electric and France’s Sefran.

Bloomberg reported last week that Beijing is finalising a plan to merge entities with combined assets of about 110 billion yuan, and that an additional 35 billion yuan would be invested in the new company by Avic and the central government. Several mainland media outlets reported the plan could be announced this week. Sichuan Chengfa Aero-Science and Technology and Avic Aviation Engine, both Shanghai-listed, and Shenzhen-listed Avic Aero-Engine Controls announced in separate stock exchange filings in October that Avic might not be their controlling shareholder after a government-related restructuring.

The demand for aircraft engines and gas turbine engines in China is estimated to exceed 2 trillion yuan in the next 20 years
Wang Chao, China Merchant Securities

The share prices of the three stocks shot up by up to 77 per cent in the month that followed, but have since plunged back down with the rest of the mainland market since the beginning of the year. Avic Aviation Engine, the largest of the three with a market capitalisation of 78 billion yuan, is now trading below the 40 yuan level it was at before the announcement, while Avic Aero-Engine Controls was trading at 30.33 yuan on Tuesday, after having almost doubled from 22.59 yuan to 40.15 yuan in the month following the announcement.

The anticipated capital injection for the new engine company coupled with a major overhaul of the People’s Liberation Army unveiled on New Year’s Day, including the creation of a rocket force, have led analysts to recommend buying related stocks despite recent volatility. Wang Chao, a Beijing-based analyst with China Merchant Securities, said in a report on Sunday: “We believe aircraft engine making has been bottleneck for the development of China’s aerospace industry. This merger and consolidation shows the country’s determination to crack this problem. The demand for aircraft engines and gas turbine engines in China is estimated to exceed 2 trillion yuan in the next 20 years, the market is huge.”

Part of an effort to upgrade Chinese industrial manufacturing as laid out in the “Manufacture 2025” blueprint, pushing ahead with an aircraft engine manufacturing project was first mentioned in the central government’s 2015 work report. China’s existing aircraft engine units mostly make products based on Soviet models and for military use. Avic chairman Lin Zuoming has said a lack of funding is a major reason why China has not made any breakthroughs in aircraft engine manufacturing, while the country has gone much further in aerospace exploration technology by comparison.

Wang Xiaoyan, an analyst with mainland brokerage Northeast Securities, said in a report last week that China’s aircraft engine development capability was stronger in military, almost blank in civilian, and weak in both categories compared with international leaders. “The main reason to blame is the existing system that mixes up aircraft making and aircraft engine making units, and lack of special funding. Now a plan to fix both the organisational and financial plight has arrived,” she wrote. Wang Xiaoyan recommended all three Avic subsidiaries involved in the plan and forecast Avic Aviation Engine would outperform the market by more than 15 percentage points in the next six months.

Sixteen stocks related to aerospace technology slid an average of 1.25 per cent on Tuesday morning, while the Shanghai Composite Index dropped 2.09 per cent and the Shenzhen Composite Index 2.32 per cent.

China Securities analyst Feng Fuzhang reiterated his confidence in aerospace and defence stocks in a report on Monday: “Regardless of short-term declines, our view has not changed, that is: the defence sector in 2016 will experience waves of gains. The beginning of the year is a good time to stock up ... There is limited further downward pressure, and once the indices stabilise, the defence sector historically rebounds the fastest.”