Korea’s defense companies emerge as coveted growth stocks

South Korea’s defense companies have been regarded as typical domestic stocks with their share performances broadly linked to the size of the state budget and orders they get from the government.

With the increasing export volume of their weapons, however, defense contractors are emerging as new growth stocks.

As a growing number of Korean defense firms are clinching major supply deals with other nations, analysts said those companies are poised to become one of the “K-industry” stocks coveted by foreign investors, mirroring the stellar performance of Korean shares associated with K-drama or K-content.

Shares of Korea Aerospace Industries Ltd. (KAI), Korea’s sole military aircraft manufacturer, rose 2.6% to close Friday at 35,750 won, bringing the stock’s gains over the past month to 21.2%.

LIG Nex1 Co., a leading defense company, has risen 17.4% over the past month, while Hanwha Aerospace Co. has advanced 15.6% and Hanwha Systems Co. has gained 13.4%. In comparison, the main bourse’s benchmark Kospi index fell 2.8% in the same period.

Market watchers say weapons export growth is behind their strong performance.

According to industry sources on Sunday, three Korean defense contractors – LIG Next 1, Hanwha Systems and Hanwha Defense, a subsidiary of Hanwha Aerospace – recently completed negotiations to sell a combined 4.2 trillion won ($3.5 billion) in missiles systems to the United Arab Emirates.

LARGEST-EVER UAE DEAL IMMINENT

If clinched, the deal would mark Korea’s single largest defense system export in terms of value.

LIG Nex1’s portion of the deal amounts to 2.6 trillion won, followed by Hanwha Systems with 1.2 trillion won and Hanwha Defense at 400 billion won, according to the sources.

The two countries are expected to soon sign the final contract and an announcement could be made during Korean President Moon Jae-in’s trip to the UAE and other Middle Eastern countries Jan. 15-22, they said.

“During President’s stay in the UAE, they will likely sign a contract. Korea may also announce other deals such as the exports of K9 self-propelled howitzers and short-range air defense systems to the Middle East,” said Daishin Securities analyst Lee Dong-hun.

The UAE’s defense ministry said in November that the Korean consortium, led by LIG, is close to a $3.5 billion deal to export its mid-range surface-to-air missile (M-SAM) system, and the two sides are in an advanced stage of talks.

The weapon, known as Cheongung II in Korean, or heaven’s bow, is designed to intercept targets at a range of 40 kilometers and an altitude of up to 15 kilometers.

Hanwha Defense, which in December inked a $788 million deal to supply K9 self-propelled howitzers to Australia, is also in talks to sell the howitzer to Egypt.

Separately, Hanwha’s Redback armored vehicle is also competing with Germany’s Rheinmetall Defence Electronics GmbH. as the final contender for Australia’s 5-trillion won (US$4.2 billion) LAND 400 phase 3 project designed to introduce next-generation infantry fighting vehicles (IFVs).

Meanwhile, KAI is said to be among the strongest contenders for Malaysia’s 1 trillion won project to replace its light fighter jets.

DEFENSE STOCKS DESERVE HIGH VALUATIONS

According to financial information provider FnGuide, LIG Nex1’s 12-month forward price-earnings ratio (PER) is now hovering around 16, up from a multiple of 10.8 a year ago.

Analysts said Korean defense stocks deserve their current valuations, although much higher from a couple of years ago, given their steady stream of revenue from exports, which will boost their earnings in the coming years.

“Just as Korean content shares soared last year on the back of the global popularity of K-dramas, notably Squid Game, Korean defense stocks are expected to emerge as the next popular K-industry shares,” said a local asset management company executive.

IBK Investment & Securities recently raised its target price for LIG Nex1 by 33.8% to 87,000 won from 65,000 won earlier. Four other local brokerages have also raised their LIG price targets since last month.

Daishin Securities has named LIG Nex1 as its top pick and Hanwha Aerospace as its second-most favored stock.

“LIG’s exports of weapons systems accounted for a mere 5.1% of its total sales in the third quarter of 2021. If its exports rise at the current pace, its earnings will considerably grow accordingly,” said Daishin’s Lee.

South Korea joined the ranks of defense exporting countries in 1975 by shipping M1 rifle ammunition to the Philippines. Korea has since expanded export items to include T-50 Golden Eagle trainer jets, submarines and armored vehicles.

Write to Hyung-gyo Seo at seogyo@hankyung.com
In-Soo Nam edited this article.