Mapping Asia's defense industry

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One could summarise Asian geopolitics as being divided into two separate sides: China-linked nations and US-linked nations. On the Chinese side, you will find Pakistan, Cambodia, Laos, Sri Lanka and potentially Myanmar. On the US side, you will find Japan, Korea, Taiwan, India and Australia. Other Southeast Asian countries such as Thailand or the Philippines could tilt either way.

Global defense spending in billions of dollars continues to be led by the United States, with China being a distant second.

But within Asia, China’s defense budget greatly exceeds that of neighbouring countries and is higher than that of India, South Korea, Japan and Taiwan combined.

Among the ASEAN nations, Singapore stands out as a major spender, followed by Indonesia and Thailand. But the numbers pale in comparison to China. I don’t believe the numbers have changed materially since 2014.

And the absolute level of spending continues to. This chart from Tom Shugart shows how lopsided military spending in East Asia has become, in favour of the People’s Republic.

The PLA Navy has a battle force of 350 vessels vs the US Navy’s 294 vessels. And the US Navy will never be fully mobilised to the Indo-Pacific region. Japan’s self-defense force only has 77 vessels, Taiwan 92 and South Korea ~150. With US Navy support, the power balance could be maintained. But whether the region can rely on US military intervention is a big if.

The main message I want to get across is that non-PRC Asian military spending will have to rise to match that of China - or face a long-term power imbalance.

The countries where defense spending/GDP has significant upside compared to the global average of 1.9% are Indonesia, Japan, Malaysia, Philippines, Thailand and Myanmar.

Operating margins for defense companies around the world have averaged 7.5% over the past 30 years, according to Standard & Poors. The average aerospace & defense stock has had a PE ratio ranging from 13x to 25x in the 2010s.

The main spending areas within the defense segment include:

1. Aircraft

2. Missiles

3. Explosives

4. Ground systems (including tanks)

5. Arms & ammunition

6. Shipbuilding

7. Space

If a war would break out over Taiwan, then spending across most of these categories would likely rise in the neighbouring region. But missiles (air-to-air, air-to-ground) would be in particularly high demand. Shipbuilding of navy vessels would certainly pick up pace.

If a war breaks out, then owning equities in either mainland China or Taiwan would be risky. Production facilities on either side of the Strait would be targets for missile attacks. Their currencies would depreciate. And further capital account restrictions might be imposed.

Better opportunities can be found in Japan, whose defense spending remains low at only 0.9% of GDP. There are also a large number of small caps in Korea, some of which also export to other countries in the regions such as Indonesia.

Here is a map of the major defense companies listed in Asia:

I will now introduce them one-by-one.

People’s Republic of China (PRC)

China’s defense spending continues to rise rapidly at around 7% per year and is currently about US$175 billion. Some organisations such as the Stockholm International Peace Research Institute questions the number and thinks true spending is now closer to US$240 billion.

The Chinese defense industry is dominated by state-owned AviChina, which is in the process of developing a passenger aircraft called COMAC meant to compete with Boeing and Airbus. But the company is also a large defense contractor. The industry is dominated by SOEs and should be seen as extensions of the state and the ruling Communist Party.

Here are the major defense contractors listed in the People’s Republic of China:

AviChina stands for Aviation Industry Corporation of China and is a major state-owned aerospace and defense conglomerate headquartered in Beijing. It has about 0.5 million employees across the globe. The company was first established in 1951 to support the People’s Republic of China during the Korean War, and has recently been used to roll-up aviation companies even outside of China, including America’s Continental Motors and aircraft manufacturer Cirrus. The main segments are manufacturing of aircraft, helicopters, autos and ships. Some of AviChina’s products aircraft include the fighter jet Chengdu J-20 and the Avicopter AC313. It’s unclear how big a proportion of AviChina’s revenues comes from defense-related products.

The Chengdu J-20, a copy of the US-made F-35

China Avionics Systems produces flight control and navigation systems, air data management and aviation lighting systems, control panels etc. But it seems that their defense exposure is relatively limited in the mid-single digits.

The cockpit of COMAC C919

Avicopter is a subsidiary of AviChina. It produces a variety of helicopters, including the AC313, the Changhe Z-18, etc but also fixed aircraft. Since the government does not allow private helicopters to operate within the country, all helicopters produced by the company are for the military.

Avicopter AC313

Hongdu is an Jiangxi-based aircraft manufacturer and a supplier to the Chinese military. It was formed as JV between the China and Italy to produce aircraft for the ROC (Taiwan) government. The company’s products include the Hongdu JL-10. I don’t have clear data on how large Hongdu’s defense exposure it, but it’s no doubt a significant part of the business.

Hongdu JL-10

Inner Mongolia First Machinery Group focuses on battle tanks, such as the Type 15 light tank and the VT4 battle tank. It also produces tankers, railway vehicle parts and heavy truck parts. The company has reportedly started to export its tanks to Pakistan and other nations. The split between civilian and defense business is unclear.

The VT4 battle tank

Shaanxi Zhongtian Rocket Technologies is involved in the manufacture of rockets, forest fire fighting bombs, artificial land mines, weather radars, aircraft broadcast systems, sounding rockets, etc. The defense exposure is roughly 50%.

Anhui Great Wall Military Industry produces mortar shells, individual rockets, bullets and other products. It’s also involved in auto parts, plastics and chemicals. The majority of revenues comes from defense-related business.

Anhui Great Wall mortar shells

Taiwan (Republic of China; ROC)

Here are the major defense contractors listed in Taiwan:

AIDC is a Taiwanese aerospace company based in Taichung, one of the two major Taiwanese defense companies with world-class levels technological development. The company produces jet fighters such as the F-CK-1 Ching-kuo fighter, . It also has a commercial aircraft component division producing for Boeing, Challenger, Honeywell and Mitsubishi. No disclosure on the split between civilian and defense business.

The F-CK-1 Ching-kuo fighter aircraft

CSBC (China Shipbuilding Corporation) is a Kaohsiung shipbuilder for both military and civilian purposes. It was originally formed as a unit of Mitsubishi Heavy Industries in Taiwan, and later nationalised as Kuomintang took over the island in 1948. CSBC has been contracted to build eight attack submarines for the ROC Navy. The commercial business includes building of containerships, patrol vessels and research vessels. It’s also involved in the offshore wind power business. No disclosure on the split between civilian and defense business.

Lungteh is also a shipbuilder, based on the East Coast of Taiwan. In the past years it has been building corvettes, minelayers, wind farm supply vessels, coastal patrol craft and high speed special forces craft, fireboats and pilot boats, mostly for the ROC Navy. It appears that a large portion of revenues comes from defense, but the exact split has not been disclosed.

The Lungteh 28M missile boat

Japan

Japan’s defense budget is abnormally low at only 1.1% of GDP. Article 9 of Japan’s constitution - imposed by the United States after WWII - outlaws war as means to settle international disputes. The ruling party wants to revise the constitution to allow the self-defense forces to possess offensive weapons and increase the navy’s international presence.

But so far, military spending has grown at just 2-3% per year. And much of the spending increase in recent years has gone to US contractors such as Lockheed Martin and Raytheon while local companies such as Mitsubishi Heavy Industries have seen their market shares drop.

Japan Military Spending/Defense Budget 1960-2021. Source: The World Bank

Here are the major defense contractors listed in Japan:

Mitsubishi Heavy Industries is an engineering conglomerate, involved in aerospace and automotive components, air conditioners, elevators, forklift trucks, machine tools, power generation equipment, printing machines, ships, railways systems and space launch vehicles. The defense exposure is probably less than 20%, and is geared towards missile systems, tanks, submarines and patrol helicopters.

The Mitsubishi Heavy Industries Type 10 Battle Tank

Kawasaki Heavy Industries is similarly an engineering conglomerate but has closer to 1/3 exposure to defense business. These include patrol aircraft, military transport aircraft, submarines, jet fighters etc. But other than defense it also manufactures rolling stock, including high-speed trains such as the Shinkansen. As well as LNG carriers, container ships, oil tankers, tunnel boring machines, gas turbines and industrial equipment. About a third of revenues comes from defense.

A Kawasaki T-4 trainer aircraft

IHI Corporation is a Tokyo based engineering company that produces ships, space launch vehicles, aircraft engines, marine diesel engines, gas turbines, railway systems, power station boilers and other facilities. The defense segment seems to revolve around the ship segment, where it produces destroyers. Roughly 1/3 of IHI Corporation’s revenues comes from defense related products.

The IHI Marine JDS Hyuga DDH-181 class helicopter destroyer

Tokyo Keiki produces navigation systems for military use. These include radar technologies, autopilot systems, magnet compasses, etc. Close to 40% of revenues comes from this segment. The remainder of revenues comes from railway maintenance related products, printing inspection products, flow measurement systems, etc.

Ishikawa Seisakusho is engaged in the manufacture of industrial machinery and textile equipment. The paper segment produces corrugated cardboard box printing machinery. The textile segment includes a variety of textile equipment. The defense segment is involved in the manufacture of naval mines. It also produces electronic equipment for aircraft. The two latter segments represent roughly 2/3 of total revenues.

Howa Machinery produces firearms for both military and civilian applications. It was created through the merger of Toyoda Loom Works with Showa Heavy Industries in 1936 to produce rifles, artillery shells and airplane parts during WWII. It appears that the vast majority of Howa’s rifles are used for hunting rather than defense purposes. But production can quickly be shifted towards Japan’s self-defense forces in the case of a ramp-up in military readiness.

The Howa Type 20 assault rifle for Japan Ground Self-Defense Force

Hosoya Pyro-Engineering manufacturers flare bombs and smoke candles for the Japanese self-defense forces. It has developed its own gunpowder technology. About 90% of revenues are from defense-related products.

A Hosoya smoke bomb

South Korea

Korea’s weapons technology is advanced. Military readiness remains high since the Korean War never officially ended. Korean defense companies appear to have a particular strengths in tanks and surface-to-air missiles. The government pays for part of the R&D, and intellectual property technically belongs to the government. The government also charges royalty fees (typically around 1%) for weapons exports.

The Korean defense budget has historically grown at a 5% CAGR. Exports are primarily to emerging markets such as Turkey and Indonesia.

Here are the major defense contractors listed in South Korea:

Korea Aerospace Industries (KAI) is an aerospace company based on the Southern coast of Korea in Sacheon. It originally started as a joint venture between Samsung Aerospace, Daewoo Heavy Industries and Hyundai Space and Aircraft Company. Over time, it become a more independent entity. Throughout the years, KAI has produced various satellites, the Korea Space Launch Vehicle KSLV-II, the KT-1 Woongbi and T-50 Golden Eagle training aircraft, the KUH-1 Surion utility helicopter, etc. It also produced commercial jets such as the 60-seat KRJ regional jet and the wings of the Gulfstream G280 business jet. Roughly 40% of KAI’s revenue comes from defense at the moment.

The T-50 Golden Eagle

Hanwha Aerospace is an aerospace company formerly known as Samsung Precision. It specialises in aircraft engines and is Korea’s only manufacturer of gas turbine engines. It started producing jet engines for Korean aircraft in 1980. In the years thereafter it entered aircraft manufacturing but then divested the aircraft business to KAI in 1999. Today, it is primarily focused on producing engines to customers such as UTAS in Turkey, Pratt & Whitney, etc. They’re also involved in avionics. The civilian / defense split is roughly half-half.

LIG Nex1 is a Korean aerospace manufacturer and defense company. It focuses on advanced precision electronic systems, including missiles, underwater weapon systems, radars, electronic warfare, avionics, fire control systems, naval combat systems and electro-optics. It’s one of the major suppliers of weapons systems for the ROK Armed Forces. Almost all revenues comes from defense.

The Haesong I missile system

Victek is primarily engaged in the production of electronic warfare support systems. It also produces military power converters and signal processing products. Its commercial segment is has a public bicycle rental system and industrial power supply systems. Over 60% of revenues are defense-related according to Bloomberg.

A Victek electronic warfare support system

i3systems produces thermal imaging detectors and x-ray detectors. Their thermal imaging cameras are used by the Korean military. The x-ray detectors are used in the dental industry. i3 also develops IR detectors for security, surveillance and night vision systems. It has been a defense contractor since 2010 and today, almost all revenues comes from defense.

Pictures produced by the i3systems Cooled IR Engine

ASTK is a specialised aircraft components company. It’s a sub-supplier via Triumph, KAI, SACC and ST Aerospace for Boeing, Embraer and Bombardier. It also produces certain metallic parts, primarily for aircraft as well. The defense portion of ASTK’s business seems relatively small, but they have not disclosed the exact figure.

ASTK’s Boeing related business

Firstec has a proprietary face recognition system, CCTV systems and RF Card reading systems. In the defense industry, it produces guns, guided weapons, automated suppression systems and various types of mobile equipment. The majority of revenues comes from defense.

A vertical take-off / landing aerial robot system produced by Firstec

Huneed Technologies produces electrical systems, electrical panels, missile warning receivers, ground control systems. It is a main supplier of and wire harnesses for the F-15 fighter jet. Most revenues appear to be from defense-related products.

Build-to-print electrical panel solution for an aerospace OEM

HizeAero produces aircraft parts, primarily for the Boeing B787, including the center wing boxes, fixed trailing edges, pivot bulkheads and assembly jigs. It is listed as a defense company but it is not clear how much real defense business the company has at this point.

HizeAero’s Boeing business

Soltworks / AIITONE develops military logistics support systems and training simulators. The AIITONE subsidiary develops realistic VR training simulators and learning systems for both the military and civilian applications. The KMT subsidiary designs display systems for VR simulations. No disclosure on product segment split.

Hanil Forging produces auto components and other industrial equipment. The main products include axle shafts, gearshifts and spindles. It primarily sells its products domestically under the brand name HF. Within defense, it produces missile bodies, warheads and airframes for tanks, warships and aircraft, as well as forging components for ships. Around 25% of revenues comes from defense.

Hanil Forging missile bodies

India

Hindustan Aeronautics is an Indian SOE headquartered in Bangalore. It is involved in the design, fabrication and assembly of aircraft, jet engines and helicopters. Its HAL HF-24 Marut fighter-bomber was the first fighter aircraft made in India. Today, its main products include the HAL Tejas fighter jet, the Indian Navy’s Advanced Light Helicopter MK III, the HJT-16 Kiran turbojet trainer, the Saras light transport aircraft.

The HAL Tejas jet fighter

Bharat Dynamics is one of India’s largest manufacturers of ammunitions and missile systems. It was established in 1970 to manufacture guided weapon systems. It is now involved in the development of a wider range of weapon systems such as surface to air missiles, air defence systems, torpedoes, air to air missiles, etc.

The Bharat Dynamics Akash medium-range surface-to-air missile system

Singapore

ST Engineering is a vertically integrated engineering group, operating within the aerospace, electronics, land and marine sectors. It was formed in 1997 as a merger of four listed companies: ST Aerospace, ST Electronics, ST Kinetics and ST Marine. The defense exposure spans the land segment, where it produces specialty vehicles such as the Agrab Mk2 mobile mortar system, but also the aerospace segment

The SRAMS mortar system

The greatest opportunities for stock-pickers

From a top-down perspective, the greatest opportunities for higher defense spending is in Japan - especially if the constitution is revised. An attack on the Senkakus would accelerate such a change to the constitution. Tokyo Keiki has a large exposure to the Japanese navy, trades at a very reasonable multiple and spends a large portion of its revenues on R&D.

In Korea, LIG Nex1 trades below 1x EV/Sales and has almost all of its revenues from surface-to-air ballistic missiles.

Another stock that piqued my interest is Hindustan Aeronautics. 12x EV/EBIT is a low multiple in an Indian context and the company enjoys long-term secular tailwinds.

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