Major domestic defense corporations are estimated to have improved profitability while increasing the domestic production rate of their components amidst a strong dollar trend. As the exchange rate rises against the U.S. dollar (the won's value declines), the revenue converted to won from export contracts increases, while the expansion of domestic production rates reduces production cost burdens, resulting in higher operating profit margins.
According to the defense and securities industries on the 1st, Hyundai Rotem is expected to achieve sales of 1.23 trillion to 1.4 trillion won and operating profit of 167 billion to 185 billion won in the fourth quarter of last year (October to December). If operating profit meets expectations, it will mark the third consecutive quarter of record-high operating profit. The operating profit margin for the fourth quarter is expected to have increased to 13% to 15%. Compared to last year’s first quarter operating profit margin of 6.0%, this represents more than double, and about 2 percentage points higher than the third quarter (12.6%).
The defense sector, which accounts for more than half of Hyundai Rotem's sales, has driven the strong performance. The significant increase in actual delivery volumes under the K2 tank export contract with Poland is now being fully reflected in the results. In August 2022, Hyundai Rotem signed a contract worth 4.5 trillion won (approximately $3.37 billion) to export 180 K2 tanks to Poland and delivered 28 tanks in the first two years. Last year, a total of 56 tanks were delivered, with 22 delivered in the fourth quarter.
Domestic defense corporations are transforming into export-oriented entities, with exchange rates and domestic production rates acting as key factors influencing profitability. Since defense export contracts are primarily made in U.S. dollars, if the exchange rate rises by the time of delivery compared to when the contract was made, the revenue converted to won increases. At the time of the K2 export contract with Poland, the exchange rate was 1,336.90 won per dollar, while last year's exchange rate averaged 1,358.35 won in the third quarter and 1,398.75 won in the fourth quarter.
As the domestic production rate increases, the pressure from costs such as component expenses decreases, leading to improved profitability. The domestic production rate for the K2 tank's third mass production is 84.3%, and full domestic production is expected to be achieved in the fourth mass production. The K2 Black Panther tanks being exported to Poland will include domestically produced tank engines developed by HD Hyundai Infracore.
Hanwha Aerospace is also expected to see a significant increase in operating profit in the fourth quarter of last year compared to the previous year and the previous quarter. Sales in the fourth quarter of last year are projected to be between 3.4 trillion and 4 trillion won, with operating profit estimated at 500 billion to 590 billion won, which amounts to about double the fourth quarter of 2023 and approximately a 27% increase compared to the previous quarter. The expected operating profit margin for the fourth quarter last year is estimated to be around 15% to 16%, maintaining a level in the high 10% range following the previous quarter (18.1%). This is attributed to increased delivery volumes of the K9 self-propelled howitzer and Cheonmu multiple launch rocket system, following the export contracts signed with Poland.
The K9 and Cheonmu are high-margin export products with operating profit margins exceeding 30%. The defense industry estimates that Hanwha Aerospace delivered 40 K9 units and 13 to 18 Cheonmu units to Poland in the last fourth quarter. Most production costs are in won, so even with a high exchange rate, the cost burden is low. For the K9, the domestic production rate for the core technology, the engine, successfully reached 99.1% in September of last year.
Korea Aerospace Industries (KAI) is expected to accelerate the domestic production of key equipment and components, which it had previously relied on imports for, following its acquisition of the aerospace and defense electronics company Genohco in November of last year. KAI noted that it would use Genohco to achieve vertical integration, reducing material costs and improving profitability. KAI aims to domesticize the engine used in the next-generation fighter KF-21 (Boramai).
Currently, Hanwha Aerospace is utilizing a license approved by General Electric (GE), the U.S. aircraft engine manufacturer, to carry out partial production at domestic factories at the processing and assembly level. Core components are supplied by GE. Due to the low domestic production rate, the license costs paid to GE vary greatly based on exchange rate fluctuations.