[This Week's Industry Insight] Concurrent Growth in Performance and Orders... The Second Half's Leading Player, 'Hyundai Rotem'

Q2 Sales Exceed 1 Trillion KRW and Operating Profit Surpasses 100 Billion KRW
Defense Business Led by K2 Tank and Other Projects

Amid concerns over an economic recession and uncertainties surrounding the U.S. presidential election emerging as risks for the Korean stock market, there is a stock that has managed to avoid these pitfalls. That stock is ‘Hyundai Rotem.’ Hyundai Rotem is a leading large-cap company in the domestic defense industry. This year, its stock price has reached record highs, rising sharply alongside its strong earnings growth.

Operating Profit Surpasses 100 Billion KRW for the First Time on a Quarterly Basis... Securities Firms Name It a ‘Must-Watch Stock’ for the Second Half

In the second quarter, Hyundai Rotem recorded sales of 1.0945 trillion KRW and an operating profit of 112.8 billion KRW. Compared to the second quarter of last year, sales increased by 10.9% and operating profit by 67.7%. Both operating profit and sales in the second quarter marked the highest quarterly performance since the company’s founding in 1977. This is also the first time Hyundai Rotem has exceeded 1 trillion KRW in sales and 100 billion KRW in operating profit on a quarterly basis. Defense projects, including the K2 tank which successfully entered exports for the first time in 2022, led the strong performance. Last year, Hyundai Rotem’s Defense Solutions (defense) business surpassed Rail Solutions (rail vehicles and equipment) in sales for the first time.

Jung Dong-ik, a researcher at KB Securities, analyzed, "The production for repayment of leased equipment to the Korean military was concentrated in the first quarter, causing a temporary slowdown in sales recognition for the Poland-bound K2 tank production, which normalized in the second quarter, driving the strong performance. Pre-tax profit and net profit also significantly exceeded market expectations due to solid operating profit and gains related to foreign exchange."

Hyundai Rotem recorded sales of 18 out of 56 K2 tanks scheduled for delivery within the year in the first half. Since 38 tanks will be reflected in the second half’s results, the second half’s performance is likely to surpass the first half. Considering that tank production typically takes about 12 months, production of 96 tanks to be delivered to Poland next year will begin in the second half of this year, leading to continuous quarterly increases in sales and profits.

Lee Sang-hyun, a researcher at BNK Investment & Securities, said, "With 56 and 96 Poland-bound K2 tanks scheduled for delivery this year and next year respectively, we expect upward-trending performance."

Hyundai Rotem’s overseas defense sales in the second quarter are estimated at 374.4 billion KRW, with an operating profit margin of over 23%. Jang Nam-hyun, a researcher at Korea Investment & Securities, stated, "The recognition of the Poland K2 sales progress, which began in earnest in the second quarter, reflects stable profitability. Such favorable overseas defense operating profit margins are expected to continue until the fourth quarter of 2025."

Considering this, Korea Investment & Securities raised Hyundai Rotem’s operating profit estimates for 2024 and 2025 by 12.8% and 16.1%, respectively. As a result, consolidated operating profit for 2024 is estimated at 397.7 billion KRW, an 89.4% increase from the previous year, and 589 billion KRW for 2025, a 48.1% growth from 2024. This is an unstoppable growth trend and explains why securities firms are eagerly naming Hyundai Rotem as the top preferred stock in the defense sector for the second half.

The stock price has nearly doubled compared to the beginning of the year. As of August 26, Hyundai Rotem’s closing price was 53,700 KRW, nearly twice the price at the start of the year. Foreign investors have actively purchased shares, with foreign ownership rising from 10.7% at the beginning of the year to 24.04% as of the 26th.

Securities firms still view Hyundai Rotem’s stock as the most undervalued among defense stocks, suggesting there is room for further gains. Jang Nam-hyun said, "Among defense companies in the second half of 2024, Hyundai Rotem has the most visible export pipeline, yet its 12-month forward price-to-earnings ratio (PER) is 12 times, the lowest in the sector. We believe it is a good time to buy without hesitation."

Securities Firms Raise Target Prices One After Another... No Impact from U.S. Election Risks or Geopolitical Conflicts

Reflecting strong earnings growth and expectations for additional order wins, securities firms have successively raised their target prices for Hyundai Rotem. KB Securities raised its target price from 47,500 KRW to 55,000 KRW, and NH Investment & Securities increased it by 22% to 60,000 KRW. Hyundai Motor Securities raised its target price from 37,000 KRW to 56,000 KRW, while Kiwoom Securities adjusted its target price upward from 57,000 KRW to 66,000 KRW.

Mirae Asset Securities also raised its target price from 48,000 KRW to 65,000 KRW, citing "the possibility of winning the Morocco high-speed rail project and the remaining 150 units of the 4th batch of domestic K2 tanks."

Korea Investment & Securities raised its target price from 50,000 KRW to 61,000 KRW, adding, "By the end of this year or early next year, we expect an order of around 300 K2 tanks for Romania."

Although geopolitical conflicts such as the Russia-Ukraine war, the Israel-Hamas war, and the Israel-Iran dispute pose significant risks to the domestic stock market, defense stocks are an exception. Ongoing conflicts between nations may increase global defense demand.

Lee Sang-heon, a researcher at LS Securities, said, "Since Russia’s invasion of Ukraine in 2022, European security dynamics have forced European countries to increase defense budgets and military build-ups for the foreseeable future. Especially in Eastern European countries, modernization of former Soviet weapon systems is accelerating, and they are pursuing defense policies that involve importing military equipment from allied and friendly countries."

Wi Kyung-jae, a researcher at Hana Securities, noted, "Under the U.S.-China rivalry, the global community has split into two camps, with alliances such as NATO and the Five Eyes (U.S., U.K., Canada, Australia, New Zealand intelligence alliance) forming. Global defense demand is expected to increase sharply compared to the past decade."

The uncertainty caused by the U.S. presidential election results, which stirred the domestic stock market at the end of last month, is not a burden for defense stocks. The defense industry is expected to expand regardless of the U.S. election outcome. Economic experts view the defense sector as relatively less affected by election uncertainties. Wi said, "The U.S. accounts for about 40% of global defense spending. Regardless of who becomes the next president, defense policies, which have been passive so far, will be strengthened."

High Expectations for Additional K2 Tank Orders... Previously Sluggish Rail Sector Also Performs Well

Expectations for additional K2 tank orders are rising significantly. Lee Sang-hyun said, "There is strong anticipation that export contracts for K2 tanks to Poland and Romania will be signed within the year. Combined, these orders could approach 10 trillion KRW."

Seok Jong-geon, head of the Defense Acquisition Program Administration, stated at the ‘2024 Eurosatory’ exhibition in June that there is a high possibility of concluding an additional export contract for Hyundai Rotem’s K2 tanks at the International Defense Industry Exhibition (MSPO) held in Poland in September. Following the 2022 contract to deliver 180 K2 tanks to Poland, this would be a second delivery contract worth around 4 trillion KRW after about two years. If the second contract is signed, it will secure stable export volumes of K2 tanks beyond 2026, following the completion of the first delivery next year.

The previously sluggish rail sector has also seen a turnaround. Last month, Hyundai Rotem signed a contract worth 275.3 billion KRW to supply high-speed trains to Uzbekistan Railways. This is the first time high-speed trains developed with domestic technology have been exported overseas. Additionally, Hyundai Rotem secured a contract worth 175.79 million USD (approximately 240 billion KRW) to supply double-decker passenger railcars to the Massachusetts Bay Transportation Authority (MBTA) in Boston, USA.

A notable aspect of new orders in the first half was the strong performance of the Rail Solutions division. As of the end of June this year, Hyundai Rotem’s order backlog totaled 18.9915 trillion KRW, with the Rail Solutions division accounting for 13.3196 trillion KRW. The strong performance of the Rail Solutions division is expected to help mitigate concerns about earnings concentration typical of the defense industry. The defense industry tends to have large order sizes but fewer contracts, which can lead to earnings deterioration during gaps between projects.

Yang Seung-yoon, a researcher at Eugene Investment & Securities, said, "It is important to note that Hyundai Rotem’s Rail Solutions division’s order backlog is steadily accumulating. Due to quality issues with low-priced Chinese electric trains, opportunities are opening up in advanced markets."