Hanwha Aerospace Co., Ltd. (A012450) Earnings Call Transcript & Summary

Good afternoon. I am Han Sang Yun, the Head of Investor Relations with Hanwha Aerospace. First of all, I'd like to thank everyone for joining the call. Now I will brief you on the 2024 first quarter performance of Hanwha Aerospace. Please refer to Pages 6 and 7 of the presentation. The consolidated sales for Q1 are KRW 1,848.3 billion, which is 9% decline year-on-year, and the operating profit has decreased year-on-year to record KRW 37.4 billion. While Hanwha Vision and Hanwha Systems have recorded strong performance, there was some base effect coming from decrease in the export volume to Poland in the Land Systems segment. The details will be explained in the performance by segment section. Pretax profit for Q1 is KRW 56.2 billion and net profit is KRW 3.1 billion, which has declined quite significantly on a year-on-year basis. This is due to the onetime gain of valuation of derivatives worth about KRW 430 billion recorded in the same period last year in relation with the acquisition of Hanwha Ocean. Please turn to Page 8 for financials. Total assets are KRW 20,525.2 billion. Total liabilities are KRW 15,895.3 billion, which has slightly increased from the end of 2023. The net debt-to-equity ratio has increased from that of the end of last year to 59%. I will share with you the performance by segment. Please turn to Page 9 for Land Systems. The Q1 sales are KRW 656.6 billion or 22% decline year-on-year. Domestic sales went down by 4% year-on-year to KRW 352.2 billion and the overseas sales by 36% year-on-year to KRW 304.4 billion. The operating profit declined year-on-year to KRW 14.2 billion. While the domestic sales did not change much on the year-on-year basis, the overseas sales volume for Q1 was not a lot as it follows the prescribed delivery schedule. Starting from Q2, however, the export to Poland is expected to be delivered. And for the remainder of the year, we expect quarterly volume sales and operating profit to grow gradually. So on an annual basis, we expect the sales and the operating profit to grow from that of last year. Please turn to Page 10 for Land Systems order backlog. As of the end of Q1, the Land Systems order backlog is about KRW 30,300 billion. As some orders are established and managed by the U.S. dollar basis, the total amount is reflective of the FX effect. Regarding the new order taking, the company had signed an additional execution plan last week with Poland on Chunmoo multi-launcher worth around KRW 2,300 billion, and the new order will be reflected on the order backlog from the second quarter. Regarding the Romanian self-propelled gun project, where the company has participated in the bidding last year, we are waiting for the result. And if there is any announcement, we will share it with the market. Please turn to Page 11 for the performance of Aerospace segment. Q1 sales are KRW 443.4 billion, which is 14% growth year-on-year, but the operating profit declined year-on-year to KRW 2.9 billion. While the sales grew with the increased delivery, the growth was mostly from the business with relatively lower profitability. Regarding the GTF RSP, the operating loss in Q1 '24 is KRW 9.9 billion. The GTF engine sales continued to increase in the first quarter with 233 from 163 in Q1 '23 and 180 in Q1 '22. Regarding the number of aircraft delivery, 225 aircraft were delivered during Q1 '24, which has declined from 257 of Q1 '23 and 237 of Q1 '22. This is believed to be associated with production restraints imposed due to the recently uncovered manufacturing defects. The number of deliveries by Airbus, however, has increased by 12% year-on-year at 142, and the airline demand for new aircraft remained still high. As for the space business, the company was selected as the preferred bidder to be the operator for the next-generation launcher, or so-called KSLV-III development project. Negotiations on the details are currently underway, and any decision that comes out from the negotiation will be shared with you by disclosure or press release. Please turn to Page 12 for performance of Hanwha Vision. Q1 sales are KRW 310 billion, which is 13% growth year-on-year, and operating profit is KRW 52 billion or 40% growth year-on-year. The demand for security industry, which has shrunk during the second half of last year, started to show signs of recovery. And the demand from the North American market rebounded and the growth from the European market, especially the U.K., and from the Asian market were notable during the quarter. The profit has increased significantly driven by such strong sales growth and the FX impact. We expect solid sales and operating profit from Hanwha Vision for the whole year as the growth is likely to continue in all regions, including the U.S., Europe and Asia, based upon the security industry's demand recovery. Please turn to Page 13 for the performance of Hanwha Systems. Q1 sales are KRW 544.4 billion, which is 24% growth year-on-year, and the operating profit is KRW 39.3 billion, which is more than threefold growth year-on-year. As for the detailed performance, outlook and progress of new business of Hanwha Systems, please refer to the earnings release of Hanwha Systems, which happened on April 26. Lastly, I will briefly share with you the performance of Hanwha Precision Machinery and Satrec I, which are included in the Others. During the first quarter, Hanwha Precision Machinery has recorded KRW 88.9 billion in sales and KRW 22.6 billion in operating loss. For Q1, Satrec I has recorded KRW 31.7 billion in sales and KRW 3.5 billion in operating loss. Satrec I has participated in the project to develop constellations of micro-satellites. On April 24, the company has made a meaningful space heritage by successfully launching NEONSAT-1, the pathfinder for the country's first-ever micro-satellite constellation system and also by communicating successfully with it. The remaining 10 micro-satellites will be launched in 2026 and 2027. This concludes the briefing, and we will have the Q&A.

The first question is from Shinhan Investment Securities, and it is to do with the profit of the Land Systems. So he said that the export has declined by KRW 300 billion. It's not a small amount. How much of it went to Poland? The answer is, during Q1, there was no volume that was added to Poland. Even though we have recorded KRW 300 billion in sales for export market, the profit was relatively low. That is because the sales from not main systems but subsystems and the margin of subsystems are relatively lower than that of the main system. Starting from the second quarter, we believe that the delivery will begin to Poland. And on a quarter-by-quarter basis, we expect the sales and the delivery volume and the operating profit to increase. The next question is from DAOL Investment & Securities. He said that things will improve from the second quarter. Can you share with us as to how much things will improve over time? So in 2023, there were quarters that have demonstrated a stronger performance. So we expect that will happen quite similarly on the quarter-by-quarter basis in 2024. And generally, we expect the second half to be better than the first half. An additional question is that he said that the margin from the Land Systems for the domestic customers are relatively lower and that for the export sales of KRW 300 billion, they're mostly the subsystems. Can you elaborate the composition? The answer is other than what is headed to Poland, we cannot disclose the destination and the composition. But what we can share is that the volume that goes outside of Poland has a different product composition and a different margin. And on top of that, so there was increase in the personnel because the total volume and the production has increased quite significantly. So during the Q1, you must have felt its impact. But on the quarter-on-quarter basis, especially during the second half, you will not be able to feel much impact. Next question is from the Nomura Investment Securities. On the conventional basis, based upon the past delivery, the margin that I have calculated out of your performance was around 15%. So that means that if the export sales was KRW 300 billion, that means the operating profit should be around KRW 45 billion. You explained that there was a onetime expense of KRW 10 billion, but it does not explain the difference altogether. So can I assume that the order that you have won last year or the previous years had the lower profitability. Are you losing money somewhere else, such as Australia? Because even though there are some onetime expense, it does not explain the differentials. The answer is that even though we do not necessarily share the margins per product, there was increase in the fixed cost that is coming from the increase in overall workforce. And especially during the Q1, there was a higher amount of the subsystem sales that had a lower margin and also the higher portion of the domestic sales that also has lower margin. So you will be able to see the improvement throughout the rest of the year. The next question is from Shinhan Investment Securities. So was there any change or shift in the profit on a quarter-by-quarter basis? The answer is that there was no particular shift or manipulation. On the first quarter, the conventional practice is that the sales is generally focused on the development project. Mostly, towards the second half of every year then, the sales from the mass production happens. And of course, that means that it will have a higher profitability as well. So what we have experienced during the first quarter is not puzzling or something that we were not able to expect to happen. As we have been communicating from last year, even though we might not be able to share the exact details or the composition, but because of the combination of manufacturers combined, the Q1 performance is lower than other quarters. But you'll be able to see that things will improve over time because out of the total order backlog, the ratio of the export will increase and that will translate very positively in our sales and operating profit performance. The next question is regarding the number of sales to Poland. Has there been any change to what has been disclosed earlier? The answer is there is no change to the guided figure that we have shared with you earlier. So the figure is for K9, 68 K9s or more and 30 Chunmoo or more. So I said or more, which represents that if and when there is a request from the customer, and if our capacity allows, then there could be the upside potential and it is most likely to happen during the fourth quarter. The next question is from DAOL Investment & Securities. So you have recent won the second round of Chunmoo order from Poland. So how does the time line pan out? Will it happen immediately after the first round? What would be the delivery schedule for those 72 Chunmoos? The answer is, yes, the delivery will start immediately after the completion of the first round. So the second round of Chunmoo delivery will begin from 2028. And the Polish government is yet to share with us the delivery schedule, so I cannot disclose any further details. And FYI, there is no current production of Chunmoo at this moment. The next question is from Shinhan Investment Securities. So for the self-propelled gun for the U.K. market, it didn't pan out. So can I understand the background a little bit better? Was there any cost associated with it? The answer is regarding the U.K. project, so the announcement was about the development of the self-propelled gun and the announcement was regarding the possible collaboration for the development. So we are internally discussing about the ways to respond to the situation. And there was no costs associated with it. The next question is from Shinhan Investment Securities. Can you share with us any progress on the local production in Poland? And another question is that, in the fourth quarter of '23, there was one Chunmoo whose sales were not recognized. So when will it happen? Let me respond first about this one Chunmoo whose sales was not recognized in the previous quarter. So it was not recognized during this quarter but will be done in the third quarter of this year. And that is in line with the customer's request. And regarding the local production for the first and second rounds of K9 and Chunmoo, so that is not something that we expect to happen. So it will be more likely for the remaining volume outside of the first and second rounds of contracts. The next question is from Nomura Financial Investment. I have a question regarding RSP. So what is the expected volume? And do you expect the size of the loss will decline? The answer is the RSP cost versus last year has improved. And that is because even though the total sales or the volume has increased, the AM sales has also increased, and that has contributed positively to reduce the size of the loss. But for the whole 2024, outside of the AM sales, then we believe that what we have shared with you for the total amount of loss for 2024 will be maintained. We expect there could be some announcement from Pratt & Whitney by the end of this year regarding the accounting treatment, possible reversal of allowances. And if and when that happens, then we will share that with you. Our next question is from DAOL Investment & Securities, and this is to do with the Romanian situation. So the answer is regarding the Romanian project, we expect to see the results by the first half at the earliest. Next question is from Hanwha Investment Securities, and it is to do with the consolidated adjustment. Can you share with us the details of the consolidated adjustment? The answer is that is to offset internal transaction among the different divisions or business units. For example, even within Hanwha Aerospace, there was transaction between the aviation and the engine division and the PGM and the Land Systems business units and also between Aerospace and the Hanwha Systems. So offset of those internal transactions could account for the majority of the adjustment. Next question is from Eugene Investment & Securities. The question is to do with Hanwha Precision Machinery and Hanwha Vision. So for Hanwha Precision Machinery, there was a large amount of loss. But for Hanwha Vision, the profit was quite favorable. So do you expect this trend to continue throughout the rest of the year? The answer, first, is to do with Hanwha Vision. In the previous quarter, or the fourth quarter of 2023, North American sales was not very favorable due to the inventory effect. So there were some concerns internally if those trends might continue. But luckily, in Q1, those inventory effect disappeared and we were able to witness the rebound in not just North America but also in Europe and Asia. So for the whole year, we expect this favorable performance to be maintained. As for the Precision Machinery, they are supplying to the semiconductor manufacturer. And they are at a very early stage of the business, so it is too early to share anything meaningful in numbers with you. Even worse, our key market is China, which is suffering from the economic slowdown and the trade conflict, so it is likely that this amount of loss will continue throughout the year. Next question is from DAOL Investment & Securities. Other than the Romania project and the second phase of Poland, what can we expect in terms of the pipeline, which area or which project? The answer is that we have 3 focus areas. First is Europe, which includes both Eastern Europe and Northern Europe. The second is Middle East. And the third is Asia Pacific, specifically Australia and India. Out of these 3 key focus areas, we are focusing on these 3 key products, mainly K9, Chunmoo and Redback. So what we have witnessed so far is that existing customers show interest in not just the existing products that they have already purchased but on other products. And we are seeing some new interested parties as well. So this will help us maintain the pipeline for this year and next year. And you must have read the media report recently that the customers with the existing purchase are showing interest in other product offering as well. Next question is from Hi Investment & Securities. Recently, you signed an MOU with Saudi Arabia. So any tangible decision that was included in the MOU? And if there is a specific time line, can you share? The answer is the MOU with Saudi Arabia, it is to confirm their interest and their willingness to cooperate on the overall weapons system. So as it is still an MOU stage, there is no definite decision that is involved in. But what I can tell you is that as the Middle East is one of our focus areas, then we will continue to discuss with Saudi authorities on the possible surface-to-air launcher and the Hanwha Systems radar assistance as well. The next question is from Shinhan Investment Securities. There was a recent revision in the Export-Import Bank of Korea Act. So will it help you with financing for your future projects? And for the Poland project, what are the logic for your delivery? The answer is the logic behind the delivery is at the request of the customer. For example, one Chunmoo whose sales was not recognized in the fourth quarter of 2023, it will be recognized in the third quarter, not the first quarter of this year. And that is at the request of the customer, and that will be used for the testing purposes. And regarding the recent revision of The Bank of Korea Act, so that might help us with the overall available funds, but it will be some time that it will led to the actual financing. But in the meantime, as you have seen with our recent contract with the Polish government, there is something that we can do on our own with our respective customers. Next question is from Nomura Financial Investment. So what will be the time line for the remaining volume for Poland? The answer is that we have just signed the second phase contract of Chunmoo last week, and the delivery will start from '28. So the remaining volume for K9 will happen sometime after 2029. So as we have signed the contract whose delivery will begin from '28, I believe that there is no sense of urgency for signing the contract for the remainder of the volume because it will be 5 or more years down the road. But generally speaking, as was the case with K9 2-1 or last week's contract for the Chunmoo Phase 2, we expect that there will be a series of future contracts coming out that confirm the existence of demand. So we remain quite hopeful for the remainder of the volume. The next question is from Shinhan Investment Securities. So in case of the accounting treatment of the volume that goes out to Poland, why do you follow the delivery-based principle? The answer is, yes, as you have mentioned, we recognize sales basis of delivery because we believe that is a logical approach. If we do it on the progress basis, and if there is any problem or delay that happens during this process, then we will have to retract that, and it's not logical at all. And that is also the opinion from the outside accounting firm, so we follow their advice as well. The next question is from Merrill Lynch. On the Q1 performance, you said that there was the increase in the personnel or the workforce. Was there any other factors contributing to this increase in the cost? The answer is that other than the increase in the fixed cost, there was a onetime expense of KRW 10 billion. So that comes out of the Polish gap filler that happened last year. So we used the volume that was sent ordinance for the domestic customers, but we have used it up for the delivery for Poland. So that means that we have to deliver to the local customers, and the materials cost associated with the delivery went up. We expect the cost will be only onetime.