South Korean defense stocks surged over the past two years as countries around the world accelerated military rearmament.
Russia’s invasion of Ukraine prompted a sharp increase in defense spending across Europe. South Korean manufacturers attracted international buyers with weapons that were competitively priced and could be delivered relatively quickly, including tanks, artillery and missile systems.
That momentum has since reversed. Shares in several of the country’s largest defense companies have fallen sharply this year.
The combined market value of South Korea’s four leading defense companies — Hanwha Aerospace, LIG D&A, Hyundai Rotem and Korea Aerospace — had dropped to about 62 trillion won ($46.18 billion) by the end of October, down from a 52-week peak of 170 trillion won, according to South Korean broadcaster SBS.
The decline has raised questions about whether South Korean defense companies, best known for exporting tanks and artillery systems, are fully prepared for a modern battlefield where drones and counter-drone technologies have become increasingly important in Ukraine and Iran.
The war in Ukraine has demonstrated how relatively inexpensive drones can threaten high-value military equipment. Drone attacks launched from Iran have also reduced stocks of costly air-defense missiles held by the United States and its Gulf allies.
“Modern warfare is being fought with less traditional weaponry — tanks, cannons and armored vehicles — which Koreans are positioned for. Even in this area, however, drones, for example, are dominated by China, pricing out potential competitors from Europe, the U.S. and Asia,” said Peter Kim, senior managing director at KB Securities.
KJ Hwang, a Korea autos and industrials analyst at Bank of America, agreed that military procurement priorities were shifting, with greater emphasis on drones, counter-drone systems and air defense.
A short-term setback?
The decline in defense stocks is not solely the result of changing battlefield requirements.
Investors are also contending with weaker-than-expected earnings, a stronger won and delays in export orders.
Capital flowing into the semiconductor sector, along with high valuations based on expectations for rapid earnings growth, has added pressure to Korean defense shares, KB Securities’ Kim said. He also noted that governments have been slower than expected to turn defense-spending pledges into approved budgets and signed orders.
Recent financial results have heightened those concerns. Hanwha Aerospace reported a more than 46% year-on-year decline in third-quarter operating profit, citing changes to delivery schedules and one-off costs. Its shares have fallen more than 28% so far this year.
Hyundai Rotem reported a decline of more than 11.1% in operating profit, while its stock has plunged by almost 60%.
Korea Aerospace Industries delivered stronger third-quarter results, with sales rising about 52% and operating profit increasing 32%. Its shares have consequently declined by just over 8% this year.
Despite the sell-off, analysts remain optimistic about the sector, particularly over the longer term.
“South Korean defense companies have continued to expand cooperation with partners in Western Europe and the Middle East, including in air-defense systems. Additional K9 howitzer orders also suggest that supply constraints and the continued importance of deterrence remain supportive of demand for conventional platforms,” BofA’s Hwang said.
Among the deals announced this year were Hanwha Aerospace’s K9 howitzer orders from Spain, valued at about 546 million euros, and a $922 million order from Norway for K239 rocket systems.
LIG D&A also secured a $94 million agreement with Malaysia for its K-SAAM naval surface-to-air guided missile system, marking the system’s first export deal.
Countries continue to rely heavily on conventional weapons to strengthen their defenses. KB Securities’ Kim said the Korean defense sector “remains attractive, given the long-term growth outlook is still in the teens.”
David Roche, a strategist at Quantum Strategy, told CNBC that military orders are placing “greater emphasis” on artificial intelligence and drone technology as major powers absorb the lessons of the war in Ukraine. However, he added that “drones cannot capture and hold terrain … So, in any mobile battlefield, infantry, tanks, armor etc, are essential.”
South Korean defense companies are also investing heavily in drones and unmanned systems. Meaningful export growth may take time because overseas buyers typically demand a proven operational record, but Kim expects more visible results to emerge in the near future.
