Incidents:

The company announced on March 27 that in 2023, it will achieve operating income (43.734 billion yuan, +17.89%), net profit after deducting non-return to mother (1,421 billion yuan, +12.17%), net profit margin (11.08%, +0.26pcts), net profit margin (3.47%, -0.17pcts), and ROE (diluted) (3.60%, +0.30pcts). In 2024, Q1 achieved operating income ($6.272 billion, +1.98%), net profit attributable to mother ($155 million, +76.03%), and net profit not attributable to mother ($106 million, +444.82%).

Investment highlights:

Operating performance increased steadily in 23 years, reaching a new high of nearly five years. Expenses remained on a downward trend during the period. In 2023, the company achieved operating income (43.734 billion yuan, +17.89%), net profit to mother (1,421 billion yuan, +12.17%), and net profit not returned to mother (1,222 billion yuan, +45.85%). The company's revenue and profit grew steadily throughout the year. Among them, net profit without return to mother increased significantly year-on-year, mainly due to increased product profitability. Gross profit margin (11.08%, +0.26pcts), gross margin increased slightly. Net interest rate (3.47%, -0.17pcts). The slight decline in net interest rate was mainly due to significant changes in income due to taxes, surcharges, financial expenses, and fair value changes. Among them, taxes and surcharges (268 million yuan, +120.65%) are mainly affected by relevant national tax reform policies, and the increase in circulation tax has led to an increase in surcharges. Financial expenses (248 million yuan, +1482.52%), changed from negative to positive and increased significantly over the same period last year. The main reasons were reflected in three aspects. One was the increase in the size of interest-bearing debt and the increase in interest expenses; second, a decrease in interest income from current deposits; and third, a decrease in exchange earnings. In terms of fair value change earnings, the company achieved revenue in 2023 (-145 million, -567.74%), which was 31 million yuan in the same period last year. The year-on-year change from profit to loss was mainly due to the share value of Bank of Guizhou held by subsidiary Liyang Power due to market fluctuations. In 2024, Q1 achieved operating income ($6.272 billion, +1.98%), net profit attributable to mother ($155 million, +76.03%), and net profit not attributable to mother ($106 million, +444.82%). Operating income has maintained steady growth, and net profit to mother has increased markedly. The main reasons are the increase in income from changes in fair value, the second is the reduction in expenses during the period, and the third is the reduction in taxes and surcharges. Net profit after deduction of non-return to mother achieved a significant year-on-year increase. The main reason was the reduction in period expenses, and the second was the reduction in taxes and surcharges.

In the 2023 reporting period, the company's expenses rate for the period (6.50%, -0.31pcts), including sales expenses ratio (1.08%, -0.14pcts), of which sales expenses increased 4.18% year-on-year, mainly due to increases in travel expenses and employee remuneration. Management expense ratio (3.58%, -0.13pcts). Among them, management expenses increased 13.80% year over year, mainly due to increases in actuarial expenses, employee remuneration, travel expenses, consulting expenses, etc. for the three types of personnel. The financial expense ratio (0.57%, +0.62pcts) is mainly due to a significant increase in financial expenses. The R&D cost rate (1.27%, -0.65pcts) is mainly due to a decrease in the company's investment in project projects. As can be seen, as the scale of the company's operations continues to expand, the company's expense ratio showed a downward trend during the period, and the scale effect continued to show.

In terms of inventory, as of the end of December 2023, there was a slight year-on-year increase in aviation engine inventory (29.663 billion yuan, +15.27%). At the end of the reporting period, aviation power had signed contracts but had not fulfilled or completed the contract revenue amount of 34.055 billion yuan. Of this, 26.909 billion yuan is expected to confirm revenue in 2024, and the rest will confirm revenue in subsequent years.

In 2023, the company achieved operating income of 43.734 billion yuan, completed 103.48% of the annual budget of 42.265 billion yuan, net profit to mother reached 1,421 billion yuan, and completed 104.649% of the budget value of 1,358 billion yuan. In 2024, the company expects to achieve operating income of 49.762 billion yuan and net profit to mother of 1,512 billion yuan.

The main business grew steadily, foreign trade subcontracting continued to resume, and there was differentiated development in subsidiary operations. Li Yang increased significantly. The company's main business includes three categories: aero engine manufacturing and derivatives, foreign trade subcontracting, non-aviation products and trade. Judging from the business share, the company's overall business structure did not change significantly in 2023, and fluctuations were small. Among them, the company's aero engine and derivatives business achieved revenue (40.893 billion yuan, +18.17%), and completed 102.30% of the budget value of 39.973 billion yuan, mainly due to increased customer demand and increased product delivery; foreign trade export subcontracting business achieved revenue (19.48 billion yuan, +18.06%), which completed 114.86% of the budget value of 1,696 billion yuan, mainly due to the recovery of the global aviation industry and increased export orders; non-aviation products and trade business achieved revenue (262 million yuan, -17.09%), completed the budget value It was 163.75% of 160 million yuan, a slight year-on-year decline, mainly due to a decrease in the company's civilian product revenue.

The company's main revenue was contributed by Western Airlines (parent company) and its three major OEMs, Liming Company, Liyang Company, and China Southern Company. The main operating conditions of the four major OEMs in 2023 are as follows: The parent company Western Airlines achieved revenue in 2023 (12.974 billion yuan, +21.13%) and realized total profit (654 million yuan, +14.74%). The company headquarters's R&D expenses for the full year of 2023 (61 million yuan, -32.97%) declined markedly from the same period last year. By the end of the 2023 annual report reporting period, the parent company had signed a contract, and the unfulfilled or unfulfilled revenue amount was 13.121 billion yuan. Of this, orders of 9.065 billion yuan are expected to confirm revenue in 2024, and the rest will confirm revenue in subsequent years.

Liming is mainly engaged in aero engines, gas turbines, etc., and its main production of medium and heavy thrust aero engines is equipped with a wide range of high-performance military aircraft in China. In the 2023 fiscal year, the company achieved operating revenue (26.235 billion yuan, +19.16%). As military aircraft installation accelerated, the company's revenue grew steadily, and total profit was achieved (678 million yuan, -13.52%), a slight decline over the previous year. In terms of revenue structure, the aero engine and derivatives business achieved revenue (25.409 million yuan, +19.09%), the foreign trade export subcontract business achieved revenue (389 million yuan, +38.48%), and non-aviation products and other businesses achieved revenue (26 million yuan, -15.06%). For the full year of 2023, Liming's R&D expenses (135 million yuan, +5.47%) increased slightly over the same period last year.

Nanfang's main products are turboshaft engines and piston engines, etc., which are widely used in various types of helicopters. In the 2023 fiscal year, Nanfang Company's revenue (7.775 billion yuan, -0.85%) and total profit (448 million yuan, +13.42%). In terms of revenue structure, the aero engine and derivatives business achieved revenue ($7.507 billion, -0.62%), while non-aviation products and other businesses achieved revenue ($41 million, -42.25%). For the full year of 2023, China Southern Company's R&D expenses (177 million yuan, +18.00%), and R&D investment increased steadily over the same period last year.

Liyang's main products are third-generation medium-thrust aero engines and other products. In the 2023 fiscal year, Liyang achieved revenue (4.908 billion yuan, +45.04%), a significant increase in revenue scale, and total profit (-0.69 billion yuan, -188.46%). Some of the company's models are in the early stages of release, and short-term profitability is insufficient. Looking at the revenue structure, the engine and derivatives business achieved revenue (4.801 billion yuan, +46.68%), accounting for almost all revenue sources of Liyang Company, and there is a trend in product delivery volume. Liyang's R&D expenses for the full year of 2023 (RMB 123 million, -57.59%).

Overall, the operating performance of the four major OEMs showed a trend of differentiation. Among them, the revenue scale of the parent company and Liming Company was steadily expanding. The significant increase in the scale of Liyang Company may indicate the gradual mass production volume of some engine models. Southern Company's revenue was almost the same as in 2022. In terms of profit, the parent company and Southern Company maintained stable profitability. Liming Company declined slightly, and Liyang Company experienced a profit to loss situation, putting pressure on short-term performance. In terms of R&D investment, Southern Company maintained a steady growth rate, while investment by Liyang and parent companies declined markedly.

◆ The completion of Wright's capital increase and share expansion project will promote the long-term development of civil aviation engines. The fund-raising project is expected to be further improved. On July 8, 2023, the company announced that Aviation Engine Power Co., Ltd. plans to increase capital and share expansion for Xi'an Western Airlines Group Wright Aviation Manufacturing Technology Co., Ltd. (hereinafter referred to as Wright Company), a wholly-owned subsidiary, to introduce no more than 400 million yuan in cash investment through public trading institutions. The company transferred its internal civil aviation engine manufacturing business to Wright and introduced external capital to increase its capital by 400 million yuan to build a dedicated civil aviation engine production line to form a well-structured mass production capacity to meet the long-term development needs of domestic civil aviation engines.

According to the company's 2023 annual report, Wright, a subsidiary of the company, implemented a capital increase and share expansion in the current period. The introduction of shareholders through public transactions through property rights trading institutions has been completed. After the capital increase is completed, the company's shareholding ratio in Wright will drop from 100% to 71.10%. Through the implementation of this capital increase, Wright's product development capacity is expected to improve significantly, which will help strengthen Wright's dominant position in the civil aircraft industry chain.

On August 19, 2023, the company issued an announcement stating that it received the “Notice Concerning the Completion and Acceptance and Filing of the China Aviation Engine Power Co., Ltd. Aircraft Engine Repair Capacity Building Project” from the Shaanxi Provincial Defense Technology Industry Office, indicating that the company's “Aero Engine Repair Capacity Building Project” has passed the completion inspection and achieved the project construction goals.

After the successful commissioning of this fund-raising project, aero-engine power can effectively improve aero engine repair methods and capabilities, upgrade the company's surface treatment production and emission levels, and build a relatively independent and complete assembly repair plant and test plant to form a relatively independent and complete turbofan engine overhaul plant by integrating the company's existing aero engine repair capabilities, adjusting the existing production layout, and supplementing some key equipment, while reserving new turbofan engine maintenance capabilities, which has a good effect on the development of China's aero engine industry.

◆Leading aero engine companies, focusing on the development opportunities of military and civil aviation engines and gas turbines. Accelerating to catch up and surpass aero engine technology is a reflection of the status of a major power and comprehensive national strength. It is a strategic high point of modern aviation technology, an essential part of modern national defense, and an important support for economic and social development. Currently, the aero engine industry is in a stage of rapid development where a new round of scientific and technological revolution, industrial revolution, and military revolution are intertwined. The world's aviation powers have stepped up their layout and advanced research on cutting-edge aerodynamics technology, and have formed a first-mover advantage. Surrounding the world's aviation powerhouses, the US adaptive variable cycle engine has completed the development of a verification machine, and the UK has released a zero-emission strategy for aviation. The application of new concepts, new technologies, and new materials such as unmanned, digitalization, electrification, hydrogen energy, additive manufacturing, and composites is rapidly accumulating quantitative changes.

The company focuses on the main business of military and civil aviation engines and gas turbines, accelerates catch-up and surpasses, and continuously improves the level of R&D and manufacturing of aero engines and gas turbines. In terms of military aero engines, it is developing in the direction of adaptive circulation, turbo-based combined hypersonic power, and all-electric propulsion systems. In terms of civil aviation engines, according to the COMAC Market Forecast Annual Report (2022 - 2041), the domestic aero engine market value will reach US$350.2 billion by 2041. As the core supplier of commercial aircraft power in China, the company will accelerate airworthiness certification and achieve commercial success for large domestic airliners and regional airliners, and will promote domestic civil aviation engines to become the company's pillar industry. In terms of gas turbines, the international environment and surrounding trends are changing. At the same time, the country has proposed a “dual carbon” strategic goal, and demand for gas turbines will also increase, and the company will usher in a new period of historical opportunity.

As the only domestic enterprise that can develop full-spectrum military aviation engines such as turbojets, turbofans, turboprops, and pistons, the company is the only platform for the overall marketing of aerodynamics under China Aviation Development, and will benefit deeply from the development cycle of China's aerodynamics.

Investment advice:

In 2023, the company's revenue increased 17.89% year on year, net profit after deducting non-return to mother increased significantly year on year. Expenses for the period were further reduced, and the scale effect was evident. At the same time, the company has plenty of orders in hand, laying a solid foundation for future company development.

The company further focuses on its main business. The scale of the aero engine manufacturing and derivative products business continues to expand, subsidiary operations have evolved in a differentiated manner, and Liyang's revenue scale has increased significantly. With the batch production volume of various engine models under development in the future, the company's overall business situation is expected to further improve.

The company successfully completed the capital increase and expansion of shares in Wright and successfully introduced external shareholders. The funds will be used to build a special civil aviation engine production line project to meet the long-term development needs of domestic civil aviation engines. At the same time, the fund-raising project “Aero Engine Repair Capacity Building Project” has successfully completed acceptance and commissioning, and the company will effectively improve aero engine repair methods and capabilities.

As a leading aero engine company, the company is also the only domestic company that can develop full-spectrum military aviation engines such as turbojets, turbofans, turboprops, and pistons. It will benefit deeply from the golden cycle of domestic aero engine industry development. Driven by the “dual track” demand of the military and civil aviation markets, the future is expected to benefit for a long time.

We expect the company's revenue for 2024-2026 to be 49.765 billion yuan, 57.122 billion yuan and 65.428 billion yuan, respectively, and net profit to mother of 1,652 billion yuan, 1,951 million yuan and 2,317 billion yuan respectively, and EPS of 0.62 yuan, 0.73 yuan, and 0.87 yuan respectively. We maintain our purchase rating. The target price is 45 yuan, which corresponds to 73 times, 62 times, and 52 times PE of the EPS forecast for 2024-2026.

Risk warning: Risk of falling gross margin due to fluctuations in raw materials; market demand declines due to fluctuations in the macro environment, etc., product delivery falls short of expectations, etc.