Industrials

Shelly Banjo is a Bloomberg Gadfly columnist covering industrial companies and conglomerates. She previously was a reporter at Quartz and the Wall Street Journal.

President Donald Trump's threat to unleash "fire and fury" on North Korea sent U.S. defense stocks to record highs last week even as the potential for nuclear warfare rattled global markets.

Manufacturers of military airplanes and weaponry in neighboring South Korea, China and Japan didn't exactly move in line, though.

Shares of Victek Co., a South Korean maker of electronic-warfare systems that has served as a barometer of agitation on the Korean peninsula in the past, rose 12 percent since Trump's incendiary comments. Korea Aerospace Industries Ltd., the nation's only aircraft maker, is down 8 percent.

The CSI National Defense Industry Index, which tracks 72 military-related stocks in China including Avic Aviation Engine Corp., finished the week flat and is down 14 percent so far this year.

Stand Guard
The CSI National Defense Industry ETF, which tracks an index of 72 military-related stocks in China, has dropped 12 percent in the last year
Source: Bloomberg

And while there are fewer pure-play defense stocks in Japan, companies like Mitsubishi Heavy Industries Ltd. and Kawasaki Heavy Industries Ltd., which make engines, aircraft and machine parts, traded lower.

Close Look
Shares in South Korean defense stocks diverged as U.S.-North Korea tensions heated up
Source: Bloomberg

In theory, mounting geopolitical tensions and a stated commitment in South Korea, Japan and China to boosting national defense budgets and spending more on weaponry should lift these stocks. Last week's divergence suggests that investors trying to play the macro trade would be better served considering the fate of individual firms instead.

Take Korea Aerospace. The aircraft and drone maker is mired in multiple scandals, including allegations that it perpetrated hundreds of billions of won in accounting fraud and an investigation into faulty engine blades manufactured for military choppers.

The Sky Is Falling
Korea Aerospace is trading at a 29 percent discount to peers, compared with an average 21 percent premium over the past two years on a blended forward enterprise value to Ebitda basis
Source: Bloomberg

KAI has denied the claims. Still, CEO Ha Sung-Yong resigned on July 20. In the last month, one-fifth of analysts covering the company downgraded the stock, as it plunged 35 percent.

Hanwha Techwin Co., which supplies engines to (and owns 6 percent of) KAI has also been dragged down: Trouble at KAI could dent Hanwha's already floundering operating profits. Shares of the imaging, engine and cannon maker dropped 27 percent in the last three months.

In Japan, the country's heavy-industrial companies are probably best positioned to benefit from Prime Minister Shinzo Abe's push to revitalize and spend more on the military, especially if North Korea continues to threaten the nation directly.

Yet the hostility in the Korean peninsula hasn't boosted shares of many of Japan's largest industrial companies.

Mitsubishi Heavy is down 19 percent so far this year as the conglomerate struggles to reform its giant web of businesses and spin off units including shipbuilding, hydraulic machinery and chemical plant engineering. Defense and space account for 12 percent of the group's sales.

In recent weeks, those turnaround efforts have been weighed down by reports that Mitsubishi would pull out of a high-speed railway project in Japan and by a legal dispute with Hitachi over a power plant joint venture.

The pattern holds across the industry: Many of the companies that ought to gain from increasing tension and escalating military spending are too caught up in their own issues to really benefit. Investors will need to choose wisely. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shelly Banjo in Hong Kong at sbanjo@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net