GADFLY

Hold On Tight at Korea Aerospace

The turmoil-hit aircraft maker will only grow in national importance as defense spending rises.
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Photographer: Brent Lewin/Bloomberg

It started with allegations of hiding safety and other flaws in a key military chopper. Then came embezzlement accusations, a government raid on company property, a CEO resignation and the exodus of its top brass. Add to that a 46 percent drop in the shares in the past 12 months, an earnings miss and an accounting inquiry that prompted a redo of multiple years of financial statements.

Korea Aerospace Industries Ltd. hasn't exactly engendered confidence among shareholders of the country's sole aircraft manufacturer. And while KAI's stock jumped by 10 percent last week on news that accountants Samil PricewaterhouseCoopers signed off on its restated financial filings, there's still a lot of confusion over the company's future.

Investors who are in it for the long haul should probably stay in their seats. 

KAI is a major South Korean institution and will only grow in national importance as President Moon Jae-in ratchets up defense spending.

An aging population means a dearth of new recruits to the armed forces, making it even more important to keep South Korea's only aircraft maker churning out the kind of updated technology the military needs to keep up with increased threats from the country's reclusive northern neighbor. 

While there's been a lot of attention on Moon's pledges to root out corruption at powerful family-run conglomerates, or chaebol, such as Samsung and Lotte, the president has also stated his mission to overhaul a defense industry that became too cozy with government officials.

So it's rational (and smart) for Moon to clean house at KAI, which benefited from years of overly generous state contracts and close ties with Park Geun-hye, the former president who was impeached and indicted on bribery charges.

But in order to get KAI back on the right path, it has got to get back to business. 

Politics aside, the company just reported its first quarterly loss in five years. Changes in how the company recognizes revenue could make its financial results bumpier from quarter to quarter. And the fact that KAI's new order pipeline is much lower than investors were expecting is worrisome: It took in 1.6 trillion won ($1.4 billion) of orders from January through July, or 24 percent of its previous 2017 target. 

More troubling, though, is the risk of losing a major contract with the U.S. government for trainer jets developed in conjunction with Lockheed Martin Corp. that could transform KAI from a regional business into a truly global defense company.

If the U.S. military perceives KAI's product quality to be sinking and the upheaval is likely to persist, it could instead choose competitor Boeing Co. for the project.

That hit would not only mean losing out on a major revenue driver that would set KAI up for years, it would also deal a blow to its reputation for sales to other countries. 

Investors with weak stomachs should probably stay away from Korea Aerospace as this promises to be a bumpy ride. Those that can take the turbulence should hold tight.

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

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