Last month, a major obstacle to the development of China’s indigenous aerospace industry appeared to be removed when the Trump administration granted a license to General Electric (GE US, $ 6.20), enabling it to supply its CFM LEAP-1C engines for China’s newest COMAC C919 passenger jet. This model is expected to compete head-to-head against the popular Boeing 737 and Airbus 320 in the global narrow-body jetliner segment in the next several years. However, given Trump’s mercurial nature and rising anti-China rhetoric, the licensing decision could be reversed overnight.
But even if this decision is ultimately reversed, China will likely find alternative engine suppliers in the United Kingdom, France and/or Russia, at least until it can effectively develop and mass-produce its own engines. For instance, in May 2018, China successfully achieved the power-on of its indigenously-developed CJ-1000AX, a high-bypass turbofan demonstrator engine originally designed for the C919 model. China developed this engine to eventually replace GE’s CFM LEAP many years into the future.
We suspect that the Trump administration will not be quick to pull back the license because of the negative employment implications in U.S. manufacturing. The global aerospace industry has suffered enormously as air travel has collapsed worldwide, but China remains one of the very few potential large-scale buyers in the market for aircraft equipment. This week, GE’s aerospace subsidiary announced 10,000 permanent payroll reductions on top of a 2,500-job cut announced last week. Together, these account for around 25% of GE Aviation’s total workforce of 52,000 worldwide.
It is possible that many of the newly-unemployed workers might eventually land in China’s aerospace and aviation sector, which would accelerate China’s move up the aerospace value chain. A similar phenomenon took place after the collapse of the Soviet Union, when many aerospace and aviation experts from Ukraine went to work for China. Richard Aboulafia, vice president at Teal Group, a market-research firm specializing in the aerospace and defense industries, recently commented: “Is there a chance China becomes its own market? Yes. You could satisfy an enormous amount of Chinese demand from about 2030 with the C919 and then you have removed [between] 25% and 30% of [global] narrow-body demand. Foreign policy is one of the biggest risks.”
Before the pandemic began, Boeing was contending with the backlash against its 737 MAX, whose faulty design contributed to two deadly crashes. Early last year, China’s aviation regulator was one of the world’s first to ground the MAX, mere hours after the Ethiopian Airlines crash on March 10th, 2019.
While the development of its own aerospace industry—a key participant in modern industrial manufacturing—has always been at the top of Beijing’s domestic policy agenda, the Boeing disasters added a new sense of urgency. In many other industries, such as home appliances, smartphones, and high-speed railways, China first began as a center of consumption, then it transformed into a center of assembly lines dependent on imported components. Out of this, China evolved into a major R&D center as more industry know-how accumulated on the mainland.
Will China’s indigenous aerospace industry repeat this experience? Only time will tell, but chances are high that it will, therefore we would not bet against Beijing’s determination to develop its domestic aerospace industry.
Case in point: China’s COMAC has already successfully achieved mass-production of the ARJ-21, an indigenously-designed single-aisle regional jet liner. Through the end of April 2020, COMAC had manufactured and delivered 24 units of the ARJ-21. There are now 596 units of the ARJ-21 in COMAC’s backlog and the company is now producing the model at a rate of one unit every 20 days (or 25–30 units per year).
Since the very first test flight of C919 in 2017, China has produced six prototypes, mainly for the purpose of testing and data collection, before going into commercial-scale production. As a result, the first C919 for commercial use is scheduled to obtain its air-worthiness certificate sometime next year and will be delivered to China Eastern, a leading domestic airline company. The C919 order-book exceeded 1,000 units as of year-end 2019.
Two listed Chinese companies that are best-suited to benefit from the rise of China’s indigenous aerospace sector are outlined below.
- AVIC Aircraft (000768 CH, CNY 17.88) is a leading Chinese developer and manufacturer of aircraft and related parts for military and commercial applications. The company designed and built the country’s first heavy airlifter, Y-20, which was delivered to the Chinese air force in 2016. AVIC Aircraft is a key supplier of the ARJ-21, C919, and AG600, which is the world’s largest amphibious aircraft.
In a major asset-restructuring program completed late last year, the company acquired a 100% equity stake in Xi’an Aircraft Industry (Group), a major supplier of the C919 jetliner, and Shaanxi Aircraft Industry (Group), a manufacturer of military aircraft. AVIC Aircraft generated 97% of its total revenue in 2019 from the aviation sector and now trades at a price-to-book ratio of 3.0x, versus its lowest P/B of 2.3x in the past five years.
- AVIC Electromechanical Systems (002013 CH, CNY 8.31) is the leading Chinese provider of electromechanical products for the military and commercial aviation industry. It provides military and commercial aircraft with a wide range of electromechanical products, such as hydraulic systems, fuel systems, environmental control systems, aviation power systems, as well as weapons suspension and launch systems.
In 2012, AVIC Electromechanical Systems went through a major restructuring under the auspices of its controller, AVIC, and has since expanded into the aviation market. This move was intended to transform the company into the electromechanical arm of the Aviation Industry Corporation of China (AVIC), a state-owned aviation conglomerate. Last year, 69% of its revenue came from the aviation industry, versus only 54% in 2014. AVIC Electromechanical Systems now trades at a price-to-book ratio of 3.1x, versus its lowest P/B of 2.2x in the past five years.