Avicopter:Take-off in the price;initiating with Hold

Strong growth potential looks priced in; initiating with Hold

    As China's largest helicopter manufacturer, we believe Avicopter is wellpositioned to ride on China's multi-year up-cycle in both the military and civilhelicoptermarkets. We expect the company to record an EPS CAGR of 32%during 2015-2017. Further asset injections seem likely but near-term visibilityremains low. After a 26% share price rally in the past month, we believe mostpositives may have been priced in. Therefore we initiate coverage with a Holdrating and a target price of Rmb63.2.

    Military helicopter demand to remain elevated; further asset injections likely

    In light of the ongoing expansion of PLA army aviation branch and acceleratingfleet upgrade cycle, we expect China’s military helicopter inventory to doubleby 2020. With Avicopter’s order backlog reaching a historical high, we expectearnings visibility to remain high in the coming years. Moreover, a further assetinjection of AVIC Helicopter’s final assembly business seems to be aconceivable next move given Avicopter is the only listing vehicle within AVIC’shelicopter segment. However, visibility of value accretion appears low.

    Civil helicopters to emerge as a new source of growth in the medium term

    In light of the anticipated opening up of China’s low-altitude airspace, we seesubstantial growth potential for China’s civil helicopter market. We forecast a25% CAGR for China’s civil helicopter fleet during 2015-2020. With a strongpipeline of new models, Avicopter is well positioned to capture such growthpotential. The rising contribution from the civil market should also lead toimproved profitability in the medium-to-long term.

    Valuation and risks

    We use an EV/Sales-based valuation methodology across all A-share listeddefense airframers, as their earnings are largely constricted by the current“cost-plus-5%” pricing mechanism for military products. Our target price ofRmb63.2 is derived based on 2.1x FY16 EV/Sales, which is one standarddeviation above its mid-cycle level in the past five years, and is justifiable givenits accelerated growth and potential asset injection. Key risks includefaster/slower-than-expected delivery of military helicopter orders and valueaccretive/dilutive asset injections.