JONHON Optronic:From a discounted defense name to a premium connector industry leader

Best proxy to China's weapon modernization; civil market to drive re-rating

    Rising electronic content in modern weapons is a secular trend and makesJonhon our preferred way to invest in the China army modernization theme. Ontop of that, our deep dive into China’s connector market leads us to believeJonhon is well positioned to expand its presence in the civil market. In theabsence of an asset injection story, Jonhon has long been known as a “cheap”outlier in the A-share defense sector, but its successful transformation into aconnector industry leader should help drive a re-rating; reiterating Buy.

    Defense business to grow at c.2x China’s weapon spending

    With rising electronic content in modern weapon systems and Jonhon’sincreasing penetration of non-aviation defense markets, we expect thecompany to record a CAGR of 22% for its defense business over 2016-20,nearly double our projected weapon spending growth for China (12% CAGRduring the same period). We also see upside potential from its newly-launchedintegrated product (i.e. aircraft equipment racks).

    Civil business to post a 26% CAGR vs. 10% for its addressable market

    China’s civil connector market is big but highly fragmented. Jonhon haspositioned itself in the high-end segment, with a unique focus on harshenvironments, where the competitive landscape is more favorable and importsubstitution potential is substantial. We expect the total size of Jonhon’sfocused civil markets to post a 10% CAGR to reach Rmb64bn by 2020. With astrong pipeline of new products and accelerating import substitution, weproject a 26% CAGR for its civil sales over 2016-20, accounting for c.50% oftotal by 2020 vs. 45% in 2015. Strong gov’t support, new capacity rollout andits management incentive scheme should facilitate civil market penetration.

    Reiterating Buy and target price of Rmb50; risks

    We make minor changes to our earnings forecasts. Our target price remains atRmb50, which is based on a 2017 P/E of 30x (vs. c.30% EPS CAGR over 2017-18E), largely in line with its historical mid-cycle level and the average of itsA-share listed connector peers. Key risks include an unexpected decrease inChina’s military spending and slower-than-expected civil market penetration.