1 Chinese Defense Stock to Buy Amid Rising US-China Tensions

Pressure on increasing national defense capabilities has continued to rise in 2020. We can see that there are more provocative actions from different superpowers in the world.

The rising technological tension has caught the world’s attention, not to mention the accusation from the US government of China trying to build a maritime empire in the South China Sea.

As government military spending continues to grow, a new cold war mentality has emerged with defense and military companies enjoying the tailwind of business growth.

Here, I’ll take a look at one state-owned Chinese marine company that has silently seen its share price advance by 35% so far in 2020.

Growth of the Chinese military industry

The stellar performance of A and H shares in the military sectors has made CSSC Offshore & Marine Engineering Company (SEHK: 317) (SH: 600685), also known as COMEC, a silent winner in 2020.

Looking at the 2020 interim reports released on June, Covid-19 has hit the international shipping industry as the global shipping trade has shrunk to 17.58 million DWT (deadweight tonnage) and US$13.8 billion, representing a decrease of 50% and 62%, respectively, from last year.

As of the end of June, the volume of global orders decreased to a low not seen since 2004.

On the other hand, the order volumes of Chinese shipbuilders are relatively positive when compared to the rest of the world.

Taking advantage of active domestic demand, COMEC undertook a total of shipbuilding orders with a value of RMB 2.2 billion (US$321.5 million).

This represented a decrease of 45% in operating income due to the financing cost of the transfer of the controlling interest of Guangzhou Shipyard International Company Limited (GSI).

The military dream of China

President Xi called on the country’s military to start a new phase of military diplomacy during his remarks in a congratulatory letter to the All China Youth Federation in Beijing.

While the Communist Party has always viewed military diplomacy as an important tool for advancing China’s international presence and safeguarding national security, this has set a precedent to strengthen the People’s Liberation Army.

At present, the military industry is facing more development opportunities. Whether or not it is based on policy tailwinds, COMEC has a long-term growth foundation supported by the rigid demands of the Chinese military.

In the context of increasing combat training and maritime construction in the South China Sea, this represents an industry turning point for the company given the long-term capital growth that will support its business.

Foolish takeaway

It might be a little old fashioned to invest in not-so-transparent Chinese military stocks.

But looking at the share performance of COMEC, despite its drop in business performance, current profits should not be a guide to its underlying earnings power.

On the bright side, the company is trading at a fairly cheap price when looking at its price-to-earnings (PE) ratio compared to the industry average.

Although COMEC is trading below the industry PE ratio, the intensification of geopolitical events may mean an upward swing for military stocks on the whole.

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