The state is increasing the volume of orders to military-industrial complex enterprises. Does it make sense to buy their shares?

The defense complex is on the rise: enterprises no longer have enough workers. “We first felt a severe shortage of blue-collar jobs about a year ago,” says Larisa Krylova, deputy general director of NPO Saturn, a manufacturer of engines for civil and military aircraft. With a total staff of 18,500, the NGO was short of 300 workers. It was necessary to urgently revive the vocational school system in Rybinsk (Yaroslavl region), where the main facilities of the enterprise are located.

The revival of the industry was a consequence of government policy in recent years. The state defense order grew from $2.2 billion in 2000 to $6.7 billion in 2005, and the export of military equipment - from $3.6 billion in 2000 to $5.7 billion in 2004. At the beginning of June, President Putin said that financing the defense complex will remain a government priority for the next three years.

The shares of military-industrial complex enterprises are growing accordingly. Over the year, their total value increased by 30%. The largest trading volumes fell on two securities - shares of the Ufa Engine-Building Association (UMPO, engines for Su-30 fighters) and the Irkut aircraft manufacturing corporation (Su-30 fighters). The total trading volume on these securities in the first quarter of 2005, however, amounted to only about $6 million, but those who bought, for example, at the beginning of last year UMPO shares at $0.6 per share, could have made good money in March 2005. selling them for $2.

As for Irkut, its shares, which traded at $0.24–0.29 in the fall of 2003, were quoted at $0.8 in March 2004, immediately after the company went public. “When Irkut was floated, the idea of diversification and moving away from commodity stocks was played out well,” explains Ruslan Bulatov, a broker at the financial company CenterInvest Securities. But can we count on long-term growth in aircraft manufacturing stocks?

It is worth recalling the sad story of one of the funds of the American investment company Oppenheimer & Co (it managed assets worth $58 billion). In the mid-1990s, the idea of making money on the Russian aviation industry captivated the then successful broker from Australia, Christopher Bremner, who headed the Oppenheimer fund, registered in Bermuda.

During 1996–1997, the fund bought 10–20% stakes in more than a dozen aerospace industry enterprises, becoming one of the largest private investors in the domestic military-industrial complex. Many people in Russia have made good money from this. Due to the massive purchase of shares of the Irkutsk aircraft plant, for example, they rose in price by more than 20 times in 1997 alone. The cost of the entire Oppenheimer aircraft manufacturing package at its peak was estimated at $500 million.

But, as one of Oppenheimer's former Russian partners told Forbes, by mid-1997 Bremner realized that he had greatly overpaid. In order to increase the value of assets, the management of the fund tried to negotiate with the Russian Ministry of Economy on a coordinated vote with their stakes in order to attract funding from abroad for the projects closest to implementation (for example, the launch of the Tu-334 aircraft into production). However, then the crisis of 1998 broke out, and the government was headed by Yevgeny Primakov, who set a course for ousting foreigners from the defense industry. The result: in 1999–2000, Oppenheimer sold off its assets for an estimated $50–60 million.

The risks are still great. Shareholders of the same Irkut, who purchased the company's shares when it went public, are hardly happy today: over the past year and a half, the shares have been showing lower dynamics than the market. The reason is that a significant part of Irkut’s profits goes to repay debts accrued in previous years.

The situation is approximately the same in UMPO. After several months of unbridled growth, the company's shares began to slide down in April 2005 - reporting for the first quarter of 2005 showed a decrease in the company's revenue and profit. “Shares in the [military-industrial] sector are unlikely to perform better than the market,” predicts Ruslan Bulatov. “I think there are better ideas to be found in the resource sectors than in mechanical engineering.”

The theoretical opportunity to make quick money on “defense” securities still remains. After all, of the ten largest producers of military products, a good half are state unitary enterprises. In the coming years, according to government plans, many of them will be corporatized. Some of the securities will hit the market, and investors will again have a chance to play this roulette.

The temptation of the defense industry