Middle East tensions are disrupting Japanese aerospace and defense, but the core long-term logic remains relatively solid

Overview

This report assesses the potential impact of escalating and prolonged Middle East geopolitical tensions on Japan's aerospace and defense industry from four angles: aircraft engines and the aftermarket, gas turbines for the Middle East, raw material and petrochemical cost inflation, and defense businesses. The conclusion is that downside risks need to be monitored in the short term, but current evidence does not support a meaningful deterioration in civil aviation engine aftermarket demand; the medium- to long-term themes for energy equipment and defense remain resilient.

Core views

The core views are as follows. First, global flight activity has broadly recovered to pre-Middle East-conflict levels, and the airline seat supply outlook shows growth slowing in March and April before improving after May, so aftermarket demand for the covered companies' aircraft engines has not yet shown a clear year-on-year decline. Second, large gas turbines destined for the Middle East may see delivery delays due to geopolitical and logistics disruptions, but global GTCC supply and demand remain tight, and the long-term growth story is unchanged. Third, cost inflation has had limited impact so far because industry contracts typically include price adjustment clauses, but margin risk would emerge if inflation exceeds the clause cap. Fourth, the view on Japan's defense business is unchanged, and the 2026 budget, long-term contracts, revisions to equipment transfer rules, and Japan-U.S. joint production remain potential upside catalysts.

Analysis framework

The report combines airline seat supply, Flightradar24 global flight tracking, the RRSP business model for aircraft engines, gas turbine delivery routes, raw material and petrochemical price pass-through, as well as Japanese policy and defense budget developments, to perform top-down thematic analysis and bottom-up company-level forecast and target price adjustments for the covered companies.

Methodology notes

• Valuation methodEV/EBITDA relative valuation

  Using the Japanese aerospace and defense sub-sector average of 14x EV/EBITDA as the benchmark, a premium or discount is applied to each company and then discounted back to the target period.

  Mitsubishi Heavy Industries is valued on FY3/30E estimates with a 40% premium to the sector; Kawasaki Heavy Industries is valued on the average FY3/27E and FY3/28E EV/EBITDA with a 20% discount; IHI is valued at the sector average of 14x with no premium or discount.

• Business modelRRSP aircraft engine revenue and risk-sharing model

  As RRSP partners to global aircraft engine OEMs, Japanese companies sell new engines at low prices and earn profits through high-margin aftermarket parts and MRO.

  When new engine deliveries increase, low-margin or loss-making new engine sales come first, and changes in the share of aftermarket revenue become a key variable in aircraft engine profit forecasts.

• Scenario analysisMiddle East geopolitical transmission framework

  Assess the impact through five channels: aircraft utilization hours, logistics deliveries, fuel and raw material prices, energy security policy, and defense budgets.

  This framework is used to distinguish short-term disruptions from medium- to long-term demand resilience, avoiding a simplistic interpretation of Middle East tensions as a full-sector downturn.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Mitsubishi Heavy Industries (7011.T)

  A leading Japanese aerospace and defense company with exposure to gas turbines, energy, nuclear power, defense, and aircraft engine-related businesses.

  Strengths

  GTCC, domestic nuclear power, and defense businesses are expected to continue driving profit growth beyond 2026; Buy rating maintained and included in the Conviction List.

  Weaknesses

  There is a risk of delivery delays for Middle East GTCC projects, and FY3/27 and FY3/28 business profit forecasts were each cut by ¥10 billion.

  Comparison

  A 40% EV/EBITDA premium to the sector reflects long-term growth quality and business mix advantages.

  Risks

  A stronger-than-assumed yen, concentrated low-margin energy projects or one-time costs, and setbacks in portfolio reform could reduce overall returns.

• Kawasaki Heavy Industries (7012.T)

  Covers aircraft engines, defense, shipbuilding, and Powersports & Engine businesses.

  Strengths

  Long-term defense and shipbuilding growth is beginning to materialize, and the relative risk-reward within the sector still supports a Buy rating.

  Weaknesses

  Competition in North American four-wheel vehicle promotions remains intense, delaying the profit recovery in Powersports & Engine; the aircraft engine margin assumptions were also slightly lowered.

  Comparison

  Target price lowered from ¥4,000 to ¥3,900, with valuation based on the sector average 14x EV/EBITDA and a 20% discount.

  Risks

  Yen appreciation, aerospace and defense margins below expectations, weaker PS&E demand and incentives, deteriorating financial conditions, or a wider conglomerate discount.

• IHI (7013.T)

  Its aircraft engine business is sensitive to changes in the profit mix between new engine deliveries and aftermarket earnings.

  Strengths

  Neutral rating maintained, with a target price of ¥4,200 under the sector-average valuation framework.

  Weaknesses

  Short-term profit forecasts were lowered because of high-thrust engine deliveries, large per-unit losses, and the timing of spare parts cost recognition.

  Comparison

  No premium or discount to the sector average 14x EV/EBITDA; target price lowered from ¥4,500 to ¥4,200.

  Risks

  Deviation from exchange-rate assumptions, aircraft engine margins higher or lower than expected, and changing market views on business portfolio reform.

• Japan Steel Works (5631.T)

  Benefits from thermal and nuclear power demand through its materials and engineering business, while also having an industrial machinery business.

  Strengths

  Materials and engineering supply-demand conditions remain tight, and profit margins are expected to exceed the highs seen around the early 2010s from FY3/28 onward; Buy rating maintained.

  Weaknesses

  Assumptions for resin machinery sales and expansion-related depreciation in industrial machinery were lowered, and FY3/27 to FY3/30 operating profit forecasts for industrial machinery were cut by an average of 3%.

  Comparison

  Target price of ¥13,000 remains unchanged as a beneficiary of the global energy theme.

  Risks

  Delays in materials and engineering production, higher-than-expected fixed-cost burden from expansion investment, and weaker industrial machinery profitability.

• SKY Perfect JSAT (9412.T)

  Linked to the satellite communications and security-related profit growth theme.

  Strengths

  Compared with other companies in the sector, the report sees limited downside risk to earnings from geopolitics and cost inflation; management's increased communication on ROE is viewed positively.

  Weaknesses

  The pace of capital expenditure and shareholder returns still needs to be delivered.

  Comparison

  Buy rating and ¥4,000 target price maintained; the report expects a payout ratio above 50% from FY3/28 to FY3/30 and ¥10 billion of annual share buybacks.

  Risks

  Security-related profit growth coming in below expectations, failure to improve capital efficiency, and changes in the macro or budget environment.

• AeroEdge (7409.T)

  Primarily supplies mass-produced aircraft engine parts, with LEAP engine low-pressure turbine blades accounting for most of sales.

  Strengths

  Higher new engine production directly benefits its mass-produced parts sales; free material supply under current contracts means it is less exposed to raw material cost inflation.

  Weaknesses

  The business is highly dependent on LEAP-related mass production supply, with relatively high customer and project concentration.

  Comparison

  Buy rating and ¥6,500 target price maintained as a direct beneficiary of civil engine delivery growth.

  Risks

  A stronger-than-expected yen, delays in production or shipments, and lower-than-expected profitability on new mass-production orders.

Key data

• Airline seat supply outlookAbout +3% year on year in March and April 2026, and about +6% year on year in MayGrowth slows to the low single digits in March and April, then is expected to return to a higher level from May onward.
• Global flight activityFlightradar24 data show it has broadly recovered to pre-Middle East-conflict levelsDetours around Middle Eastern airspace may lengthen flight times and, in some cases, increase engine operating hours.
• Mitsubishi Heavy Industries target price¥6,000, Buy, Conviction ListTarget price maintained; FY3/27 and FY3/28 business profit forecasts were each cut by ¥10 billion.
• Kawasaki Heavy Industries target price¥3,900, Buy, prior ¥4,000FY3/27 and FY3/28 business profit forecasts were cut by 3% and 2%, respectively.
• IHI target price¥4,200, Neutral, prior ¥4,500FY3/26 to FY3/27 business profit forecasts were lowered by 3% versus previously.
• Japan Steel Works target price¥13,000, BuyRating and target price maintained, benefiting from the global energy theme.
• SKY Perfect JSAT target price¥4,000, BuyRating and target price maintained; the report sees limited downside from geopolitics and cost inflation.
• AeroEdge target price¥6,500, BuyRating and target price maintained; the supply contract for LEAP engine low-pressure turbine blades reduces the impact of raw material cost inflation.
• GTCC assumption adjustmentAverage sales reduced by 5% for FY3/27 to FY3/28, with shortages pushed back to FY3/29 and beyondThis reflects the risk of delayed GTCC deliveries to the Middle East, but overall supply-demand tightness remains unchanged.

Impact & implications

In terms of investment implications, the report does not turn fully defensive because of Middle East tensions; instead, it splits the impact into short-term earnings disruptions and the continuation of long-term themes. The aircraft engine chain needs to track aftermarket demand and the profit structure of new engine deliveries. Energy equipment continues to be supported by tight GTCC supply-demand, coal-fired power maintenance, hydrogen and ammonia, and energy security. The defense chain continues to be driven by Japan's budget and Japan-U.S. cooperation. The target price cuts mainly reflect company-level earnings forecast and balance sheet assumption revisions rather than a fundamental reversal in industry logic.

Risks

• Higher jet fuel prices could raise airline operating costs, which in turn may affect engine flight hours and aftermarket demand.
• If Middle East geopolitical and logistics disruptions persist, deliveries of large gas turbines to the Middle East could be delayed.
• If rising costs for raw materials, petrochemicals, and CFRP structural parts exceed the cap of price adjustment clauses, margins may be compressed.
• A stronger yen than assumed by analysts would affect the earnings of many Japanese exporters and global businesses.
• Rising new engine deliveries may initially bring low-margin or loss-making sales, temporarily worsening the profit mix in the aircraft engine business.
• If Japan's defense budget, equipment transfer rules, or Japan-U.S. joint production progress falls short of expectations, the defense theme catalyst could weaken.

What to watch

• Whether global flight activity on Flightradar24, airline seat supply, and engine operating hours continue to recover.
• The pass-through pace of jet fuel prices, crude oil prices, petrochemicals, and carbon fiber composite materials.
• Whether logistics, delivery schedules, and revenue recognition for Middle East GTCC orders are materially delayed.
• Progress on Japan's FY3/28 defense budget, long-term defense contracts, and revisions to the three principles of equipment transfer.
• Whether restrictions on low-efficiency coal-fired power plant operations in Japan are eased, and whether policies related to IGCC, hydrogen, and ammonia accelerate.
• Whether Kawasaki's North American Powersports & Engine promotional environment eases.
• Whether SKY Perfect JSAT management's ROE targets, dividends, and buybacks are delivered.