Deutsche Bank Markets Research

Rating Company Date 3 March 2017 Buy Shenzhen Inovance Company Update Asia China Reuters Bloomberg Exchange Ticker Price at 2 Mar 2017 (CNY) 21.91 Industrials 300124.SZ 3000124 CH SHZ 300124 Price target - 12mth (CNY) 26.80 Manufacturing 52-week range (CNY) 22.10 - 16.00

Shenzhen Index 2,090

NEV powertrain trip reaffirms our Sky Hong, CFA Nick Zheng, CFA positive stance Research Analyst Research Analyst (+852 ) 2203 6131 (+852 ) 2203 6198 Huge potential for China's NEV market and Inovance is well positioned [email protected] [email protected] We visited major NEV (new energy vehicles) powertrain OEMs in China recently, which strengthened our confidence in Inovance. Most powertrain OEMs are upbeat about China's long-term NEV growth potential, despite short- Price/price relative term headwinds. While third-party OEMs and automakers equally share the 40 powertrain market at the moment, OEMs will likely gradually gain market share 36 32 as NEV sales rise. We like Inovance's strategic positioning in the NEV 28 powertrain market, which we believe will be a major growth driver from 2018. 24 20 Powertrain OEMs remain positive on China’s NEV market 16 12 Most OEMs believe China’s NEV market is intact, despite a subsidy cheating 3/15 9/15 3/16 9/16 issue. The fall in NEV subsidies creates short-term headwinds but many view it Shenzhen Inovance Te as a long-term positive that will help accelerate industry consolidation. OEMs Shenzhen Index (Rebased) focusing on passenger NEV are more bullish, guiding 70-100% sales growth Performance (%) 1m 3m 12m for 2017, while commercial NEV-focused OEMs (including Inovance) expect 30-50% growth, driven by logistics NEVs. Margins are under downward Absolute 6.4 4.8 27.6 pressure in 2017 on ASP cuts (10-20%), but rising economies of scale and Shenzhen Index 4.2 -4.2 13.5 production process upgrades could potentially mitigate this. Source: Deutsche Bank

External sourcing vs. in-house production The current market share split is 50%/50%, but third-party OEMs are likely to Related recent research Date prevail over automakers, going forward. Automakers’ intention to master the Shenzhen Inovance: The next 12 Sep 2016 core technology is obvious but most local NEV automakers are final assemblers driver - passenger NEV; raising earnings and target price that lack the R&D capability to support in-house production. Moreover, when Sky Hong, CFA production volume ramps up significantly, substantial quality risk and cost China Industrial Automation: 16 Feb 2017 pressure would emerge, which would make in-house production less optimal. 4Q16 - a V-shaped recovery By building a world-class supply-chain system, partnering with Brusa to formed; strong momentum to strengthen its technology in motors and reduction drive, and leveraging on its sustain sharp market insights, Inovance is well positioned for the rising NEV market. Sky Hong, CFA Source: Deutsche Bank

Reiterating Buy; risks We retain our earnings forecasts and our DCF-based target price of Rmb26.8 (WACC: 8% and TGR: 2%). We reiterate Buy as Inovance’s medium-term growth outlook has strengthened with a continuing recovery in China’s IA market and an emerging passenger NEV drive business (c.25% of sales by 2020). Downside risks: slower-than-expected NEV growth and an IA demand recovery.

Forecasts And Ratios Year End Dec 31 2014A 2015A 2016E 2017E 2018E Sales (CNYm) 2,242.6 2,770.5 3,515.3 4,268.5 5,461.8 EBITDA (CNYm) 749.4 912.0 1,101.6 1,355.1 1,705.4 Reported NPAT (CNYm) 666.3 809.3 963.0 1,170.2 1,475.8 DB EPS FD(CNY) 0.43 0.51 0.61 0.74 0.93 DB EPS growth (%) 18.2 20.1 18.1 21.5 26.1 PER (x) 34.4 42.3 36.2 29.8 23.6 Source: Deutsche Bank estimates, company data 1 DB EPS is fully diluted and excludes non-recurring items 2 Multiples and yields calculations use average historical prices for past years and spot prices for current and future years, except P/B which uses the year end close

______Deutsche Bank AG/Hong Kong Distributed on: 03/03/2017 05:01:19 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.

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Model updated:16 January 2017 Fiscal year end 31-Dec 2013 2014 2015 2016E 2017E 2018E

Running the numbers Financial Summary Asia DB EPS (CNY) 0.36 0.43 0.51 0.61 0.74 0.93 Reported EPS (CNY) 0.36 0.43 0.51 0.61 0.74 0.93 China DPS (CNY) 1.00 0.50 0.50 0.18 0.22 0.28 BVPS (CNY) 7.9 4.4 5.1 2.9 3.5 4.2 Manufacturing Weighted average shares (m) 1,550 1,560 1,578 1,590 1,590 1,590 Shenzhen Inovance Technolog Average market cap (CNYm) 14,305 22,933 34,216 34,846 34,846 34,846 Enterprise value (CNYm) 12,367 21,271 33,051 33,309 32,560 31,554 Reuters: 300124.SZ Bloomberg: 3000124 CH Valuation Metrics P/E (DB) (x) 25.5 34.4 42.3 36.2 29.8 23.6 Buy P/E (Reported) (x) 25.5 34.4 42.3 36.2 29.8 23.6 Price (2 Mar 17) CNY 21.91 P/BV (x) 1.78 3.21 4.56 7.53 6.33 5.25

Target Price CNY 26.80 FCF Yield (%) 2.7 1.7 1.7 2.1 2.9 3.7 Dividend Yield (%) 10.8 3.4 2.3 0.8 1.0 1.3 52 Week range CNY 16.00 - 22.10 EV/Sales (x) 7.2 9.5 11.9 9.5 7.6 5.8 Market Cap (m) CNYm 34,846 EV/EBITDA (x) 19.6 28.4 36.2 30.2 24.0 18.5 EV/EBIT (x) 20.6 30.1 38.4 32.3 25.5 19.5 USDm 5,063 Income Statement (CNYm) Company Profile Sales revenue 1,726 2,243 2,771 3,515 4,268 5,462 Founded in 2003, Shenzhen Inovance mainly focuses on Gross profit 912 1,127 1,343 1,694 2,044 2,588 R&D, manufacture and sales of industrial automation EBITDA 632 749 912 1,102 1,355 1,705 products. The company's product portfolio includes low- Depreciation 22 26 32 46 50 54 voltage inverters, servo systems, PLCs, HMIs, specialized Amortisation 9 16 19 25 28 34 control & drive system for elevators, new energy vehicle EBIT 601 707 862 1,031 1,277 1,617 controllers and traction & control system for rail. Net interest income(expense) 67 69 45 57 78 111 Associates/affiliates 0 -1 -1 0 0 0 Exceptionals/extraordinaries 0 0 0 0 0 0 Other pre-tax income/(expense) -1 0 0 0 0 0 Profit before tax 667 775 905 1,088 1,355 1,728 Price Performance Income tax expense 98 85 71 95 149 207 Minorities 9 24 25 29 36 45 40 Other post-tax income/(expense) 0 0 0 0 0 0 36 Net profit 560 666 809 963 1,170 1,476 32 28 DB adjustments (including dilution) 0 0 0 0 0 0 24 DB Net profit 560 666 809 963 1,170 1,476 20 16 Cash Flow (CNYm) 12 Mar 15Jun 15Sep 15Dec 15Mar 16Jun 16Sep 16Dec 16 Cash flow from operations 452 524 802 881 1,137 1,436 Net Capex -71 -127 -207 -139 -142 -145 Shenzhen Inovance Technolog Free cash flow 381 397 594 742 995 1,291 Shenzhen Index (Rebased) Equity raised/(bought back) 21 77 190 0 0 0 Margin Trends Dividends paid -237 -401 -411 -398 -289 -351 Net inc/(dec) in borrowings 0 0 -5 -2 0 -3 38 Other investing/financing cash flows -99 63 -495 57 78 111 36 Net cash flow 67 137 -127 399 784 1,048 35 Change in working capital -94 -148 -30 -125 -69 -62 33 32 Balance Sheet (CNYm) 30 Cash and other liquid assets 2,100 1,836 1,408 1,807 2,591 3,640 29 Tangible fixed assets 297 455 595 608 621 633 13 14 15 16E 17E 18E Goodwill/intangible assets 167 157 459 516 568 612 EBITDA Margin EBIT Margin Associates/investments 0 4 3 3 3 3

Other assets 1,231 2,220 3,483 3,994 4,505 5,250 Growth & Profitability Total assets 3,795 4,671 5,947 6,929 8,288 10,138 Interest bearing debt 0 0 15 13 13 10 35 30 Other liabilities 562 1,025 1,642 2,031 2,473 3,156 30 25 Total liabilities 562 1,025 1,657 2,044 2,486 3,167 25 20 Shareholders' equity 3,072 3,468 4,060 4,625 5,506 6,631 20 15 15 Minorities 162 178 230 260 295 340 10 10 Total shareholders' equity 3,234 3,646 4,290 4,885 5,802 6,971 5 5 Net debt -2,100 -1,836 -1,393 -1,794 -2,578 -3,629 0 0 13 14 15 16E 17E 18E Key Company Metrics Sales growth (%) nm 29.9 23.5 26.9 21.4 28.0 Sales growth (LHS) ROE (RHS)

DB EPS growth (%) na 18.2 20.1 18.1 21.5 26.1 Solvency EBITDA Margin (%) 36.6 33.4 32.9 31.3 31.7 31.2 EBIT Margin (%) 34.8 31.5 31.1 29.3 29.9 29.6 0 Payout ratio (%) 276.7 117.0 97.5 30.0 30.0 30.0 -10 ROE (%) 18.2 20.4 21.5 22.2 23.1 24.3 -20 Capex/sales (%) 4.1 5.7 7.5 4.0 3.3 2.7 -30 Capex/depreciation (x) 2.3 3.0 4.1 2.0 1.8 1.6 -40 Net debt/equity (%) -65.0 -50.3 -32.5 -36.7 -44.4 -52.1 -50 -60 Net interest cover (x) nm nm nm nm nm nm

-70 Source: Company data, Deutsche Bank estimates 13 14 15 16E 17E 18E

Net debt/equity (LHS) Net interest cover (RHS)

Sky Hong, CFA +852 2203 6131 [email protected]

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Summary of key findings

Who did we visit during this trip?

Figure 1: Major NEV controller/motor suppliers and their exposure to NEV brands (the companies we visited are highlighted in grey) English names UAES Shanghai E-drive Huayu Auto Dajun Tech Inovance V&T JJE JEE

Chinese names 联合汽车电子 上海电驱动 华域汽车 上海大郡 汇川技术 蓝海华腾 精进电动 安徽巨一 Passenger NEV SAIC √ √ √ √ FAW √ √ √ Great Wall √ √ BAIC √ √ √ √ √ √ √ Dongfeng √ √ √ JAC √ √ √ Brilliance √ GAC √ √ √ Zotye √ √ √ Commercial NEV √ √ √ Bus √ √ √ Foton √ √ Suzhou Kinglong √ √ √ Nanjing Kinglong √ √ √ √ Xiamen Kinglong √ √ √ √ Xiamen √ √ Source: Company data, Deutsche Bank

Figure 2: China’s NEV controller market share Figure 3: China’s NEV motor market share breakdown breakdown (2016) (2016)

Others BYD BYD Others 35% 25% 25% 37%

Gen-weill BAIC BAIC 2% 9% Zotye 9% 3%

Zotye Yutong Bus UAES 3% Deyang 5% JMEV 7% Electronics 3% 3% JEE JEE Shanghai E- Deyang Shanghai E- JMEV 4% 4% Shenzhen JJE drive Electronics drive 3% UAES Inovance 3% 4% 3% 4% 5% 4% Source: GGII, Deutsche Bank Source: GGII, Deutsche Bank

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Three key questions answered

Question #1: What are third-party motor/controller OEMs’ views on China’s NEV market and their growth outlook? They are upbeat in general. The government’s determination to promote NEV is clear and most motor/controller OEMs we visited believe the country’s NEV development targets will be achieved. Three key rationales behind China’s push for NEV are frequently mentioned: 1) energy structure; 2) pollution concerns; and 3) ambition for technology leadership.

The revised NEV subsidy scheme might bring about short-term headwinds, but many view it as long-term positive, as industry consolidation will accelerate.

For 2017, OEMs with significant exposure to passenger NEV (e.g. Shanghai Edrive and Dajun Tech) appear more optimistic on growth, expecting 70-100% YoY growth. Those with substantial exposure to commercial NEV, on the other hand, are guiding for 30-50% YoY growth, driven by logistics NEV, as sales of NEV bus drives are expected to remain flattish YoY.

Question #2: How will the competitive landscape for the NEV powertrain market evolve in China – OEMs vs. in-house production in particular? Most believe OEMs will likely gain market share going forward, compared to the 50/50 split between third-party OEMs and in-house production.

NEV makers’ decisions between external sourcing and in-house production vary, depending on the different stage of development and each automaker’s R&D capability. NEV makers’ intention to master the technology know-how is beyond doubt. Many OEMs believe this is a way for automakers to gain more bargaining power, but in reality, few of them have strong enough R&D capability to support the in-house production of powertrain.

In addition, when volume significantly rises, in-house production may not be The consolidation of the home an optimal way forward, not only from a cost perspective but also from a risk appliance motor sector is a perspective. good case in point.

Having a strong supply-chain system is frequently cited as the key barrier to entry for passenger NEV powertrain. On this front, traditional auto component makers, like UAES and Huayu, seem to have a natural advantage while earlier movers, like Shanghai Edrive and Dajun Tech, have put themselves in a favorable position. That said, the competitive landscape is yet to be shaped, until volume significantly ramps up (likely in 2018-19).

Question #3: What are the implications for Inovance? We believe Inovance is well positioned to China’s NEV growth.

 Establishing a strong supply-chain system is its priority in 2017 (the company is preparing to acquire ISO26262 and TS16949 certification), which should prepare them when passenger NEVs take off in 2018-19.

 Inovance’s technology know-how for NEV controllers is widely recognized by its competitors. We believe its technology partnership with Brusa should address its weakness in motors and reduction drives.

 Inovance has a proven track record in IA and the NEV bus segment and has been known for its accurate market insights on customer needs.

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Detailed trip notes

Broad-Ocean Motors (002249.SZ)

Company background  Founded in 1994 and listed on the Shenzhen Stock Exchange, Broad- Ocean has mainly focused on the manufacture and sale of motors for the home appliance industry (air conditioners, office equipment, ventilators, etc.)

 The company entered the NEV market in early 2009 through strategic cooperation with the Beijing Institute of Technology and later strengthened its positioning alongside the NEV supply chain through a series of acquisitions and equity investments, including Prestolite Electric (2013 and 2015), Generator Automotive (2011) and Shanghai Edrive (2016) and Ballard (2016).

 Other than the NEV component business, the company has also been expanding its NEV business portfolio by entering NEV finance, charging facilities, insurance, etc. View on China’s NEV market  China’s NEV market has been a policy-driven market.

 The government has expressed clear support to the industry by labeling it as one of the country’s “pillar industries” recently (vs. a strategic emerging industry previously).

 From an economic perspective, China is coal-abundant but oil-deficient. Annual vehicle sales already exceed 20m units, which has not only put a huge burden on oil consumption but also raised pollution concerns. Implications of revised subsidy scheme  In the near term, the company sees a negative impact on the industry’s growth and profitability. Broad-Ocean expects 10-15% ASP reduction for its NEV powertrain products this year.

 The company has identified two positive drivers that could potentially cushion the ASP pressure including: 1) economies of scale (raw material cost saving) and 2) production process upgrades (e.g. by introducing molding and tooling).

 In the longer term, this should benefit the industry, as it lifts the barriers to entry and concerns on oversupply. The company expects its long-term sustainable net margin for NEV powertrain to reach 10% (vs. 6-8% currently), similar to the current level for its home appliance motor business. Acquisition of Shanghai Edrive  Shanghai Edrive is one of the few first movers in China’s NEV powertrain market, with a wide coverage of customers and technology reserves.

 By combining Broad-Ocean’s rich experience in the industrialization of motor businesses and Shanghai Edrive’s strong R&D capability in the NEV powertrain segment, the company sees synergies from the acquisition.

 Following the acquisition, the company has reorganized its NEV business segment by appointing Shanghai Edrive’s president as the new segment

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lead. Broad-Ocean has also sent a VP from its home appliance motor segment to help improve production efficiency. Competitive landscape for NEV powertrain in China  Auto producers have the clear intention to master the core technology but in reality, many local producers do not have strong enough R&D capabilities (capital is not the key, technology is). At the current stage, in- house R&D, partnership with OEMs, and sourcing from third-parties are all viable options.

 As a case in point, home appliance manufacturers used to produce motors in-house, as they viewed them as a core component. Nevertheless, as the industry matures, their motor operations have either been acquired or consolidated by third-party OEMs.

 In the long term, the company believes third-party OEMs have competitive advantages over auto makers, as they can capture the demand for the entire industry.

 The company believes Inovance has very good technology in NEV controllers and is a strong competitor. That said, its competitiveness in motors and the industrialization of its NEV powertrain business is yet to be proven.

 The company expects Shanghai Edrive’s market share (excluding auto producers) to reach 30-40% in the medium-to-long-term. Broad-Ocean expects its NEV business to post a CAGR of 50% in the coming years (+100% YoY in the coming two years). Shenzhen V&T (300484.SZ)

Company background  Shenzhen V&T is a Shenzhen-based company that is mainly engaged in the research, development, manufacture and sale of medium- and low- voltage inverters and motor controllers.

 The company was listed in Shenzhen GEM in 2016. V&T’s NEV business exposure and competitive landscape  c.80% of its total sales come from its NEV drive business (for commercial NEV), half of which is derived from logistics NEVs.

 The company currently only focuses on NEV controllers. Its motors are mainly sourced from Jiangte Motor and Hepu Power.

 Key customers include Dongfeng (logistics NEV), (NEV bus), and WUTEP (NEV bus).

 The company expects to launch passenger NEV controller products in 2017 and expand its production capacity if needed.

 The company believes integrated powertrain is the future trend for passenger NEV. However, due to limited resources, V&T does not plan to expand into the NEV powertrain business at the moment.

 V&T believes only those automakers with strong R&D capabilities and financial strength may go with in-house production for controllers/motors. Third-party OEMs have a clear cost advantage and more expertise.

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Growth outlook for NEV drive business  The company expects its total sales to grow 30% YoY in 2017 and the NEV segment should see higher growth.

 For 2017, V&T expects logistics NEV to be the key growth driver, with sales likely doubling. Implications of revised subsidy scheme  V&T is still in negotiation with NEV producers to finalize the ASP reduction.

 GPM for the NEV segment was down 2-3ppts YoY in 2016 and the company expects this year’s GPM drop to be bigger than last year’s. Shenzhen Inovance (300124.SZ)

Growth guidance for NEV segment  Inovance guides for 30-50% YoY growth for the NEV segment in 2017 (vs. 30% guided previously).

 The incrementally more positive guidance is mainly because of: 1) higher penetration in non-Yutong commercial NEV customers (by supplying auxiliary controllers and motors) including BYD, Zhongtong, King Long, Yinlong, etc. and 2) a rising sales contribution from logistics NEV (Rmb200m guided for 2017).

 Key customers in the logistics NEV segment include Dongfeng and Shaanxi Kissun Auto. Implications of revised subsidy scheme  ASP reduction for NEV bus controllers has not yet been finalized by Yutong. At the moment, Inovance is expecting a 10-15% ASP cut for 2017 (vs. >20% anticipated previously).

 The company expects the sales contribution from Yutong to stay flat YoY in 2017, with the volume increase largely offset by the ASP reduction. Progress on passenger NEV powertrain business  Major local competitors in the passenger NEV segment include Shanghai Edrive and Shanghai Dajun Technology.

 Inovance is currently supplying auxiliary controller products in small batches to passenger NEV customers like Zotye, Dongfeng- and BAIC Yinxiang.

 Inovance will focus on establishing a comprehensive supply system that can meet automakers’ requirement for R&D, production, sales, and quality control. Inovance aims to obtain ISO26262 and TS16949 certification and benchmark its system to Bosch and Continental.

 Inovance is working closely with Brusa to develop its powertrain system for passenger NEV. Brusa will help the company on the motor design.

 Brusa has been strengthening its technology partnership with Volkswagen, which should help Inovance’s brand extension in the future.

 The company expects its passenger NEV powertrain business to take off in 2018.

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Gaogong Industry Institute

Company background Gaogong Industry Institute is an independent research firm specializing in new energy vehicles and NEV components, including NEV motors, NEV controllers and NEV batteries.

View on China’s NEV market  Competition for China’s NEV market will be primarily in the passenger NEV segment, led by domestic players. JV brands will likely enter the PHEV market first and then the EV market when the subsidy is phased out.

 The NEV bus market is dominated by Yutong, Zhongtong, and King Long. Gaogong expects sales of the 8-10m long NEV bus to take off after the introduction of the revised subsidy scheme, as the government has significantly slashed the subsidy for the 6-8m long NEV bus.

 Lower barriers to entry has caused intensifying competition in China’s logistics NEV segment, with light vehicles (<3.5 tons) being the mainstream vehicle type. Dongfeng and Kissun are among the top players in this segment.

 Sales volume for logistics NEV jumped in 4Q16 following its inclusion in the fourth/fifth NEV catalogue.

 Gaogong projects sales volume for passenger NEV/NEV bus/specialized NEV to post a CAGR of 57%/14%/55% respectively during 2017-2020. View on China’s NEV motor/controller market  NEV makers like BYD/Yutong/Zhuzhou CRRC internally develop and produce controllers/motors to retain core competitiveness. BYD dominated the passenger NEV motor/controller market, while Yutong (through an exclusive controller supply agreement with Inovance) dominated the NEV bus motor/controller market.

 Permanent magnet synchronous motors will be the mainstream product because of higher power density, efficiency, durability, etc.

 The power density of electric motors produced by local players is significantly lower than for those produced by foreign players. The government aims to narrow the gap substantially by 2020.

 The current average ASP for controllers/motors is Rmb250/KW. Gaogong expects the unit pricing to fall to Rmb200/KW in 2017 and Rmb100/KW by 2020. OEMs’ costs can be reduced via economies of scale and product integration (i.e. by integrating controllers, motors and reduction drives into powertrain systems).

 Major local players are expanding their production capacity in the hope of the passenger NEV market taking off.

 Overall, Gaogong projects China’s NEV controller/motor market to post a CAGR of 39% (2017-20) to reach Rmb59bn by 2020. Implications of revised subsidy scheme  China’s NEV market has been a policy-driven market and 2016 was the year of transition in terms of government policy. Investigation results in relation to subsidy cheating were unveiled in September, and the revised subsidy scheme was released in December. Over 30 industry policies were introduced last year, 40% of which are regulation-related.

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 Under the revised subsidy scheme, the local government subsidy should not exceed 50% of the central government subsidy, and eligibility for the subsidy has been tightened.

 In the near term, the revised scheme may put pressure on NEV makers’ profitability but should bring about long-term positives for the sector as the industry consolidates.

 The government is currently exploring new policy measures like a “dual- credit system” to stimulate the market and mitigate the subsidy pressure.

 Gaogong estimates that component producers could sustain a 10%-20% ASP drop every year, against the backdrop of subsidy phase-out and rising raw material costs. United Automotive Electronic Systems (UAES)

Company background  A between SAIC’s subsidiary – Zhong-Lian Automotive Electronics (49%) and Robert Bosch (51%).

 The product portfolio includes: gasoline engine management systems, transmission control systems, body electronics and components, and hybrid and electric vehicle power train systems and components.

 The NEV powertrain segment was established in 2009 and the segment’s main operation is in Shanghai.

 It has three R&D centers (Shanghai, Wuhu and Chongqing) and six production plants (Xi’an, Wuxi, Shanghai, Liuzhou, Wuhu and Chongqing).

 Total revenue was Rmb18.5bn in 2016. View on China’s NEV market and growth  UAES expects China’s total NEV sales volume (including EV, PHEV and hybrid vehicle) to reach 2.73m units by 2020 and 5.83m units by 2025.

 Its NEV powertrain business (mainly for passenger NEV) has been growing rapidly in the past few years, with its sales reaching Rmb700-800m in 2016 (vs. Rmb100m in 2014 and Rmb300m in 2015).

 EV will be the development priority for China in the coming 3-5 years as hybrid vehicles and PHEV will require ICE technology which China lacks.

 By 2025, UAES expects the market share split between local and JV auto brands to be 38%/62%. In terms of different types of NEVs, the company expects EV, PHEV and hybrid vehicles to account for 36%, 42% and 22% respectively by 2025. Implications of revised subsidy scheme and NEV policy  The revision is negative for demand and profitability but in the long term, when the supply chain matures after volume ramps, costs should also see a significant reduction.

 China is considering introducing a dual-credit scheme for gasoline cars’ fuel consumption and NEV production. The draft policy was unveiled by MIIT in September 2016.

 The scheme has outlined fixed percentage points of credits that automakers must earn from 2018 by producing new energy cars, and such credits can be used to enhance their gasoline fuel consumption efforts, so they have a clear goal at the very beginning.

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 According to the proposed scheme, new energy vehicles' credits should account for 8% of an automaker's total in 2018, 10% in 2019 and 12% in 2020, with one new energy vehicle calculated as two to five units, depending on their mileage on one charge.

 If such a scheme were to be implemented in 2018, this would imply annual NEV sales volume of c.2m units, based on the 8% target. Competitive landscape for NEV powertrain in China  In the longer term, UAES believes in-house production should only account for small portion of the overall market.

 Possible rationales for BYD to produce motors/controllers in-house: 1) existing OEMs’ resources are unable to fully meet their requirement; 2) cost control; 3) mastering the technology know-how would give it more bargaining power over OEMs in the future.

 NEV makers’ volume is still small at the moment. When volume ramps up significantly to 100k units, significant risks will emerge (recall risk in particular).

 The upfront R&D investment for NEV makers to develop their own powertrain system internally is insignificant, therefore should not be the reason for them to stick to in-house production in the future.

 Third-party OEMs will have significant cost advantages when volume ramps up and industrialization is complete.

 Keys for third-party OEMs to survive: 1) customer relationships in the auto industry; 2) track record; 3) a strong system for production and quality management that can meet automakers’ requirements; 4) technology platform and R&D personnel.

 Market share for China’s NEV powertrain sector at the moment is not very meaningful, as UAES believes 2009-16 is an important period for OEMs to position themselves, while the competitive landscape should be clearer in 2018-19. Shanghai Edrive

Company background  Established in 2008, Shanghai Edrive focuses on the R&D, manufacture, and sale of e-motor systems which are mainly used in new energy vehicles. Its main products are used in all kinds of new energy passenger cars, commercial cars, special vehicles, etc. The company has become the industry's leading supplier in solutions for e-motor systems in China’s NEV industry.

 In January 2016, Shanghai Edrive was wholly acquired by Broad-Ocean (002249.SZ).

 Key customers include: FAW, Chery, Chang’an, SAIC, Dongfeng, Geely, JAC, Brilliance, Great Wall, Zhonghua, GAC, Zhongtong, Hengtong, Yutong, Sunwin and King Long. View on China’s NEV market and growth  Three reasons for China to promote NEV: 1) energy security; 2) pollution concerns; and 3) auto industry upgrades.

 In terms of different types of NEV, China will likely prioritize the development of EVs (especially for PVs) to overcome its weakness in ICE

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(internal combustion engine) technology. In contrast, Japan will mainly focus on hybrid vehicles while the US will likely promote PHEV.

 The company guides for a total revenue of Rmb130-150m for 2017 (or 30- 50% YoY growth vs. 2016’s Rmb100m). Implications of revised subsidy scheme  The company believes the revised subsidy scheme is positive for the industry in the longer-term. It should accelerate the industry consolidation and enhance the competitiveness of China’s NEV industry.

 ASP reduction was roughly 15-20% in the past couple of years and the company expects another 15-20% pricing cut this year. Long-term sustainable net margin for NEV powertrain producers is around 5-10%.

 To mitigate the pricing pressure and rising raw material costs, the company plans to upgrade its production process to lower the overall production costs. Shanghai Edrive believes the scope for cost reduction is substantial if volume ramps up. Competitive landscape for NEV powertrain market in China  The two rationales for auto producers to source powertrain externally: 1) unlike traditional vehicles, NEV’s design is less dependent on powertrain; and 2) cost concerns when volume ramps up.

 The barriers to entry for commercial NEV powertrain (including bus and logistics vehicles) are lower than for passenger NEV powertrain. Passenger NEV makers have very high requirements for production and quality management systems. Most PV producers have their own system certification for production and quality management. Once component makers obtain the qualification, auto producers (especially those foreign brands) will work with them to further improve their system. Typically, it takes 2-3 years for auto producers and OEMs to work together to test controllers/motors. Therefore, the switching cost is high once the relationship is established.

 Integrated drive products (controller + motor) are only adopted by large commercial NEV producers, like Yutong and Foton. Most other commercial NEV producers are just final assemblers.

 Most passenger NEV producers intend to master the core technology to increase their bargaining power over suppliers. That said, it’s very difficult for auto producers to develop powertrain systems from scratch. Therefore, most passenger NEV producers would choose to partner with third-party OEMs at the beginning.

 In the longer term, when the supply chain matures, controllers and motors will likely be sourced from different suppliers. Economies for customized powertrain for passenger NEV could be low when production is in small batches.

 Shanghai Edrive aims to achieve 30-40% share in China’s NEV powertrain market (excluding in-house production) in five years. The remaining 60- 70% will be controlled by 3-5 OEMs. The company views Inovance as a meaningful competitor in the NEV controller segment. Local passenger NEV controller/motor competitors include Shanghai Dajun Technology and Jing-Jin Electric Technologies.

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Shanghai Dajun Technology – Investor Day takeaways

Company background Established in 2005, Shanghai Dajun Tech focuses on the R&D, manufacture, and sale of electric motor systems used in Hybrid Electric Vehicles (HEV) and Electric Vehicles (EV), the main products are used in all kinds of new energy passenger cars, commercial cars, special vehicles, etc. and it has become the industry's leading supplier in offering solutions for NEV motor systems.

 In April 2015, it was acquired by Zhenghai Magnetic Material (300224.SZ)

 Key customers include: Geely, Zotye, BAIC, GAC and Dongfeng

 Total NEV drive sales were Rmb700m, of which Rmb300m was derived from passenger NEV and Rmb400m came from commercial NEV.

 Total production capacity is 100k units of motors p.a. and total sales volume was 32k units in 2016 (6% market share according to the company). View on China’s NEV market and growth  Dajun expects China’s installed base for NEV to reach 5m units and annual production volume to reach 2m units by 2020.

 The company expects China’s total production volume for NEV motor/controller to reach 700k-800k units in 2017.

 Dajun is bullish on its NEV drive business, expecting sales to reach Rmb1.2bn in 2017 (or +70% YoY vs. Rmb700m in 2016). Sales split between passenger NEV and commercial NEV is expected to be 70%/30%.

 Dajun’s key customers, namely BAIC and GAC, set out aggressive production plans for NEV. More specifically, BAIC plans to sell/produce 170k units of NEVs in 2017 compared to 15k units in 2016. Dajun mainly supplies motor to BAIC’s EC series and has the lion’s share of the market in these models. In the meantime, GAC’s NEV production plan looks for 15k units in 2017 vs. c.4k units in 2016.

 The company has been actively positioning in the logistics NEV drive segment, which will be one of Dajun’s focuses for 2017. Implications of revised subsidy scheme  ASP for Dajun’s NEV drive was down 15% (for both commercial and passenger NEV) and the company expects the ASP reduction to continue after the introduction of the revised subsidy scheme.

 GP margin was 35% in 2015 and it fell to 27-28% in 2016, which the company believes is likely the bottom.

 The company expects economies of scale and design optimization should help mitigate the margin pressure. The company expects its profitability to see significant improvement when volume reaches 100k units. Competitive landscape for NEV powertrain  Dajun aims to achieve 7-8% share in China’s NEV motor/controller market in 2017 and 15-20% market share by 2020.

 For passenger NEV, a lot of automakers are partnering with third-party OEMs to co-develop motors/controllers. In the longer term, the company expects third-party OEMs to have a lion’s share of the market.

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 Most NEV producers’ technology know-how in the drive area is relatively weak compared to third-party OEMs. More importantly, cost should not be the primary concern for auto components – quality and performance should be instead.

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Appendix 1

Important Disclosures

*Other information available upon request

Disclosure checklist Company Ticker Recent price* Disclosure Shenzhen Inovance Technology Co., Ltd. 300124.SZ 21.91 (CNY) 2 Mar 17 NA Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/Disclosure.eqsr?ricCode=300124.SZ

Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Sky Hong/Nick Zheng

Historical recommendations and target price: Shenzhen Inovance Technology Co., Ltd. (300124.SZ) (as of 3/2/2017)

80.00 Previous Recommendations

Strong Buy 70.00 Buy Market Perform 60.00 Underperform Not Rated 50.00 Suspended Rating Current Recommendations 40.00 Buy Hold

Security PriceSecurity 30.00 Sell 1 2 Not Rated 20.00 Suspended Rating

*New Recommendation Structure 10.00 as of September 9,2002

**Analyst is no longer at Deutsche 0.00 Bank

Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Sep 16 Dec 16 Date

1. 11/07/2016: Upgrade to Buy, Target Price Change CNY23.20 Sky 2. 12/09/2016: Buy, Target Price Change CNY26.80 Sky Hong, CFA Hong, CFA

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Equity rating key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total 500 54 % share-holder return (TSR = percentage change in 450 share price from current price to projected target price 400 350 plus pro-jected dividend yield ) , we recommend that 300 36 % investors buy the stock. 250 200 Sell: Based on a current 12-month view of total share- 150 18 % 11 % 100 17 % 20 % holder return, we recommend that investors sell the 50 stock 0 Buy Hold Sell Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not Companies Covered Cos. w/ Banking Relationship recommend either a Buy or Sell. Asia-Pacific Universe Newly issued research recommendations and target

prices supersede previously published research.

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