Consumer Discretionary / China 18 June 2015

Initiation: pockets of strength China Autos Sector

• Even though overall 2015 PV sales growth is likely to slow to just Positive 8% YoY, demand growth for SUV/MPVs should remain strong Neutral (initiation) • Local brands trump the foreign JV brands; among the foreign JVs, we prefer luxury marque Mercedes-Benz Negative

• Initiating coverage with a Neutral sector view; our stock pecking order is Geely, BAIC, BYD, GWM and GAC How do we justify our view?

local brands in price-sensitive lower- We like Geely as we expect its net tier cities over 2015-16. profit to rebound sharply YoY in 2015, and because it is reducing its 2. SUV makers are cashing in. exposure to Russia. Long term, we In 2015-16, we expect the OEMs to expect Geely to become one of the Kelvin Lau launch more new SUV models, the strongest local brands in terms of (852) 2848 4467 segment in which we expect demand technology and quality. Among the [email protected] growth to be the strongest. We foreign JV brands, we like BAIC forecast SUV/MPV sales volumes for Motor (BAIC; 1958 HK, HKD9.30, Brian Lam 2015-16 to rise by 25-40% YoY (vs. a Buy [1]), due to the strong earnings (852) 2532 4341 3% YoY decline for sedans). Further contribution from Mercedes-Benz. [email protected] out, competition in the SUV segment

is likely to intensify. We think BYD Company (BYD, ■ Investment case 1211 HK, HKD49.50, Outperform 3. Selective luxury JV brands We initiate coverage of the China [2]) will appeal to investors looking still shine. Autos Sector with a Neutral view. to play the NEV theme. Finally, our Among the foreign JV brands in Based on our regression analysis, we least preferred stock is GAC because China, we prefer European luxury forecast just 8% YoY growth in of its focus on mid-range sedans. (specifically Mercedes-Benz) over passenger vehicle (PV) sales volume the Japanese brands, as we see Benz in China for 2015 (vs. 10% for 2014 ■ Risks being less affected by the licence and 6% YTD). We expect the The major upside risks to our sector plate restrictions in top-tier cities. In economic slowdown and declining view would be: stronger-than- response to these new rules, we M2 growth to reduce buyers’ expected sales, especially for new SUV expect more affluent first- appetite for mid-range sedans over models. Further licence restrictions time/replacement buyers to jump to 2015-16. As for recent industry and price cuts are downside risks. better-quality cars and bypass mid- developments, we see the new- range sedans. registration restrictions now in place Key stock calls in tier-1 and tier-2 cities affecting ■ Catalysts New Prev. our 5 featured stocks to varying The main share-price catalysts Geely Automobile (175 HK) degrees. But we do see some pockets would be if monthly auto sales pick Rating Buy of strength. up in 2H15, in line with our Target 5.00

expectations. Any new government Upside  35.1% 1. Local OEMs looking secure, policies promoting new-energy BAIC Motor (1958 HK) especially in lower-tier cities. Rating Buy vehicles (NEV) would also likely For the most part, we prefer the local Target 12.00 drive share prices selectively. For the OEM brands such as Geely (175 HK, Upside  29% foreign JV brands, forex fluctuations HKD3.70, Buy [1]) and Great Wall BYD (1211 HK) could lower the cost of importing Motor (GWM; 2333 HK, HKD38.00, Rating Outperform components, which could boost Target 56.00 Hold [2]) over the foreign JV ones, investor sentiment. Upside  13.1% especially the mid-range Japanese Guangzhou Automobile Group (2238 HK) brands under Guangzhou ■ Recommendations Rating Sell Automobile Group (GAC; 2238 In order, our preferred stocks are: Target 6.20 HK, HKD7.37, Sell [5]), driven by Geely, BAIC, BYD, GWM and GAC. Downside  15.9% strong demand growth for economy Source: Daiwa forecasts.

See important disclosures, including any required research certifications, beginning on page 102 Consumer Discretionary / China 18 June 2015

Contents

Investment thesis ...... 4 Falling PV sales, but there are pockets of strength ...... 4 Adapting to a slower pace ...... 8 Overall PV sales growth declining ...... 8 Margin improvements, but for selected players only ...... 9 Local brands: not created equal ...... 11 Quality local brands emerging ...... 13 SUVs still the focus over 2015-17 ...... 14 Singling out China’s long-term winners ...... 16 What’s next for China’s automakers? ...... 16 Battlefield should extend to overseas markets in the long run ...... 19 Fuel-consumption standards should raise entry barriers ...... 21 Growth of related business ...... 23 Valuations and recommendations ...... 25 Sector expected to move in line with market over 12 months ...... 25 Recommendations ...... 26 Valuations: no longer cheap ...... 26 Risks to our sector view ...... 27 Appendix: historical data for the China auto market ...... 29

Company Section Geely Automobile ...... 35 BAIC Motor ...... 47 BYD ...... 59 Great Wall Motor ...... 73 Guangzhou Automobile Group ...... 85

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Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg BAIC Motor 1958 HK 9.30 Buy 12.00 0.910 1.133 BYD 1211 HK 49.50 Outperform 56.00 0.529 1.089 Geely Automobile 175 HK 3.70 Buy 5.00 0.288 0.373 Great Wall Motor 2333 HK 38.00 Hold 39.90 3.771 4.571 Guangzhou Automobile Group 2238 HK 7.37 Sell 6.20 0.546 0.611

 China Auto Sector (OEMs): key assumptions (YoY %) Sales volume (Units) 2013 2014 2015E 2016E 2017E 2013 2014 2015E 2016E 2017E Geely 549,468 417,851 503,717 561,369 626,241 13.6% -24.0% 20.5% 11.4% 11.6% Greatwall 770,619 732,989 928,323 1,083,497 1,219,378 24.0% -4.9% 26.6% 16.7% 12.5% BAIC BJ Motor 202,280 309,468 464,202 603,463 724,155 159.3% 53.0% 50.0% 30.0% 20.0% BJ Benz 116,006 145,468 210,929 263,661 329,576 12.6% 25.4% 45.0% 25.0% 25.0% GAC GAC Self-owned 146,188 161,160 180,499 194,939 210,534 50.6% 10.2% 12.0% 8.0% 8.0% Guangqi Honda 435,479 480,060 561,670 645,921 697,594 37.6% 10.2% 17.0% 15.0% 8.0% GAC Toyota 303,088 374,108 404,037 436,360 471,268 21.2% 23.4% 8.0% 8.0% 8.0% GAC Fiat 48,375 68,090 68,090 71,495 75,069 328.6% 40.8% 0.0% 5.0% 5.0% GAC Mitsubishi 43,036 63,199 78,999 90,849 104,476 1572.0% 46.9% 25.0% 15.0% 15.0% BYD Conventional 470,000 373,000 365,540 358,229 351,065 11.9% -20.6% -2.0% -2.0% -2.0% NEV 3,142 20,859 59,404 107,972 144,035 n.a. 563.9% 184.8% 81.8% 33.4% (YoY %) ASP (CNY ) 2013 2014 2015E 2016E 2017E 2013 2014 2015E 2016E 2017E Geely 52,246 52,024 56,186 60,119 64,327 2.6% -0.4% 8.0% 7.0% 7.0% Greatwall 69,809 80,964 92,299 99,683 107,657 6.5% 16.0% 14.0% 8.0% 8.0% BAIC BJ Motor 33,852 40,178 44,195 46,405 48,725 -25.0% 18.7% 10.0% 5.0% 5.0% BJ Benz 286,364 302,036 302,036 302,036 302,036 -0.6% 5.5% 0.0% 0.0% 0.0% GAC GAC Self-owned 123,977 133,735 140,422 147,443 147,443 -5.3% 7.9% 5.0% 5.0% 0.0% Guangqi Honda 134,191 124,586 118,357 112,439 112,439 -2.0% -7.2% -5.0% -5.0% 0.0% GAC Toyota 172,842 144,020 132,498 132,498 132,498 -4.6% -16.7% -8.0% 0.0% 0.0% GAC Fiat 104,429 100,076 95,072 95,072 95,072 -40.2% -4.2% -5.0% 0.0% 0.0% GAC Mitsubishi 90,841 118,325 136,073 142,877 142,877 -71.7% 30.3% 15.0% 5.0% 0.0% BYD 53,452 66,699 66,699 66,699 66,699 -0.4% 24.8% 0.0% 0.0% 0.0% (YoY %) Net profit (CNYm) 2013 2014 2015E 2016E 2017E 2013 2014 2015E 2016E 2017E Geely 2,663 1,431 2,531 3,285 3,945 30.5% -46.3% 76.9% 29.8% 20.1% Greatwall 8,224 8,042 11,472 13,907 16,263 44.5% -2.2% 42.7% 21.2% 16.9% BAIC 2,714 4,511 6,834 8,505 10,181 -20.6% 66.2% 51.5% 24.5% 19.7% GAC 2,653 3,185 3,511 3,932 4,344 133.9% 20.1% 10.2% 12.0% 10.5% BYD 553 86 1,345 2,982 4,161 579.6% -84.5% 1467.4% 121.6% 39.6% (YoY pp.) Gross Margin (%) 2013 2014 2015E 2016E 2017E 2013 2014 2015E 2016E 2017E Geely 20.08% 18.23% 19.20% 20.20% 20.20% 1.57 (1.86) 0.97 1.00 0.00 Greatwall 25.93% 24.98% 24.65% 24.25% 23.85% 1.86 (0.95) (0.33) (0.40) (0.40) BAIC 3.25% 15.94% 16.94% 18.06% 18.41% 8.03 12.69 1.00 1.13 0.35 GAC 10.60% 11.38% 11.12% 10.58% 10.27% 5.27 0.79 (0.26) (0.54) (0.31) BYD 13.09% 13.77% 14.08% 13.87% 14.42% 1.54 0.68 0.31 (0.21) 0.55 (YoY pp.) Net Margin (%) 2013 2014 2015E 2016E 2017E 2013 2014 2015E 2016E 2017E Geely 9.28% 6.58% 8.94% 9.73% 9.79% 0.99 (2.70) 2.36 0.79 0.06 Greatwall 15.03% 13.33% 13.30% 12.82% 12.34% 1.33 (1.69) (0.04) (0.48) (0.48) BAIC 21.23% 8.00% 8.11% 7.90% 7.55% (75.86) (13.23) 0.11 (0.21) (0.35) GAC 14.09% 14.24% 13.33% 13.14% 13.38% 5.35 0.14 (0.90) (0.19) 0.24 BYD 1.11% 0.16% 1.73% 3.05% 3.71% 0.93 (0.96) 1.58 1.31 0.66 Source: companies, Daiwa forecasts

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The main 3 pockets of strength that we see for the sector over 2015-17 are as follows: 1. The local OEM makers that focus mainly on the lower-tier (tier-3) cities, such as Geely. 2. The local SUV makers, particularly new entrants to Investment thesis the segment that come to the market with innovative products. Although we forecast 2015-16 SUV/MPV sales to increase by 25-40% YoY (the We expect PV sales growth to slow to 7.5- largest such increase in the total PV sales growth 8.0% YoY over 2015-16, vs. 10% for 2014. pie), we do see this segment becoming more But we see sales growth of local brands in competitive and hence margin pressure intensifying over the next decade. We highlight Geely and GWM China’s lower-tier cities remaining as the stocks to watch in this segment. strong, driven by growing disposable 3. Selected luxury foreign JV brand makers, ie, Benz. incomes. Specifically, we expect Mercedes-Benz to continue to do well and even to benefit from the new-car registration restrictions, as affluent buyers may Falling PV sales, but there are decide to jump straight up to the luxury segment if pockets of strength they are lucky enough to get their hands on a licence. Hence, BAIC is the stock to watch in this Slowing GDP and M2 growth eating into segment, in our view. car sales  PV penetration: comparison of main auto-making countries We initiate coverage of the China Auto Sector with a ('1000 people) Neutral rating against the backdrop of expected slower 500 GDP growth and M2 growth in the country over 2015- 450 16. We believe the weakening economic outlook will be 400 a drag on overall demand growth for PVs. 350 300 At the industry level, the ongoing imposition of licence 250 restrictions in China’s top-tier cities (7 cities so far) is 200 150 squeezing demand in those cities, particularly for mid- 100 range Korean and Japanese automakers and their 50 related joint ventures. We believe these restrictions will 0 prompt the more affluent first- and second-time buyers Japan USA S. Korea China in these cities to jump to either luxury brands or SUVs, Source: statista.com effectively cutting out demand for mid-range sedans. In this report, we focus on 5 companies, each of which However, as China’s car penetration rate is still low is exposed to one or more of the major trends that we compared with the US and Japan, we believe the worst expect to play out in the sector in 2015 and beyond. is behind the industry in terms of earnings growth, with 2014 being the year when PV demand growth Geely and GWM are the major local brands that we see started to weaken (10% YoY for 2014, from 16% YoY for as well placed in their market positioning in the near 2013) significantly and inventory adjustments began. term.

Given the low base for 2014 and consequent caution While most of the foreign joint-venture brands face a from industry players in terms of their production tough climate, we see BAIC as standing out for its output, plus new product launches, we expect the exposure to further sales growth for Beijing Benz and a earnings of most of the OEMs that we cover to rebound potential earnings turnaround for its own brand significantly in 2015. operation. Our outlook for Benz is in marked contrast to the weak China sales being experienced by Audi As such, we see balanced positive and negative factors (down YoY for the first time in more than 2 years) and for the industry and thus initiate coverage of the sector BMW. with a Neutral rating.

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BYD offers exposure to the NEV segment, which is not  China Auto OEMs: sales performance (January – May 2015) affected by the new-registration restrictions. May YoY YTD YoY Company May YTD 2015 growth % growth % And we expect GAC’s stable of Japanese brands being Geely 39079 221125 27.77 40.99 squeezed as buyers in tier-1 and tier-2 cities favour BAIC - Beijing Benz 16107 80818 57.16 48.71 luxury cars or SUVs, either as a first-time purchase or BAIC - Beijing Hyundai 80022 450084 -12.09 -3.48 replacement demand, over mid-range marques. BAIC - BAIC Motor 17030 100039 -9.96 31.31 BAIC - BAIC Yinxiang 18321 103943 44.24 123.54 BYD 34410 192210 0.48 11.65  Benz, BMW and Audi sales in China (January - May 2015) GWM 57745 317984 42.10 30.35 May 2015 May YoY YTD 2015 YTD YoY GAC - GAC Fiat 2896 15691 -50.43 -41.74 Company Model Sales Growth % Sales Growth % GAC - GAC Motor 13406 53868 16.86 5.38 Beijing Benz GLK Subtotal 5808 17.9 27703 24.3 GAC - GAC Toyota 37068 154644 20.43 4.99 GLA Subtotal 1930 2295 GAC - Guangqi Honda 51262 196141 52.11 38.60 E-Class Subtotal 4936 59.4 24035 23 GAC- GAC Mitsubishi 6006 24712 -9.22 11.56 C-Class Subtotal 3433 54.3 26785 113.9 Brilliance - BMW Brilliance 21998 115963 -8.71 -0.18 Benz Subtotal 16107 57.2 80818 48.7 Brilliance – Jinbei 18305 100020 27.38 -0.86 FAW Volkswagen Q3 Subtotal 4644 -45.3 26286 -21.1 Chang'an 93011 546221 10.69 22.51 Audi A3 Lim Subtotal 2850 15452 Chang'an - Chang'an Ford 61778 353785 -8.93 6.30 A6 Subtotal 10581 -32.3 62536 -12.4 Chang'an - Chang'an Suzuki 10632 58937 -30.34 -22.28 A4 Subtotal 10493 -4.2 45340 -10.4 Chang'an Mazda 10519 65052 39.49 99.33 Q5 2.0T 10888 14.8 46563 1.5 Chang'an PSA 3709 11938 37.27 60.26 Audi Subtotal 41760 -11 204554 0.5 Changhe 5690 44296 -45 -7 BMW Brilliance BMW X1 2944 -25.7 16486 -11.8 Chery 36461 197464 11.52 15.25 3-Series Subtotal 8482 6.3 39116 1.6 DFM 38862 233368 -5.81 6.70 5-Series Subtotal 10569 -10.6 60131 3 DFM - Dongfeng Honda 32348 131279 22 -7 BMW Subtotal 21995 -7.4 115733 0.2 DFM - Dongfeng Nissan 84109 354794 1 -8 Source: China Auto Market DFM - Dongfeng Peugeot-Citroën Auto 61053 306352 0.78 7.19 DFM - Dongfeng Yueda Kia 49005 265652 -5.93 2.29 Geely is our top pick, followed by BAIC ; DFM - Dongfeng Yulon 4252 24105 51.05 122.74 local OEMs trump the JV brands overall DFPV 6032 43750 -0.23 31.11 FAW - FAW Haima 5683 32213 -10.46 -0.01 Overall, we prefer the local OEMs to the foreign joint FAW - FAW Toyota Motors Sales 55452 213429 41.57 1.71 ventures, as we expect new car sales volume growth in FAW - FAW Volkswagen 125240 696501 -22 -8 the top-tier cities to slow due to the licence restrictions FAW - FAW Xiali 5377 33519 21.82 -0.97 FAW Car 19569 103382 -11 -10 now in place in these cities and because these markets FAW Group 1785 15195 -40 -21 are relatively mature. JAC Motors 25704 137622 97.68 73.62 SAIC 12512 56196 -28.05 -34.01 As such, we see more sales-revenue growth SAIC - SAIC GM Wuling 124933 755683 1.81 10.43 SAIC - Shanghai GM 122769 651504 -9.74 -5.54 opportunities in the lower-tier cities over 2015-17, as SAIC - Shanghai Volkswagen 144008 807842 -0.87 0.23 disposable incomes grow. Saying that, these consumers Source: China Auto Market remain more price sensitive than their counterparts in tier-1 and 2 cities, which means the local brands stand Accordingly, of the domestic OEMs that we cover, to benefit more than the foreign brands, which are still Geely is our top pick because of its large exposure to unaffordable for many prospective buyers in these tier-3 cities, potential for a strong rebound in its areas. earnings for 2015, and scope for further brand building over the next decade. It is important to note that we do not expect licence restrictions to be imposed in these cities any time soon, GWM is an alternative major local brand, but we think as these cities as still at the growth stage in terms of Geely will set the pace with a net-profit rebound in GDP. Indeed, this is evident in the divergent 2015 (Geely: 77% YoY, GWM: 43% YoY). We think performances of the OEMs in China, where we have Geely’s edge here rests on the diminishing impact of its seen much better sales growth for the local OEMs dealership network restructuring, a decline in its compared with the foreign JVs. Among the local OEMs, business in Russia, and more new product launches in the traditional Big-4 China carmakers (except China. Also, we believe Geely is leading the other local Chang’an), such as SAIC Motor, Dongfeng Motor and players in terms of attaining technology independence, FAW Group (all not rated), are registering weaker sales and we see it as well placed to become a globally growth than the smaller H-share listed OEMs such as recognised brand in the next decade. Geely and GWM, due to weakness in foreign JV brands.

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 China: disposable income growth in tier-1 cities vs. other We believe that new entrants to the SUV market will cities benefit most from the sales strength of the segment, as CNY 40,000 these companies’ profitability should have more scope 35,000 to expand compared with the established SUV players. 30,000 25,000 Of the foreign JV brands, we pick BAIC; 20,000 GAC is a worry 15,000 Among the foreign JV brands, we see Mercedes-Benz 10,000 outperforming mid-range Japanese brands like Toyota, 5,000 Honda and Nissan because the licence restrictions in 0 tier-1 and tier-2 cities, where these brands focus their efforts, mean that buyers are now more likely to buy a 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Tier 1 Other tiers luxury car, either as a first-time purchase or a Source: CEIC replacement purchase, especially as we have seen more entry-level models in China in the past 2 years. In the long run, we expect the local brands (ie, Geely, Thus, we see GAC and its stable of Japanese brands GWM and BYD) to emerge as globally recognised being affected by this trend, and initiate coverage with brands and compete with their international a Sell rating. counterparts. Currently, Geely, GWM and BYD each have a PV market share in China of just 2-3%, well For BAIC, even though we expect the sales volume behind those of the traditional Big-4 China carmakers growth of its Beijing Hyundai operation to remain (SAIC Motor, Dongfeng Motor, FAW Group and weak (just 2% YoY growth in its net-profit contribution Chang’an). in 2015-16E), we look for Beijing Benz to deliver strong sales growth (25-45% YoY for 2015-16E), backed by However, as they continue to move up the technology improvements in its distribution network and model curve and roll out new models, we look for the local line-up. This is a company-specific factor that will, in brands to expand their market share, mirroring what our view, lead to Beijing Benz outperforming peers like has happened historically to the local brands in Japan Audi and BMW, which have both had fewer product and Korea. launches recently.

 China: 2014 PV market share by sales volume Plus, we look for BAIC to see a narrower loss from its BYD Geely Others own brand operation this year, Beijing Auto (Senova), Chery 2.2% 2.2% 5.7% Brilliance 2.3% (around –CNY500m, vs. –CNY2.6bn for 2014), and a 2.6% modest net profit for 2016 (around CNY300m), which GWM SAIC should support a rebound in BAIC’s net profit over our 3.1% GAC 26.5% 5.8% forecast horizon.

BAIC GROUP 8.6% DFM NEV sales-volume growth should increase 16.5% sharply for 2015-17; BYD is our pick FAW Chang'an 14.1% We expect China’s NEV sales-volume growth to remain 10.5% strong, at 50-100% pa for 2015-17, due to the government’s ongoing support for the NEV makers and Source: CAM buyers, as well as the technological improvements that the OEMs are making in terms of battery life and SUV sales likely to be earnings drivers for driving range. Longer term, we believe the planned new entrants, such as Geely implementation of tougher fuel-consumption and emissions standards in 2020, together with the existing We look for SUV/MPV sales to remain strong in 2015, restrictions on new-car registrations for conventional and continue to lead car sales in China. While we do cars, will support NEV sales-volume growth in China. not expect a reversal of this trend in the near term, competition will likely increase significantly in the next One beneficiary of the NEV trend is BYD, upon which 2-3 years due to more OEMs focusing on this segment. we initiate coverage with an Outperform (2) rating. On As such, we foresee sedan sales remaining weak in our forecasts, the company’s mobile phone component 2015, with a 3% YoY decline, particularly for the A- shipments should remain steady in 2015 while its class segment, as replacement demand prioritises more conventional car and battery businesses should recover comfortable vehicles. - 6 - Consumer Discretionary / China 18 June 2015

from their net losses of 2014, on more product launches and the increasing use of its batteries in the NEV segment, respectively.

 China: NEV sales

(units) 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 2011 2012 2013 2014 2015E 2016E 2017E Source: China Association of Automobile Manufacturers, Daiwa forecasts

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According to the China Association of Automobile Manufacturers, the YTD May PV sales were up by 6.4% YoY, a slowdown compared with the April YTD figure of 7.7% YoY.

We expect weaker PV sales volume growth for June Adapting to a slower 2015 of around 2% YoY from a high base. The growth rate should pick up to around 8-9% YoY from July 2015 pace onwards, on our forecasts.

We expect China’s slowing economy to  Regression analysis: China PV sales and M2 growth continue to weigh on PV sales over 2015- 100%

16 and industry margins to remain under 80% R2=0.56 pressure, particularly for the foreign JV 60% brands. However, SUV demand should remain strong, with the quality local SUV 40% brands outperforming the foreign JV 20% brands on stronger product launches 0% over 2015-16. -20% 10% 14% 18% 22% 26% 30% Source: Bloomberg Overall PV sales growth declining  China: PV sales and M2 growth Economic factors having clear impact on 35% demand 30% In order to assess the outlook for PV sales in China, we 25% have carried out a regression analysis, from which 20% China’s M2 growth emerges as the key factor in PV 15% demand growth (R2 = 0.56) rather than GDP growth (R2 = to 0.25). 10% 5%

Although our analysis shows that a 1pp increase in M2 0% growth would lead to a 3.6% rise in PV sales, we do not 2010 2011 2012 2013 2014 2015E 2016E expect PV sales to continue to be a multiple of M2 M2 growth PV sales growth growth, given: 1) the high base of sales set in recent Source: CEIC, Daiwa forecasts years, 2) the restrictions on new-car registrations now in place in some tier-1 cities, and 3) weaker sentiment Policy not working in auto sector’s favour when it comes to overall spending on consumer Apart from China’s weakening economy, concerns discretionary products. about air pollution and traffic congestion in many cities have resulted in the implementation of many policies Considering the sales-volume trends in China over the unfavourable to the auto industry, such as restrictions past 3 years, we estimate that, going forward, a 1pp increase in M2 growth would lead to only a 0.75 pp on new-car registrations over 2012-14 (with more cities likely to follow). increase in PV sales.

Daiwa’s chief economist Kevin Lai expects M2 growth For example, on 29 December 2014, the Shenzhen government imposed a 5-year policy limiting the to continue to slow, to 10.0-10.5% YoY for 2015-16, from 12.2% YoY for 2014. Accordingly, in light of our number of new car licences to 100,000 pa (80,000 for conventional PVs, 20,000 for electric cars). As a result, regression analysis, we expect PV sales to increase by according to the Shenzhen Traffic Control Bureau, new 7.5-8.0% YoY for 2015-17, down from 10% YoY for 2014. car PV sales (including new licences and replacement cars) are expected to decline by 50-60% YoY for 2015.

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Currently, 7 cities have implemented similar policies to Good news: inventory adjustments look to restrict new car sales. This has led to demand being be coming to an end front-loaded in some cities, with people buying cars According to the China Automobile Dealers Association just before the restrictions are rolled out, setting a high (CADA), the Vehicle Inventory Alert Index (VIA) base for each of the past 3 years for some cities such as declined to 57.3% in May 2015, from 67.5% in March Beijing. Even without this front-loading effect, China is 2015, and hence is now closer to the normal level of already the world’s biggest producer of cars annually, 50%. We believe the weak demand is fully reflected in with sales of close to 20m PVs in 2014 alone. the current inventory level and do not expect much

downside from here. Thus, inventory adjustments for From this high base, we believe the China OEMs face most of the China automakers should have been an uphill struggle to realise the kind of YoY growth in completed and we expect PV sales-volume growth, and overall PV sales volumes they were seeing, say, 5 years only minor ASP cuts, for the rest of 2015 (note: ASPs ago, when annual PV sales were around 14m units. might decline slightly, but margins should remain

stable overall due to better product mixes across the Hence, we see replacement demand, which is not board). affected by the restrictions on new-car registrations, being one of the major earnings-growth drivers in In terms of industry fundamentals, we see the car- China’s top-tier cities, a situation that we see as normal ownership penetration rate in China remaining much given the more mature status of the market. lower than it is in developed countries, even though the

 China: PV licence restrictions in different cities market is the largest in the world in terms of the Cities New car plates Implementation date Quota number of autos made. Therefore, we still see room for obtained via sales growth for the China Autos Sector, even though Shanghai Bidding 1994 ~130,000 we expect PV sales growth to moderate over 2015-16, Beijing Lottery 12/23/2010 150,000 due to slower economic growth and the high base a Guiyang Lottery 7/11/2011 24,000 Guangzhou Bidding and lottery 6/30/2012 120,000 decade ago.

Tianjin Bidding and lottery 12/15/2013 100,000  China: Vehicle Inventory Alert Index (VIA Index) Hangzhou Bidding and lottery 3/25/2014 80,000 Shenzhen Bidding and lottery 12/29/2014 100,000 80% Source: local governments, various media reports 70%  Example of impact of licence restrictions in Beijing: newly registered cars 60%

(Units) YoY % 50% 900,000 60%

800,000 40% 40% 700,000 20% 600,000 30% 500,000 0% Jul-14 Apr-14 Oct-14 Apr-15 Jan-14 Jun-14 Jan-15 Feb-14 Mar-14 Feb-15 Mar-15 Aug-14 Sep-14 Nov-14 Dec-14 May-14 400,000 (20%) May-15 VIA Index 300,000 (40%) 200,000 Source: China Auto Dealers Association 100,000 (60%) 0 (80%) 2008 2009 2010 2011 2012 2013 New register cars (LHS) Growth (YoY %, RHS) Margin improvements, but for Note: licence restrictions implemented 23 December 2010. Source: China Automotive Information Net (CAIN) selected players only

We believe the government’s anti-graft measures are ASPs could decline YoY having only a slight negative impact on auto sales in We expect the ASPs for most PVs to remain flat YoY, general, as the majority of demand still comes from except for the middle-class foreign JV brands, such as consumption by end-customers rather than by officials Toyota, Honda and Nissan, where we see more ASP via the gift market. However, there has been some pressure over 2015-17, due to their low penetration impact on car purchases by government officials, in rates in the low-tier cities, and high competition in top- that they now have to buy local brands or lower-tier tier cities, especially given the restrictions on new-car foreign JV brands rather than luxury brands. And we registrations. expect this trend to continue, given the government’s support of the local OEMs.

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As for the other automakers, we expect them to remain  H-share auto makers: margin comparison cautious when it comes to raising prices, as overall (%) consumer sentiment in China will likely remain weak 35 over the next 12 months given economic headwinds. 30 Rather than raising prices, we believe the automakers 25 will aim to improve their product mixes in order to 20 support their gross margins. 15  China automakers: gross margin comparison 10 (%) 5 30 0 2010 2011 2012 2013 2014 2015E 2016E 2017E 25 Gross Margin Net Margin 20 Source: Bloomberg, Daiwa forecasts

15  A-share auto makers: margin comparison 10 (%) 5 20

0 2013 2014 2015E 2016E 2017E 15 BAIC GEELY GWM GAC BYD Source: Bloomberg, Daiwa forecasts 10

Product-mix changes have led to margin 5 improvements for some OEMs 0 Over the past 2 years, demand for sedans shrank and 2010 2011 2012 2013 2014 2015E 2016E 2017E we saw more automakers starting to launch Gross Margin Net Margin SUVs/MPVs as a result. We expect this trend to Source: Bloomberg, Daiwa forecasts continue over 2015-17, as we see demand for SUVs remaining strong, with more customers looking for BAIC’s input costs affected by forex more comfort when they replace their vehicles (more fluctuations details on page 14). This should help new entrants such as Geely enhance their margins on better product mix, Based on our market research, many OEMs in China as SUV/MPVs are more profitable than sedans. import components from manufacturers in other countries. And some of the foreign JV brands under We therefore think that the OEMs that originally GAC, Brilliance and BAIC import most of their produced sedans have more chance of improving their components from Japan and Germany, the cost of 2015-17 gross margins by shifting production to which is often in a foreign currency such as the Yen or SUV/MPVs than the original SUV-focused OEMs like Euro. GWM, as GWM has had good SUV margins for the past 3 years and is likely to face more competition going Daiwa’s economics team forecasts the Euro to forward. As a result, we forecast the sector’s net margin depreciate by 19% YoY against the Renminbi in 2015 growth to be flat YoY over 2015-17, but select OEMs, and then appreciate by 3% YoY in 2016 due to the such as Geely, BYD and BAIC, should see margins Renminbi’s depreciation against the US dollar. For the improve. Yen, Daiwa forecasts 3-6% pa appreciation against the Renminbi for 2015-16. By extension, we think the We expect SUV and MPV sales to continue to foreign JV OEMs (ie, BAIC) are likely to continue to outperform those of other segments over 2015-17, with record forex gains in 2015, while the Japan OEMs such growth of around 25-40% pa, much higher than the as GAC record exchange losses. As such, we expect overall PV sales growth that we expect of 7.5-8.0% pa. BAIC’s net-profit margin to improve further in 2015, We expect the market share of SUVs+MPVs to be and for the improvement to be better than that seen for around 40% by 2020, from 30% in 2014, which is more its gross margin. comparable to the US level currently.

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 CNY:EUR exchange rate China Automotive Dealers Association, with the goal of 12 securing better sales margins from the OEMs.

11 However, according to our discussions with the Hong 10 Kong-listed China OEMs and dealers, the margin 9 enhancement for dealers will likely be restricted to 8 certain brands, such as BMW, which previously offered

7 dealers relatively low sales margins.

6 Indeed, local brands such as Geely, which in the past 5 used relatively high sales margins as a way to 4 incentivise the dealers, have reduced their offers to the 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E dealers as they have restructured their dealer networks Source: Bloomberg, and Daiwa forecasts and now enjoy greater brand awareness in China.

 JPY:CNY exchange rate And for the Japanese brands, there has been no change 25 in what they offer to the dealers, according to GAC, as 23 historically they have offered better sales margins than 21 have the foreign luxury brands. 19 17 In sum, we believe that 2015 is shaping up to be a year 15 13 of margin expansion for the dealers, especially those 11 selling brands that historically have had very low 9 margins. But, in the long term, we do not expect the 7 dealers to extend this sales-margin improvement to 5 other brands, as the entry barriers to the dealer 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E segment are not high and more dealers are likely to

Source: Bloomberg, Daiwa forecasts enter if profitability improves.

How sustainable are OEM net margins?  Gross margin comparison of global auto OEMs by region 2010 2011 2012 2013 2014 2015E 2016E 2017E Even though the net margins of the China automakers China H-share listed 13.8 9.2 11.3 15.1 15.8 17.8 18.3 18.5 are currently higher than those for the foreign China A-share listed 16.2 14.2 14.8 16.7 14.8 16.0 16.4 17.0 automakers (ie, the Japan, Korea and US brands), we US 11.7 12.1 2.4 12.0 12.8 13.6 14.2 14.5 see this mainly as a profit-structure issue. In other Europe 20.0 19.2 18.7 19.1 19.1 22.6 23.0 22.8 Japan 15.9 15.5 16.1 20.0 20.9 20.6 21.4 21.9 words, some foreign JV OEMs, such as BAIC, GAC, and Korea 22.0 24.4 21.5 21.4 20.2 20.6 20.9 20.9 even Dongfeng Motor (not rated) and Brilliance China Source: Bloomberg Automotive (Brilliance) (not rated), earn most of their profit from the income of the jointly controlled entity  Net margin comparison of global auto OEMs by region or associates, meaning their standalone revenue is 2010 2011 2012 2013 2014 2015E 2016E 2017E relatively low and thus they tend to report a relatively China H-share listed 6.2 26.9 30.9 13.4 11.5 15.9 16.9 17.9 China A-share listed 9.8 7.3 5.6 7.3 5.3 8.4 8.7 9.2 high net margin on their income statement. US 2.2 21.0 3.7 5.4 2.5 4.7 5.1 5.4 Europe 6.8 5.2 5.7 5.2 4.2 6.0 6.4 6.5 And we have seen similar gross and net margins for the Japan 2.6 2.1 2.2 6.9 6.9 6.9 7.2 7.6 H-share OEMs. Therefore, looking at the gross margins Korea 8.0 8.6 7.4 8.9 5.8 7.5 7.7 7.9 of the China OEMs, which mostly comprise local Source: Bloomberg brands, their gross margins are still lower than those of their global peers, due to the fact that many local Local brands: not created equal brands are still loss-making.

Since 2014, some China automakers have cut the Local brands losing share of sedan market number of dealers in their networks. This development, Local-brand sales as a proportion of total PV sales have coupled with the low average profitability in the declined from a high point of 46% for 2010 to 38% for industry in 2014, has prompted some dealers to exit 2014. In our view, the major reason for the decline has the market altogether. The remaining dealers have been their decreasing share of the sedan market, partly therefore had more bargaining power in 2015, a due to the aggressive sales strategies of the German situation they have sought to cement by forming the brands over the past 3 years. Also, replacement

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demand over the same period appears to have been Non-SOE OEMs look to be moving in a focusing on the luxury foreign JV brands rather than more profitable direction the local brands. With replacement demand focusing on SUVs and/or

luxury sedans rather than small cars in the top-tier The decline in the sedan market (the largest segment in cities, we believe that the more aggressive sales the China auto industry) has also been driven by many strategies of the foreign JV brands, and a lack of new local OEMs focusing on launching more SUVs than product launches by some of the local brands sedans, as SUVs are more profitable. Among the (especially the SOEs), have led to the overall decline in foreign brands, the market-share gains of the sedan market share for local brands. market by the German auto OEMs have been the most noticeable, while we have seen the Japan OEMs lose However, we expect the Hong Kong-listed OEMs such share over 2010-14. as Geely to continue to increase their market share on

 China: PV market sales by car brand (originating country) the back of product innovation and more product launches planned for the next few years. As the 50% competition intensifies and demand growth slows, the 40% sales performance of local brands should start to diverge, with current quality brands outperforming the 30% others, in our view.

20% Over 2015-17, we believe quality local brands such as

10% Geely will benefit the most from strong demand growth in the lower-tier cities. We expect the SOE OEMs such 0% as SAIC Motor and FAW Group (both not rated) to lose 2010 2011 2012 2013 2014 market share, while Geely and GWM should improve China Germany Japan their market share. BYD is likely to focus on increasing US S.Korea France Source: CAAM its share of the NEV market, while the conventional  carmakers (like GAC) should continue to lose market  China: sedan market sales by car brand (originating country) share. 35%  China Auto Sector: PV market shares by sales volume 30% 10% 25%

20% 8%

15% 6% 10%

5% 4% 0% 2011 2012 2013 2014 2% China Germany Japan US S.Korea France 0% Source: CAAM 2010 2011 2012 2013 2014 2015E Geely BAIC GWM GAC  China: market share of the auto market by car type Source: CAIN, Daiwa forecasts?

100% 9% 7% 18% 16% 15% 19% 7% 10% 3% 80% 2% 3% 3% 6% 10% 11% 13% 17% 21% 60%

40% 72% 70% 69% 69% 67% 63% 20%

0% 2009 2010 2011 2012 2013 2014 Sedan SUV MPV Cross Source: CAIN

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 China Auto Sector: BAIC, GAC, GEELY and GWM SUV market  China: car sales volume distribution by tier city share comparison 100% 16% 80% 38% 14% 42% 46% 47% 50-60% 12% 60% 10%

8% 40% 62% 6% 58% 54% 53% 4% 20% 40-50% 2% 0% 0% 2007 2009 2009 2010 2015E 2010 2011 2012 2013 2014 2015E Tier 1-2 cities Tier 3-4 cities Geely BAIC GWM GAC Source: PWC, Daiwa forecasts Source: CAIN, Daiwa forecasts Strong product launches due in 2015-16  China Auto Sector: BAIC, GAC, GEELY and GWM sedan market share comparison We expect more new models to be launched by quality local brands over 2015-16, such as the Xindihao and 10% Borui by Geely and the H8 and H6 Coupe by GWM.

8% Meanwhile, some of the foreign JV brands have also launched their own local brands in 2015 YTD, such as 6% Brilliance’s Huasong 7 and GAC’s Trumpchi GS4.

4% Based on what we have seen so far in 2015, we expect the local OEM sales to be stronger than for the JV 2% foreign brands due to their new model launches. In the past few months, more foreign JV brands have cut 0% 2010 2011 2012 2013 2014 2015E prices vs. the China brands, which we believe has been Geely BAIC GWM GAC due to increasing competition between the local brands Source: CAIN, Daiwa forecasts and the foreign mid-range JV brands.

 China: price cuts by the China brands (local and foreign JVs) Quality local brands emerging OEMs Price cut details FAW Toyota Crown Tagged price adjusted to CNY279.8k from CNY319.8k (CNY40k price cut) FAW Red Flag H7 Tagged price CNY50k price cut Demand growth in lower-tier cities to sedan Shanghai GM Buick Tagged price adjusted to CNY109.9k from CNY129.9k (CNY20k price benefit some local brands Excelle GT cut). We see the new-generation Excelle GT as Shanghai GM's pricing As demand for PVs in the top-tiered cities is close to strategy (lower price, lower quality) to compete with Shanghai VW's low- end Lavida mid-size sedan saturation, and there are licence restrictions in place in GAC Honda Vezel Tagged price adjusted to CNY128.8k, from CNY138.8k (CNY10k price cut) some of these cities, we believe one of the main Geely GX7 Tagged price adjusted to CNY69.9k from CNY79.9k (CNY10k price cut) earnings-growth drivers over the next 1-2 years will be GAC Toyota Highlander Tagged price adjusted to CNY239.8k from CNY248.8k (CNY9k price cut) demand in lower-tier cities. Our view reflects 2 factors: SAIC Cadillac ATS Tagged price CNY10-30k price cut SAIC Buick Ecelle Tagged price CNY10k price cut 1) disposable income growth in lower-tier cities should SAIC Buick Encore Tagged price CNY10k price cut be faster than in top-tier cities, and 2) we do not expect SAIC Buick Regal Tagged price CNY10-20k price cut licence restrictions to be imposed in the lower-tier SAIC Chevrolet Captive Tagged price CNY40-54k price cut cities over this timeframe, as their PV markets are still SAIC Chevrolet Trax Tagged price CNY10k price cut in the growth stage. SAIC Chevrolet Cruze Tagged price CNY10k price cut Beijing Motor 2-year interest-free car loan, equivalent to a CNY5-20K saving DF Peugeot 3008, 508, Subsidies for vehicle-purchase tax, compulsory traffic accident insurance, We expect demand there to come from more first-time 408, 308, 301 vehicle and vessel tax, licence fee and car-loan interest rebate up to buyers than from replacement demand, and that these CNY20K Chang Ford all models Subsidies for vehicle purchase taxes, saving ranging from CNY7-20K consumers are more price-sensitive when it comes to GWM Havel H2 Tagged price CNY 5k price cut making purchase decisions. We think this will benefit GWM Havel H6 Tagged price CNY6k price cut the local OEMs more as they are more price- Source: companies competitive than the foreign JV brands and local customers typically have a higher acceptance of local brands.

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 Product list for selected China OEMs in 2015 and beyond Foreign luxury brands still facing less Company New model pipeline 1H15 2H 15 2016 pricing pressure GWM More of the top-tier cities are likely to implement H6 Coupe H7 licence restrictions in the next decade, and we foresee Geely Emgrand Electric this affecting the sales-growth opportunities of the GC9 B-segment Sedans Vehicles Emgrand Cross Vehicles foreign mid-range JV brands (such as Toyota and Emgrand SUVs Emgrand 4-door Sedans Honda) more than the local brands and selected Compact SUVs foreign luxury brands. GAC GAC Motor New Class-A SUV GS4 GAC Fiat- As mentioned in this report, we expect the local brands Chrysler Class D SUV Cherokee to seek sales-growth opportunities in the lower-tier GAC Toyota Highlander cities, where the auto markets are still growing, and Guangqi Honda City DFM because we believe the governments in these cities are DFM Honda XRV CRV unlikely to impose licence restrictions for at least the Infiniti QX50 long next 3 years. DF Nissan wheelbase Murano Infiniti Q50L QashQai Lannia For the foreign luxury JV brands, we see less pressure Venucia T70 on pricing as their sales are mainly for replacement DF PSA Citroën C4L C4 Picasso demand, with many customers choosing a luxury brand Citroën C-Elysée rather than a mid-range foreign JV brand to replace Citroën C-Quatre their car. Citroën C3-XR Peugeot 308S Peugeot 508 BAIC SUVs still the focus over 2015-17 Beijing Hyundai Sonata 9 Tuscon New C-Class (regular- Consumers looking for more comfort Beijing Benz wheelbase) New E-Class As at the end of 2014, the proportion of SUV/MPVs as GLA New GLK a percentage of total car ownership in China was 30%, Beijing Motor Senova X65 behind the US, at 40%. For 2014, the proportion of Senova D80 large PVs, such as SUVs and MPVs, increased by 38% Senova CC YoY and 49% YoY, respectively, as a percentage of the 2 new SUV Changan whole, while the proportion of sedans (as a percentage Changan Auto EADO CS15 of the whole) increased by 3% YoY, according to EADO EV CS95 CAAM. EADO XT CS35 We expect SUV and MPV sales to continue to CS75 Changan Ford Kuga Taurus outperform those of other segments over 2015-17, Edge rising by around 25-40% pa. And we expect the market New Focus share of SUVs+MPVs to be around 40% by 2020, from Changan Mazda CX-5 30% in 2014, which is more comparable to the US FAW FAW VW New Sagitar Golf GTI level. Jetta Magotan  China: sales volume growth of different types of vehicles Bora 200% Brilliance Zhoungghua V3 Huasong 7 150% Brilliance BMW 2-Series BYD 100% Song Yuan 50% Chery Arrizo 7 QQ 0% Arrizo M7 Arrizo 5 Tiggo 5 -50% Arrizo 7 (PIEV version) 2010 2011 2012 2013 2014 Arrizo 3 (EV version) Sedan MPV SUV Cross Source: Companies, news reports Source: CAIN

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 US: SUV as a % of total PV sales models, and we expect the trend to move against GWM 45% in 2015-16. 40% 35%  Major OEMs in China: new SUV products (2015-16E) 30% OEM New SUV pipeline GWM H7 25% Geely Compact SUVs 20% GAC Motor New Class-A SUV GS4 15% GAC Fiat-Chrysler Class D SUV Cherokee GAC Toyota Highlander (replacement model) 10% DFM Honda XRV 5% CRV 0% DF Nissan QashQai Venucia T70

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Beijing Hyundai 1 new SUV Source: Wards Beijing Benz GLA New GLK We believe the major appeal of an SUV compared with Beijing Motor 2 unknown SUV Changan Auto CS35 a sedan is the size of the vehicle (especially the A- CS75 class), which means more comfort for the driver and CS95 passengers. Also, the higher ground clearance of SUVs Changan Ford Kuga makes them well suited to China’s road conditions Edge Brilliance Zhoungghua V3 (many roads in lower-tier cities are still poorly Brilliance BMW X1 (replacement model) constructed and maintained). This factor is particularly X3 (replacement model) important given the growing trend of private car BYD Song ownership in China, which we expect to last for at least Yuan the next 5 years. Chery Tiggo 5 (replacement model) Source: Companies, news reports

Competition is intensifying Apart from the ongoing impact of the economic As demand for sedans has slowed significantly over the slowdown in China, the strong product cycles of most past 5 years, especially the A/A-0 class of small PVs, local brands, and the increasing focus on the SUV OEMs such as Geely, BAIC and GAC have devoted segment, we expect China’s auto market to follow in more resources to the SUV market in recent years, and the footsteps of Japan and Korea, with some local plan to launch more SUVs this year and next. brands going on to gain global prominence and establish manufacturing facilities overseas. At the Shanghai Auto Show on 20-26 April 2015, many OEMs (from China and overseas) placed their SUV models front and centre on their podiums, and some used the event to launch new SUVs. Among the high- profile launches were Audi’s first Asian SUV, the Q7, Mercedes-Benz’s first China SUV, the GLE, GWM’s long-awaited H8, and GAC’s own-brand SUV, the Trumpchi GS4.

The key takeaway is that demand for SUVs is fast increasing, unlike demand for sedans, and seemingly every car player wants a piece of the pie. With competition intensifying, we recommend that investors focus on the OEMs that have recently entered the SUV market (eg, Geely and GAC), as they should see the most margin upside.

Conversely, the more established SUV OEMs, such as GWM, should be exposed to more competition and hence face the risk of margin compression. Indeed, according to the International Business Times (17 June 2015), GWM has just responded to the increasing competition by cutting the prices of its H6 and H2

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 Auto OEMs and car-components manufacturers: R&D expenditure (2014) R&D expenditure R&D to sales Company (EURm) 2014 2010-14 CAGR% ratio (%) GEELY AUTOMOBILE 222.9 95.1% 7.2% TESLA MOTORS 413.5 95.1% 14.6% JIANGLING MOTORS 222.7 43.0% 6.1% Singling out China’s GREAT WALL MOTOR 368.5 54.1% 4.1% KIA MOTORS 1011.5 32.1% 2.7% FIAT 2537.0 8.5% 2.6% long-term winners VOLKSWAGEN 13120.0 17.8% 6.5% BMW 4566.0 13.3% 5.7% GUANGZHOU AUTOMOBILE 228.3 28.9% 7.1% We expect the China brands to become DONGFENG MOTOR 336.8 5.0% 2.9% more competitive over the next decade as DAIMLER 5680.0 6.4% 4.4% FAW CAR 73.4 15.6% 1.5% they follow the road travelled by the NISSAN MOTOR 3649.5 1.6% 4.4% HONDA MOTOR 4572.7 2.4% 5.4% Japan and Korea brands. Also, new fuel GENERAL MOTOR 6585.4 6.5% 4.7% consumption standards in China could RENAULT 1721.0 1.0% 4.2% TOYOTA MOTOR 6569.2 0.7% 3.5% give the OEMs an added incentive to FORD MOTOR 6140.4 9.6% 4.8% develop NEVs. HYUNDAI MOTOR 1695.6 22.0%* 2.4% SAIC MOTOR 979.0 12.2%* 3.4% CHONGQING CHANGAN 288.3 31.4%* 3.8% DONGFENG AUTOMOBILE 85.3 19.2%* 3.4% What’s next for China’s XIAMEN JINGLONG MOTOR 54.2 3.3%* 1.8% Source: Annual Report On Automotive Industry In China (2014), companies automakers? Note: 60% of the R&D costs of the European and Korean OEMs are amortised

We believe the historical development of the Japan and In addition, the local OEMs have launched premium Korea automakers is good reference point for investors product lines, such as Geely’s Emgrand (2009) and seeking to figure out the future of China’s automakers. Brilliance’s Huasong (2014), as part of an effort to After all, the Japan and Korea players went through build out their product lines and boost their branding. much the same process initially, in terms of We expect the local OEMs to continue to develop cooperating with international partners in order to premium brands going forward. develop their own brands. At the same time, the foreign JV brands, such as BAIC, On the same basis, we believe that some of the China GAC and Brilliance, are pushing ahead with plans to automakers are in a transition period, where they are develop their own brands (Senova, Trumpchi and moving from having technological independence to Huasong, respectively). starting the process of becoming globally recognised. We note that the foreign partners now appear more In this section we discuss some of the likely next steps open to jointly developing local brands if doing so helps for China automakers looking to follow in the them gain entry to China’s lower-tier markets. For slipstream of the now established brands of Japan and example, Brilliance’s Huasong 7 is built mostly using Korea. components from BMW, but is sold for a much lower price than a JV brand product with similar Launching more premium products specifications. We think this approach is a sound way As we expect consumers in China to seek better-quality for Brilliance to raise the profile of its own brand while cars as their disposable incomes rise, we expect the allowing BMW to gain a foothold in lower-tier cities foreign JV brands (especially the luxury carmakers) to without having to cut its own prices. Another example remain attractive to investors in the coming years. is Mercedes-Benz allowing BAIC to use its E-class series technology to develop BAIC’s own brand. However, over the next decade or so, we expect the quality of local brands such as Geely and GWM to catch up with that of the JV brands, which would allow the local brands to offer a better price-performance proposition. Indeed, over the past 5 years, the local OEMs have been investing heavily in R&D, which we expect to bear fruit in the next decade.

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 China OEMs: premium auto models What can be learned from Hyundai’s brand DFM development Model Price (CNY) Type DF Fengxing CM7 130-170K MPV The China automakers are currently in a similar DF U-Van 130-250K MPV situation to what happened to the automakers in Korea Brilliance and Japan. For example, Hyundai Motor (005380 KS, Model Price (CNY) Type Huasong 7 240-290K MPV KRW136,000, Buy [1]) originally produced Cortinas for Geely Ford in 1968. By 1975, it had developed its first own Model Price (CNY) Type brand, the ‘Pony’, using a design from ItalDesign and GC9 120-230K Sedan engine technology from Mitsubishi. GX9 130-150K SUV Emgrand EC8 90-120K Sedan GAC Over 1978-1991, Hyundai invested heavily in R&D and Model Price (CNY) Type rolled out the Sonata model in 1989, but was still Trumpche GA5 100-200K Sedan reliant on Mitsubishi’s engine technology. By 1991, Trumpche GA6 120-200K Sedan Hyundai Motor had developed and started using its Trumpche GS4 100-150K SUV Trumpche GS5 120-230K SUV first petrol engine, the four-cylinder Alpha, and its own BAIC transmission system. Since then, it has been an Model Price (CNY) Type independent automaker using its own technology. Senova D20 50-80K Sedan Senova D50 70-120K Sedan However, it took years for Hyundai to go from being a Senova D60 120-170K Sedan Senova D70 140-220K Sedan carmaker in Korea using its own technology to a brand Senova D80 200-270K Sedan recognised and bought the world over. Hyundai has Senova CC 100-150K Sedan been selling cars in the US since 1986, but in the early Senova X65 100-150K SUV days it faced scepticism among prospective buyers FAW Model Price (CNY) Type about the quality and durability of its vehicles. Hongqi H7 250-500K Sedan Hongqi L5 5000K Sedan In response, Hyundai has invested heavily in BYD improving its quality and design, and now offers a 10- Model Price (CNY) Type year or 100,000-mile (160,000km) warranty for its Tang 300-600K SUV Changan cars sold in the US. Industry recognition finally arrived Model Price (CNY) Type in 2004, when Hyundai was ranked second in a quality Raeton 110-200K Sedan survey carried out by well-known marketing research Zunxing 160-210K MPV firm J.D. Power and Associates. Hyundai is currently GWM th Model Price (CNY) Type ranked by J.D. Power as the 4 -largest automaker in Havel H5 90-160K SUV the world in terms of production. Havel H6 100-160K SUV Havel H6 Coupe 140-170K SUV Havel H8 200-260K SUV Havel H9 230-270K SUV

Source: Companies, auto.sohu

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 Hyundai Motor: a brief history

Phase I (1967–1977) Phase II (1978-1991) Phase III (1992 – present) Starts to learn about basic technologies by Now has its core technology and has Becomes one of the world’s top-tier setting up JVs or cooperating with foreign achieved technology independence automotive manufacturers brands

• 1967-1973: Hyundai manufactures • 1978: Hyundai starts cooperating • Produces a wide range of 4- auto components with Ford in with 26 foreign auto technology cylinder and 6-cylinder engines for order to obtain assembly companies. All these companies PVs technology and manufacturing have licensed proprietary products • Manufactures its own Modern V-8 experience and technology to Hyundai. By engine; uses its Tau engine in its • 1973-1975: Hyundai cooperates 1985, Hyundai owns 54 auto- Genesis luxury sedan with Mitsubishi to produce auto related patents components and modules. During • 1982: Hyundai starts sending this period, Hyundai signs a engineers aboard to acquire auto technological agreement with technology. The number increases Mitsubishi allowing it to use from 83 in 1982 to 351 in 1986 Mitsubishi’s power system and Key measures design for its own brand • 1974: the chairman of Hyundai travels to Europe to hire a well- known auto designer and management

• George Turnbull hires 6 top • 1983: Hyundai focuses on • Makes 2L and 2.4L engines for engineers from Europe to focus on developing its own auto engine. Mitsubishi and Chrysler developing the Pony Finally launches its first petrol • Mercedes-Benz announces it is • 1968: Hyundai launches the engine, the 4-cylinder Alpha, and interested in cooperating with

Cortina with Ford its own transmission system. Hyundai on manufacturing a • 1975: Hyundai launches the Pony • 1989: Hyundai launches the 4-cylinder engine with the engine provided by Sonata, which uses an engine

Milestones Mitsubishi and the design by from Mitsubishi and Hyundai’s own ItalDesign multipoint fuel-injection technology • 1978: Hyundai sets up the first auto research institute in S. Korea

Source: China's Automotive Industry's Golden Decade

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 Hyundai: timeline for development of new car features foreign JV brands, such as BAIC and Brilliance, could Manufacturing Power Wheelbase catch up with the international brands, as their Model date Styling Body design system design Pony 1975 1 1 1 1 international counterparts are open to sharing their Stellar 1983 1 3 1 2 technology in order to jointly develop the local brands. Excel 1985 1 3 1 2 Sonata 1988 1 3 1 2  China: market shares of domestic branded PVs and domestic N - Excel 1999 3 3 1 2 branded sedans Scoupe 1990 3 3 3 2 Elantra 1990 3 3 1 2 50% 45.60% NGrandeur 1992 3 3 1 1 43.74% 44.30% 45% 41.47% 42.23% 41.85% Sonatall 1993 3 3 1 2 40.47% 39.92% 40.30% Accent 1994 3 3 3 3 40% Marcia 1995 3 3 2 3 Avante 1996 3 3 3 3 35% 30.89% 1. Technology introduction/authorisation from 29.67% 29.11% 28.38% 27.47% foreign brands 30% 26.07% 25.67% 26.28% 25.92% 2. Upgraded based upon imported technology 25% 3. Hyundai’s own technology Source: China's Automotive Industry's Golden Decade 20% 2005 2006 2007 2008 2009 2010 2011 2012 2013  Hyundai: timeline for development of engine technology Market share of domestic brands: PV Market share of domestic brands: Sedan Introduction Date Provider Related technology Source: Annual Report On Automotive Industry In China (2014) 19/5/1987 Ricardo Engine design (diesel engine noise control) 14/6/1978 Ricardo Engine design 13/7/1978 Ricardo Engine design Battlefield should extend to 10/3/1978 Elko Converted gas (gasoline?) engines to diesel 25/7/1984 Ricardo Alpha engine development overseas markets in the long run 22/10/1984 Mr. Daeun Lee CAD for diesel engine development 25/7/1985 Mr. C Mears Alpha engine development Currently, the China brands see modest earnings 20/9/1985 Ricardo Saturn engine (mid-sized engine) 16/10/1985 AVL Cirius engine development contributions from export sales. However, as the local 30/6/1987 AVL Gamma (2400cc) engine development brands’ image and technology continue to improve over 24/9/1984 Ricardo Alpha engine 2nd the next few years, we believe the export business will 26/2/1988 Mr. J. W Holdman Transmission development play a more important role, as has been the case for the 11/4/1988 Mitsubishi E - W type auto transmission production 24/12/1988 AVL Delta engine (3000cc DOHC) development Korea and Japan automakers. 7/26/1989 Mr. C. H. Suh Employed Mr Suh as advisor for transmission development 26/7/1989 Mr. Fukushima Employed Mr. Fukushima to lead development of gear and Stepping onto the world stage transmission systems 27/12/1990 AVL Jetta engine (small diesel) development Since 2010, some of the China auto OEMs, such as 16/1/1991 FFD Automatic transmission Geely and GWM, have been expanding their presence 25/2/1991 FFD 4-wheel drive transmission overseas (eg, Russia, the Middle East and South Source: China's Automotive Industry's Golden Decade America). We expect this trend to continue over the next 10 years. Ultimately, we look for these companies Over the past decade, China’s local brands have to derive a large proportion of income from exports. cumulatively claimed a domestic market share of But we think they will first have to go through several around 40%. The equivalent figures for the domestic phases of development. players in Korea and Japan are around 85% and 95%, respectively. There are many reasons for this disparity, Phase 1: exporting foreign-brand cars or components including the impact of import duties and the recent that are manufactured in China. This is the early stage, rise in popularity of HEVs, but we think the China whereby foreign OEMs form JVs with China companies brands do have scope to gain market share at home. to make use of China’s cheap labour and land. However, the China partners do not receive a lot of With reference to the chart on page 18, we think many recognition from their overseas customers at this stage of the China automakers are at the end of phase II in the process. (becoming independent in terms of technology) and heading into phase III (becoming globally recognised Phase 2: acquiring a foreign brand (or forming a JV brands). overseas), its technology and facilities, but continuing to sell the finished autos under the foreign brand In terms of the evolution process, we think the local overseas. This happens when the China OEMs have brands may progress faster in gaining global accumulated sufficient manufacturing experience but recognition than the foreign JVs, as the local brands lack broad recognition of their own brands. One have invested more in R&D. But it is possible that some - 19 - Consumer Discretionary / China 18 June 2015

example: Geely bought Volvo in 2010 and acquired the US. However, Toyota took the opportunity during Manganese Bronze in 2007 to produce London taxis. the oil crisis in the 1970s to push out its small cars, such as the Crown and the Corolla, to meet demand for Phase 3: China brands are exported and, crucially, more fuel-efficient cars at that time. accepted in overseas markets. This happens when the China OEMs become confident enough in their Since then, Toyota has been investing in quality and products, or have a competitive edge in certain design to improve its products. Also, and partly to segments, for example, when GWM started selling its offset the impact of import tariffs in the US, the vans to Europe in 2006. company established plants in the US in the early 1980s to cut its production costs. Currently, most of the China brands are using low price points to establish a presence overseas, and focusing But to build up their presence in the US in the 1990s, only on certain segments, such as SUVs. We think it is the Japan OEMs did not use cheaper pricing to get sensible for the China brands to try to establish a ahead. Rather, they tried to improve the resale value of foothold overseas using their best models, particularly their products, which had become attractive, allowing as local regulations may require that the configurations buyers to get more for their cars when reselling them. of these models are fine-tuned prior to sale. In sum, Toyota appears to have done the following: Gross-profit margins globally are lower than they are in 1) Gained a foothold in a particular segment of the China currently. But the Japan automakers, for market initially. example, derive most of their revenue internationally, and we see strong potential for the China automakers 2) Maintained a certain level of quality while looking to to develop their overseas businesses as their brands improve it incrementally. mature and the domestic market becomes saturated. 3) Invested in local manufacturing to lower its costs, and established local R&D departments to For Geely and GWM, only 14% and 7% of their understand demand better. respective sales volumes came from overseas in 2014, whereas the proportion was more than 80% for all the However, the strategy in China appears to be different, Japan and Korea automakers. In order to maintain as the second-hand market is relatively small. Over the their gross margins in the long run, we think the China next decade, the second-hand market can be expected OEMs need to build their brand equity and step up to expand, which we think will help to improve the their localisation efforts overseas. brand equity of the local brands within China.

 China, Japan and Korea OEMs: comparison of sales volume  China: second-hand car transaction volume proportion by region (2014) Sales volume ('000 units) (YoY %) proportion by 7,000 50% region Toyota* Nissan* Honda* Hyundai Kia Geely GWM 6,000 Domestic 19% 17% 21% 14% 16% 86% 93% 40% Overseas 81% 83% 79% 86% 84% 14% 7% 5,000 Source: Companies 4,000 30% Note*: FY15 figures for Japan companies 3,000 20%  China, Japan and Korea OEMs: comparison of sales revenue 2,000 10% proportion by region (2014) 1,000 Sales revenue proportion by 0 0% region Toyota* Nissan* Honda* Hyundai Kia Geely GWM 2006 2007 2008 2009 2010 2011 2012 2013 2014 Domestic 22% 22% 19% 45% 38% 81% 95% Used car transaction volume ('000 units, LHS) YoY growth (%, RHS) Overseas 78% 78% 81% 55% 62% 19% 5% Source: China Automobile Dealers Association Source: companies Note*: FY15 figures for Japan companies  Second-hand car sales volume as proportion of new car sales volume in major markets What China OEMs can learn from Toyota’s China US Germany Japan S. Korea overseas strategy 1/4 3.3x 2.3x 1.5x 1.5x Source: Chinanews.com Toyota Motor Corporation (7203 JP, JPY8,184, Outperform [2]) was founded in 1937, and started to Comparing the China automakers with Toyota, the export to the US with its Crown model in 1956. China OEMs appear to be mostly focusing on one Initially, Toyota’s small cars were not well received in segment of the market, and offering attractive pricing

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as well. In the longer term, we are confident that the quality of their autos will be comparable to that of their Fuel-consumption standards peers, which should mean they can offer their should raise entry barriers customers a better price-to-performance ratio. Looking to save energy Globally, it is fair to say that China autos are not yet widely recognised. On the margin side, even though Apart from the need for the China automakers to their overseas businesses are likely to drag down their develop their brands and push their overseas overall gross-profit margins in the coming years, the expansion plans, we think development of more fuel- China OEMs, such as Geely and GWM, are both efficient cars will be a long-term trend as the planning to increase localisation to save on logistics government has made clear its commitment to reduce costs in the future (similar to what Toyota did). pollution.

However, we expect their overall overseas revenue More fuel-efficient cars should help to reduce CO2 proportions to remain low (sub-10%) over 2015-17. emissions and reduce pollution, both of which are One major swing factor would be unexpected factors growing concerns for many cities in China. From the influencing economic growth in emerging countries in country’s perspective, having a larger proportion of the Middle East, South America and Russia, as these fuel-efficient cars would help China to rely less on oil are the main countries to which the China OEMs are imports and enable the China auto players to become exporting currently. more competitive with international brands.

 China: price-performance index comparison of domestic and In order to achieve its goal of reducing air pollution, foreign brands the China government has 2 main policy strands:

PP 100 Index 1) it has set higher fuel consumption standards for 834 900 conventional cars in order to reduce their emissions, 800 and 2) it has encouraged, through subsidies and 700 separate licence quotas for NEVs, the use of electric

600 473 469 vehicles (EV), including plug-in (PEV) and plug-in 406 500 399 380 368 hybrid (PHEV) vehicles. 400 306 318 258 300 438 224 232 212 155  China: brief history of energy-saving and new energy vehicle 200 331 development 246 278 100 221 190 189 Phase Major policies 167 173 142 0 135 131 117 104 Phase I: Early-1995-2008 China establishes the framework for research, innovation and the 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 industrialisation of pure electric vehicles, hybrid electric vehicles Domestic brands Foreign brands and fuel-cell electric vehicles by providing research and technical support. The use of NEVs at the Beijing Olympics under the EV- Source: Annual Report On Automotive Industry In China (2014) related projects carried out by the Ministry of Science and Technology helps to promote NEVs.  China: top-15 automotive manufacturers by ranking Phase II: 2009-12 Besides offering ongoing research and technological support for research and production, large-scale promotional campaigns are Rank Company Production Market share (%) run in 25 cities to highlight energy-saving measures and NEVs. 1 SAIC MOTOR 4,479,378 23.24% The government also improves the managements of energy- 2 DONGFENG MOTOR 3,079,279 15.98% saving and new energy vehicle manufacturers and their products, 3 FAW GROUP 2,657,469 13.79% accelerating industry standardisation. 4 CHANGAN AUTOMOBILE 1,930,889 10.02% Phase II: After June 2012 The government releases a 'Notice of the State Council on 5 BAIC MOTOR 1,672,974 8.68% Issuing the Planning for the Development of the Energy-Saving 6 GUANGZHOU AUTOMOBILE 703,270 3.65% and New Energy Automobile Industry 7 BRILLIANCE AUTO 639,822 3.32% (2012-20)', which aims to improve the innovation and industrialisation capacities of energy-saving and new energy 8 GREAT WALL MOTORS 624,426 3.24% vehicles. Since September 2013, the Ministry of Finance, the 9 CHERY AUTOMOBILE 563,951 2.93% Ministry of Science and Technology, the Ministry of Industry and 10 ZHEJIANG GEELY HOLDING 494,648 2.57% Information Technology and the National Development and 11 ANHUI JIANGHUAI AUTOMOBILE 476,356 2.47% Reform Commission have announced a 'Notice on Implementing 12 BYD AUTO 455,444 2.36% Popularisation Work of Energy Saving and Environmentally 13 CHONGQING LIFAN PASSENGER VEHICLE CO. 272,657 1.41% Friendly Vehicles of 1.6L or less' and a 'Notice on Continuing the Promotion and Application of New Energy Automobiles' and to 14 CHINA NATIONAL HEAVY DUTY TRUCK 127,792 0.66% this end identified 28 model cities. GROUP 15 HUNAN JIANGNAN AUTOMOBILE 117,051 0.61% Source: Annual Report On Automotive Industry In China (2014) MANUFACRTURING CO. Total of the top 15 18,295,406 94.93% Total of China 19,271,808 100.00% Source: Annual Report On Automotive Industry In China (2014)

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 Description of acronyms for eco-friendly vehicles  CO2 emissions targets: major car markets Acronyms Vehicle name Comments Year (g/km) US EU Japan China S. Korea NEV 2005 212 162 153 n.a. 325 NEV New Energy Vehicle EV + PHEV + FCV 2010 188 140 128 180 175 ICE Internal Combustion Engine Conventional petrol/diesel-engine cars 2015 167 130 110 161 153 EV (Pure) Eclectic Vehicle Electric motors, 2020 126 95 105 117 153 no combustion engines 2025 103 68~78 105 117 153 Hybrid Electric Vehicle 5-YoY (%) US EU Japan China S. Korea Plug-in Hybrid Electric Vehicle Hybrid with plug-in charger option 2010 -11.3% -13.6% -16.3% n.a. -46.2% Fuel Cell Electric Vehicle Uses fuel cells to power an electric motor 2015 -11.2% -7.1% -14.1% -10.6% -12.6% Battery 2020 -24.6% -26.9% -4.5% -27.3% 0.0% LiB Lithium-ion Battery 2025 -18.3% -17.9~-28.4% 0.0% 0.0% 0.0% LFP Lithium Iron Phosphate Improvement (%) US EU Japan China S. Korea LMO Lithium Manganese Oxide 2010-25 -45.2% -44%~-51% -18.0% -35.0% -12.6% NMC Nickel Manganese Cobalt Oxide 2015-25 -38.3% -39%~-48% -4.5% -27.3% 0.0% LCO Lithium Cobalt Oxide Source: The International Council on Clean Transportation (ICCT) kWh Kilowatt Hour Note: No official guidance on emissions has been provided by Korea (beyond 2015), Japan Others ( beyond 2020), or China (beyond 2020) MPG Miles per Gallon Source: Daiwa  Summary of fuel-efficiency targets: major markets in terms of car manufacturing or exports Higher fuel standards likely negative for km/l (mpg) US EU Japan China S. Korea 2005 12.4 (29.0) 15.8 (37.2) 16.7 (39.3) 11.0 (25.9) 12.3 (28.9) new entrants and SUV OEMs 2010 13.9 (33.0) 18.0 (42.3) 19.6 (46.1) 14.4 (33.9) 14.8 (34.8) China’s new fuel consumption standard, targeted to be 2015 15.4 (36.0) 19.7 (46.3) 21.0 (49.4) 15.7 (36.9) 16.7 (39.3) 2020 19.9 (47.0) 25.8 (60.7) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) implemented for PVs by end-2015, is 30.8 (72.4) ~ 35.0 6.9L/km (or 15.7km/litre), which is due to be reduced 2025 23.9 (56.0) (82.3) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) to 5.0L/km (or 21.3km/litre) by 2020. For context, this 5-YOY (%) US EU Japan China S. Korea is lower than the current US standard and close to 2010 12.1% 13.9% 17.4% 30.9% 20.3% 2015 10.8% 9.4% 7.1% 9.0% 12.8% Japan’s (see table). Meanwhile, China has also 2020 29.2% 31.0% 11.4% 35.7% 0.0% announced that it plans to cut CO2 emissions by 27% 2025 20.1% 19.4%~35.7% 0.0% 0.0% 0.0% by 2020. Improvement (%) US EU Japan China S. Korea 2010-25 71.9% 71.1%~94.4% 19.4% 47.9% 12.8% China’s fuel-consumption target is calculated by taking 2015-25 55.2% 56.3%~77.7% 11.4% 35.7% 0.0% Source: ICCT the weighted average number of vehicles sold and then Note: No official guidance on fuel efficiency has been provided by Korea (beyond 2015), determining the corresponding fuel consumption per Japan (beyond 2020), or China (beyond 2020) OEM. Thus, we think the OEMs are likely to develop more EVs in the coming years, as doing so would allow Developing EVs takes time them to reduce their blended fuel consumption figures. Many of China’s local governments have announced We note, however, that the manufacturers are currently policies to encourage the use of EVs, include not subject to penalties for non-compliance with these subsidising both the OEMs and buyers. However, we targets. believe there is still a long way to go before EVs become popular in China due to a lack of investment in We expect the new fuel-consumption requirements to charging stations. pose a challenge for new entrants, as they may not have the technology needed to develop fuel-efficient vehicles In the US, even though there are only slightly more or EVs. And we see risks for the SUV OEMs, as they than 50,000 charging stations, many people live in will need to develop more fuel-efficient models, given houses with garages, where they can plug in their EVs that SUVs typically consume a lot of fuel. overnight. In China, however, most people live in apartments and therefore may find it difficult to find a place nearby to charge an EV. Indeed, there are only around 25,000 charging stations across China. At the same time, the battery life of domestically produced EVs is still much shorter than EVs made in the US or Europe, though batteries in China have an acceptable standard range of 300km once fully charged.

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 China: 2016 New Energy PV subsidies Subsidies (CNY/vehicle) Pure electric driving range [R] in km Growth of related business 100 ≤ R < 150 150 ≤ R < 250 R ≥ 250 R ≥ 50 Pure EV 25,000 45,000 55,000 ／ Auto financing a new revenue stream Plug-in hybrid electric vehicle ／ ／ ／ 30,000 Source: NDRC Auto financing is fast emerging as a lucrative new business line for car makers. Some of the Japanese  China: 2016 fuel-cell vehicle subsidies OEMs have already embraced this business area, with Vehicle type Subsidy (CNY/vehicle) one of the pioneers being Toyota, which set up its auto- Fuel-cell PV 200,000 finance business more than a decade ago. To illustrate Fuel-cell light CV 300,000 Fuel-cell mid-large CV 500,000 the profitability of this business, Toyota’s gross-profit Source: NDRC margin on its vehicle sales is around 10%, while that for the auto-finance business is 20%; and Toyota’s finance  US, China and Japan: number of charging stations (end-2014) business contributes 5-6% of its revenue and around US Japan China 12-24% of its EBIT. >50,000 >40,000 >25,000 Source: ScienceNet  Given the licence restrictions now in place in major  Comparison of EVs: BYD e6 vs. Tesla Model S 70D cities such as Beijing, Shanghai and Guangzhou, and Spec BYD e6 Tesla Model S 70D taking into account rising disposable income levels, we Battery (kWh) 61 70 think more people will be inclined to purchase luxury Range (km) 300 442 vehicles. In turn, we think this trend of drivers Top speed (km/h) 140 225 upgrading to luxury cars is, in the long term, likely to Charging time (fast charge) 40mins 1hr Charging time (standard charge) 6 hrs 10hrs spur demand for auto financing. Acceleration (0-97km/h) <14s 5.4s Source: Companies Most of the listed OEMs in China do not offer auto financing but some plan to do so in the future, Among the different types of EV, we believe HEVs will including Geely and BAIC. To that end, Geely recently be popular in China, as they are more affordable than set up a JV with BNP Paribas to form an auto-financing EVs and arguably better suited to China, given its unit. Judging from the profit contribution of Toyota’s relative dearth of charging stations. auto financing operation, this new business area holds considerable potential for the China players, in our According to Daiwa’s SY Chung and Eiji Hakomori, view. (see Green-car market set to bloom, published on 14 November 2014), Toyota is the market leader in green  cars, with HEVs accounting for around 40% of its shipments. We note the Japanese company’s Prius HEV is currently much more affordable than its FCV.

 Green cars: price comparison (HEVs/EVs and FCVs) (November 2014)

MSRP (USD) 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Toyota FCV Toyota 2015 Prius Nissan 2015 Leaf Source: Companies, Daiwa

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 China: selected auto finance company comparison We believe that car owners in China tend to spend less Service on maintenance if the purchase price for their car was Setup area in Company Notes Time China Services provided low, as within a few years they would be looking to Volkswagen New N.A. 2004 >240 cities First hand and second upgrade to a new model (perhaps a luxury one) or buy Mobility Services hand car financing a new local-brand model. Mercedes-Benz N.A. 2012 Dealer Provides automobile Leasing network leasing and relevant covered >2 leasing services (including  Toyota: EBIT mix 14 cities purchase, trade and JPYbn FY13 FY14 FY15 FY16E FY17E return) to individuals and Auto 944.7 1,938.8 2,325.3 2,673.0 2,900.0 enterprises Financial 315.8 294.9 361.8 402.0 390.0 Toyota Motor Finance N.A. 2005 N.A. Provision of auto finance Others 53.6 64.3 65.7 65.0 70.0 (China) services Eliminations 6.7 -5.8 -2.2 0.0 0.0 Beijing Hyundai Auto Joint investment of 2012 317 cities Provide auto financing Total 1,320.9 2,292.1 2,750.6 3,140.0 3,360.0 Finance BAIC and Hyundai products and services in Motor the PRC, including % FY13 FY14 FY15 FY16E FY17E wholesale financing Auto 72% 85% 85% 85% 86% solutions to auto dealers Financial 24% 13% 13% 13% 12% to finance the purchase of Others 4% 3% 2% 2% 2% cars as well as retail Eliminations 1% 0% 0% 0% 0% financing solutions to end- customers Source: Company, Daiwa forecasts Brilliance-BEA Auto Joint venture of 2014 N.A. Supporting Brilliance's Note: Year ended 31 March Finance Brilliance, Bank of sales of its minibus and East Asia and MPVs , and Huanchen's CaixaBank Sedan products BMW Automotive Joint investment of 2010 >400 Retail and Wholesale auto Finance Brilliance China and outlets finance BMW Dongfeng Peugeot Joint investment of 2006 N.A. Provision of auto finance Citroen Auto Finance DFM and PSA services Peugeot Citroën Chery HuiYin Motor JV of Chery Motor 2009 ~300 cities First hand and second Finance Service and Huisheng Bank hand car financing Geely Auto Finance JV of Geely and 2015 N.A. Aims to provide auto BNP Paribas financing products and services in the PRC, including wholesale financing solutions to auto dealers to finance the purchase of cars as well as retail financing solutions to end- customers Tianjin Great Wall JV of GWM and 2014 N.A. Provide automobile Binyin Automotive Tianjin Binhai Rural purchasing loan, auto Finance Commercial Bank finance leasing and other auto-related financial services Fortune Auto Finance JV of Jianhuai 2013 N.A. Provision of auto finance Automobile and services Banco Santander Source: companies

Sale of components Apart from auto financing, we think the sale of components and parts will also be a lucrative business for OEMs in the long run. At Toyota, the sale of components, which it refers to as after-sales service, accounts for 8% of the company’s total revenue and 20% of its EBIT. Plus, Toyota’s gross profit margin on these services is around 20%, compared with around 10% for car sales.

For the China OEMs, the sale of components as a proportion of total revenue is still very small as the demand for maintenance is low, likely due to the relatively low purchase prices of the OEMs’ products.

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 EPS growth: automakers vs. market 80%

30% Valuations and recommendations (20%) 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E Cap-weighted H-share listed auto makers We prefer local brands in both the near MSCI China H Index MSCI China Financials Index MSCI China Utilities GICS Sector Index term and long term, with our top pick MSCI China Consumer Discretionary Index being Geely. In terms of foreign JV Source: Bloomberg brands, we expect BAIC to outperform. Profitability: pockets of strength Over our forecast horizon, we expect the local OEMs to Sector expected to move in line outperform the foreign JV brands in sales-volume with market over 12 months growth, especially the Japanese automakers. Among the local OEMs, we expect Geely and BYD to record the best profit growth as they have strong product cycles Sector valuation is low but same as market this year, as well as low bases set last year. Out of the The weighted index for the H-share automakers is foreign JV brands, we expect BAIC to outperform. trading currently at 2015-16E PERs of 15-26x, above the past-3-year (2012-14) range of 14-20x. Similarly,  EPS growth comparison of Hong Kong-listed auto makers MSCI China is trading currently at 2015-16E PERs of 9- Bloomberg EPS growth (%) 10x, higher than the past-3-year average of 8-9x. Name Code FY15E FY16E China H-share listed Geely Automobile * 175 HK 76.9 29.8 We consider both to be justified, as we forecast median BAIC Motor Corp Ltd-H * 1958 HK 29.5 24.5 EPS growth of 21-30% YoY for the H-share automakers BYD Co Ltd-H * 1211 HK 1,395.8 105.8 and 4-11% YoY growth for MSCI China in 2015-16 Great Wall Motor Company-H * 2333 HK 42.7 21.2 (Bloomberg data), higher than the average of 18% YoY Guangzhou Automobile Group-H * 2238 HK 10.3 12.0 Dongfeng Motor Grp Co Ltd-H 489 HK 1.2 9.8 for the H-share automakers and 6% YoY for MSCI Brilliance China Automotive 1114 HK 8.8 18.8 China in 2012-14. Total Weighted average 378.77 40.54 High 1395.8 105.8 We do not see the auto industry as trading very cheaply Low 1.2 9.8 against MSCI China, and as such, expect it to move in Median 29.5 21.2 Source: Bloomberg, *Daiwa forecasts line with the market over the next 12 months. Balance sheets still strong, with decent  PER comparison: automakers vs. market 30x ROEs On the balance sheet side, the A-share and H-share listed automakers stayed in good shape in 2014, with 20x low net gearing of 23-26%, which was better than the levels for both Japan and Europe. 10x In terms of ROE, the China automakers posted stable

0x ROEs in a range of 15-20%, which we expect to be 2008 2008 2008 2008 2008 2008 2008 2015E 2016E 2017E maintained for 2015-17. Even though balance sheets Cap-weighted H-share listed auto makers MSCI China H Index should remain strong, dividends are likely to remain MSCI China Financials Index low as we expect the OEMs to preserve cash for R&D MSCI China Utilities GICS Sector Index MSCI China Consumer Discretionary Index and other product development. Therefore, the Source: Bloomberg automakers are unlikely to be yield plays in the near term, in our view.

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 Global auto OEMs: net debt/equity ratio comparison (2010-14) Besides, the first Geely model based on the company’s 2010 2011 2012 2013 2014 shared platform with Volvo (referred as CMA – China H-share listed 8 12 17 32 26 Compact Modular Architecture) is due to enter China A-share listed 6 4 17 28 23 US Net cash Net cash Net cash 127 Net cash production in November 2016, and should lead to a Europe 145 145 151 133 153 more cost-efficient way for Geely to get full access to Japan 78 81 86 89 70 the Volvo’s technology. With its plan for further Korea 61 49 34 24 25 localisation, Geely is a strong brand not only in China Source: Bloomberg but also overseas, in our view.

 Global auto OEMS: ROE comparison (2011-17E) 30 Among the JV brands, we favour BAIC

25 In terms of foreign JV brands, we prefer luxury German marques (such as Mercedes Benz) to Japanese 20 brands (such as Toyota and Honda), as we believe that 15 given the licence restrictions, the demand for luxury cars will exceed that for Japanese cars. 10 5 Among the luxury brands, we see the sales momentum

0 for Mercedes Benz being stronger than for BMW, due 2011 2012 2013 2014 2015E 2016E 2017E to the former’s more aggressive promotional activity in China H-share listed China A-share listed 2014-15. Also, a new sales strategy and improved US Europe Japan Korea distribution agency network looks to be contributing to Source: Bloomberg a sharp turnaround for Mercedes’ business in China this year.  China: H-share listed auto maker yield comparison (2010-17E) Bloomberg In the longer term, as Mercedes seems willing to Name code 2010 2011 2012 2013 2014 2015E 2016E 2017E BAIC 1958 HK n.a. n.a. n.a. n.a. 4.17 4.16 5.36 6.78 cooperate with BAIC on developing local brands (such GEELY 175 HK 0.75 1.58 1.06 1.25 1.01 1.13 1.44 1.74 as sharing its E-class technology), we believe BAIC will DFM 489 HK 1.58 1.67 1.56 1.90 2.28 2.19 2.42 2.62 be able to move more quickly than other JV brands in BYD 1211 HK 0.95 n.a. 0.00 0.17 0.00 0.10 0.14 0.09 gaining technology independence. GAC’s Japanese GAC 2238 HK 2.20 3.81 1.63 2.42 2.83 2.96 3.50 4.22 partner does not seem to have a clear strategy in China GWM 2333 HK 2.46 2.17 2.90 2.45 2.27 2.69 3.33 3.81 BRILLIANCE 1114 HK 0.00 0.00 0.00 0.00 0.87 1.36 1.63 2.44 or to be willing to share much of its technology yet. As Weighted average 1.35 1.28 1.15 1.24 1.78 1.96 2.38 2.83 such, we look for BAIC’s sales-volume growth to Source: Bloomberg outperform those of other foreign JV brands such as Note: Historical yield calculated by DPS/share price in the last trading day of the GAC both in the near and long term. corresponding year

Recommendations Valuations: not expensive

Geely is our top pick Recent share price weakness offers a better As mentioned, we believe the local brands, such as entry point Geely and GWM, will outperform the foreign JV Many auto and related stocks rallied in early April due brands, such as BAIC and GAC, due to the former’s to the positive sentiment toward the sector on the better growth opportunities in lower-tier cities. Among anticipation of strong liquidity flows from China. the local brands, we prefer Geely to GWM as we However, most of them have retreated and are now consider the near-term profit turnaround to be trading below their past-3-year averages, such as Geely stronger for Geely due to its low base last year and the and GAC. launches of SUV models, such as the GX7 and GX9. In the longer term, China’s fuel efficiency standards We use PER for our valuation comparison as we believe should also favour Geely’s sedan sales, in our view. it is the most direct way of establishing the earnings prospects of the China OEMs. Also, we see Geely being able to move faster than peers in terms of gaining technology independence, as it already has its own engine technology, and very soon should launch its own transmission system.

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 Geely: forward PER (2012 – present)  GAC: forward PER (2012 – present) (PER) (PER) 20 40 18 35 16 30 14 25 12 20 10 15 8 6 10 4 5 2 0 Jul-12 Jul-13 Jul-14 Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Jan-12 Jan-13 Jan-14 Jan-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Mar-12 Mar-13 Mar-14 Mar-15 May-12 May-13 May-14 May-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 May-12 May-13 May-14 May-15 Trading PER Average + 1SD -1 SD Trading PER Average + 1SD -1 SD Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

 GWM: forward PER (2012 – present) (PER) Risks to our sector view 16 14 Weaker-than-expected demand 12 The major downside risk to our view on the sector is 10 weaker-than-expected sales volume and margins. We 8 believe the risk for foreign JV brands is greater than for 6 the local brands, as we are already seeing Japanese 4 brands cutting prices, whereas local brands are keeping 2 their pricing relatively stable, except for recent price cuts by GWM. YTD, the volumes recorded by foreign Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 May-12 May-13 May-14 May-15 JV brands have been weaker than those of the local Trading PER Average + 1SD -1 SD ones. Source: Bloomberg, Daiwa forecasts

 BAIC: forward PER (Since listing) Political risk (PER) We see the major political risk being between the China 10 and Japan governments. For example in 2012, when

9 China and Japan came into conflict over the Daioyu Island, sales for Japanese OEMs, such as GAC and 8 DFM, slowed significantly. Therefore, we believe the political relationship between China and Japan would 7 adversely affect the sales performance of Japanese

6 brands while benefiting their competitors.

5 Upside risk: currency impact Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Depreciation of the Yen and Euro has been positive for Trading PER Average + 1SD -1 SD foreign JV OEMs such as BAIC, Brilliance, GAC and Source: Bloomberg, Daiwa forecasts Dongfeng (DFM), as it has brought down the price of

imported components. As such, most of the foreign JV OEMs recorded exchange gains for 2014. If the currencies continue to depreciate against the Renminbi, then the foreign JV OEMs would likely record exchange gains again for 2015, which we think would boost investors’ sentiment on these stocks.

- 27 - Consumer Discretionary / China 18 June 2015

 DFM: annual sales and growth (2010-14) (units) (YoY %) 3,000,000 40% 35% 2,500,000 30% 2,000,000 25% 20% 1,500,000 15% 1,000,000 10% 5% 500,000 0% 0 (5%) 2010 2011 2012 2013 2014 Sales volume (LHS) YoY % (RHS) Source: Company

 GAC: annual sales and growth (2010-14) (units) (YoY %) 1,400,000 50%

1,200,000 40% 1,000,000 30% 800,000 20% 600,000 10% 400,000 200,000 0% 0 (10%) 2010 2011 2012 2013 2014 Sales volume (LHS) YoY % (RHS)

Source: Company

- 28 - Consumer Discretionary / China 18 June 2015

 Major products of GAC (2014) OEM Brand Model Sales volume 2014 Type GAC Honda Everus S1 4547 Sedan Honda Odyssey 34839 MPV Vezel 22558 SUV Fit 84702 Sedan City 45393 Sedan Appendix: historical Crosstour 22325 Sedan Crider 157207 Sedan data for the China auto Accord 108489 Sedan GAC Fiat Fiat Viaggio 47651 Sedan Ottimo 20439 Sedan market GAC Toyota Toyota Highlander 84490 SUV Levin 49112 Sedan  China: commonly used car size classification Camry 150311 Sedan EZ 16896 MPV Class A00 A0 A B C D YARiS L 73299 Sedan Engine displacement (L) <1.0 1.0 - 1.3 1.3 - 1.6 1.6 - 2.0 2.0 - 2.5 2.5 - 3.0 GAC Mitsubishi Mitsubishi Pajero 2325 SUV Total length (m) 3.3 - 3.7 3.7 - 4.0 4.0 - 4.2 4.2 - 4.45 4.45 - 4.8 4.8 - 5.2 Pajero Sport 5454 SUV Wheelbase (m) 2.0 - 2.2 2.2 - 2.3 2.3 - 2.45 2.45 - 2.6 2.6 - 2.8 2.8 - 3.0 ASX 55420 SUV Weight (kg) <680 680 - 800 800 - 970 970 - 1150 1150 - 1380 1380 - 1620 GAC Trumpchi GS5 75300 SUV Source: Various sources GA3 36944 Sedan GA5 4059 Sedan  Major products of BAIC (2014) GA6 10 Sedan OEM Brand Model Sales volume 2014 Type Gonow E Mei 199 Sedan Beijing Benz Mercedes-Benz GLK 56456 SUV GX5 969 SUV C-Class 35468 Sedan GX6 184 SUV E-Class 53544 Sedan G5 722 SUV Beijing Hyundai Hyundai IX25 24721 SUV Jetstar 9 SUV IX23 145304 SUV Xinglang 8848 MPV Mistra 134997 Sedan Xingwang 3587 MPV Moinca 9587 Sedan Leopard CS6 291 SUV Verna 236024 Sedan Q6 2536 SUV Sonata 54946 Sedan Feitang 456 SUV Tucson 26107 SUV Heijingang 13807 SUV New Santa 71424 SUV Source: China Auto Market Elantra 32236 Sedan Elantra Langdong 132363 Sedan Elantra Yuedong 252338 Sedan BAIC Motor BAIC Senova D50 42622 Sedan Senova D70 3827 Sedan E-Series 83175 Sedan Beijing40 7675 SUV Wevan 205 23229 MPV Wevan 206 1197 MPV Wevan 306 71478 MPV Wevan M20 90440 MPV Yongshi 1049 SUV Luba 89 SUV Qishi / Yusheng007 281 SUV BAIC Yinxang BAIC Huansu 84696 SUV Source: China Auto Market

 Major products of Brilliance (2014) OEM Brand Model Sales volume 2014 Type Brilliance BMW BMW X1 46719 SUV 3-Series 93932 Sedan 5-Series 138484 Sedan Brilliance Jinbei Jinbei S30 32645 SUV S50 688 SUV Granse 15041 MPV Source: China Auto Market

- 29 - Consumer Discretionary / China 18 June 2015

 Major products of DFM (2014)  Major products of GWM (2014) OEM Brand Model Sales volume 2014 Type OEM Brand Model Sales volume 2014 Type DF Nissan Murano 208 SUV GWM GWM C20R 1701 Sedan March 6926 Sedan C30 52463 Sedan X-Trail 114459 SUV C50 38611 Sedan Teana 109290 Sedan V80 266 MPV Sunny 69372 Sedan Havel H1 13049 SUV Sylphy 300058 Sedan H2 49351 SUV Qashqai 87448 SUV H5 45945 SUV Livina 57448 Sedan H6 315881 SUV Tiida 92465 Sedan H9 5102 SUV Infiniti Q50L 2441 Sedan M-series 90117 SUV Venucia D50 39468 Sedan Source: China Auto Market R30 14208 Sedan R50 59777 Sedan  Major products of Geely (2014) Leaf EV 582 Sedan OEM Brand Model Sales volume 2014 Type DF Honda Honda Elysion 7634 MPV Emgrand EC7 165239 Sedan CR-V 168179 SUV Emgrand EC8 3186 Sedan Jade 63210 MPV Englon TX4 2788 Sedan Spirior 5783 Sedan Englon SC7 26281 Sedan Civic 51869 Sedan Englon Kingkong 80282 Sedan XR-V 526 SUV Gleagle Vision 38317 Sedan CIIMO CIIMO 11014 Sedan Gleagle Panda 26890 Sedan DF PSA Citroen C3-XR 1246 SUV Gleagle Free Cruise 18991 Sedan C4 65896 Sedan Gleagle GX7 63799 SUV C5 33872 Sedan Source: China Auto Market Elysee 126479 Sedan C-Quatre 92517 Sedan Peugeot Peugeot 2008 44977 SUV  China: top-15 automotive manufacturers by ranking Peugeot 207 11510 Sedan Rank Company Production Market share (%) Peugeot 3008 42127 SUV 1 SAIC MOTOR 4,479,378 23.24% Peugeot 301 70753 Sedan 2 DONGFENG MOTOR 3,079,279 15.98% Peugeot 307 5908 Sedan 3 FAW GROUP 2,657,469 13.79% Peugeot 308 94466 Sedan 4 CHANGAN AUTOMOBILE 1,930,889 10.02% Peugeot 408 63921 Sedan 5 BAIC MOTOR 1,672,974 8.68% Peugeot 508 24679 Sedan 6 GUANGZHOU AUTOMOBILE 703,270 3.65% ZZ Nissan Nissan Paladin 3341 SUV 7 BRILLIANCE AUTO 639,822 3.32% Nissan Rich 43 Pick-up truck 8 GREAT WALL MOTORS 624,426 3.24% Dongfeng Succe 26737 MPV 9 CHERY AUTOMOBILE 563,951 2.93% Dongfeng Yumsun 184 MPV 10 ZHEJIANG GEELY HOLDING 494,648 2.57% DFM Fengshen E30 178 Sedan 11 ANHUI JIANGHUAI AUTOMOBILE 476,356 2.47% A30 10037 Sedan 12 BYD AUTO 455,444 2.36% A60 23192 Sedan 13 CHONGQING LIFAN PASSENGER VEHICLE CO. 272,657 1.41% AX7 8127 SUV 14 CHINA NATIONAL HEAVY DUTY TRUCK GROUP 127,792 0.66% H30 12983 Sedan 15 HUNAN JIANGNAN AUTOMOBILE 117,051 0.61% S30 25590 Sedan MANUFACRTURING CO. DF Liuzhou Dongfeng Joyear 115669 MPV Total of the top 15 18,295,406 94.93% Future 125230 MPV Total of China 19,271,808 100.00% Source: China Auto Market Source: China Auto Market

 Major products of BYD (2014) OEM Brand Model Sales volume 2014 Type BYD BYD M6 6356 MPV S6 98720 SUV S7 6549 SUV E6 3560 Sedan F0 38179 Sedan F3 110296 Sedan G3 2854 Sedan G5 12687 Sedan G6 8112 Sedan L3 54531 Sedan Qin 14747 Sedan Sirui 7865 Sedan Surui 73269 Sedan Denza 132 Sedan Source: China Auto Market

- 30 - Consumer Discretionary / China 18 June 2015

 Top-20 global automotive manufacturing countries in 2014  China: top-10 sedan manufacturers by sales volume (2014) Rank Country Production YoY % FAW-Volkswagen 1 China 23,722,890 7% Sales Shanghai GM 2 United States 11,660,699 5% 3 Japan 9,774,558 2% Shanhai Volkswagen 4 Germany 5,907,548 3% Beijing Hyundai 5 South Korea 4,524,932 0% Dongfeng Nissan 6 India 3,840,160 -2% 7 Mexico 3,365,306 10% Dongfeng Peugeot-Citroën 8 Brazil 3,146,118 -15% Changan Ford 9 Spain 2,402,978 11% Dongfeng Yueda 10 Canada 2,393,890 1% 11 Russia 1,886,646 -14% FAW TOYOTA Guangqi Honda 12 Thailand 1,880,007 -24% (units) 13 France 1,817,000 4% 0 500,000 1,000,000 1,500,000 2,000,000 14 United Kingdom 1,598,879 0% 15 Indonesia 1,298,523 8% Source: CAAM 16 Czech Republic 1,251,220 10% 17 Turkey 1,170,445 4%  China: top-10 PV manufacturers by sales volume (2014) 18 Iran 1,090,846 47% FAW-Volkswagen 19 Slovakia 993,000 2% Shanhai Volkswagen 20 Italy 697,864 6% Source: The International Organization of Motor Vehicle Manufacturers (OICA) Shanghai GM SAIC-GM-Wuling  Top-20 global automotive manufacturers in 2013 Beijing Hyundai Rank Group Country Total Chongqing Changan 1 Toyota Japan 10,324,995 2 GM United States 9,628,912 Dongfeng Nissan 3 Volkswagen Group Germany 9,379,229 Changan Ford 4 Hyundai South Korea 7,233,080 Dongfeng Peugeot-Citroën 5 Ford United States 6,077,126 Dongfeng Yueda 6 Nissan Japan 4,950,924 (units) 7 Fiat Chrysler Automobiles Italy / United States 4,681,704 0 500,000 1,000,000 1,500,000 2,000,000 8 Honda Japan 4,298,390 Source: CAAM 9 Suzuki Japan 2,842,133 10 PSA France 2,833,781 11 Renault France 2,704,675  China: top-10 SUV models by sales volume (2014) 12 BMW Germany 2,006,366 Havel H6 13 SAIC China 1,992,250 Sales Volkswagen Tiguan 14 Daimler AG Germany 1,781,507 15 Mazda Japan 1,264,173 Chery Tiggo 3 16 Dongfeng Motor China 1,238,948 Honda CRV 17 Mitsubishi Japan 1,229,441 Hyundai ix35 18 Changan China 1,109,889 19 Tata India 1,062,654 Ford Kuga 20 Geely China 969,896 Toyota RAV4 Source: OICA Nissan X-Trail  Audi Q5  China: PV market sales by car brand (origin) 2014 Changan CS35 France (units) S.Korea 3.7% 0 50,000 100,000 150,000 200,000 250,000 300,000 350,000 9.0% Source: CAAM

US China 12.9% 38.6%

Japan 15.8%

Germany 20.1% Source: Source: Ministry of Industry and Information Technology of the PRC

- 31 - Consumer Discretionary / China 18 June 2015

 China: top-10 sedan models by sales volume (2014) Ford Focus Sales VW Lavida Hyundai Sonata Nissan Sylphy VW Sagita VW Jetta Buick Excelle

Chevrolet Cruze

Chevrolet Sail Hyundai Elantra Langdong (units) 0 100,000 200,000 300,000 400,000 Source: CAAM

 China: top-5 and other auto OEMs’ market share by sales volume (2010-14) 35%

30% 25%

20% 15%

10%

5% 2010 2011 2012 2013 2014 SAIC MOTOR DONGFENG MOTOR GROUP FAW GROUP China Chang'an Automobile Group BAIC GROUP Others Source: CAIN

- 32 - Consumer Discretionary / China 18 June 2015

 Global auto OEMs: valuation comparison 1-Yr Bloomberg Trading Share Market target Name Code Currency price Cap Rating price PER (x) EV/EBITDA(x) Div yield (%) ROE (%) 18-Jun-15 USDm FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E China H-share listed Geely Automobile Holdings Lt * 175 HK HKD 3.70 4201 Buy 5.00 10.3 7.9 4.7 3.6 1.2 1.5 13.7 15.5 Baic Motor Corp Ltd-H * 1958 HK HKD 9.30 9111 Buy 12.00 8.2 6.6 8.3 6.0 6.2 7.7 19.2 21.0 Byd Co Ltd-H * 1211 HK HKD 49.50 22856 Outperform 56.00 74.9 36.4 14.7 11.6 n.a. n.a. 3.9 6.7 Great Wall Motor Company-H * 2333 HK HKD 38.00 18909 Hold 39.90 8.1 6.7 5.7 4.6 3.7 4.5 30.2 29.2 Guangzhou Automobile Group-H * 2238 HK HKD 7.37 14322 Sell 6.20 10.8 9.7 51.9 31.3 3.0 3.3 9.6 10.0 Dongfeng Motor Grp Co Ltd-H 489 HK HKD 10.86 12069 NR NR 5.9 5.4 24.1 21.0 2.6 2.9 16.1 15.6 Brilliance China Automotive 1114 HK HKD 10.86 7040 NR NR 7.9 6.6 n.a. n.a. 1.5 1.8 28.1 26.4

China A-share listed Byd Co Ltd -A 002594 CH CNY 67.64 22856 NR NR 77.7 64.2 19.8 16.5 0.0 0.1 8.5 8.7 Guangzhou Automobile Group-A 601238 CH CNY 17.96 14322 NR NR 27.8 24.0 107.6 78.2 1.1 1.3 10.0 11.3 Great Wall Motor Co Ltd-A 601633 CH CNY 42.76 18909 NR NR 11.0 8.8 7.4 6.1 2.5 3.0 29.6 28.7 Saic Motor Corp Ltd-A 600104 CH CNY 23.57 41876 NR NR 8.3 7.5 10.5 9.3 6.2 6.8 18.8 18.5 Chongqing Changan Automobi-B 200625 CH HKD 18.53 14810 NR NR 6.4 5.3 18.9 14.9 2.7 3.5 33.4 30.9 Faw Car Company Limited-A 000800 CH CNY 26.00 6819 NR NR 39.7 31.5 19.9 15.2 0.6 0.8 10.1 13.4 Anhui Jianghuai Auto Co-A 600418 CH CNY 17.35 4091 NR NR 18.5 13.3 11.8 9.1 1.6 2.0 15.6 19.2 Jiangsu Yueda Investment C-A 600805 CH CNY 20.42 2800 NR NR 13.3 11.2 11.6 10.1 0.7 0.7 17.2 17.0 Tianjin Faw Xiali Automobi-A 000927 CH CNY 11.18 2874 NR NR n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Lifan Industry Group Co Lt-A 601777 CH CNY 21.80 4418 NR NR n.a. 32.5 n.a. n.a. n.a. n.a. n.a. n.a. Haima Automobile Group Co-A 000572 CH CNY 10.84 2873 NR NR n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Shenyang Jinbei Automotive-A 600609 CH CNY 7.19 1269 NR NR n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

US Ford Motor Co F US USD 15.02 59710 NR NR 9.4 8.0 4.7 4.0 3.9 4.3 26.6 24.5 General Motors Co GM US USD 35.81 57554 NR NR 8.0 6.9 3.0 2.7 3.9 4.1 20.3 19.7

Europe Daimler Ag-Registered Shares DAI GR EUR 81.31 98148 NR NR 10.7 9.5 3.6 3.3 3.6 4.0 17.0 17.2 Bayerische Motoren Werke Ag BMW GR EUR 96.50 70592 NR NR 10.0 9.4 7.6 7.3 3.5 3.6 15.8 15.3 Volkswagen Ag VoW GR EUR 205.53 110878 NR NR 8.5 7.6 7.1 6.5 2.8 3.2 12.6 13.1

Japan Honda Motor Co Ltd ** 7267 JP JPY 3960.00 58495Neutral 4000.00 12.7 11.4 9.5 8.1 2.2 2.5 8.9 9.1 Nissan Motor Co Ltd ** 7201 JP JPY 1217.00 44864Neutral 1300.00 11.3 9.8 4.1 3.7 2.7 3.4 9.8 10.2 Toyota Motor Corp ** 7203 JP JPY 8184.00 228108Outperform 9000.00 11.8 10.4 11.4 10.1 2.5 2.9 14.2 14.1

Korea Hyundai Motor Co * 005380 KS KRW 131500.00 26234 Outperform 150000 5.8 5.5 4.0 3.5 2.8 3.5 9.9 9.7 Kia Motors Corp * 000270 KS KRW 45350.00 16649 Hold 47000 6.2 5.7 3.8 3.3 2.3 2.5 12.4 12.0

India Tata Motors Ltd ** TTMT IN INR 445.45 22043 NR NR 8.0 7.6 3.9 3.5 0.5 0.5 24.2 24.8 Mahindra & Mahindra Ltd ** MM IN INR 1253.95 12213 NR NR 20.2 16.3 13.8 9.7 1.2 1.2 15.5 15.6 Total Weighted average 13.38 11.17 10.21 8.48 2.83 3.19 15.62 High 77.7 64.2 107.6 78.2 6.2 7.7 33.4 30.9 Low 5.8 5.3 3.0 2.7 0.0 0.1 3.9 6.7 Median 10.3 9.1 8.9 7.7 2.5 2.9 15.6 15.6 Source: Bloomberg, *Daiwa forecasts Notes: **Year ended 31 Mar; share prices as of 18 June 2015 except for US and Europe (17 June 2015)

- 33 - Consumer Discretionary / China 18 June 2015

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Consumer Discretionary / China 175 HK Consumer Discretionary / China 18 June 2015

Geely Automobile

Geely Automobile Target (HKD): 5.00 Upside: 35.1% 175 HK 18 Jun price (HKD): 3.70

Initiation: a leading brand in the making 1 Buy (initiation) 2 Outperform • We forecast net-profit growth of 77% YoY for 2015, due to the 3 Hold low base in 2014 and strong demand in lower-tier cities 4 Underperform • We are positive on Geely’s brand strategy over the next 5 years, 5 Sell especially after it has absorbed Volvo’s technology • Initiating coverage with a Buy (1) rating and 12-month target price of HKD5.0; Geely is our top sector pick

How do we justify our view?

First, as its technology capability is a ■ Risks few steps ahead of the other China The major risks to our call would be: brands, and given that its C-segment 1) a lower-than-expected sales Modular Architecture (CMA) volume of its key models, and 2) a platform is due to be launched in lower-than-expected net margin due Kelvin Lau 2016, we believe Geely will be able to to fierce competition and weak (852) 2848 4467 utilise Volvo to further improve its demand. [email protected] technological know-how. Second, we expect its export business to become Brian Lam more profitable after further (852) 2532 4341 localisation of production in some [email protected] key export markets. Third, we are Share price performance

positive on its initiative in auto- (HKD) (%) 4.7 145 finance, which we expect to be a new ■ Investment case 4.0 129 source of earnings, just as it has We expect Geely, a major China 3.4 113 become for some Japan OEMs. carmaker focused on economy 2.7 96 2.0 80 sedans, to see its earnings recover ■ Catalysts Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 strongly in 2015, due partly to the The major share-price catalysts Geely Auto (LHS) Relative to HSI (RHS) low base last year, which was caused would be strong sales of its key by the negative impact of its models, like the EC7/Xindihao, as dealership network restructuring, as 12-month range 2.44-4.67 well as its new SUV GX9, which Market cap (USDbn) 4.20 well as the depreciation of the Ruble. would create better sentiment 3m avg daily turnover (USDm) 26.31

towards the stock. Also, a strong Shares outstanding (m) 8,801 In 2015-16, we expect Geely’s sales- Major shareholder LI Shu Fu (45.0%) earnings recovery in 2015 and volume growth to outperform that of product launches in 2015-16 would its peers given its exposure to the Financial summary (CNY) likely serve as catalysts. lower-tier cities where demand for Year to 31 Dec 15E 16E 17E Revenue (m) 28,302 33,749 40,285 inexpensive cars remains strong. We ■ Valuation Operating profit (m) 3,453 4,455 5,318 are positive on its entry into the We initiate coverage with a Buy (1) call Net profit (m) 2,531 3,285 3,945 higher-margin SUV segment. Also, Core EPS (fully-diluted) 0.288 0.373 0.448 and a 12-month target price of Geely has a busy product launch EPS change (%) 76.9 29.8 20.1 HKD5.0, based on a PER of 12x schedule which should enable it to Daiwa vs Cons. EPS (%) (1.8) 5.8 8.9 capture both new and replacement applied to the average of our 2015-16E PER (x) 10.3 7.9 6.6 EPS forecasts. With Geely shares still Dividend yield (%) 1.2 1.5 1.8 demand. In the long term, we see trading below the past-3-year average, DPS 0.035 0.045 0.054 Geely, as a China brand, becoming a PBR (x) 1.3 1.2 1.0 valuation looks undemanding. We see globally-recognised car maker. EV/EBITDA (x) 4.7 3.6 2.7 earnings turning around sharply in ROE (%) 13.7 15.5 16.2

2015, and rising for 2016-17E. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 102 Consumer Discretionary / China 175 HK 18 June 2015

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Geely: net profit and net profit growth We forecast Geely’s net profit to rise by 77% YoY to (CNYm) CNY2.5bn for 2015, a strong recovery from CNY1.4bn 4,500 100% in 2014, driven by the diminishing impact of its 4,000 80% 3,500 60% network restructuring in 1H14. For 2016 and 2017, we 3,000 40% forecast net-profit growth of 30% YoY and 20% YoY, 2,500 20% respectively, due to ongoing strong demand from 2,000 0% lower-tier cities, more product launches in 2015-16, and 1,500 an improvement in its overseas export margins due to 1,000 (20%) increased localisation. Also, its roll-out of the CMA 500 (40%) platform with Volvo should help Geely reduce costs 0 (60%) starting from 2017. 2010 2011 2012 2013 2014E 2015E 2016E 2017E Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts

 Valuation  Geely: 1-year forward PER (x) The shares are trading at a PER of 7.9x for 2016E, (PER) around 1SD below their past-3-year average of 10.5x. 18 The stock was derated in 2014, due partly to sluggish 16 earnings growth on the back of weak sedan-sales 14 12 volume, and the dealership network restructuring. 10 Moreover, the depreciating Ruble also led to negative 8 sentiment toward the stock. Our 12-month target price 6 of HKD5.0, which is based on 12x PER applied to our 4 average 2015-16E EPS, implies a 2016E PER of 10.6x, 2 on our forecasts. Jul-14 Jul-13 Jul-12 Jan-15 Jan-14 Jan-13 Jan-12 Mar-15 Mar-14 Mar-13 Mar-12 Sep-14 Nov-14 Sep-13 Nov-13 Sep-12 Nov-12 May-15 May-14 May-13 May-12 Trading PER Average + 1SD -1 SD Source: Company, Daiwa forecasts

 Earnings revisions  Geely: revisions to the Bloomberg-consensus EPS forecasts We have seen continuous downward revisions by the (CNY) consensus to Geely’s EPS over the past year due mainly 0.50 from the negative impact of its dealership network 0.45 restructuring, and the depreciation of the Ruble against the CNY. We are slightly more optimistic than the 0.40 consensus on Geely’s future strategy, including the 0.35 rolling out of the CMA platform with Volvo, which should support strong net-profit growth over 2016-17E. 0.30 Our EPS forecasts for 2016-17E are 6-9% above the 0.25 consensus numbers. Jul-14 Oct-14 Apr-14 Apr-15 Jan-14 Jun-14 Jan-15 Mar-14 Mar-15 Feb-14 Feb-15 Aug-14 Sep-14 Nov-14 Dec-14 May-14 May-15 2015E 2016E Source: Company, Bloomberg

- 36 - Consumer Discretionary / China 175 HK 18 June 2015

Financial summary

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales volume (unit) 415,843 421,611 483,483 549,468 417,851 503,717 561,369 626,241 Sales volume (YoY %) 27.3 1.4 14.7 13.6 (24.0) 20.5 11.4 11.6 ASP 48,334 49,726 50,939 52,246 52,024 56,186 60,119 64,327 ASP (YoY %) 12.2 2.9 2.4 2.6 (0.4) 8.0 7.0 7.0

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Domestic revenue 18,505 18,924 19,305 21,962 17,646 22,975 27,396 32,702 International revenue 1,594 2,041 5,323 6,745 4,092 5,327 6,353 7,583 Other Revenue 00000(0)00 Total Revenue 20,099 20,965 24,628 28,708 21,738 28,302 33,749 40,285 Other income 765 991 1,046 976 1,016 1,323 1,578 1,883 COGS (16,379) (17,145) (20,069) (22,942) (17,776) (22,868) (26,932) (32,147) SG&A (2,386) (2,459) (2,881) (3,474) (3,083) (3,304) (3,940) (4,702) Other op.expenses 00000000 Operating profit 2,098 2,352 2,723 3,267 1,896 3,453 4,455 5,318 Net-interest inc./(exp.) (192) (167) (195) (40) (24) (47) (26) 9 Assoc/forex/extraord./others (5) (1) 0 77 71 32 32 32 Pre-tax profit 1,900 2,183 2,529 3,304 1,943 3,438 4,462 5,359 Tax (351) (467) (479) (624) (494) (874) (1,135) (1,363) Min. int./pref. div./others (181) (172) (10) (17) (19) (33) (43) (51) Net profit (reported) 1,368 1,543 2,040 2,663 1,431 2,531 3,285 3,945 Net profit (adjusted) 1,368 1,543 2,040 2,663 1,431 2,531 3,285 3,945 EPS (reported)(CNY) 0.186 0.207 0.271 0.317 0.163 0.288 0.373 0.448 EPS (adjusted)(CNY) 0.186 0.207 0.271 0.317 0.163 0.288 0.373 0.448 EPS (adjusted fully-diluted)(CNY) 0.161 0.181 0.252 0.303 0.163 0.288 0.373 0.448 DPS (CNY) 0.023 0.023 0.032 0.036 0.020 0.035 0.045 0.054 EBIT 2,098 2,352 2,723 3,267 1,896 3,453 4,455 5,318 EBITDA 2,603 2,993 3,583 4,345 2,770 4,399 5,553 6,571

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 1,900 2,183 2,529 3,304 1,943 3,438 4,462 5,359 Depreciation and amortisation 504 642 860 1,078 874 946 1,097 1,252 Tax paid (214) (281) (711) (610) (497) (874) (1,135) (1,363) Change in working capital (701) (1,647) 1,503 (449) (960) (504) (559) (376) Other operational CF items 492 310 256 238 673 80 59 27 Cash flow from operations 1,983 1,208 4,438 3,562 2,033 3,086 3,925 4,899 Capex (2,072) (2,197) (1,922) (2,022) (2,421) (2,561) (2,611) (2,663) Net (acquisitions)/disposals 122 (788) (232) 313 429000 Other investing CF items6043283844524000 Cash flow from investing (1,346) (2,953) (2,071) (865) (1,468) (2,561) (2,611) (2,663) Change in debt (639) 716 (1,460) (930) (274) (200) (700) (700) Net share issues/(repurchases) 106 14 618 110000 Dividends paid (148) (170) (170) (264) (320) (174) (308) (399) Other financing CF items (52) (166) (193) (183) 1,766 (113) (92) (59) Cash flow from financing (732) 393 (1,206) (1,366) 1,172 (487) (1,099) (1,158) Forex effect/others 00000000 Change in cash (95) (1,352) 1,160 1,330 1,737 39 215 1,078 Free cash flow (90) (989) 2,515 1,540 (388) 525 1,314 2,236 Source: FactSet, Daiwa forecasts

- 37 - Consumer Discretionary / China 175 HK 18 June 2015

Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 4,393 3,030 4,189 5,478 7,203 7,242 7,457 8,535 Inventory 987 1,358 1,822 1,784 1,620 2,083 2,454 2,929 Accounts receivable 9,913 12,215 13,476 14,785 16,385 21,332 25,438 30,364 Other current assets 392 403 368 204 95 104 111 120 Total current assets 15,684 17,006 19,855 22,251 25,303 30,761 35,460 41,948 Fixed assets 5,467 6,796 7,008 6,209 5,861 6,285 6,693 7,084 Goodwill & intangibles 2,823 3,708 4,282 4,392 5,346 6,537 7,642 8,662 Other non-current assets 0 87 235 747 771 803 836 868 Total assets 23,974 27,597 31,380 33,599 37,280 44,386 50,631 58,562 Short-term debt 1,097 2,532 1,379 966 692 492 292 92 Accounts payable 10,508 12,114 15,183 16,075 17,017 21,891 25,782 30,774 Other current liabilities 174 339 131 197 137 178 212 253 Total current liabilities 11,778 14,985 16,693 17,237 17,845 22,561 26,285 31,119 Long-term debt 1,562 843 525 0 1,820 1,820 1,320 820 Other non-current liabilities 1,556 1,619 958 133 149 149 149 149 Total liabilities 14,897 17,447 18,176 17,370 19,814 24,530 27,754 32,088 Share capital 139 140 153 161 161 161 161 161 Reserves/R.E./others 7,883 9,443 12,734 15,907 17,127 19,484 22,461 26,007 Shareholders' equity 8,022 9,582 12,887 16,068 17,288 19,645 22,623 26,169 Minority interests 1,056 568 317 162 178 211 254 305 Total equity & liabilities 23,974 27,597 31,380 33,599 37,280 44,386 50,631 58,562 EV 25,407 26,914 23,923 21,062 20,882 20,644 19,739 17,979 Net debt/(cash) (1,734) 344 (2,285) (4,512) (4,691) (4,930) (5,845) (7,623) BVPS (CNY) 1.078 1.285 1.560 1.826 1.964 2.232 2.570 2.973

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 42.9 4.3 17.5 16.6 (24.3) 30.2 19.2 19.4 EBITDA (YoY) 33.1 15.0 19.7 21.3 (36.3) 58.8 26.2 18.3 Operating profit (YoY) 31.9 12.1 15.8 20.0 (42.0) 82.1 29.0 19.4 Net profit (YoY) 15.7 12.8 32.2 30.5 (46.3) 76.9 29.8 20.1 Core EPS (fully-diluted) (YoY) (2.5) 12.6 39.2 20.1 (46.3) 76.9 29.8 20.1 Gross-profit margin 18.5 18.2 18.5 20.1 18.2 19.2 20.2 20.2 EBITDA margin 12.9 14.3 14.5 15.1 12.7 15.5 16.5 16.3 Operating-profit margin 10.4 11.2 11.1 11.4 8.7 12.2 13.2 13.2 Net profit margin 6.8 7.4 8.3 9.3 6.6 8.9 9.7 9.8 ROAE 19.0 17.5 18.2 18.4 8.6 13.7 15.5 16.2 ROAA 6.4 6.0 6.9 8.2 4.0 6.2 6.9 7.2 ROCE 19.4 18.6 19.0 20.2 10.2 16.4 19.1 20.5 ROIC 26.8 20.7 20.6 23.4 11.5 18.6 20.8 22.1 Net debt to equity net cash 3.6 net cash net cash net cash net cash net cash net cash Effective tax rate 18.5 21.4 19.0 18.9 25.4 25.4 25.4 25.4 Accounts receivable (days) 145.8 192.6 190.4 179.7 261.7 243.2 252.9 252.8 Current ratio (x) 1.3 1.1 1.2 1.3 1.4 1.4 1.3 1.3 Net interest cover (x) 10.9 14.1 14.0 81.7 80.0 72.9 171.7 n.a. Net dividend payout 12.3 11.0 11.7 11.5 12.2 12.2 12.2 12.2 Free cash flow yield n.a. n.a. 9.6 5.9 n.a. 2.0 5.0 8.6 Source: FactSet, Daiwa forecasts

 Company profile Listed on the Hong Kong Stock Exchange in 2003, Geely Automobile is engaged principally in the manufacture and trading of automobiles, automobile parts and related automobile components. Focused on the economy car segment, the company currently has 3 self-owned brands, Gleagle, Emgrand and Englon, with an aggregated 2.1% market share in China’s passenger car market. However, over the next 2 years, these 3 brands will gradually be consolidated into a single brand under “Geely”.

- 38 - Consumer Discretionary / China 175 HK 18 June 2015

21% YoY volume growth in 2015E However, we believe Geely is set for a strong recovery in 2015, after the completion of its dealership network restructuring and continuous demand for cheaper sedans in China’s lower-tier cities. Given the strong A leading brand in the demand for the Xindihao/EC7, New Vision and GX7, which saw 65%/245%/22% YoY sales-volume growth for making May, and the 4 new sedan/SUV models to be rolled in out in 2015, we believe management’s target of 450,000 unit sales (an 8% YoY increase) is conservative. We Geely is our top sector pick not only forecast Geely to record sales volume of 504,000 units because of its potential to stage a in 2015, representing 21% YoY growth. significant profit turnaround in 2015, but  Geely: sales volume trend for its long-term strategy on brand (Units) (YoY % ) 27% 700,000 30% development and overseas expansion. 21% 626,241 549,468 561,369 600,000 15% 14% 20% 483,483 503,717 11% 12% 500,000 415,843 421,611 417,851 Strong earnings turnaround 1% 10% 400,000 0% likely in 2015 300,000 -10% 200,000 Weak 2014 earnings due to one-off events -24% 100,000 -20% Geely sold a total of 417,851 units of vehicles in 2014, 0 -30% down 24.0% YoY as a result of fierce competition in 2010 2011 2012 2013 2014 2015E 2016E 2017E China’s sedan market. Its domestic volume was down Sales volume (LHS) YoY gro wth (%, RHS) 17% as a result of its dealer network restructuring, Source: Company, Daiwa forecasts while export volumes declined by 50% YoY following the significant depreciation of the Ruble against the Rich pipeline of new models CNY, which affected its exports to Russia, one of the We expect Geely’s 4 new models due to be launched in largest export markets for Geely. 2015 to support its sales-volume growth over the rest of the year, including that for GC9 B-segment sedans Its ASP was largely flat at about CNY52,000 per unit launched in April 2015, 2 SUVs and 1 Emgrand electric in 2014. As a result, Geely’s revenue declined by 24% to vehicle due to be launched in the second half this year. CNY21.7bn and net profit was down 46% YoY to CNY1.4bn (including a CNY654m forex loss due to the We look for Geely’s blended ASP to increase by 8% YoY 42% depreciation of the Ruble in 2014). for 2015, helped by its favourable product mix with the aforementioned new models and existing model  Geely: top export destinations in 2014 (units sold) upgrades. Any good news from strong sales of its new

Others 3,365 models would create positive sentiment toward the Algeria 1,169 stock, in our view.

Oman 1,324  Geely: ASP trend Cuba 1,554 ASP (CNY/vehicle) (YoY % ) Sri Lanka 1,986 70,000 12% 64,327 14% Ukraine 3,128 60,119 60,000 56,186 12% 50,939 52,246 52,024 Uruguay 3,150 48,334 49,726 50,000 8% 10% 7% 7% Iran 3,508 8% 40,000 Saudi Arabia 4,445 6% 30,000 3% Belarus 9,522 2% 3% 4% Russia 10,037 20,000 2% 0% Egypt 16,533 10,000 0%

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 0 -2% 2010 2011 2012 2013 2014 2015E 2016E 2017E Source: Company ASP (LHS) YoY growth (%, RHS) Source: Company, Daiwa forecasts

- 39 - Consumer Discretionary / China 175 HK 18 June 2015

 Geely: launch schedule in 2015-16  Geely: product mix proportion New model Launch schedule (% ) GC9 B-segment Sedans April-2015 100% 0% 0% 0% 6% Emgrand Electric Vehicles 2H 2015 12% 15% 14% 16% 17% Emgrand SUVs End-2015 80% 40% 40% Compact SUVs End-2015 45% 32% 28% 27% Emgrand Cross Vehicles Early-2016 61% 30% 27% Emgrand 4-door Sedans Early-2016 60% Source: company 40% 60% 60% 56% 58% 57% 56% 49% 54% Earnings momentum should 20% 39% continue in 2016-17 0% 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E Mid-size Sedans Others SUVs Diversifying into SUV market Source: Company, Daiwa forecasts

Geely entered China’s SUV market in 2012, when it  Geely: product mix launched its first SUV, the GX7, on the back of increasing demand in the country for SUVs and the 2014 more lucrative higher margins offered by this segment 71% 29% compared to others. 2013 68% 32% We expect Geely’s SUV models to be one of the key drivers of the company’s overall sales volume growth 2012 55% 45% over 2015-17E. In order to capitalise on the growing demand for SUVs in China and its increasing SUV 2011 45% 55% market share in China’s passenger vehicle market, Geely launched its third SUV model, the GX9, in 0% 20% 40% 60% 80% 100% October 2014 and has received a good response from Higher margins models Other models the market. Source: Company, Daiwa * higher margin models include EC7, SC7, GC7, Vision, Xindihao, GX7, SX7 and GX9 On our estimates, the completion of its SUV capacity expansion at the Chengdu plant in mid-2013 and CMA platform injection in 2016 potential addition of more SUV production facilities, After Geely’s parent company’s (Geely Holdings) together with its scheduled launch of 2 more SUV acquisition of Volvo Car in 2010, it established an R&D models in 2H15, will drive Geely’s volume growth over centre in Sweden to develop the C-segment Modular the next few years. We are positive on Geely’s entry Architecture (CMA) platform, with the help of Volvo. into the SUV segment as it should help the company to The platform is scheduled to be launched in 2016. We improve its net-profit margin in the near term. expect the model designs developed by Geely’s parent using the CMA platform to be injected into Geely at  Geely: product mix chart (SUVs vs. sedans) cost, starting in 2016. (Units) 700,000 A total of 6 Geely models are due to be developed via 600,000 the CMA platform and launched under the Geely 500,000 brand. Also, we believe the CMA design platform will 400,000 allow Geely to gradually absorb technology from Volvo. 300,000 Profitability remains strong with robust 200,000 volume and margin recovery 100,000 We forecast 30% YoY revenue growth driven by 21% 0 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E YoY unit volume growth, an 8% YoY increase in ASP Mid-size Sedans Others SUVs and 1.0pp YoY gross-profit margin improvement to Source: Company, Daiwa forecasts 18.2% in 2015 (slightly offset by initial lower margins on the 4 new models launched in 2015), on the back of the completion of the restructuring of the dealership network.

- 40 - Consumer Discretionary / China 175 HK 18 June 2015

On the cost side, we estimate administration costs 2014. The stock is trading currently trading at (excluding R&D costs) as a percentage of revenue will 10.3x/7.9x PERs on our 2015/16E forecasts, which we return to a normal level of about 5% in 2015 (vs. 7.5% view as attractive given the company’s strong profit in 2014), as management has already capped its growth outlook. As such, we forecast a strong EPS exposure to the Ruble to around USD100m of assets in CAGR of 27% from 2014-17E. Russia. Geely has already stopped importing completely knocked down (CKD) units and completely  Geely: valuation built units (CBU) into Russia. Therefore, we do not 2015-16 EPS average (CNY) 0.33 expect a strong sales decline or exchange loss due to PER (x) 12.0 x Exchange rate, 1HKD = x CNY 0.80 Ruble depreciation to occur in 2H15. Equity value/share (HKD/share) 5.00 Current price (HKD) 3.70 Even though there would still be a negative impact Potential share price upside/downside (%) 35% from Russia in 1H15, we are overall positive on the Implied target 16E PER 10.6 prospect of the overseas business improving in the long Source: Daiwa forecast term when manufacturing locally in targeted export  Geely: PER bands countries is achieved. (PER) 18 Positive on auto financing business in the 16 long run 14 12 In 2013, Geely tied up with BNP Paribas to form a JV 10 to develop an auto-finance business in China. Geely 8 holds 80% of the JV. The JV focuses on supporting the 6 financing needs of tier-1 and tier-2 customers of both 4 the Volvo and Geely brands. The ultimate goal is to 2 expand to the whole China. Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 May-12 May-13 May-14 May-15 Trading PER Average + 1SD -1 SD We are positive on Geely expanding into this ancillary service as we see the auto-finance business accounting Source: Company, Daiwa forecasts for a large part of its earnings when Geely’s business becomes more mature. As an example, we note that the Risks to our call auto-financing business accounts for around 14% of the EBIT for Toyota. ASP and margin deterioration  Toyota: EBIT mix Keen competition among domestic brands and JV JPYbn FY12 FY13 FY14E FY15E FY16E brands in China may lead to a price war or higher- Auto 944.7 1,938.8 2,330.0 2,673.0 2,900.0 than-expected price discounting, and therefore Financial 315.8 294.9 390.0 402.0 390.0 negatively impact the company’s gross margin. Its new Others 53.6 64.3 60.0 65.0 70.0 model, Xingdihao, which is of a higher quality (and Eliminations 6.7 -5.8 0.0 0.0 0.0 Total 1,320.9 2,292.1 2,780.0 3,140.0 3,360.0 therefore higher COGS) than its old version, EC7, may % FY12 FY13 FY14E FY15E FY16E see a gross margin deterioration if the company has to Auto 72% 85% 84% 85% 86% start offering discounts in the event of a price war. Financial 24% 13% 14% 13% 12% Others 4% 3% 2% 2% 2% Eliminations 1% 0% 0% 0% 0% Regulatory risk on licence restrictions Source: Company, Daiwa forecasts In an effort to ease the air pollution and traffic congestion issues, more of China’s cities are expected to restrict the number of new car licences, which Valuation and recommendation should therefore curb new car demand. But even so, we believe Geely will be less affected by the licence We have a 12-month target price of HKD5.00, based on restrictions, as its main addressable market is the a PER of 12.0x applied to the average of our 2015-16 lower-tier cities where the traffic is lighter, so there are EPS forecasts. Our target multiple is set at around 1SD potentially more revenue growth opportunities here. above Geely’s past-3-year average trading PER of 10.5x, as it factors in our optimistic view of Geely being Overseas/export market risk China’s top domestic brand backed by its leading Geely’s overseas export volume was down 50% YoY in technology. We believe Geely’s share price has 2014, due to unstable political situations in a number bottomed out from its weak operating performance in of its key export countries. Geely’s top-3 export - 41 - Consumer Discretionary / China 175 HK 18 June 2015

destinations in 2014 were Egypt, Russia and Belarus, respectively. Despite a lower auto penetration rate in these emerging countries, we see higher political risk too. The company recorded a CNY654m foreign exchange loss in 2014 on a 42% depreciation of the Ruble against the CNY, primarily because of Russia being one of its key overseas markets, accounting for 17% of its export volume in 2014.

Company background

Listed on the Hong Kong Stock Exchange in 2003, Geely is engaged principally in the manufacturing and trading of automobiles, automobile parts and related automobile components. The company is 45%-owned by the founder and current CEO, Mr. Li Shu Fu.

Focused on the economy car segment, Geely currently has 3 self-owned brands, GLEagle, Emgrand and Englon, with an aggregated 2.1% share of China’s passenger car market. However, it plans to gradually consolidate these models into a single brand under “Geely” within the next 2 years. At the end of 2014, Geely had 16 sedan and SUV models, with a focus on small sedans and relatively low ASP models.

As of May 2015, Geely had more than 751 dealers in China; 38 sales agents, 476 sales and service outlets in 35 overseas countries.

 Geely: revenue by geography 2014 Central and Korea Africa South America 1.4% 3.0% 1.2% Other countries Middle East 1.6% 2.6% Europe 8.9%

PRC 81.2%

Source: Company, Daiwa forecasts

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 Geely: management profile Mr. Li Shu Fu Executive director, aged 51, joined the company on 9 June 2005 as the Chairman of the board of directors of the company and an Executive Director, and is responsible for overall strategic planning, board leadership, corporate governance and formulation of the corporate policies of the Group. Currently, Mr. Li is the controlling shareholder, founder, and Chairman of the board of Zhejiang Geely Holding Group Company Limited. Mr. Li has over 28 years of experience in the investment and management of the automobile manufacturing business in the PRC. Mr. Li is a member of the Chinese People’s Political Consultative Conference. Mr. Li was accredited as one of the “50 Most Influential Persons in China’s Automotive Industry in the 50 Years” by China Automotive News. Mr. Yang Jian Executive director, aged 53, joined the group on 9 June 2005 as an Executive Director, and is responsible for assisting the Chairman in Board leadership and corporate governance of the Group. Mr. Yang was appointed the Vice Chairman of the Board on 1 July 2008, and was appointed the vice chairman of the board of directors of Geely Holding on 29 December 2011. Mr. Yang was also the chairman of the five 99%-owned key operating subsidiaries of the Group, namely, Zhejiang Jirun Automobile Company Limited (“Zhejiang Jirun”), Shanghai Maple Guorun Automobile Company Limited, Zhejiang Kingkong Automobile Company Limited, Zhejiang Ruhoo Automobile Company Limited and Hunan Geely Automobile Components Company Limited. Mr. Yang focuses on production management. Since joining Geely Holding in 1996, Mr. Yang has been involved in a number of job functions within the group, including product R&D, engineering and construction, manufacturing, quality improvement, marketing, after-sales service and the operation and management of the Group in the PRC and overseas. Mr. Gui Sheng Yue Executive Director, aged 51, joined the group on 9 June 2005 as an Executive Director and is responsible for the overall administration, risk management and compliance of the group. Mr. Gui was appointed the Chief Executive Officer of the company with effect from 23 February 2006. He was also the chairman of DSI Holdings Pty Limited, a former wholly-owned subsidiary of the company. Mr. Gui has over 28 years of experience in administration and project management. Mr. An Cong Hui Executive Director, aged 45, joined the group on 30 December 2011 as an Executive Director, and is responsible for the overall administration of the group. Mr. An has been a vice president of Geely Holding since 2003, and was appointed the president of Geely Holding with effect from 29 December 2011. Mr. An is currently the chairman of the principal operating subsidiary, namely Zhejiang Jirun, and a director of certain subsidiaries of the group. Mr. An was previously in charge of the overall operation under the “Emgrand” product brand following the implementation of multi-brand strategy by the group and production of gearboxes, engines and drivetrain systems of the group. Mr. An has extensive professional knowledge and senior managerial experience in the automotive industry, particularly in the field of automotive engineering. Since 1996, Mr. An has held various key positions in Geely Holding, including chief engineering officer and general manager. Mr. Ang Siu Lun, Lawrence Executive Director, aged 55, joined the group on 23 February 2004 as an Executive Director and is mainly responsible for the international business development, capital market and investors’ relationship of the group. Prior to joining the group, Mr. Ang worked in a number of major international investment banks for 17 years with extensive experience in equity research, investment banking and financial analysis. Mr. Liu Jin Liang Executive Director, aged 50, joined the group on 9 June 2005 as an Executive Director. Mr. Liu has been responsible for the group’s sales and marketing of new energy vehicles with effect from 16 May 2013. Mr. Liu is also a vice president of Geely Holding. Mr. Liu focusing on industrial enterprise management. Since his joining to Geely Holding in 1995, Mr. Liu has about 20 years of experience in domestic sales and marketing of motor vehicles, brand building, development of logistics management, development of customer service and enterprise operation management in the PRC. Ms. Wei Mei Executive Director, aged 46, joined the group on 17 January 2011 as an Executive Director. Ms. Wei is a vice president of Geely Holding, where she has been responsible for human resources management and training since June 2009. From 2003 to 2007, Ms. Wei was the group human resources director of Beiqi Foton Motor Co., Ltd. (“Foton Motor”) and focused on Foton Motor’s human resources management, control and training. Ms. Wei was in charge of organisational management, operation appraisal, quality system management and human resources, and directed the operation management of Haier dishwashers and other small appliances. Mr. Cheung Chung Yan, David Senior Management, aged 39, joined the group as the Financial Controller and Company Secretary on 17 May 2005. He was also a director of DSI Holdings Pty Limited, a former wholly-owned subsidiary of the company. He is a fellow member of the Association of Chartered Certified Accountants and a member of The Hong Kong Institute of Directors. Mr. Cheung has over 17 years of experience in auditing, accounting and financial management. Mr. Dai Yang, Daniel Senior Management, aged 60, joined the group as the Vice President (International Business) on 5 May 2005 and is mainly responsible for the investor relation and international business in Hong Kong. Prior to joining the Company, Mr. Dai has mainly focused his career on projects investment. Mr. Poon Chi Kit Senior Management, aged 35, joined the group as the Senior Manager on 1 July 2011, and he is in charge of risk assessment and monitoring, internal audit, and internal control infrastructure development of the group. He is also the Group Financial Controller of Kandi Electric Vehicles Group Co., Ltd., a joint venture of the group. He is a member of the Hong Kong Institute of Certified Public Accountants. Mr. Poon has over 9 years of experience in auditing, accounting and financial management. Source: Company

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 Geely: development milestones Year Event 1986 Li Shufu started the entrepreneurial course of Geely with refrigerator parts business as the starting point 1989 Geely shifted focus to decoration materials and developed the first magnaliu bending board in China 1994 Geely entered the motorcycle industry and manufactured the first deluxe pedal motorcycle in China 1996 Geely Group Co., Ltd. was founded, signifying the beginning of large-scale development 1997 Geely entered the autos industry and became the first private automobile manufacturing enterprise in China 1998 The first automobile of Geely group rolled off the production line in Linhai City, Zhejiang Province, starting the era of automobile manufacturing by private enterprises 2001 Geely was officially listed in the National Automobile Announcement Geely ranked in China Top 9 Automobile Manufacturers (3+6 pattern). Geely began its business transformation from a family-owned enterprise to a modern joint-equity enterprise 2002 with the help of professional management 2003 Geely exported its autos for the first time Geely Holding Group started business process reengineering and established a governance structure for operations and its management committee under the leadership of 2004 board of directors 2005 Geely was listed on the Hong Kong Stock Exchange (0175 HK), an important step on its road to internationalisation Representing the HK-listed company of Geely Holding Group Co., Ltd. (0175HK) and Shanghai Maple Auto, Li Shufu, Board Chairman of Geely, signed official agreements on manufacturing of branded taxis by joint investment with Manganese Bronze Holding (MBH) signalling a new era for automobile manufacturing by Sino-foreign joint ventures. Jia 2006 Qinglin, President of CPPCC, and Baroness Amos, Leader of the House of Lords and Lord President of the Council, were present at the signing ceremony 2007 The Ukraine SKD Project was officially launched, with the first 300 sets of KD parts being exported, signalling a breakthrough for Geely to manufacture overseas 2007 Geely became the first automobile enterprise in China to declare its entry into strategic transformation 2008 Geely’s BMBS appeared at the 2008 North American International Auto Show, where it received Special Contribution Awards for Invention and Innovation Practice Organised by the British government and British Think London, “A Tour into London” was officially launched in Beijing. The first TX 4 manufactured by LTI Automobile Company 2008 was modified by the British correspondent as a “Mobile Ambassador” for use at the 2012 London Olympics 2008 Geely launched its multi-brand strategy. The launch ceremony of the Green Action “Let the World Be Filled with Geely” and the Activity of Summoning “Green Volunteers” took place at the Geely’s headquarters in 2009 Hangzhou; in the same month, Geely was rated as a “Star-class Benchmark Enterprise of China’s Green Company in 2008” 2009 Geely made a successful acquisition of the world second largest automatic transmission company, Australia’s DSI HK-Geely Holding Group Co., Ltd. (175 HK) announced an agreement with Goldman Sachs Capital Partners (GSCP) whereby GSCP could invest in Geely by subscribing 2009 convertible bonds and warrants. Geely would receive HKD2.586bn (USD0.33bn) after the issuance of convertible bonds and full execution of warrants 2009 Geely was named as the 2009’ “Most Honoured Enterprise in China” Geely’s project “Innovative Engineering Construction of Technological System for Geely’s Strategic Transformation” won second prize in the China Science and Technology 2010 Progress Awards Li Shufu, Board Chairman of Geely, and Lewis Booth, Chief Financial Officer of Ford, attended a delivery signing ceremony in London after Geely had completed the buyout of 2010 Volvo Automobile Company, formerly a brand of Ford 2011 The 48 Group Club of Britain granted Geely “European Most Influential Investment Award in 2011” Source: Company

 Geely: organisation chart

Zhejiang Geely Holding & Related Public Volvo Cars Companies

54.57% 45.43%

1% The London Taxi Co. Geely Automobile Holdings

100% 99%

DSIH Australia Geely Automobile Manufacturing

Source: company

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 Geely: GC9 sedan  Geely: New Vision sedan

Source: company

 Geely: GX9 SUV Source: Company

 Geely: Xindihao sedan

Source: Company Source: Company

 Geely: EC7 sedan

Source: company

- 45 - Consumer Discretionary / China 175 HK 18 June 2015

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Consumer Discretionary / China 1958 HK Consumer Discretionary / China 18 June 2015

BAIC Motor

BAIC Motor Target (HKD): 12.00 Upside: 29.0% 1958 HK 18 Jun price (HKD): 9.30

Initiation: top luxury car pick 1 Buy (initiation) • Rich new model pipeline from Mercedes-Benz should help BAIC 2 Outperform to meet luxury car demand despite licence restrictions 3 Hold • Losses at Beijing Motor should decline and new capacity at 4 Underperform Beijing Hyundai serve as an additional share-price catalyst 5 Sell • Initiating with a Buy (1) call and 12-month target price of HKD12.0 (9.5x PER on average of 2015-16E EPS)

How do we justify our view?

independence, thus outperforming brand operation, could trigger a the other foreign JV brands in this rerating for BAIC to at least the regard. For the local brand business, average multiple of its peers. 3 of 5 new models slated to launch in 2015 are SUVs, the segment with the ■ Risks Kelvin Lau highest sales growth currently. Its Risks to our call include: 1) more (852) 2848 4467 local brand can leverage E-class and stringent regulations, and 2) slower- [email protected] Saab technology, and we are more than-expected car sales. optimistic than the market in Brian Lam forecasting it to break even in 2016 (852) 2532 4341 and register profits in 2017. [email protected] Share price performance

Separately, we expect Beijing Hyundai (HKD) (%) 11.5 110 to continue to make stable profit ■ Investment case 10.6 104 contributions, albeit with limited We expect BAIC Motor’s sales 9.8 98 growth in the near term due to growth to outperform that of its 8.9 91 capacity constraints. We look for 8.0 85 foreign JV peers, on the back of its stronger earnings growth in 2017, as Dec-14 Mar-15 strong product launch plans for new models are due and new capacity BAIC Motor (LHS) Relative to HSI (RHS) 2015-16 (especially new Benz is slated to come on line in 2016. models) and its sales strategy in

China, which we expect to help it to 12-month range 8.07-11.50 ■ Catalysts Market cap (USDbn) 9.01 gain market share. We believe the Strong sales of key models and new 3m avg daily turnover (USDm) 10.79 licence restrictions in top-tier cities products due to be launched in Shares outstanding (m) 7,508 would only have a limited impact on Major shareholder BAIC Group (45.0%) 2015-16 would likely be share-price replacement demand for luxury cars catalysts. An upturn in Beijing in the face of residents’ rising Financial summary (CNY) Motor’s performance in 2015 should consumption power. Year to 31 Dec 15E 16E 17E lift investor sentiment, in our view. Revenue (m) 84,224 107,639 134,829

Operating profit (m) 5,031 7,535 9,907 In our view, Daimler AG, BAIC’s key ■ Valuation Net profit (m) 6,834 8,505 10,181 foreign partner, is now more willing Core EPS (fully-diluted) 0.910 1.133 1.356 We initiate on BAIC with a Buy (1) to cooperate with the company in EPS change (%) 29.5 24.5 19.7 call and 12-month target price of developing local brands, as Daiwa vs Cons. EPS (%) 4.6 3.9 5.9 evidenced by its recent move to HKD12, set at a 9.5x PER on the PER (x) 8.2 6.6 5.5 average of our 2015-16E EPS Dividend yield (%) 6.2 7.7 9.2 share its E-class technology. In the forecasts. We believe stronger-than- DPS 0.460 0.572 0.685 long run, we expect BAIC to be one PBR (x) 1.5 1.3 1.1 expected growth in sales volumes for of the fastest among the China auto EV/EBITDA (x) 8.3 6.0 4.7 Beijing Benz, as well as the potential OEMs to achieve technology ROE (%) 19.2 21.0 22.2 earnings breakeven for the local Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 102 Consumer Discretionary / China 1958 HK 18 June 2015

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  BAIC: net profit and growth (2011-17E) Following on from BAIC’s net profit growth of 66% YoY (CNYm) (YOY%) in 2014, we forecast growth of 52% YoY to CNY6,834m 12,000 80% in 2015. We expect the main earnings drivers this year to 10,000 60% be strong sales of Benz models and the local brand operation reaching earnings breakeven. 8,000 40% 6,000 20%

For 2016, we highlight a further upturn at Beijing Motor 4,000 0% together with strong replacement demand for luxury cars as likely earnings drivers. From the high base set by 2,000 (20%) 2015E earnings, we expect BAIC’s earnings growth for 0 (40%) 2016-17 to moderate to 20-24% YoY. 2011 2012 2013 2014 2015E 2016E 2017E Net profit (LHS) Growth YoY (RHS) Source: Company, Daiwa forecasts

 Valuation  BAIC: 12-month forward PER (since listing) On our forecasts, BAIC is trading at PERs of 8.2x for (PER) 2015E and 6.6x for 2016E. Our target price of HKD12.0 10 is based on a 9.5x PER applied to the average of our 9 2015-16E EPS forecasts, in line with the China auto sector’s past 3-year-average, and implies a 2016E PER of 8 8.6x. 7 We believe the market has yet to factor in fully the 6 earnings growth potential of Beijing Benz, backed by its rich new product launch cycle. Plus, we believe the stock 5 could be rerated as the market comes to recognise that Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Beijing Motor could turn profitable in 2017. Trading PER Average + 1SD -1 SD Source: Bloomberg, Daiwa forecasts

 Earnings revisions  BAIC: consensus EPS revisions (2015) Compared with the Bloomberg consensus, we are (CNY) slightly more optimistic on Beijing Motor’s sales volume 1.20 growth potential, and our net profit forecasts for BAIC 1.10 for 2015-17 are therefore 4-6% above those of the 1.00 market. We expect the market to revise up its forecasts when BAIC reports its 1H15 results in September 2015. 0.90 0.80

0.70

0.60 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 2015E 2016E Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Volume - Beijing Motor (unit) n.a. 24,000 78,000 202,280 309,468 464,202 603,463 724,155 Volume - Mercedes Benz (unit) n.a. 93,000 103,000 116,006 145,468 210,929 263,661 329,576 Volume - Hyundai (unit) n.a. 740,000 860,000 1,030,808 1,120,048 1,142,449 1,199,571 1,319,529 Volume growth - Beijing Motor (%) n.a. n.a. 225.0 159.3 53.0 50.0 30.0 20.0 Volume growth - Mercedes Benz (%) n.a. n.a. 10.8 12.6 25.4 45.0 25.0 25.0 Volume growth - Hyundai (%) n.a. n.a. 16.2 19.9 8.7 2.0 5.0 10.0

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Beijing Motor n.a. 1,916 3,520 6,847 12,434 20,516 28,004 35,285 Beijing Benz n.a. n.a. n.a. 5,934 43,937 63,708 79,635 99,544 Other Revenue n.a. n.a. n.a. 00000 Total Revenue n.a. 1,916 3,520 12,782 56,370 84,224 107,639 134,829 Other income n.a. 99 732 496 1,418 1,769 969 1,213 COGS n.a. (1,888) (3,688) (12,367) (47,387) (69,959) (88,195) (110,003) SG&A n.a. (753) (1,536) (3,520) (9,102) (11,003) (12,878) (16,131) Other op.expenses n.a. 0000000 Operating profit n.a. (627) (972) (2,609) 1,299 5,031 7,535 9,907 Net-interest inc./(exp.) n.a. (82) (158) (474) (533) (635) (733) (695) Assoc/forex/extraord./others n.a. 3,297 4,835 6,147 5,932 5,925 6,044 6,165 Pre-tax profit n.a. 2,588 3,704 3,065 6,698 10,321 12,845 15,377 Tax n.a. (21) (226) (114) (857) (1,320) (1,643) (1,966) Min. int./pref. div./others n.a. 32 (61) (237) (1,331) (2,167) (2,698) (3,229) Net profit (reported) n.a. 2,598 3,417 2,714 4,511 6,834 8,505 10,181 Net profit (adjusted) n.a. 2,598 3,417 2,714 4,511 6,834 8,505 10,181 EPS (reported)(CNY) n.a. 0.535 0.683 0.484 0.703 0.910 1.133 1.356 EPS (adjusted)(CNY) n.a. 0.535 0.683 0.484 0.703 0.910 1.133 1.356 EPS (adjusted fully-diluted)(CNY) n.a. 0.535 0.683 0.484 0.703 0.910 1.133 1.356 DPS (CNY) n.a. 0.000 2.999 0.322 0.303 0.460 0.572 0.685 EBIT n.a. (627) (972) (2,609) 1,299 5,031 7,535 9,907 EBITDA n.a. (474) (779) (1,790) 3,663 8,102 11,419 14,647

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax n.a. 2,588 3,704 3,065 6,698 10,321 12,845 15,377 Depreciation and amortisation n.a. 153 193 818 2,364 3,072 3,885 4,740 Tax paid n.a. (10) (8) (258) (1,365) (1,320) (1,643) (1,966) Change in working capital n.a. (250) 237 721 1,282 589 4,754 5,591 Other operational CF items n.a. (3,498) (4,750) (6,802) (6,717) (4,951) (5,006) (5,127) Cash flow from operations n.a. (1,017) (624) (2,457) 2,262 7,712 14,836 18,614 Capex n.a. (4,258) (5,659) (7,236) (11,785) (13,102) (14,362) (14,501) Net (acquisitions)/disposals n.a. (800) (328) 3,775 (2,691) 0 0 0 Other investing CF items n.a. 2,608 298 6,394 4,535 4,357 4,444 4,533 Cash flow from investing n.a. (2,449) (5,690) 2,933 (9,941) (8,745) (9,918) (9,968) Change in debt n.a. 2,549 5,998 7,194 7,396 2,000 2,000 (2,000) Net share issues/(repurchases) n.a. 1,500 3,003 6,132 7,910000 Dividends paid n.a. 0 (1,500) (212) (2,273) (2,279) (3,452) (4,296) Other financing CF items n.a. (2,001) (115) 141 (210) (975) (1,038) (1,038) Cash flow from financing n.a. 2,048 7,386 13,254 12,822 (1,253) (2,490) (7,334) Forex effect/others n.a.0000000 Change in cash n.a. (1,419) 1,072 13,730 5,143 (2,287) 2,428 1,312 Free cash flow n.a. (5,275) (6,283) (9,692) (9,524) (5,390) 474 4,113 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment n.a. 1,818 2,891 16,790 21,923 19,636 22,064 23,376 Inventory n.a. 441 835 7,479 11,068 16,340 20,600 25,694 Accounts receivable n.a. 155 527 6,004 6,422 12,634 16,146 20,224 Other current assets n.a. 2,047 4,841 3,490 4,905 5,414 5,841 6,338 Total current assets n.a. 4,461 9,094 33,763 44,319 54,024 64,651 75,632 Fixed assets n.a. 2,899 7,151 24,755 34,218 44,251 54,759 64,577 Goodwill & intangibles n.a. 4,076 5,025 11,012 13,598 13,596 13,566 13,508 Other non-current assets n.a. 10,365 10,513 15,866 17,723 19,292 20,892 22,523 Total assets n.a. 21,801 31,782 85,396 109,859 131,163 153,867 176,241 Short-term debt n.a. 3,851 4,008 9,273 18,574 19,809 20,806 21,999 Accounts payable n.a. 472 1,493 11,112 14,978 20,288 25,576 31,901 Other current liabilities n.a. 3,354 1,787 16,535 17,948 23,984 30,652 38,395 Total current liabilities n.a. 7,677 7,288 36,920 51,500 64,081 77,035 92,295 Long-term debt n.a. 2,533 8,069 15,122 13,935 15,935 17,935 15,935 Other non-current liabilities n.a. 292 413 2,300 2,455 2,455 2,455 2,455 Total liabilities n.a. 10,501 15,770 54,342 67,890 82,471 97,425 110,685 Share capital n.a. 5,000 5,462 6,382 7,508 7,508 7,508 7,508 Reserves/R.E./others n.a. 5,859 10,336 17,310 25,847 30,402 35,455 41,340 Shareholders' equity n.a. 10,859 15,798 23,692 33,355 37,910 42,963 48,848 Minority interests n.a. 441 215 7,362 8,614 10,781 13,479 16,708 Total equity & liabilities n.a. 21,801 31,782 85,396 109,859 131,163 153,867 176,241 EV n.a. 51,201 54,874 58,249 61,065 67,185 68,852 68,330 Net debt/(cash) n.a. 4,566 9,185 7,606 10,586 16,107 16,677 14,558 BVPS (CNY) n.a. 2.234 3.159 4.221 4.443 5.049 5.722 6.506

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. n.a. 83.7 263.2 341.0 49.4 27.8 25.3 EBITDA (YoY) n.a. n.a. n.a. n.a. n.a. 121.2 40.9 28.3 Operating profit (YoY) n.a. n.a. n.a. n.a. n.a. 287.2 49.8 31.5 Net profit (YoY) n.a. n.a. 31.5 (20.6) 66.2 51.5 24.5 19.7 Core EPS (fully-diluted) (YoY) n.a. n.a. 27.8 (29.2) 45.3 29.5 24.5 19.7 Gross-profit margin n.a. 1.4 n.a. 3.2 15.9 16.9 18.1 18.4 EBITDA margin n.a. n.a. n.a. n.a. 6.5 9.6 10.6 10.9 Operating-profit margin n.a. n.a. n.a. n.a. 2.3 6.0 7.0 7.3 Net profit margin n.a. 135.6 97.1 21.2 8.0 8.1 7.9 7.6 ROAE n.a. 47.9 25.6 13.7 15.8 19.2 21.0 22.2 ROAA n.a. 23.8 12.8 4.6 4.6 5.7 6.0 6.2 ROCE n.a. n.a. n.a. n.a. 2.0 6.3 8.4 10.0 ROIC n.a. (3.9) (4.4) (7.9) 2.5 7.5 9.5 11.3 Net debt to equity n.a. 42.0 58.1 32.1 31.7 42.5 38.8 29.8 Effective tax rate n.a. 0.8 6.1 3.7 12.8 12.8 12.8 12.8 Accounts receivable (days) n.a. 14.8 35.3 93.2 40.2 41.3 48.8 49.2 Current ratio (x) n.a. 0.6 1.2 0.9 0.9 0.8 0.8 0.8 Net interest cover (x) n.a. n.a. n.a. n.a. 2.4 7.9 10.3 14.2 Net dividend payout n.a. 0.0 438.9 66.6 43.2 50.5 50.5 50.5 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. 0.8 7.4 Source: FactSet, Daiwa forecasts

 Company profile BAIC Motor is the second-largest Hong Kong-listed passenger vehicle manufacturer by volume. The company's manufacturing business operates under 3 brands: self-owned Beijing Motor, 51%-owned Beijing Benz, and 50%-owned JV Beijing Hyundai. BAIC has a diverse product portfolio, including economy and premium cars, small CUVs and sedans, and large SUVs and MPVs.

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Beijing Benz: major profit driver

New model launches to meet rising replacement demand for luxury cars Harnessing strong In the YTD, Mercedes-Benz has recorded stronger sales growth in unit terms in China than BMW, which we demand for luxury cars attribute to its aggressive promotions and enhanced distribution network and sales strategy. Factoring in the impact of new models set to be launched in 2015 Beijing Benz looks well placed to meet and 2016, we forecast Beijing Benz’s net profit to grow China’s strong demand for luxury cars, by 60% YoY in 2015E and 25% YoY in 2016E. Beijing Benz plans to launch 3 new models in 2015, with replacement demand for luxury comprising the New C-class with standard wheel base models likely to increase despite the in 2Q15 (vs. long wheel base C-class launched in 2H14), current licence restrictions. launched a compact SUV GLA in April, and a new version of the GLK SUV in 4Q15. Plus, it expects to launch the new E-class model in 2016. Daimler: big role in BAIC’s Reflecting our expectation that buyers will respond success positively to these launch plans, we forecast Beijing Benz’s sales volume to grow by 45% YoY in 2015E, 25% Under the existing licence restrictions imposed by the YoY in 2016E, and 25% YoY in 2017E, backed by the government, we believe that buyers in the market for new models and increased operating leverage as a replacement cars, especially in China’s top-tier cities, result of stronger sales volumes. will tend to favour luxury cars. Among the Sino-foreign JV brands, the luxury European cars, such as the On our estimates, around 30% of BAIC’s earnings in Mercedes Benz models produced in China by BAIC 2015E will likely come from the Beijing Benz JV, rising Motor, are likely to outperform other JV brand peers in to 35% in 2016E. terms of sales growth this year.  Beijing Benz: sales volume and growth (2013-17E) Indeed, Daimler AG, BAIC’s key partner, appears to be (units) (YoY % ) more willing now to cooperate with BAIC in developing 350,000 50% the latter’s local brands, as evidenced by its recent 300,000 move to share its E-class technology. As a result, we 40% believe BAIC will be one of the fastest among the China 250,000 auto OEMs in terms of increasing its technology 200,000 30% independence in the long term. In turn, we expect 150,000 20% BAIC to outperform the other foreign JV brands in 100,000 terms of sales growth in the longer term. 10% 50,000 In the long run, we expect BAIC to be one of the fastest 0 0% 2013 2014 2015E 2016E 2017E among the China auto OEMs in terms of increasing its Sales volume (LHS) Growth (%, RHS) technology independence, thus outperforming the Source: Company, Daiwa forecasts other foreign JV brands in this regard  Beijing Benz: new model pipeline Model Type Schedule New C-class (with standard wheel base) Sedan 2Q15 GLA SUV 2Q15 New GLK SUV 4Q15 New E-class Sedan 2016 Source: Company

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Beijing Motor: forecast to move Beijing Hyundai: set to shine into the black from 2017

We expect the local brand operation to Focusing on improving margins in 2015-16 break even in 2016 We expect Beijing Hyundai to continue to see steady We look for BAIC’s self-owned brand operation, Beijing volume growth over our forecast horizon, at 2% YoY for Motor, to post a narrower net loss of less than CNY1bn 2015E, 5% YoY for 2016E, and 10% YoY for 2017E, and for 2015, an improvement on the CNY2bn loss it to remain a major earnings contributor for BAIC (86% registered for 2014. On our forecasts, Beijing Motor’s of total earnings in 2015, falling to 69% in 2016). gross margin will widen to 4%/8% in 2015/16E, from -14%/-0.6% in 2013/14, backed by 50%/30% YoY sales Due to its limited production capacity and full volume growth in 2015/16E as a result of new model utilisation of its existing plants, Beijing Hyundai is launches during the period. The company is guiding for building new plants in Hebei and Chongqin which it a total of 5 models to be launched in 2015E, including 2 expects to enter service by end-2016. Through these sedans and 3 SUV models. new facilities, Beijing Hyundai’s production capacity is targeted to improve by 65% to 1.65m units per annum, Management itself is guiding for Beijing Motor to break from 1.05m currently. even in 2016E and start contributing profits from 2017E. Armed with Saab and E-class platform As for its launch plans in 2015, Beijing Hyundai technology, Beijing Motor should be on a faster track expects to roll out 2 new models, comprising the new than the other China OEMs to achieving technology Sonata 9 (launched in 1Q15) and the Tucson SUV independence, in our view. (2H15). According to management, its focus this year and next will be on enhancing margins in order to  Beijing Motor: sales volume and growth (2013-17E) maintain stable earnings growth. (units) (YoY % ) 800,000 180% We forecast only 2% YoY volume and net-profit growth 700,000 160% for Beijing Hyundai in 2015, reflecting its existing 600,000 140% capacity constraints. However, with its new production 120% 500,000 plants due to come on line in late 2016, we look for its 100% 400,000 volume and net profit growth to accelerate in 2017. 80% 300,000 60%  Beijing Hyundai: sales volume and growth (2013-17E) 200,000 40% (units) (YoY % ) 100,000 20% 1,400,000 25% 0 0% 2013 2014 2015E 2016E 2017E 1,200,000 20% Sales volume (LHS) Growth (%, RHS) 1,000,000 Source: Company, Daiwa forecasts 800,000 15%  Beijing Motor: new model pipeline 600,000 10% Model Type Schedule 400,000 Senova CC Sedan 2015 5% Senova D80 Sedan 2015 200,000 Senova X65 SUV 2015 0 0% 2 New SUVs SUV 2015 2013 2014 2015E 2016E 2017E Source: Company Sales volume (LHS) Growth (%, RHS) Source: Company, Daiwa forecasts

 Beijing Hyundai: new model pipeline Model Type Schedule Sonata 9 Sedan 1Q15 Tucson SUV 2H15 Source: Company

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Overall, we forecast BAIC to see net profit growth of  BAIC: 12-month forward PER (since listing) 52% YoY to CNY6,834m for 2015, following on from (PER) net profit growth of 66% YoY in 2014. We expect the 10 main earnings drivers this year to be strong sales of 9 Mercedes-Benz models and the local brand operation reaching earnings breakeven. 8

7 For 2016, we highlight the likelihood of a further upturn in the performance of Beijing Motor, together 6 with strong replacement demand for luxury cars, as 5 potential earnings drivers. From the high base set by Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 2015E earnings, we expect BAIC’s earnings growth for Trading PER Average + 1SD -1 SD 2016-17 to moderate to 20-24% YoY. Source: Bloomberg, Daiwa forecasts

Valuation and recommendation Risks

We initiate coverage of BAIC Motor with a Buy (1) Licence plate restrictions could curb rating and a 12-month target price of HKD12.0, based overall auto demand in China on a 9.5x PER applied to the average of our 2015-16E EPS forecasts, broadly in line with the China auto In an effort to address air pollution and traffic sector’s past-3-year-average. Our target price is congestion, some of China’s cities are restricting the equivalent to a 2016E PER of 8.6x, on our forecasts. number of car licences they issue. Although we believe Hence, we consider the stock’s prevailing PERs of 8.2x Beijing Benz could benefit from these licence caps as for 2015E and 6.6x for 2016E as attractive, particularly replacement car buyers are likely to favour quality considering its dividend yield for 2015E of 6%. luxury cars, we think such policies could have a negative impact on Beijing Hyundai, which positions Our positive view on BAIC reflects the following itself between luxury European cars and the less factors: 1) Beijing Benz’s new product pipeline, which expensive domestic brands. should meet the surging demand for luxury cars in the face of China’s restrictions on the number of car Currency risk licences issued, 2) the likelihood of narrower losses at Depreciation of the Euro is positive for Beijing Benz as Beijing Motor, which we expect to achieve technology it lowers the price of imported components. Beijing independence, helped by its access to Saab and Benz E- Benz recorded a foreign-exchange gain of CNY733m for Class technology, and 3) our expectation of stable profit 2014, when the Euro depreciated by 10% against the contributions from Beijing Hyundai in 2015 and 2016, CNY, as the company imported around 50% of its followed by stronger earnings growth from 2017 as the components from Europe. company taps its expanded production capacity. Conversely, if the Euro appreciates against the  BAIC: PER valuation Renminbi, Beijing Benz would likely record an 2015-16 EPS average (CNY) 1.02 exchange loss. However, Beijing Hyundai, due to its PER (x) 9.5 Exchange rate, 1HKD = x CNY 0.80 localisation rate of more than 90% currently, is less Equity value/share (HKD/share) 12.00 sensitive to KRW movements. Current price (HKD) 9.30 Potential share price upside/downside (%) 29% Fierce competition among domestic Implied target 16E PER (x) 8.6 Source: Daiwa estimates brands could hurt Beijing Motor Leveraging its ties with Daimler and Saab, Beijing Motor plans to roll out 5 new models in 2015, which we expect to boost its sales volume by 50% YoY and pave the way for the domestic brand operation to break even in 2016. However, more intense-than-expected competition among the domestic brands could extend the time taken it takes for Beijing Motor to reach break-even.

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In 2010, BAIC Group’s core passenger vehicle assets Company background (including its equity interest in Beijing Hyundai) were injected into BAIC Motor. In 2011, BAIC Motor Listed in Hong Kong in December 2014, BAIC Motor is acquired Saab technology, and started to produce a leading manufacturer of passenger vehicles in China. passenger vehicles under its own brand in Zhuzhou. Its history dates back to 1959, when Beijing Automobile Factory, the predecessor to BAIC Group, BAIC Motor’s In 2013, BAIC Motor acquired Beijing Benz from its controlling shareholder, was incorporated. parent company and increased its stake in the venture to 51% in the same year. Beijing Benz became a In 2002, BAIC Group in conjunction with Hyundai subsidiary of BAIC Motor, making it the only Sino- Motor established Beijing Hyundai, the first joint- foreign joint venture focused on passenger vehicle venture vehicle manufacturer following China’s manufacturing to be controlled by a China automobile accession to the World Trade Organisation. In 2005, manufacturer. BAIC Group and Daimler AG jointly reorganised Beijing Benz, signalling the group’s entry to the luxury passenger vehicle market.

 BAIC: management profile Mr. Xu Heyi Mr. Xu , aged 57, is the chairman of the Board, as well as the secretary of the party committee and a non-executive director of the company. Mr. Xu is also the chairman of the board of BAIC Investment, Beijing Benz, Beijing Hyundai and BAIC Hong Kong. He has over 30 years of experience in industry and management. Mr. Zhang Xiyong Mr. Zhang Xiyong, aged 51, is a senior accountant and senior engineer. At present, Mr. Zhang is a non-executive director of the company. He is also a director, deputy secretary of the party committee and general manager of BAIC Group. In addition, he is the chairman of the board of directors of Beijing BAIC Rocar Automobile Services & Trade Co., Ltd., an executive director of Beijing Automobile International Development Co., Ltd. and vice chairman of the board of directors of BAIC Foton Automobile Co., Ltd. Mr. Zhang has over 30 years of experience in industry and management. Mr. Li Zhili Mr. Li Zhili, aged 59, is a non-executive director, deputy secretary of the party committee and secretary of the discipline committee of the company. He is also a director, deputy secretary of the party committee and secretary of the discipline committee of BAIC Group. Mr. Li has over 30 years of experience in the industry and management. Mr. Li Feng Mr. Li Feng, aged 51, is the executive director, president and deputy secretary of the party committee of the company. He is also a director of Beijing Benz and Beijing Hyundai and a director and a member of the standing committee of the party committee of BAIC Group. In addition, Mr. Li is a vice president of the Academic Committee of Beijing Automotive Engineering Society and a member of the Marketing Expert Committee (Automotive) of China Association of Marketing. Mr. Li has over 30 years of experience in industry and management. Mr. Ma Chuanqi Mr. Ma Chuanqi, aged 59, at present is a non-executive director of the company as well as a director of BAIC Investment, the chairman of the board of directors of Beijing Hainachuan Investment Co., Ltd., a director of Beijing Benz and a director of BAIC Hong Kong. He is also a director and the chief financial officer of BAIC Group, mainly responsible for financial management of BAIC Group. In addition, he is the chairman of the board of directors and secretary of the party committee of BAIC Finance. Currently, Mr. Ma is also the vice chairman of Beijing Association of Chief Financial Officers, among other positions. Mr. Ma has over 30 years of experience in finance and management. Mr. Qiu Yinfu Mr. Qiu Yinfu, aged 47 at present is a non-executive director of the company. He is also a director of BAIC Investment, the deputy secretary of the party committee, director, deputy general manager and chairman of the labour union of Shougang Limited, and the secretary of the party committee of Shougang Qian’an Iron & Steel Co. Mr. Qiu is also the deputy head of the management committee of the Metallurgical Equipment Sub-committee of the Chinese Society for Metals. Mr. Qiu has over 20 years of experience in industry and management. Mr. Hubertus Troska Mr. Hubertus Troska, aged 55, is a non-executive director of the company. He is also the deputy chairman of the board of directors and director of Beijing Benz, responsible for participating in formulating corporate business and strategies of Beijing Benz through its board of directors. He is also a member of the board of management of Daimler AG, responsible for its businesses in Greater China, and serves as the chairman and chief executive officer of Daimler Greater China. Mr. Troska has 27 years of experience in the automobile industry. Mr. Bodo Uebber Mr. Bodo Uebber, aged 55, is a non-executive director of the company and a member of the board of management of Daimler AG, responsible for finance and controlling as well as Daimler Financial Services and in charge of mergers & acquisitions. Mr. Uebber has 30 years of experience in finance and management. Ms. Wang Jing Ms. Wang Jing, aged 43, is a non-executive director of the company and director of Beijing New Energy Automobile Co., Ltd. Ms. Wang has over 20 years of experience in the industry and management. Mr. Yang Shi Mr. Yang Shi, aged 59, is a non-executive director of the company. He is also a director of BAIC Investment, director and general counsel of Beijing Energy Investment, director of Investment Beijing International Co., Ltd. and member of the audit committee under the board of directors of Beijing International Trust Co., Ltd. Mr. Yang has over 30 years of experience in the law industry and management. Source: Company

- 54 - Consumer Discretionary / China 1958 HK 18 June 2015

 BAIC: development milestones Year Events 1958 Establishment of Beijing Automobile Factory, the predecessor to BAIC Group 1983 Beijing Jeep Motor Co., Ltd., the predecessor of Beijing Benz and the first Sino-foreign joint venture automobile company founded in China, which mainly engaged in the development and manufacturing of off-road vehicles, was incorporated by Beijing Automobile Factory and American Motors Corporation 1994 Establishment of BAIC Holding, the predecessor of controlling shareholder BAIC Group 2002 BAIC Group established Beijing Hyundai with Hyundai Motor; Beijing Hyundai was the first approved joint-venture vehicle manufacturer following China’s accession to the World Trade Organization; in the same year, Beijing Hyundai Passenger Vehicle No. 1 factory commenced production 2005 BAIC Group and Daimler AG reorganised Beijing Benz and thus BAIC Group entered the luxury passenger vehicle market 2006 Beijing Benz MRA factory commenced production 2008 Beijing Hyundai Passenger Vehicle No. 2 factory commenced production 2009 The company’s controlling shareholder, BAIC Group, acquired Saab technology through BAIC Hong Kong 2010 Establishment of BAIC Motor; contribution to the company’s capital by injection of core passenger vehicles assets (including equity interest in Beijing Hyundai) by BAIC Group 2011 BAIC Motor acquired the entire equity interest in BAIC Hong Kong from BAIC Group and obtained Saab technology 2012 BAIC Motor entered into a series of agreements with BAIC Group and Daimler AG to further strengthen the strategic alliance by: 1) establishing Benz Sales Service, and 2) obtaining, on a royalty-free basis, the permanent licence to use the Mercedes-Benz E-Class LWB V212 platform and related technologies 2013 BAIC Motor acquired Beijing Benz from its parent company BAIC Group and increased its stake to 51% in the same year 2014 The Senova D50 sedan was launched. BAIC Motor completed its acquisition of a 100% equity interest in Guangzhou Company from BAIC Group Source: Company

 BAIC: organisational structure

Other State-owned DAIMLER BAIC Group Financial Investors Public Float Enterprises

10.2% 45.6% 21.5% 6.2% 16.5%

BAIC

100% 100% 100% 100% 100% 100% 100% 51% 50% 97.95% 49% ejn eniEgn at and Beijing Beinei Engine Parts hzo (BAIC) Motor Sales Zhuzhou ComponentsLtd. Co., Guangzhou Company ezSlsService Benz Sales ACHn Kong BAIC Hong BAIC Investment hzo Branch Zhuzhou ejn Branch Beijing ejn Benz Beijing BAIC Sales Powertrain Co., Ltd.

Beijing Beinei Moto Spare Parts 100% Sales Co., Ltd.

Beijing Hainachuan Investmnet 80% Co., Ltd.

Beijing Hyundai 50%

Source: Company

- 55 - Consumer Discretionary / China 1958 HK 18 June 2015

 Beijing Benz: new c-Class (LWB) sedan  Beijing Benz: E-class sedan

Source: Company Source: Company

 Beijing Benz: GLK SUV  Beijing Benz: GLA SUV

Source: Company Source: Company

 Beijing Hyundai: Sonata 9  Beijing Hyundai: Elantra Langdong Sedan

Source: Company Source: Company

- 56 - Consumer Discretionary / China 1958 HK 18 June 2015

 Beijing Hyundai: Mistra Sedan  Beijing Hyundai: Verna Sedan

Source: Company Source: Company

 Beijing Hyundai: ix25 SUV  Beijing Hyundai: ix35 SUV

Source: Company Source: Company

 BAIC Motor: Senova D20 Sedan  BAIC Motor: Senova D50 Sedan

Source: Company Source: Company

- 57 - Consumer Discretionary / China 1958 HK 18 June 2015

 BAIC Motor: Senova X65 SUV

Source: Company

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Consumer Discretionary / Hong Kong 1211 HK Consumer Discretionary / Hong Kong 18 June 2015

BYD

BYD Target (HKD): 56.00 Upside: 13.1% 1211 HK 18 Jun price (HKD): 49.50

Initiation: staying power 1 Buy • BYD looks well positioned to capture the market-share growth 2 Outperform (initiation) of the NEV segment over 2015-17 3 Hold • Its electronics business should provide steady net-profit growth 4 Underperform over this period, given the rising popularity of PMH casings 5 Sell • Initiating coverage with an Outperform (2) rating and 12-month SOTP-based target price of HKD56

How do we justify our view?

continue to take a hit on slowing 2015-16 following its new NEV overall demand, and we look for a product launches in 2014. 2% YoY decline in sales volume over 2015-17E. Beyond 2017, China’s ■ Risks growing NEV market should be large The main downside risks: lower- Kelvin Lau enough to boost BYD’s sales volume than-expected NEV sales volume in (852) 2848 4467 growth, even with the potential 2015-17 and an unexpected change [email protected] threat of competition from Japan’s in policy support for these vehicles. NEV makers. Ongoing licence Brian Lam restrictions in tier-1 cities should (852) 2532 4341 also boost BYD’s NEV sales, as it is [email protected] easier to secure a licence for NEVs Share price performance

than for conventional cars. (HKD) (%) 60 125 ■ Investment case Besides, we forecast BYD’s handset 51 106 The government’s targets for cutting 43 88 components and assembly revenue air pollution and CO2 emissions 34 69 to rise by 7-14% YoY over 2015-17E, stand to benefit car maker BYD’s 25 50 driven by higher global handset Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 new-energy vehicle (NEV) sales. We shipments and its rising share of the BYD (LHS) Relative to HSI (RHS) forecast its NEV sales volume to rise China mobile-phone market. by 33-185% YoY over 2015-17, on

50-100% YoY rises in NEV demand 12-month range 25.05-59.30 ■ Catalysts in China over the same period. As Market cap (USDbn) 17.48 Stronger-than-expected sales of 3m avg daily turnover (USDm) 52.20 such, we initiate coverage with an BYD’s NEV models in 2015, more Shares outstanding (m) 2,737 Outperform (2) rating and SOTP- Major shareholder Mr. Wang Chuan-fu (23.1%) official policy support for the NEV based 12-month TP of HKD56. segment, and tighter licence Financial summary (CNY) restrictions on conventional PVs Near term, we expect BYD’s NEV Year to 31 Dec 15E 16E 17E should support BYD’s share price, in Revenue (m) 77,554 97,849 112,152 Qin model to be its main revenue our view. A rise in global handset Operating profit (m) 3,256 4,696 6,126 driver, while strong sales of its shipments and the launch of more Net profit (m) 1,345 2,982 4,161 recently launched Tang should boost China mobile phones would benefit Core EPS (fully-diluted) 0.529 1.089 1.520 investor sentiment. Other revenue EPS change (%) n.a. 105.8 39.6 its mobile components business. streams will come from its public Daiwa vs Cons. EPS (%) (35.8) 13.2 22.6 PER (x) 74.9 36.4 26.1 transport vehicle business, where we Dividend yield (%) 0.0 0.0 0.0 expect the e6 and K9 electric buses ■ Valuation We believe the stock’s 2016E PER of DPS 0.000 0.000 0.000 to continue to gain share of the taxi PBR (x) 2.5 2.4 2.2 37x, higher than the peer average, is and bus markets. Meanwhile, its EV/EBITDA (x) 14.7 11.6 9.5 conventional car business will likely justified, given we see stronger- ROE (%) 3.9 6.7 8.6 than-peers’ net-profit growth over Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 102 Consumer Discretionary / Hong Kong 1211 HK 18 June 2015

1 Buy How do we justify our view? 2 Outperform (initiation)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  BYD: net profit and growth We forecast BYD’s recurring net profit to grow to (CNYm) CNY1.35bn for 2015, from CNY86m a year earlier, as 4,500 1600% a result of the 100% EV sales volume and 220% PHV 4,000 1400% 3,500 1200% sales volume growth that we forecast for this period. 3,000 1000% We expect the strong demand momentum for NEVs 2,500 800% to continue, driven by the government’s favourable 2,000 600% policies. 1,500 400% 1,000 200% For 2016-17E, we forecast recurring net-profit growth 500 0% of 122% YoY and 40% YoY respectively, helped by the 0 (200%) launch of a number of new EV models and continued 2010 2011 2012 2013 2014E 2015E 2016E 2017E rise global handset shipments. Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts

 Valuation  BYD: SOTP valuation We initiate coverage on BYD with an Outperform (2) NAV 2016E rating and an SOTP-derived 12-month target price of Valuation Multiple(x) (CNYm) Rechargeable batteries PBR 1.0x 11,978 HKD56. Mobile handsets PER 10.0x 20,372 Autos - Conventional PER 8.0x 3,823 We value BYD’s NEV business at a PER of 30x, given Autos - NEV PER 30x 96,232 the high shipment growth momentum of NEVs that we Sub-total 132,405 - Net debt/cash (6,888) expect over 2015-17. We value BYD’s rechargeable- - Minority interest (4,367) battery business at a PBR of 1.0x, on our BVPS forecast Equity value (CNYm) 121,150 for 2016, as we believe a PER valuation does not Exchange rate, HKD:CNY 0.8 accurately capture its intersegmental transactions. We Equity value (HKDm) 151,438 value BYD’s conventional autos business at a PER of Equity value/share (HKD) 56.00 Source: Company, Daiwa forecasts 8.0x on our 2016 EPS forecast, which is at the low-end of the range of 8.0-11x that we apply to the auto OEMs that we cover.

 Earnings revisions  BYD: Bloomberg-consensus EPS forecast revisions The Bloomberg consensus 2015-16 EPS forecasts have (CNY) been stable for the past year. However, we think the 1.40 consensus might raise its forecasts on the rising 1.20 demand for NEVs and the government’s NEV- 1.00 supportive policies. 0.80 0.60 Our 2016-17 EPS forecasts are 13-23% above 0.40 consensus, as we assume strong NEV demand which 0.20 should drive BYD’s profit growth. 0.00 Jul-14 Apr-15 Apr-14 Oct-14 Jan-15 Jan-14 Jun-14 Feb-15 Mar-15 Feb-14 Mar-14 Aug-14 Sep-14 Nov-14 Dec-14 May-15 May-14 2015E 2016E Source: Bloomberg

- 60 - Consumer Discretionary / Hong Kong 1211 HK 18 June 2015

Financial summary

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E BYD NEV volume (units) n.a. n.a. 3,344 3,142 20,859 59,404 107,972 144,035 Volume growth - NEV (%) n.a. n.a. n.a. (6.0) 563.9 184.8 81.8 33.4 Battery shipment (%) n.a. 0.8 1.2 7.4 (0.8) 1.0 1.0 1.0 Handset shipment (%) n.a. (4.8) (12.3) 13.4 23.9 14.0 14.0 7.0

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Rechargeable Battery n.a. 4,620 4,675 5,018 4,980 5,030 5,080 5,131 Mobile handset n.a. 19,557 17,155 19,459 24,116 27,493 31,341 33,535 Other Revenue n.a. 22,136 22,551 25,291 26,270 45,031 61,427 73,485 Total Revenue n.a. 46,312 44,381 49,768 55,366 77,554 97,849 112,152 Other income n.a. 846 718 651 950 1,120 1,325 1,417 COGS n.a. (39,445) (39,255) (43,252) (47,743) (66,637) (84,276) (95,975) SG&A n.a. (5,299) (4,717) (5,364) (6,694) (8,781) (10,201) (11,468) Other op.expenses n.a. 0000000 Operating profit n.a. 2,414 1,127 1,803 1,879 3,256 4,696 6,126 Net-interest inc./(exp.) n.a. (687) (812) (947) (1,292) (1,192) (773) (791) Assoc/forex/extraord./others n.a. 1 (25) (24) 287 1,650 0 0 Pre-tax profit n.a. 1,727 291 832 874 3,713 3,923 5,335 Tax n.a. (132) (78) (56) (134) (520) (549) (747) Min. int./pref. div./others n.a. (210) (132) (223) (306) (446) (392) (427) Net profit (reported) n.a. 1,385 81 553 434 2,748 2,982 4,161 Net profit (adjusted) n.a. 1,385 81 553 86 1,345 2,982 4,161 EPS (reported)(CNY) n.a. 0.598 0.035 0.235 0.179 1.081 1.089 1.520 EPS (adjusted)(CNY) n.a. 0.598 0.035 0.235 0.035 0.529 1.089 1.520 EPS (adjusted fully-diluted)(CNY) n.a. 0.598 0.035 0.235 0.035 0.529 1.089 1.520 DPS (CNY) n.a. 0.000 0.000 0.050 0.000 0.000 0.000 0.000 EBIT n.a. 2,414 1,127 1,803 1,879 3,256 4,696 6,126 EBITDA n.a. 5,091 4,383 5,336 6,092 8,073 10,182 12,265

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax n.a. 1,727 291 832 874 3,713 3,923 5,335 Depreciation and amortisation n.a. 2,678 3,256 3,533 4,212 4,817 5,485 6,139 Tax paid n.a. (344) (299) (246) (192) (520) (549) (747) Change in working capital n.a. 1,179 1,132 (2,913) (6,106) 5,321 1,064 530 Other operational CF items n.a. 744 1,175 1,230 1,251 (360) 1,386 1,482 Cash flow from operations n.a. 5,985 5,555 2,436 38 12,972 11,309 12,739 Capex n.a. (8,942) (7,150) (5,764) (8,578) (8,767) (9,099) (9,449) Net (acquisitions)/disposals n.a. (280) 2,573 80 480 575 0 0 Other investing CF items n.a. 299 (32) (168) 197 0 0 0 Cash flow from investing n.a. (8,923) (4,610) (5,851) (7,901) (8,192) (9,099) (9,449) Change in debt n.a. 3,733 (3,085) 3,232 5,314 2,327 2,327 2,327 Net share issues/(repurchases) n.a. 1,368 0 0 3,342 15,000 0 0 Dividends paid n.a. 0 0 0 (124) 0 0 0 Other financing CF items n.a. (366) 1,868 1,276 (1,262) (1,290) (1,386) (1,482) Cash flow from financing n.a. 4,736 (1,217) 4,508 7,271 16,037 941 845 Forex effect/others n.a.0000000 Change in cash n.a. 1,798 (271) 1,093 (592) 20,817 3,151 4,136 Free cash flow n.a. (2,958) (1,595) (3,328) (8,540) 4,205 2,209 3,291 Source: FactSet, Daiwa forecasts

- 61 - Consumer Discretionary / Hong Kong 1211 HK 18 June 2015

Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment n.a. 3,737 3,487 4,511 3,950 24,767 27,918 32,053 Inventory n.a. 6,596 7,345 8,221 9,978 13,327 16,855 19,195 Accounts receivable n.a. 9,782 9,937 13,135 22,435 23,266 29,355 33,646 Other current assets n.a. 2,665 2,555 4,099 4,471 5,642 6,713 7,469 Total current assets n.a. 22,780 23,324 29,966 40,834 67,003 80,841 92,363 Fixed assets n.a. 30,723 33,659 34,147 36,379 39,935 42,217 44,331 Goodwill & intangibles n.a. 6,689 7,983 9,623 10,821 12,290 13,622 14,817 Other non-current assets n.a. 6,689 5,042 4,279 5,974 5,974 5,974 5,974 Total assets n.a. 66,881 70,008 78,015 94,009 125,202 142,654 157,485 Short-term debt n.a. 11,342 11,288 16,172 19,173 19,173 19,173 19,173 Accounts payable n.a. 17,236 19,933 22,293 25,851 33,318 42,138 47,988 Other current liabilities n.a. 6,050 6,008 4,879 7,998 11,204 14,136 16,202 Total current liabilities n.a. 34,628 37,228 43,344 53,022 63,695 75,446 83,362 Long-term debt n.a. 7,079 7,341 8,652 10,979 13,306 15,633 17,960 Other non-current liabilities n.a. 1,194 1,294 1,162 1,113 1,113 1,113 1,113 Total liabilities n.a. 42,901 45,863 53,158 65,114 78,114 92,192 102,436 Share capital n.a. 2,354 2,354 2,354 2,476 2,737 2,737 2,737 Reserves/R.E./others n.a. 18,770 18,843 19,356 22,890 40,376 43,357 47,519 Shareholders' equity n.a. 21,125 21,197 21,710 25,366 43,113 46,095 50,256 Minority interests n.a. 2,856 2,947 3,147 3,529 3,974 4,367 4,794 Total equity & liabilities n.a. 66,881 70,008 78,015 94,009 125,202 142,654 157,485 EV n.a. 125,504 125,678 130,914 136,854 118,810 118,379 116,997 Net debt/(cash) n.a. 14,684 15,143 20,313 26,202 7,712 6,888 5,080 BVPS (CNY) n.a. 9.127 9.004 9.222 10.245 15.750 16.839 18.360

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. n.a. (4.2) 12.1 11.2 40.1 26.2 14.6 EBITDA (YoY) n.a. n.a. (13.9) 21.7 14.2 32.5 26.1 20.5 Operating profit (YoY) n.a. n.a. (53.3) 60.0 4.2 73.2 44.3 30.4 Net profit (YoY) n.a. n.a. (94.1) 579.6 (84.5) 1,467.4 121.6 39.6 Core EPS (fully-diluted) (YoY) n.a. n.a. (94.2) 579.6 (84.9) 1,395.8 105.8 39.6 Gross-profit margin n.a. 14.8 11.6 13.1 13.8 14.1 13.9 14.4 EBITDA margin n.a. 11.0 9.9 10.7 11.0 10.4 10.4 10.9 Operating-profit margin n.a. 5.2 2.5 3.6 3.4 4.2 4.8 5.5 Net profit margin n.a. 3.0 0.2 1.1 0.2 1.7 3.0 3.7 ROAE n.a. 13.1 0.4 2.6 0.4 3.9 6.7 8.6 ROAA n.a. 4.1 0.1 0.7 0.1 1.2 2.2 2.8 ROCE n.a. 11.4 2.6 3.9 3.5 4.7 5.7 6.9 ROIC n.a. 5.8 2.1 4.0 3.2 5.1 7.2 9.0 Net debt to equity n.a. 69.5 71.4 93.6 103.3 17.9 14.9 10.1 Effective tax rate n.a. 7.7 26.8 6.8 15.3 14.0 14.0 14.0 Accounts receivable (days) n.a. 38.5 81.1 84.6 117.2 107.5 98.1 102.5 Current ratio (x) n.a. 0.7 0.6 0.7 0.8 1.1 1.1 1.1 Net interest cover (x) n.a. 3.5 1.4 1.9 1.5 2.7 6.1 7.7 Net dividend payout n.a. 0.0 0.0 21.3 0.0 0.0 0.0 0.0 Free cash flow yield n.a. n.a. n.a. n.a. n.a. 3.9 2.0 3.0 Source: FactSet, Daiwa forecasts

 Company profile Listed in Hong Kong in 2002, BYD is engaged in the R&D, manufacture and distribution of automobiles, rechargeable batteries and mobile phone components. It owns 65% of BYD Electronics (285 HK, Not rated). BYD focuses on autos (especially NEVs), rechargeable batteries (lithium-ion and nickel batteries used in mobile phones and other portable electronic devices), as well as mobile-phone components and its assembly mobile phones business (casings, keypads, mobile-phone designs, etc.).

- 62 - Consumer Discretionary / Hong Kong 1211 HK 18 June 2015

 China: brief history of energy-saving and new energy vehicle development Phase Major policies Phase I: Early-1995-2008 China establishes the framework for research, innovation and the industrialisation of pure electric vehicles, hybrid electric vehicles and fuel-cell electric vehicles by providing research and technical support. The use of NEVs at the Beijing Olympics under the EV- related projects carried out by the Ministry of Science and Well placed for future Technology helps to promote NEVs. Phase II: 2009-12 Besides offering ongoing research and technological support for opportunities research and production, large-scale promotional campaigns are run in 25 cities to highlight energy-saving measures and NEVs. The government also improves the managements of energy-saving and new energy vehicle manufacturers and their products, accelerating We see robust demand for NEVs, BYD’s industry standardisation. Phase II: After June 2012 The government releases a 'Notice of the State Council on Issuing core business, over 2015-17 driven by the the Planning for the Development of the Energy-Saving and New Energy Automobile Industry (2012-20)', which aims to t improve the government’s favourable policies amid its innovation and industrialisation capacities of energy-saving and new energy vehicles. Since September 2013, the Ministry of fight to tackle the country’s air pollution Finance, the Ministry of Science and Technology, the Ministry of Industry and Information Technology and the National Development and Reform Commission have announced a 'Notice on Implementing Popularisation Work of Energy Saving and EVs are the way of the future Environmentally Friendly Vehicles of 1.6L or less' and a 'Notice on Continuing the Promotion and Application of New Energy In line with China’s long-term plans Automobiles' and to this end identified 28 model cities. Source: Annual Report On Automotive Industry In China (2014) Due to rising concerns about China’s air pollution and the government’s long-term goal of becoming less China’s sales volume growth was significant for 2014, reliant on oil imports, the government has been when it recorded a 324% YoY increase in overall NEV pushing the development of the country’s NEV sales. Also, NEVs are becoming a popular option for industry since 1995 – this includes electric vehicles public transport, which bodes well for BYD. For (EV), hybrid electric vehicles (HEVs) and fuel-cell example, the market share of NEV buses in China vehicles (FCVs). increased from less than 2% in 2010, to at least 10% in 2013. In the past few decades, the government has implemented 2 policy directions: 1) it has set standards And even though NEVs still only account for less than a to cut the emissions released and fuel consumption of 1% share of the PV market in China, we see large PVs, and 2) it has been encouraging the use of NEVs by market-share potential for BYD in the long term (note providing subsidies to manufacturers and tax that plug-in hybrid electric vehicles (PHEVs) have incentives to buyers (eg, exemptions from having to more than a 90% share of the market in Japan, based pay the vehicle purchase tax), as well as having fewer on our estimates). We forecast BYD’s NEV sales restrictions on the issuance of new licences for NEVs volume to increase by 33-185% YoY for 2015-17E. compared with conventional cars.  China: NEV sales (units) 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 2011 2012 2013 2014 2015E 2016E 2017E

Source: China Association of Automobile Manufacturers, Daiwa forecasts

- 63 - Consumer Discretionary / Hong Kong 1211 HK 18 June 2015

 China: breakdown of NEV sales]  CO2 emissions targets: major markets (units) Year (g/km) US EU Japan China S. Korea 2005 212 162 153 n.a. 325 80,000 2010 188 140 128 180 175 70,000 2015 167 130 110 161 153 60,000 29,715 2020 126 95 105 117 153 50,000 2025 103 68~78 105 117 153 Growth: 878.1% 5-YoY (%) US EU Japan China S. Korea 40,000 2010 -11.3% -13.6% -16.3% n.a. -46.2% 30,000 2015 -11.2% -7.1% -14.1% -10.6% -12.6% 20,000 Growth: 208.5% 45,048 2020 -24.6% -26.9% -4.5% -27.3% 0.0% 3,038 2025 -18.3% -17.9~-28.4% 0.0% 0.0% 0.0% 10,000 14,604 Improvement (%) US EU Japan China S. Korea 0 2010-25 -45.2% -44%~-51% -18.0% -35.0% -12.6% 2013 2014 EV PHV 2015-25 -38.3% -39%~-48% -4.5% -27.3% 0.0% Source: The International Council on Clean Transportation (ICCT) Source: BYD, China Association of Automobile Manufacturers Note: No emissions guidance have been provided for Korea (from 2015), Japan (from 2020), or China (from 2020)  BYD: sales volume of NEV (2013 - 2017E) (units)  Summary of fuel-efficiency targets for major markets 160,000 600% km/l (mpg) US EU Japan China S. Korea 140,000 2005 12.4 (29.0) 15.8 (37.2) 16.7 (39.3) 11.0 (25.9) 12.3 (28.9) 500% 2010 13.9 (33.0) 18.0 (42.3) 19.6 (46.1) 14.4 (33.9) 14.8 (34.8) 120,000 2015 15.4 (36.0) 19.7 (46.3) 21.0 (49.4) 15.7 (36.9) 16.7 (39.3) 400% 100,000 2020 19.9 (47.0) 25.8 (60.7) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) 80,000 300% 2025 23.9 (56.0) 30.8 (72.4) ~ 35.0 (82.3) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) 60,000 5-YOY (%) US EU Japan China S. Korea 200% 2010 12.1% 13.9% 17.4% 30.9% 20.3% 40,000 100% 2015 10.8% 9.4% 7.1% 9.0% 12.8% 20,000 2020 29.2% 31.0% 11.4% 35.7% 0.0% 0 0% 2025 20.1% 19.4%~35.7% 0.0% 0.0% 0.0% 2013 2014 2015E 2016E 2017E Improvement (%) US EU Japan China S. Korea Sales volume (LHS) Growth (RHS) 2010-25 71.9% 71.1%~94.4% 19.4% 47.9% 12.8% Source: Company, Daiwa forecasts 2015-25 55.2% 56.3%~77.7% 11.4% 35.7% 0.0% Source: ICCT Note: No official fuel efficiency guidance has been provided for Korea (from 2015), Japan Higher standards in the future to drive (from 2020), or China (from 2020) NEV demand As we have mentioned, one of the reasons why the Licence restrictions to help to push up government is pushing NEV production is because it demand for NEVs has set stricter emissions and fuel consumption Apart from the new standards for emissions and fuel standards for manufacturers in order to tackle the consumption, which are likely to boost consumer country’s air pollution. According to the government, demand for NEVs, the licence restrictions imposed in 7 the fuel consumption target to be enforced for PVs by of China’s tier-1 cities are also likely to boost demand the end of 2015 is 6.9 litres/km (or 15.7 km/litre). This for new NEVS, as the new-car restrictions focus more will be cut to 5 litres/km (or 21.3km/litre) by 2020, on conventional cars at the moment. which would then be lower than the US standard and close to Japan’s. At the same time, China’s CO2 For example, on 29 December 2014, the Shenzhen emissions target is to reduce emissions by 27% by government imposed a 5-year policy restricting annual 2020, from 161 g/km in 2015. new car licences to 100,000 in the city (80,000 for normal PVs and 20,000 for electric cars). The quota for China’s fuel-consumption target is calculated by taking electric cars is more than sufficient to meet the current the weighted average number of vehicles sold and then market demand, which could result in some new-car determining the corresponding fuel consumption per owners shifting to NEVs (we note that 7 cities in China OEM. Thus, we think the OEMs are likely to develop have implemented restrictions on new conventional car more EVs in the coming years, as doing so would allow licences, but the restrictions on NEVs are limited in them to reduce their blended fuel consumption figures. that the designated quota, where there is one, is large We note, however, that the manufacturers are currently enough to cater to current NEV demand). not subject to penalties for non-compliance with these targets.

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 China: PV licence restrictions in different cities technology, especially for its batteries, is much better System used to Implementation Quota Quota set for than that of the other local brands. Cities designate new plates date (annual) NEVs Shanghai Bidding 1994 132,000 20,000 Beijing Lotteries 12/23/2010 150,000 10,000-30,000  EV launch schedules for the various OEMs Guiyang Lotteries 7/11/2011 24,000 N.A. OEMs Model Type Schedule Guangzhou Bidding and lottery 6/30/2012 120,000 12,000 BYD Tang PHEV 1H 2015 Tianjin Bidding and lottery 12/15/2013 100,000 10,000 BYD Shang PHEV 2H 2015 Hangzhou Bidding and lottery 3/25/2014 80,000 N.A. DFM A60 EV Late-2015 Shenzhen Bidding and lottery 12/29/2014 100,000 20,000 Brilliance Zhonghua H230 EV EV 2015 Source: local government and various media Geely EC7-EV EV 2015 GAC Toyota Leahead i1 EV 2016 GAC Trumpchi GA6 EV Late-2015 PHEV: going in the right direction GAC Trumpchi GS4 EV Early-2016 As we mentioned in the sector section of this report, we LiFan 620 EV EV 1H 2015 FAW Toyota Ranz E50 EV 2015 believe HEVs will become more popular in China as Jianghuai iEV5 EV 1H 2015 they are more affordable than EVs, and also better Haima Aishang EV 2015 suited to China due to the lack of charging stations. Volvo XC90 T8 PHEV 2015 Volvo X60L PHEV 2015 Thus, we are positive on BYD’s fixed focus on the Volkswagen Golf GTE PHEV 2015 Audi A3 e-tron PHEV 2015 PHEV market over the pure EV market. According to a Source: Companies, various media reports Daiwa report published on 14 November 2014, called “Green-car market set to bloom” , around 40% of However, we think the foreign models, especially the Toyota’s shipments are HEVs (Toyota is the current Japanese brands that are the global leaders in both the global market leader in green cars). NEV/EV segments could pose a threat to BYD’s share of the China NEV market. For example, Toyota has  Green cars: price comparison (HEVs/EVs and FCVs) (2015) already started to sell a hybrid version of the Camry in MSRP (USD) China and may add a new hybrid model, such as the 80,000 Toyota Levin, in the near future. 70,000 60,000 And according to news flow and Honda’s management, 50,000 the company may launch its hybrid version of the 40,000 Accord in China soon. Thus, we see China’s NEV car 30,000 market being affected by the Japanese brands in the long term, even though strong sale volume growth in 20,000 China should enable significant growth opportunities 10,000 for BYD over 2015-16. Comparatively, we think the 0 more price-sensitive segments, such as public Toyota FCV Toyota 2015 Prius (HEV) Nissan 2015 Leaf (EV) transport, are a more sustainable segment (in terms of Source: Companies, Daiwa revenue) for BYD.

More competition from foreign players Currently, BYD has become more widely known for than local ones making public transport-related NEVs, ie, taxis and Given the looming stricter fuel consumption standards, buses. For taxis, the company targets to raise its sales many automakers have started to produce NEVs given volume from 15,000/year in 2014 to 60,000/year in their lower average fuel consumption. Apart from BYD, 2016, which would allow it to account for 20% of other early entrants in the NEV segment, such as BAIC, China’s taxi market share. For public buses, BYD SAIC, and new entrants such as Geely and GWM, have targets to increase its sales volume from around launched many new NEV models in the past year, and 3,000/year in 2014 to 9,000/year in 2016. Overall, we expect more to come for the rest of 2015 and 2016. BYD aims to get at least a 30% share of government However, we believe the companies are developing and vehicle purchases by 2016. launching these NEVs to meet the new standards (ie, to lower their average fuel consumption figures), rather than to make a profit.

Accordingly, we believe BYD is the only China automaker to seriously invest in R&D in order to develop its NEV brand. Thus, we believe BYD’s

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 Global EV shipment market share by manufacturer (2013)  EV comparison: BYD e6 vs. Tesla’s Model S Spec BYD e6 Tesla Model S 70D Ford BYD VW BMW Others Jac 1.7% 1.5% 1.3% 1.2% 3.0% Battery (kWh) 61 70 2.2% Range (km) 300 442 Daimler Top speed (km/h) 140 225 Chery 3.7% Charging time (fast charge) 40mins 1hr 4.5% Charging time (standard charge) 6 hrs 10 Nissan Acceleration (0-97km/h) <14s 5.4s Mitsubishi 42.5% 5.6% Source: Company

Renault 12.9% Other businesses

Tesla 19.9% More mobile devices being launched Source: Wards Automotives, compiled by Daiwa We see the ongoing migration of users from 3G to 4G globally leading to rising replacement demand by  Global HEV shipment market share by manufacturer (2013) mobile-phone users switching to newer mobile devices. GM This will generate continuous global demand for Others HMG Renault-Nissan 3.0% 4.0% 1.0% handset components and BYD should benefit as it has a 4.0% technological advantage in that it produces the newest Ford version of plastic-metal hybrid (PMH) casings. 5.0% According to Daiwa’s regional head of Honda 10.0% technology/semiconductors Rick Hsu, he expects the penetration rate for 4G phones to rise from around 30% in 2014 to over 45% in 2015.

Toyota In addition, BYD supports domestically manufactured 73.0% mobile phones, such as by Xiaomi, which has seen its market share increase since 2011. In 1Q15, the market Source: Edmunds.com, Daiwa share of the China brands combined globally exceeded

that of Samsung and Apple, which we see as a sign that Obstacles to overcome the China brands have been accepted globally. We see Even though we expect BYD’s NEV sales volume to this as an additional benefit for BYD. increase by 50-100% YoY for 2015-17E, we see the main obstacle to increasing mass popularity as the  Global smartphone shipments current lack of investment in infrastructure (ie, (m units) charging stations), where China still has a long way to 2,000 80% go. As mentioned in our sector report, even though 70% there are only slightly more than 50,000 NEV charging 1,500 60% stations in the US, many drivers can charge their cars 50% at home. However, in China, as most people live in 1,000 40% apartments, they would find it difficult to find a way to 30% charge their cars as there are around only 25,000 500 20% charging stations in China currently. 10% 0 0% Translating this for BYD, we think the performance of 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E Smartphone Growth (RHS) its EVs, namely battery life, acceleration and maximum speed, still lags those of its global peers. In our view, Source: Daiwa forecasts the price-performance ratio in China is still not that attractive compared to conventional cars. 

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 BYD: segmental profit But, other businesses to offer 100% limited earnings growth 29% 25% 80% 42% 8% 55% 12% 63% Battery demand to be driven by NEV 60% demand, photovoltaic business still weak 12% 40% 8% 62% Demand growth for BYD’s Li-ion batteries and Ni 55% 6% 43% batteries is stable currently, and we expect this 20% 35% business’s main earnings growth driver to come from 29% NEVs in the long term, with the adoption of LFP 0% 5% 5% 4% 3% 2% (lithium iron phosphate) batteries increasing the 2013 2014 2015E 2016E 2017E Rechargeable Battery Mobile handset overall performance of BYD’s NEV business. We Auto - Conventional Auto - NEV & Gov't subsidy forecast that this business will see a revenue CAGR of Source: Company, Daiwa forecasts only 1% over 2015-17E. Stronger balance sheet Meanwhile, we expect the photovoltaic business to In February 2015, BYD disposed of its entire equity remain week in 2015, and that it would be hard for interest in Shenzhen BYD Electronic Components for a BYD to breakeven in 2015 due to antidumping total consideration of CNY2.3bn, of which 25% was to measures imposed by the US and EU. be paid in cash and 75% in new shares in Holitech (not rated), the acquirer. Earnings forecasts In June 2015, BYD announced it plans to issue 261.32m shares (representing 10% of its enlarged share Strong profit growth supported by the NEV capital) at CNY57.4 per share and that it expects to segment for 2015 raise a total of CNY15bn in cash through an A-share Excluding a one-off gain from the disposal of one of its placement. subsidiaries that focus on electronic components in 1Q15 (to the tune of CNY1.63bn), we forecast BYD’s As such, we forecast BYD to record a positive free cash recurring 2015 net profit to grow to CNY1.35bn, from flow in 2015, and expect its net gearing to decline to CNY85m for 2014, driven by the 100% YoY EV sales 18% for 2015, from 103% for 2014, as its book value has volume growth and the 220% YoY PHV sales volume increased by 70% since the placement. growth that we forecast for the same period.

We expect the strong NEV demand momentum over Valuation and recommendation our forecast period to continue, backed by the government’s policy support. Accordingly, for 2016-17, We initiate coverage of BYD with an Outperform (2) we forecast recurring net-profit growth of 122% YoY rating as we like its NEV business and the fact that and 40% YoY, respectively, helped by the launch of new government support for this business is unlikely to EV models and rising demand for global handset wane any time soon. Due to BYD’s diversified business shipments. structure, we believe an SOTP valuation is the most appropriate way to value the company, as we see Stable handset revenue expected different earnings-growth potential for each of its Thus, we forecast BYD’s mobile-phone components business segments. and assembly revenue to rise by 7-20% YoY over 2015- 17E, driven by the increase in global handset shipments Given that we forecast high NEV demand (a 50% and the rising share of the China mobile phone market CAGR) in China over 2015-20, we value BYD’s NEV globally. We forecast BYD’s segmental profit for its business at a 30x PER. We think this supports our NEV handset business to grow by 27% and 14% YoY for 2015 shipment growth forecasts of 185% YoY for 2015 and and 2016, respectively, supported by 14% YoY 82% for 2016. Our target multiple for BYD’s NEV shipment growth and slight gross margin expansion. business is at a discount to that for Tesla (based on the Bloomberg-consensus forecasts), which is trading currently at a 2016 PER of 79x, as Tesla is regarded as a leading and dominant player in the NEV segment, with its own direct sales distribution channel, which BYD does not have.

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We value BYD’s conventional auto business at a PER of 8.0x, on our 2016 EPS forecast, which is at the low end Risks to our call of the PER range of 8-11x that we assign to the auto OEMs under our coverage universe. We assign a low- The main risk to our call is lower-than-expected NEV end PER as we do not see BYD’s conventional car sales volume for BYD, as competitors continue to enter business being a future revenue growth driver for the the NEV market in a bid to increase their average fuel company, due to the intensifying competition in this efficiency rates, as required by the government’s area. We believe BYD might phase out its conventional regulations. Any change in the government’s stance on autos business in the long term. subsidies for EVs could also affect BYD’s earnings.

We value BYD’s rechargeable-battery business at a Secondary downside risks include weaker-than- 2016E PBR of 1.0x, as we believe a PER valuation does expected global handset demand, and if BYD’s lithium not accurately capture the company’s intersegmental ion phosphate battery technology were to lose market transactions and the batteries supplied to BYD’s NEV share to competing technologies, such as the nickel business. We assign a 2016E PER of 10x to BYD’s manganese cobalt oxide technology used in the Toyota handset segment, in line with the average 2016E PER Prius and BMW i3. for its domestic handset components peers, based on the Bloomberg-consensus forecasts.

Our 12-month target price of HKD56 is based on our SOTP valuations for the aforementioned business segments. Our target price implies 13% upside potential from current share-price levels.

 BYD: SOTP valuation Valuation Multiple (x) NAV16E (CNYm) Rechargeable batteries PBR 1.0x 11,978 Mobile handsets PER 10.0x 20,372 Autos - Conventional PER 8.0x 3,823 Autos - NEV PER 30.0x 96,232 Sub-total 132,405 - Net debt/cash (6,888) - Minority interest (4,367) Equity value (CNYm) 121,150 Exchange rate, HKD:CNY 0.8 Equity value (HKDm) 151,438 Equity value/share (HKD) 56 Source: Daiwa forecasts

 BYD: NAV breakdown (2016E) Rechargeable Battery 9.0% Mobile handset 15.4%

Auto - Conventional 2.9%

Auto - NEV 72.7%

Source: Daiwa forecasts

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In 2008, Berkshire Hathaway Energy, a flagship Background information investment company under Warren Buffett’s Berkshire Hathaway Inc, acquired 225m BYD H shares at Listed in Hong Kong in 2002, BYD is engaged in the HKD8.00 per share, representing 9% of the company’s R&D, manufacture and distribution of autos, shareholding. rechargeable batteries and mobile-phone components. It owns a 65% stake in BYD Electronics.  BYD: revenue breakdown (2014)

Automobile - Rechargeable BYD focuses on autos (especially NEVs), rechargeable NEV (EV+PHV) Battery batteries (lithium-ion and nickel batteries used in 13.1% 9.0% mobile phones and other portable electronic devices), as well as mobile-phone components and mobile- phone assembly (casings, keypads, mobile-phone designs, etc). Automobile - Conventional Mobile handset BYD is one of the largest (in terms of shipments) 43.6% suppliers of rechargeable batteries in the world, and 34.4% has the largest market share in nickel-cadmium batteries, handset Li-ion batteries, cell-phone chargers and keypads worldwide. It is the largest supplier of Source: Company rechargeable batteries and also has the second-largest market share for cell-phone shells in the world.

 BYD: management profile Mr. Wang Chuan-fu Executive director. Mr. Wang has held positions as vice supervisor at Beijing Non-Ferrous Research Institute, and general manager at Shenzhen Bi Ge Battery. In February 1995, he founded Shenzhen BYD Battery with Mr. Lu Xiang-yang and took the position of general manager. He is the chairman, an executive director and president of the company and responsible for overseeing general operations and determining the business strategies. He is a non-executive director and the chairman of BYD Electronic (International), a director of Shenzhen BYD Daimler New Technology, vice-chairman of Shenzhen Pengcheng Electric Automobiles Renting, a director of Tianjin BYD Auto, and the chairman of Sheng Shi Xin Oi Electric Automobile Service. Mr. Lu Xiang-yang Non-executive director. In February 1995, Mr. Lu founded Shenzhen BYD Battery with Mr. Wang Chuan-fu. He is the vice-chairman and a non-executive director of the company and vice-chairman of BYD’s charity foundation. Mr. Xia Zuo-quan Non-executive Director. Mr. Xia Zuo-quan joined Shenzhen BYD Battery in 1997 and has held the positions of Executive Director and Vice-President. He is also a non- executive director of the company and the vice-chairman of BYD’s charity foundation. Source: Company

 BYD: development milestones Year Event 1995 BYD was founded with capital of CNY2.5m and 20 members. 1998 The first overseas subsidiary was founded in Europe. 2000 The construction begins of Shenzhen’s Kuichong Industrial Park, which was BYD’s first industrial park. 2000 BYD became the first lithium ion battery supplier in China for Motorola 2002 BYD became the first China-based lithium ion battery supplier for Nokia 2002 BYD was listed on the Hong Kong Stock Exchange Main Board. 2003 BYD purchased Xi’an Tsinchuan Auto and formed the present BYD Auto. 2005 BYD’s F3 hit the market. 2007 The construction of Pingshan Industrial Park was completed, where BYD’s headquarters is currently located. 2008 Berkshire Hathaway Energy, a flagship investment company under investment guru Warren Buffett's Berkshire Hathaway Inc, announced plans to acquire 225,000,000 BYD H shares at HKD8.00 per share 2008 The BYD F3DM, the world’s first dual-mode electric vehicle hit the market in Shenzhen. 2010 BYD signed a contract with Daimler AG and founded the Shenzhen BYD Daimler New Technology, with both parties holding half the shares. 2010 Warren Buffet, Charles Thomas Munger and Bill Gates travel to BYD for a 4-day visit to the company. 2011 BYD is listed on the Shenzhen Stock Exchange (Code: 002594). 2011 As the exclusive vehicle supplier of the 26th World Universiade Shenzhen, BYD sponsored 200 BYD eBUS-12 pure electric buses and 300 e6 pure electric taxies for the Games. 2014 BYD issues its “5-4-2 Initiative”, setting performance targets for BYD’s future vehicle models. Source: Company

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 BYD: organisational chart

Lu Xiang Yang Wang Chuan Fu H Shareholders Bershire Hathaway A Shareholders (Vice Chairman) (Chairman)

27.8% 9.7% 23.1% 9.1% 30.3%

BYD Company (1211.HK)

100% 65.76% 45% 50% 50% 51% Technology Guang Qi BYD Qi Guang BYD Electronic BYD Electric Car Pengcheng Chuzu Pengcheng BYD Auto Industry Shenzhen Shenzhen BYD Daimler New

Source: Company

 BYD: the Surui sedan  BYD: the Qin sedan

Source: Company Source: Company

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 BYD: the F3 sedan  BYD: the S6 SUV

Source: Company Source: Company

 BYD: the S7 SUV [  BYD: the Tang SUV

Source: Company Source: Company

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- 72 -

Consumer Discretionary / China 2333 HK Consumer Discretionary / China 18 June 2015

Great Wall Motor

Great Wall Motor Target (HKD): 39.90 Upside: 5.0% 2333 HK 18 Jun price (HKD): 38.00

Initiation: SUV play, but competition is mounting 1 Buy 2 Outperform • We believe GWM is well placed to tap strong demand for SUVs 3 Hold (initiation) in China, though margin pressures are likely to intensify 4 Underperform • We think R&D is central to GWM’s long-term prospects and 5 Sell hence expect its related spending to remain high • Initiating with Hold (3) rating and 12-month target price of HKD39.9 Among the local brands, we prefer Geely over GWM

How do we justify our view?

Despite our expectation that GWM’s ■ Risks margins will contract as the other The major risks to our Hold (3) auto OEMs roll out a range of SUV rating: weaker- or better-than- models, we forecast the company to expected sales of its models and net see net profit growth of 43% YoY to margin contraction/expansion Kelvin Lau CNY11.5bn in 2015, driven by robust depending on the extent of (852) 2848 4467 sales volume growth of 45% YoY for competition in the SUV segment. [email protected] SUVs (though its sedan sales are forecast to fall by 25% YoY). From Brian Lam this higher base, we expect GWM’s (852) 2532 4341 net earnings growth to slow to 21% [email protected] YoY for 2016 and 17% YoY for 2017. Share price performance

(HKD) (%) 60 175 ■ Catalysts ■ Investment case 51 154 We believe that strong SUV sales in We believe that Great Wall Motor 43 133 China, especially of GWM’s models (GWM) is well placed to benefit 34 111 such as the new H8, would be a 25 90 from the strong demand for SUVs in Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 China, which we forecast to rise by positive share-price catalyst. 25-40% pa over 2015-17. However, Planned launches of the H6 and H7 Great Wall (LHS) Relative to HSI (RHS) with more automakers entering this Coupe, which will allow GWM to segment and GWM’s R&D spending better address the CNY150-200k 12-month range 28.45-59.75 SUV segment, should likewise boost Market cap (USDbn) 14.91 increasing, we think the company is 3m avg daily turnover (USDm) 64.11 set to face margin pressure over our investors’ sentiment. Conversely, the potential decline in GWM’s gross Shares outstanding (m) 3,042 forecast horizon (we forecast its net Major shareholder Baoding Great Wall Asset (56.0%) margin to narrow from 13.3% in margin in 1H15 would likely weigh on sentiment toward the shares. 2015 to 12.3% in 2017). Financial summary (CNY) Year to 31 Dec 15E 16E 17E ■ Valuation On a long-term view, we are positive Revenue (m) 86,280 108,490 131,753 We initiate coverage of GWM with a Operating profit (m) 13,640 16,503 19,251 on the company’s move to beef up its Net profit (m) 11,472 13,907 16,263 R&D, which we think should Hold (3) rating and 12-month target price of HKD39.9, based on a PER of Core EPS (fully-diluted) 3.771 4.571 5.345 accelerate its move toward EPS change (%) 42.7 21.2 16.9 technology independence and help it 7.7x applied on the average of our Daiwa vs Cons. EPS (%) (0.8) (1.5) 0.9 2015-16E EPS forecasts, a 10% PER (x) 8.1 6.7 5.7 to develop a hybrid SUV that Dividend yield (%) 3.7 4.5 5.3 complies with new fuel consumption discount to the stock’s past-3-year average. We view the stock as fairly DPS 1.141 1.384 1.618 standards due to be implemented in PBR (x) 2.2 1.7 1.4 priced on its prevailing 2015E and China in 2020. EV/EBITDA (x) 5.7 4.6 3.9 2016E PERs of 8.1x and 6.7x, ROE (%) 30.2 29.2 27.6 respectively. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 102 Consumer Discretionary / China 2333 HK 18 June 2015

1 Buy How do we justify our view? 2 Outperform

3 Hold (initiation)  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  GWM: net profit growth (2010-17E) Following on from its flattish net profit growth in (CNYm) 2014, we forecast GWM to record net profit growth of 18,000 70% 43% YoY to CNY11.5bn in 2015, driven by robust sales 16,000 60% 14,000 50% of SUVs, volumes of which we expect to expand by 12,000 40% 45% YoY. 10,000 30% 8,000 20% From this higher base, we project growth in GWM’s 6,000 net earnings for 2016-17 to slow to 21% YoY and 17% 4,000 10% YoY, respectively. 2,000 0% 0 (10%) 2010 2011 2012 2013 2014 2015E 2016E FY17E Net Profit (LHS) Growth (YoY, RHS) Source: Bloomberg, Daiwa forecasts

 Valuation  GWM: 12-month forward PER (2012 – 2015) We find GWM is trading currently at a PER of 6.7x for (PER) 2016E. Our 12-month target price of HKD39.9 is 16 based on a 7.7x PER applied to the average of our 14 2015-16E EPS forecasts, a 10% discount to the stock’s 12 past-3-year-average multiple to factor in more 10 intense competition. 8 6 We like GWM’s increasing exposure to the SUV 4 segment at a time when volume growth in the overall 2 passenger car market is decelerating. However, with Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Nov-12 Nov-13 Nov-14 Sep-12 Sep-13 Sep-14 May-12 May-13 May-14 more players launching new SUV models and May-15 production capacity expanding, we think margins in Trading PER Average + 1SD -1 SD the segment will come under increasing pressure. Source: Bloomberg, Daiwa forecasts

 Earnings revisions  GWM: consensus 2015 – 2016E EPS revisions Our earnings forecasts are largely in line with those of (CNY) the Bloomberg consensus, as is our bullish view of 5.5 China’s SUV markets in the face of slowing overall 5.0 passenger car demand growth. However, we are 4.5 mindful of the risks associated with GWM’s heavy 4.0 exposure to the SUV segment and note that any delay in the launch of new energy vehicles (NEVs) could 3.5 have negative implications for the timing of launches 3.0 of its other new SUV models. 2.5 Jul-14 Apr-15 Apr-14 Oct-14 Jun-15 Jun-14 Jan-15 Jan-14 Feb-15 Mar-15 Feb-14 Mar-14 Aug-14 Sep-14 Nov-14 Dec-14 May-15 May-14 2015E 2016E Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales volume (unit) 363,482 462,679 621,438 770,619 732,989 928,323 1,083,497 1,219,378 Sales volume growth (%) 73.2 27.3 34.3 24.0 (4.9) 26.6 16.7 12.5 SUV (unit) 136,982 147,341 279,956 420,302 523,208 758,652 925,555 1,064,388 Sedan (unit) 122,843 187,504 199,256 205,451 87,479 65,609 59,048 56,096 Pick up truck (unit) 98,643 121,673 136,694 136,132 121,602 103,362 98,194 98,194 Others (unit) 5,014 6,161 5,532 8,734 700 700 700 700

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Revenue - New car sales 21,725 28,178 40,728 53,796 59,346 85,683 108,006 131,275 Revenue - After-sales 761 1,212 1,974 2,674 3,034 3,640 4,368 5,242 Other Revenue (311) (353) (1,137) (1,743) (2,062) (3,044) (3,884) (4,764) Total Revenue 22,175 29,037 41,565 54,727 60,317 86,280 108,490 131,753 Other income 35 47 74 233 352 503 632 768 COGS (17,298) (22,594) (31,562) (40,538) (45,252) (65,016) (82,183) (100,333) SG&A (1,944) (2,477) (3,400) (4,643) (5,907) (8,127) (10,436) (12,937) Other op.expenses 0 0 0 00000 Operating profit 2,967 4,014 6,678 9,779 9,510 13,640 16,503 19,251 Net-interest inc./(exp.) 22 48 106 87 76 36 93 169 Assoc/forex/extraord./others5268575354767676 Pre-tax profit 3,041 4,131 6,841 9,920 9,640 13,752 16,672 19,496 Tax (214) (620) (1,119) (1,688) (1,599) (2,281) (2,765) (3,234) Min. int./pref. div./others (126) (84) (30) (8) 0 0 1 1 Net profit (reported) 2,701 3,426 5,692 8,224 8,042 11,472 13,907 16,263 Net profit (adjusted) 2,701 3,426 5,692 8,224 8,042 11,472 13,907 16,263 EPS (reported)(CNY) 0.986 1.217 1.871 2.703 2.643 3.771 4.571 5.345 EPS (adjusted)(CNY) 0.986 1.217 1.871 2.703 2.643 3.771 4.571 5.345 EPS (adjusted fully-diluted)(CNY) 0.986 1.217 1.871 2.703 2.643 3.771 4.571 5.345 DPS (CNY) 0.500 0.300 0.570 0.820 0.800 1.141 1.384 1.618 EBIT 2,967 4,014 6,678 9,779 9,510 13,640 16,503 19,251 EBITDA 3,516 4,713 7,622 10,935 11,183 15,704 19,020 22,263

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 3,041 4,131 6,841 9,920 9,640 13,752 16,672 19,496 Depreciation and amortisation 549 700 944 1,155 1,672 2,065 2,517 3,013 Tax paid (917) (1,473) (2,602) (4,352) (4,999) (2,281) (2,765) (3,234) Change in working capital (147) 303 (2,278) (288) (3,569) (3,153) (3,625) (5,025) Other operational CF items (105) (94) 1,100 877 1,901 (20) (20) (20) Cash flow from operations 2,421 3,567 4,005 7,313 4,644 10,363 12,778 14,230 Capex (2,602) (3,343) (4,370) (6,204) (6,636) (7,136) (7,806) (8,543) Net (acquisitions)/disposals (262) (1,535) (177) (575) (632) 0 0 0 Other investing CF items 974 459 1,029 1,591 1,701 647 453 317 Cash flow from investing (1,890) (4,418) (3,518) (5,188) (5,567) (6,489) (7,353) (8,226) Change in debt 0 5 1 182 (14) 0 0 0 Net share issues/(repurchases) 0 0 0 00000 Dividends paid (274) (552) (917) (1,729) (2,506) (2,434) (3,472) (4,209) Other financing CF items (764) 4,217 264 (95) 299 0 0 0 Cash flow from financing (1,038) 3,670 (652) (1,641) (2,220) (2,434) (3,472) (4,209) Forex effect/others 00000000 Change in cash (506) 2,819 (166) 484 (3,143) 1,440 1,953 1,795 Free cash flow (181) 225 (365) 1,109 (1,992) 3,227 4,972 5,687 Source: FactSet, Daiwa forecasts

- 75 - Consumer Discretionary / China 2333 HK 18 June 2015

Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 962 3,775 3,602 4,074 926 2,366 4,318 6,113 Inventory 2,104 2,777 2,695 2,764 3,470 4,644 5,870 7,167 Accounts receivable 9,255 10,033 16,337 20,764 26,979 37,100 46,651 59,289 Other current assets 2,504 3,789 3,214 3,424 3,938 3,603 3,416 3,378 Total current assets 14,825 20,374 25,848 31,026 35,314 47,713 60,256 75,947 Fixed assets 7,313 10,443 14,009 18,646 22,548 27,259 32,199 37,389 Goodwill & intangibles 1,113 1,871 2,216 2,445 2,815 3,174 3,524 3,864 Other non-current assets 448 447 497 487 669 689 709 729 Total assets 23,698 33,135 42,569 52,605 61,345 78,836 96,688 117,930 Short-term debt 0 0 0 1820000 Accounts payable 8,279 10,011 13,039 15,252 18,231 23,406 27,942 34,113 Other current liabilities 3,608 4,702 6,280 7,406 7,913 11,192 14,073 17,091 Total current liabilities 11,887 14,714 19,319 22,839 26,145 34,598 42,015 51,204 Long-term debt 0 0 0 00000 Other non-current liabilities 1,410 1,400 1,607 1,757 1,682 1,682 1,682 1,682 Total liabilities 13,298 16,113 20,926 24,597 27,827 36,280 43,698 52,886 Share capital 1,095 3,042 3,042 3,042 3,042 3,042 3,042 3,042 Reserves/R.E./others 8,920 13,695 18,472 24,953 30,409 39,447 49,883 61,936 Shareholders' equity 10,015 16,737 21,514 27,996 33,452 42,490 52,925 64,979 Minority interests 385 284 129 12 67 66 66 65 Total equity & liabilities 23,698 33,135 42,569 52,605 61,345 78,836 96,688 117,930 EV 91,885 89,047 89,094 88,682 91,683 90,223 88,249 86,434 Net debt/(cash) (962) (3,775) (3,602) (3,892) (926) (2,366) (4,318) (6,113) BVPS (CNY) 9.144 5.501 7.071 9.202 10.995 13.966 17.396 21.358

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. 30.9 43.1 31.7 10.2 43.0 25.7 21.4 EBITDA (YoY) n.a. 34.0 61.7 43.5 2.3 40.4 21.1 17.1 Operating profit (YoY) n.a. 35.3 66.4 46.5 (2.8) 43.4 21.0 16.6 Net profit (YoY) n.a. 26.9 66.1 44.5 (2.2) 42.7 21.2 16.9 Core EPS (fully-diluted) (YoY) n.a. 23.4 53.7 44.5 (2.2) 42.7 21.2 16.9 Gross-profit margin 22.0 22.2 24.1 25.9 25.0 24.6 24.2 23.8 EBITDA margin 15.9 16.2 18.3 20.0 18.5 18.2 17.5 16.9 Operating-profit margin 13.4 13.8 16.1 17.9 15.8 15.8 15.2 14.6 Net profit margin 12.2 11.8 13.7 15.0 13.3 13.3 12.8 12.3 ROAE 53.9 25.6 29.8 33.2 26.2 30.2 29.2 27.6 ROAA 22.8 12.1 15.0 17.3 14.1 16.4 15.8 15.2 ROCE 57.1 29.3 34.5 39.2 30.8 35.9 34.5 32.6 ROIC 58.5 30.1 35.7 38.5 28.0 31.3 31.0 29.8 Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cash Effective tax rate 7.0 15.0 16.4 17.0 16.6 16.6 16.6 16.6 Accounts receivable (days) 76.2 121.2 115.8 123.7 144.5 135.5 140.9 146.7 Current ratio (x) 1.2 1.4 1.3 1.4 1.4 1.4 1.4 1.5 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 50.7 24.6 30.5 30.3 30.3 30.3 30.3 30.3 Free cash flow yield n.a. 0.2 n.a. 1.2 n.a. 3.5 5.4 6.1 Source: FactSet, Daiwa forecasts

 Company profile Great Wall Motor is the largest manufacturer of SUVs and pickups in China. In 2014, the company sold 733,000 vehicles (71% SUVs, 17% pickups, and 12% sedans), derived 95% of its revenue from new car sales and 5% from after sales, and generated 5% of its revenue and 7% of its sales volume from export sales.

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 China: car sales volume by tier of city 100%

80% 38% 42% 46% 47% 50-60% Strong SUV market, 60% 40% 62% 58% 54% 53% but competition is 20% 40-50% mounting 0% 2007 2009 2009 2010 2015E We believe GWM is well placed to benefit Tier 1 - 2 cities Tier 3 - 4 cities Source: PWC, companies from strong demand for SUVs in China. However, its margins are likely to come SUV demand likely to remain strong under pressure from intensifying In recent years, replacement demand and even new buyers in China have been focusing on SUVs, likely competition in the SUV segment. because their cabins are more comfortable than those of small sedans while they are lower priced than luxury China’s SUV market likely to sedans. As at end-2014, the SUV/MPV segment in China accounted for 30% of new-car sales, and we remain strong expect the proportion to rise to 40% in the long term, mirroring the trend in the US. Lower-tier cities seen fuelling demand We believe that demand growth in China’s lower-tier We expect sales in the SUV and MPV segment to cities will likely remain strong over 2015-16E, backed continue to outperform the broader market in 2015-17, by rapid growth in disposable income levels and the with volume growth of 25-40% YoY for the segments as lack of licence restrictions in such cities. We believe the a whole. Apart from SUVs’ advantages in comfort and local brands, including GWM, are the best placed to tap price, demand has also been driven by increased self- this demand growth because residents of lower-tier drive travel. For example, the number of self-drive cities are relatively price sensitive and hence higher- travellers in China increased by 27% YoY in 2013 to end international JV brands may struggle to penetrate 1.73bn persons-times, and we expect this growth trend such markets. to continue over the next 5 years as disposable income levels increase and more people take to the roads. Alongside our expectation of strong growth in the demand for local brands, we expect customers to focus In addition, we think SUVs’ high ground clearance on size upgrades (ie, replacing their small sedans with makes them well suited to the rough roads typical of SUVs), which should play to the strengths of GWM’s lower-tier cities. SUV line-up.  China: sales volume growth of different types of vehicle (2010 - 2014)  China: disposable income growth in tier-1 and other cities 200% (CNY) 40,000 150% 35,000 30,000 100% 25,000 20,000 50% 15,000 10,000 0% 5,000 0 -50% 2010 2011 2012 2013 2014

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sedan MPV SUV Cross Tier 1 Other tiers Source: CAIN Source: CEIC, Daiwa compiled

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 US: SUV to PV sales ratio  Major OEMs: new SUV products (2015-16E) 45% OEMs New SUV pipeline 40% GWM H7 Geely Compact SUVs 35% GAC Motor New Class-A SUV GS4 30% GAC Fiat-Chrysler Class D SUV Cherokee 25% GAC Toyota Highlander (replacement model) 20% DFM Honda XRV CRV 15% DF Nissan QashQai 10% Venucia T70 5% Beijing Hyundai 1 new SUV Beijing Benz GLA 0% New GLK

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Beijing Motor 2 unknown SUV Changan Auto CS35 Source: Wards CS75 CS95  China: Market share in auto market by car type Changan Ford Kuga 100% 9% 7% Edge 19% 18% 16% 15% 7% 10% Brilliance Zhoungghua V3 3% 80% 2% 3% 3% Brilliance BMW X1 (replacement model) 6% 10% 11% 13% 17% 21% X3 (replacement model) BYD Song 60% Yuan Chery Tiggo 5 (replacement model) 40% Source: Companies, news reports 72% 69% 70% 69% 67% 63% 20% New capacity to add more pressure

0% Apart from the threat of margin pressure arising from 2009 2010 2011 2012 2013 2014 mounting competition in the SUV segment, we think Sedan SUV MPV Cross GWM’s plan to bring on line more capacity in Xushui Source: CAIN by July 2015, which will boost its annual capacity by 250,000 units (mainly for the H7 model), should also weigh on the company’s margins this year. Longer Competition likely to weigh on term, we are positive on the capacity increase. margins  GWM: gross and net margin trend (2010-17E) 28% Every OEM is entering the SUV segment 26% Demand for sedans in China (in absolute terms) has 24% slowed significantly over the past 5 years, particularly for A/A-0 class small sedans. As a result, all OEMs, 22% including Geely, BAIC and GAC, have turned their 20% attention to the SUV segment and plan to launch more 18% such products in 2015-16. 16% 14% Therefore, even though we expect growth in demand 12% for SUVs (as well as MPVs) to exceed that for other 2010 2011 2012 2013 2014 2015 2016 2017 vehicle types over our forecast horizon, competition GPM NPM will likewise intensify, which suggests to us that Source: Company, Daiwa forecasts margins will come under pressure. Given its exposure  GWM: 3 major production bases to the SUV segment, we think GWM would be most Baoding Plant affected by such margin pressure. Design capacity (units) 400,000 Car model under planning Wingle, H1, H5, M4, C30 Tianjin Plant Phase 1 Phase 2 Design capacity (units) 250,000 250,000 Car model under planning H6 C50, H2, H6 Xushui Plant Phase 1 Phase 2 Completion time 2013.11 2015.7 Design capacity (units) 250,000 250,000 Car model under planning H8, H9, Coupe C H7 Source: Company - 78 - Consumer Discretionary / China 2333 HK 18 June 2015

the US and Europe, China automakers will have to R&D investment should continue balance their model portfolios if they are to meet the average fuel efficiency requirements by 2020. Already invested more in R&D GWM has been allocating an increasing proportion of Although currently there are no financial penalties its investment to R&D over the past 5 years. For 2014, imposed on automakers that fail to meet China’s fuel its R&D investment increased by 48% YoY to consumption requirements, any delay in the launch of CNY2.5bn, which is equivalent to 4.2% of its total the hybrid H7 (scheduled for end-2016/early 2017), a revenue. After setting up 1 R&D centre in 2010, GWM model that should boost the overall fuel efficiency of plans to open another R&D centre in 2015 to beef up its GWM’s model range, could lead to delays in other R&D capabilities, particularly for NEVs. product launches further down the line.

Currently, GWM has the ability to produce its own Hence, we see a clear need for GWM to improve its engines but is still reliant on imports for transmission technology in the coming years so that its new SUV systems. We like the company’s move to strengthen its models meet the emission requirements due to take R&D capabilities, as we think it will accelerate its move effect in 2020. towards technology independence, though we think Geely is a step ahead of GWM on this front.  Summary of fuel-efficiency targets for major markets km/l (mpg) US EU Japan China S. Korea 2005 12.4 (29.0) 15.8 (37.2) 16.7 (39.3) 11.0 (25.9) 12.3 (28.9)  GWM: R&D investment and R&D to sales ratio (2010 - 2014) 2010 13.9 (33.0) 18.0 (42.3) 19.6 (46.1) 14.4 (33.9) 14.8 (34.8) (CNY m) (YOY %) 2015 15.4 (36.0) 19.7 (46.3) 21.0 (49.4) 15.7 (36.9) 16.7 (39.3) 3,000 5% 2020 19.9 (47.0) 25.8 (60.7) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) 2025 23.9 (56.0) 30.8 (72.4) ~ 35.0 (82.3) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) 2,500 4% 5-YOY (%) US EU Japan China S. Korea 2,000 2010 12.1% 13.9% 17.4% 30.9% 20.3% 3% 2015 10.8% 9.4% 7.1% 9.0% 12.8% 1,500 2020 29.2% 31.0% 11.4% 35.7% 0.0% 2% 2025 20.1% 19.4%~35.7% 0.0% 0.0% 0.0% 1,000 Improvement (%) US EU Japan China S. Korea 2010-25 71.9% 71.1%~94.4% 19.4% 47.9% 12.8% 500 1% 2015-25 55.2% 56.3%~77.7% 11.4% 35.7% 0.0% 0 0% Source: ICCT 2010 2011 2012 2013 2014 Note: No official fuel efficiency guidance has been provided for Korea (from 2015), Japan R&D expense (LHS) R&D to Sales (RHS) (from 2020), or China (from 2020) Source: Company

Focusing on SUVs to penetrate overseas Financial forecasts markets In terms of its expansion in international markets, Rich new model pipeline to drive earnings GWM has a 3-tier strategy, where it focuses on growth amid solid SUV demand emerging markets, such as Russia, by building GWM launched the long-awaited Haval H8 SUV in April production facilities there and keeping down logistics 2015 and H6 Coupe C SUV in 2Q15, and the H7 SUV is costs by taking advantage of high levels of localisation. scheduled for end-2015. Higher engine displacement In some markets, such as Iran and Indonesia, local versions of the H8 and H9 are also slated for 2H15. For OEMs assemble GWM models using knock-down kits. the H8, which we view as a major earnings driver, the And in other key markets, such as Australia, GWM is company is targeting monthly sales of 4,000 units or keen to set up its own sales network. more. Further out, GWM intends to introduce a new- generation H6 in 2016 and Hybrid H7 in 2017. Currently, GWM’s efforts to penetrate overseas markets revolve around its SUV product line, which we On the back of its new model pipeline and China’s see as a sound approach to build up brand recognition robust demand for SUVs, we forecast GWM total before expanding more aggressively. revenue to rise by 43% YoY for 2015, 26% YoY for 2016, and 21% YoY for 2017. Our forecasts call for YoY Long-term emission targets are a concern sales volume growth for the same years of 27%, 17%, In China, emissions standards call for a fuel and 13%, respectively. Within our 2015-17E volume consumption target for PVs of 6.9 litre/km (or 15.7 forecasts, we look for 45%, 22%, and 15% growth in km/litre) in 2015, falling to 5.0 litre/km (or 21.3 SUV volumes YoY, set against declines of 25%, 10% and km/litre) by 2020. Just as with the manufacturers in 5% in sedan sales for the same period.

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Forecasting strong earnings growth  GWM: SUV sales volume and growth (2013-17E) despite margin declines due to competition ('000 units) (YoY %) 1,200 60% We believe that GWM’s gross margins will likely come under pressure over our forecast horizon, given 1,000 50% margins are typically low during the ramp-up period 800 40% for new models and as other OEMs enter the SUV 600 30% segment with a full range of models. Hence, we forecast GWM’s gross margin on new car sales to decline from 400 20% 27.9% in 2014 to 26.7% in 2017E, though we think the 200 10% likely increase in SUVs as a portion of total volumes 0 0% should mitigate the contraction. 2013 2014 2015E 2016E 2017E Sales volume (LHS) Growth (RHS) In sum, we forecast GWM to record net earnings Source: Company, Daiwa forecasts growth of 43% YoY to CNY11.5bn in 2015, 21% YoY to CNY13.9bn, and 17% YoY to CNY16.3bn in 2017.  GWM: overall blended and new car sales gross margin (2013-17E)

 GWM: sales volume by vehicle type (2013-17E) 29% 100% 1% 11% 9% 8% 18% 17% 5% 27% 7% 5% 80% 12% 27% 25% 60% 23% 87% 40% 82% 85% 71% 55% 21% 20% 2013 2014 2015E 2016E 2017E Blended New car sales 0% Source: Company, Daiwa forecasts 2013 2014 2015E 2016E 2017E SUV Sedan Pick up truck Others Source: Company, Daiwa forecasts Valuation and recommendation

 GWM: sales volume and growth (2013-17E) We initiate coverage of GWM with a Hold (3) rating ('000 units) (YoY %) and a 12-month target price of HKD39.9, based on a 1,400 30% 7.7x PER applied to the average of our 2015-16E EPS 25% 1,200 forecasts. Our target multiple is at a 10% discount to 20% 1,000 the stock’s past-3-year-average multiple of 8.5x to 15% 800 factor in more intense competition. 10% 600 5% We highlight the following positives at GWM: 1) the 400 0% company’s large but increasing exposure to the SUV 200 (5%) segment at a time when growth in the overall passenger 0 (10%) car market is slowing, and 2) its exposure to lower-tier 2013 2014 2015E 2016E 2017E Sales volume (LHS) Growth (RHS) cities, where disposable incomes are increasing and Source: Company, Daiwa forecasts there are fewer licence restrictions capping demand.

However, we also have some concerns about GWM. With more companies now launching SUVs and production capacity increasing, margins within the segment could come under pressure.

We find the stock is trading currently at a PER of 6.7x for 2016E and offers a 4-5% dividend yield for 16-17E, which we view as attractive.

- 80 - Consumer Discretionary / China 2333 HK 18 June 2015

 GWM: 12-mth forward PER (2012 – 2015)  GWM: sales volume by vehicle type (2014) (PER) Others 16 Pick up truck 0.1% 16.6% 14 12 10 Sedan 8 11.9% 6 4 2 SUV 71.4% Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 May-12 May-13 May-14 May-15 Trading PER Average + 1SD -1 SD Source: Bloomberg, Daiwa forecasts Source: Company

 GWM: valuation Key car models and new models 2015-16 EPS average(CNY) 4.17  GWM: Haval H2 SUV PER (x) 7.7x Exchange rate, 1HKD = x CNY 0.80 Equity value/share (HKD/share) 39.90 Current price (HKD) 38.00 Potential share price upside/downside (%) 5.0% Implied target 16E PER (x) 7.0 Source: Daiwa forecasts

Risks

Major risks that could prevent GWM shares from reaching our 12-month target price include: 1) worse- than-expected margin contraction amid fierce competition in the SUV segment and lower-than- Source: Company expected margins on new products (ie, those in the ramp-up stage), and 2) delays in the launch of NEVs,  GWM: Haval H6 SUV which could result in a failure to comply with fuel efficiency standards.

Upside risks to our call include: 1) stronger-than- expected sales of its SUV models and industry SUV segment in China, 2) regulatory policies loosening in lower tier cities.

Background information

Listed on the Hong Kong Stock Exchange in 2003 and Source: Company Shanghai Stock Exchange in 2011, Great Wall Motor is the largest manufacturer of SUVs and pickups in China. In 2014, it sold 733,000 vehicles, of which 71% were SUVs, 17% pickups, and 12% sedans. The company also sells auto parts and components.

In 2014, GWM derived some 5% of its total revenue from after sales and 95% from new car sales. The company sell its products both domestically and internationally, with exports accounting for 5% of its revenue and 7% of sales volume in 2014.

- 81 - Consumer Discretionary / China 2333 HK 18 June 2015

 GWM: Haval H6 Coupe SUV  GWM: Haval H9 SUV

Source: Company Source: Company

 GWM: Haval H8 SUV

Source: Company

 GWM: management profile Mr. Wei Jian Jun Mr. Wei, aged 51, is the chairman and executive director of the company. Mr. Wei joined Baoding Great Wall Motor Industry Company (the predecessor of the company) as the general manager in 1990. He has been the chairman of the company since June 2001. He is responsible for the overall strategic planning and business development of the group, and is a director of the company’s substantial shareholder, Baoding Innovation Great Wall Asset Management Company Limited. Mr. Liu Ping Fu Mr. Liu, aged 65, is an assistant political work professional, and vice chairman and executive director of the company. He has been the general manager of the Management Centre of Collective Assets of Nandayuan Town, Nanshi District, Baoding since 2001, and the vice chairman of the company since June 2001. Ms. Wang Feng Ms. Wang, aged 44, is an executive director and general manager of the company. Ms. Wang joined the company in 1991 and is responsible for sales and marketing management. Ying Ms. Wang has been acting as the general manager of the company since November 2002. She is concurrently the general manager of Baoding Great Wall Automobile Sales Company Limited. She has been acting as an executive director of the company since June 2001. Mr. Hu Ke Gang Mr. Hu, aged 69, is a senior economist, and an executive director and deputy general manager of the company. Mr. Hu joined the company in 1995. He is currently responsible for the research and development as well as production of the group’s engines. Moreover, he has been acting as a deputy general manager of the company since May 2005 and executive director of the company since June 2007. Ms. Yang Zhi Juan Ms. Yang, aged 48, is an executive director of the company. Ms. Yang is currently an assistant to the deputy general manager of the company and is responsible for the management of foreign investment and construction. She has been an executive director of the company since August 2001. Source: Company

- 82 - Consumer Discretionary / China 2333 HK 18 June 2015

 GWM: timeline of development Year Event 1987 Great Wall Motor manufacturing plant was founded 1990 Wei Jianjun took up the post of general manager of Great Wall Motor Industry Company 1991 - 1994 GWM began to manufacture Great Wall light-duty passenger and cargo vehicles 1995 - 1996 The 1st Great Wall Deer pickup rolled off the production line 1997 Great Wall Deer ranked top in sales in the China pickup market 1997 GWM established a marketing service network of 200 service outlets 1997 The first batch of Great Wall pickups was exported to the Middle East, signalling the globalisation of Chinese autos 1998 GWM’s pickup ranked 1st in sales in the domestic pickup market for the first time 2000 Great Wall Motor Company Limited was established through restructuring. The sailor pickup entered production 2002 Great Wall Motor Technology Research Institute was established 2002 The Safe SUV ranked among the top 3 in the China SUV market 2003 GWM became the first domestic private automaker listed on the Hong Kong Stock Exchange 2004 GWM was listed among “China's Top 500 Enterprises” for the first time 2004 GWM’s pickup ranked first in sales in the China pickup market for a seventh consecutive year. It SUVs ranked first in sales in the China SUV market for a second consecutive year 2005 GWM’s production base with an annual capacity of 100,000 units was finished and the Hover CUV entered production 2006 The Haval was exported to Italy 2007 200,000-units pa manufacturing base was completed; GWPeri and Cowry rolled off the production line 2008 New Haval powered by 2.5TCI diesel engine jointly developed by GWM and Bosch was launched 2009 GWM’s Haval SUV manufactured at GWM's assembly plant in Vietnam was launched in Vietnam 2010 The launch ceremony for the independent-branded high-end SUV-Haval H5-T held in Beijing 2011 Sales of the Haval SUV topped 600,000 units 2012 At China's auto industry conference, GWM was the only independent automaker included in the "Top 10 Most Satisfactory Auto Brands for Distributors" 2013 The Haval brand became independent officially, giving GWM 2 distinct brands 2014 GWM is the only automaker listed among the top ten Chinese brands most familiar to overseas consumers Source: Company

 GWM: organisation chart

Source: Company

- 83 - Consumer Discretionary / China 2333 HK 18 June 2015

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Consumer Discretionary / China 2238 HK Consumer Discretionary / China 18 June 2015

Guangzhou Automobile Group

Guangzhou Automobile Group Target (HKD): 6.20 Downside: 15.9% 2238 HK 18 Jun price (HKD): 7.37

Initiation: facing speed bumps 1 Buy • Impacted by licence restrictions as buyers shift to premium cars, 2 Outperform as well as the popularity of entry-level cars in lower-tier cities 3 Hold • GAC’s sales volume likely to be sluggish, with China PV sales 4 Underperform forecast to slow YoY for 2015E 5 Sell (initiation) • Initiating with a Sell (5) rating and 12-month TP of HKD6.2 based on an 8.5x PER, at the low end of the range for peers

How do we justify our view?

would further dampen the growth ■ Risks potential of Japanese JV brands. In The key upside risks to our call are: our view, SUVs are eating into the 1) potential further depreciation of market share for sedans in China’s the Yen, which could lower the PV market, yet GAC only has a import price of auto components for Kelvin Lau limited range of SUVs, and as such, GAC’s Japanese JVs, and 2) better- (852) 2848 4467 limited revenue potential from these than-expected sales volume for [email protected] products. While we are positive on newly launched SUV models. GAC’s plan to launch its self-owned Brian Lam GS4, Fiat Cherokee and new (852) 2532 4341 Highlander in 2015-16, we do not [email protected] think these new products would Share price performance

offset the losses in the sedan (HKD) (%) 10.0 115 business in the short term. ■ Investment case 9.1 104

We initiate coverage of auto maker 8.3 93 ■ Catalysts GAC with a Sell (5) rating. Among 7.4 81 We see a lack of share-price catalysts 6.5 70 the foreign JV OEMs, we think Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Japanese brands, which focus on for GAC in the near term. Potentially mid-range sedans and to which GAC worse-than-expected 1H15 earnings, Gzhou Auto (LHS) Relative to HSI (RHS) has large exposure through its JVs due to market-share erosion and with Toyota and Honda, could be aggressive price discounts amid stiff 12-month range 6.71-9.78 domestic competition could drive Market cap (USDbn) 6.12 materially impacted by the 3m avg daily turnover (USDm) 13.03 strengthening of licence restrictions. down GAC’s share price in 2H15. Shares outstanding (m) 6,435 This is premised on our view that Major shareholder GZ Auto Industry Grp (57.6%) ■ Valuation first-time buyers, as well as We have a Sell (5) rating on GAC replacement buyers, in higher-tier Financial summary (CNY) cities where the restrictions are now with a 12-month TP of HKD6.2, Year to 31 Dec 15E 16E 17E in place, are now more likely to based on a PER of 8.5x applied to Revenue (m) 26,334 29,928 32,464 the average of our 2015-16E EPS, at Operating profit (m) (983) (980) (840) purchase/upgrade to a luxury car Net profit (m) 3,511 3,932 4,344 than a mid-range sedan, not only the low end of the target PER range (8.5-12.0x) we apply to the auto Core EPS (fully-diluted) 0.546 0.611 0.675 because they can afford it but as the EPS change (%) 10.3 12.0 10.5 opportunity to own a luxury car may OEMs. We see a risk of GAC being Daiwa vs Cons. EPS (%) (10.6) (17.9) (24.9) derated further over concerns about PER (x) 10.8 9.7 8.7 not arise again amid the restrictive Dividend yield (%) 3.0 3.3 3.7 environment. Japanese cars losing market share to premium European brands under DPS 0.176 0.198 0.218 PBR (x) 1.0 0.9 0.9 the licence-plate restrictions, as well The restrictions being rolled out in EV/EBITDA (x) 51.9 31.3 18.7 more cities over the next few years as the popularity of cheaper local ROE (%) 9.6 10.0 10.3 brands in lower-tier cities. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 102 Consumer Discretionary / China 2238 HK 18 June 2015

1 Buy How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell (initiation)  Earnings revisions

 Growth outlook  GAC: net profit and growth (2010-17E) We look for GAC’s net profit to rise by just 10% YoY to (CNYm) CNY3.5bn for 2015, slowing from 20% YoY growth for 5,000 150% 2014, due to a potential decline in its margins, caused 4,000 100% by aggressive price cuts and slowing sales volume. Japanese JV brands have been cutting prices over the 3,000 50% past few months, and we expect pricing pressure on mid-range JV brands, such as those that GAC makes, to 2,000 0% continue. 1,000 (50%)

For 2016-17, we forecast net-profit growth of 12% YoY 0 (100%) and 10% YoY, respectively, partly helped by the 2010 2011 2012 2013 2014 2015E 2016E 2017E company’s launch of some new SUV models. Net Profit (LHS) Growth YoY (RHS) Source: Company, Daiwa forecasts

 Valuation  GAC: forward 12-month PER (2012-15) Our 12-month target price of HKD6.2 is based on an (PER) 8.5x PER applied to the average of our 2015-16E EPS, 40 which is at the low end of the target PER range of 8.5- 35 30 12.0x we apply to the auto OEMs under our universe. 25 20 We see potential for a further derating of GAC on 15 concerns over Japanese cars losing market share to 10 premium European brands under stronger licensing 5 restrictions, the popularity of cheaper local brands in 0 lower-tier cities, and intensifying competition in the Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 sedan market. May-12 May-13 May-14 May-15 Trading PER Average + 1SD -1 SD Source: Bloomberg, Daiwa forecasts

 Earnings revisions  GAC: consensus EPS revisions (2014-15E) We have seen continuous downward earnings revisions (CNY) from the street since June 2014, and see further 1.20 downside risk to the market’s forecasts. Our EPS 1.00 forecasts for 2015-17E are 11-25% below the consensus, 0.80 as we assume slower passenger vehicle (PV) sales- volume growth in China and expect Japanese JV 0.60 brands, the core profit contributors for GAC, to lose 0.40 market share to rivals. 0.20 0.00 Jul-14 Apr-14 Apr-15 Oct-14 Jan-14 Jun-14 Jan-15 Feb-14 Mar-14 Feb-15 Mar-15 Aug-14 Sep-14 Nov-14 Dec-14 May-14 May-15 2015E 2016E Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Volume - PV (unit) 719,518 721,095 680,017 970,781 1,157,376 1,293,295 1,439,562 1,558,942 Volume - CV (unit) 4,704 19,299 32,137 23,440 14,934 14,187 13,478 13,478 Volume - Motorcycle (unit) 810,389 900,099 950,999 1,000,099 1,062,288 1,115,402 1,171,173 1,229,731 Volume growth - PV (%) n.a. 0.2 (5.7) 42.8 19.2 11.7 11.3 8.3 Volume growth - CV (%) n.a. 310.3 66.5 (27.1) (36.3) (5.0) (5.0) 0.0 Volume growth - Motorcycle (%) n.a. 11.1 5.7 5.2 6.2 5.0 5.0 5.0

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Vehcicle-related operations 7,460 10,719 12,713 18,124 21,553 25,346 28,742 31,042 Other revenue 1,282 266 251 700 823 988 1,185 1,423 Other Revenue 0 0 0 00000 Total Revenue 8,742 10,984 12,964 18,824 22,376 26,334 29,928 32,464 Other income (27) 836 8 117 340 400 455 493 COGS (7,999) (10,560) (12,274) (16,830) (19,829) (23,406) (26,762) (29,131) SG&A (842) (1,806) (2,147) (2,784) (3,715) (4,312) (4,601) (4,666) Other op.expenses 0 0 0 00000 Operating profit (126) (545) (1,449) (672) (827) (983) (980) (840) Net-interest inc./(exp.) (128) (41) (193) (169) (307) (458) (589) (709) Assoc/forex/extraord./others 5,773 4,643 2,641 3,470 4,187 4,821 5,355 5,731 Pre-tax profit 5,520 4,057 1,000 2,629 3,053 3,380 3,786 4,182 Tax (2) 110 65 (101) (126) (140) (156) (173) Min. int./pref. div./others (1,225) 105 69 124 259 270 303 335 Net profit (reported) 4,295 4,272 1,134 2,653 3,185 3,511 3,932 4,344 Net profit (adjusted) 4,294 4,272 1,134 2,653 3,185 3,511 3,932 4,344 EPS (reported)(CNY) 0.919 0.695 0.178 0.412 0.495 0.546 0.611 0.675 EPS (adjusted)(CNY) 0.919 0.695 0.178 0.412 0.495 0.546 0.611 0.675 EPS (adjusted fully-diluted)(CNY) 0.919 0.695 0.178 0.412 0.495 0.546 0.611 0.675 DPS (CNY) 0.263 0.209 0.091 0.160 0.160 0.176 0.198 0.218 EBIT (127) (545) (1,449) (672) (827) (983) (980) (840) EBITDA 72 (55) (781) 279 388 458 724 1,135

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 5,520 4,057 1,000 2,629 3,053 3,380 3,786 4,182 Depreciation and amortisation 199 490 668 951 1,216 1,441 1,704 1,975 Tax paid (42) (81) (117) (172) (83) (140) (156) (173) Change in working capital (825) (422) 1,555 566 612 149 425 300 Other operational CF items (5,859) (4,677) (2,621) (3,426) (4,450) (4,004) (4,368) (4,507) Cash flow from operations (1,008) (633) 485 548 348 827 1,392 1,778 Capex (1,349) (2,244) (2,948) (1,904) (3,511) (3,696) (3,806) (3,922) Net (acquisitions)/disposals (835) (1,079) (1,307) (1,077) (89) 0 0 0 Other investing CF items 4,143 3,056 6,585 3,689 348 3,345 3,857 4,284 Cash flow from investing 1,960 (267) 2,329 708 (3,252) (351) 51 362 Change in debt 461 429 38 4,041 28 2,500 4,000 5,000 Net share issues/(repurchases) 0 0 0 00000 Dividends paid (840) (686) (1,757) (538) (1,172) (1,030) (1,135) (1,271) Other financing CF items (55) 56 (31) 9 235 (817) (988) (1,224) Cash flow from financing (434) (201) (1,749) 3,512 (909) 654 1,878 2,505 Forex effect/others 00000000 Change in cash 518 (1,102) 1,065 4,767 (3,813) 1,129 3,320 4,645 Free cash flow (2,356) (2,877) (2,463) (1,356) (3,163) (2,870) (2,415) (2,144) Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 9,382 8,239 9,316 14,083 10,268 11,397 14,717 19,362 Inventory 1,353 1,537 1,397 2,036 2,661 2,601 2,974 3,237 Accounts receivable 2,845 2,980 3,303 4,725 5,515 6,490 7,376 8,001 Other current assets 6,242 8,903 6,258 5,669 8,434 8,434 8,434 8,434 Total current assets 19,822 21,659 20,274 26,514 26,878 28,923 33,501 39,035 Fixed assets 3,028 4,309 5,927 7,366 8,536 9,916 11,250 12,535 Goodwill & intangibles 2,112 3,257 4,141 4,234 5,499 6,373 7,142 7,804 Other non-current assets 13,558 15,388 19,091 19,729 21,459 22,935 24,433 25,880 Total assets 38,520 44,612 49,434 57,843 62,372 68,148 76,327 85,254 Short-term debt 1,053 2,100 2,515 9,397 9,541 10,041 11,041 12,041 Accounts payable 3,254 4,069 6,376 8,637 10,645 11,703 13,381 14,566 Other current liabilities 33 37 139 25 37 43 49 53 Total current liabilities 4,339 6,206 9,030 18,059 20,222 21,787 24,471 26,659 Long-term debt 7,950 7,737 7,776 4,775 4,769 6,769 9,769 13,769 Other non-current liabilities 386 483 564 893 1,212 1,212 1,212 1,212 Total liabilities 12,676 14,426 17,370 23,727 26,203 29,768 35,452 41,641 Share capital 6,148 6,148 6,435 6,435 6,435 6,435 6,435 6,435 Reserves/R.E./others 19,463 23,062 24,707 26,876 28,938 31,419 34,217 37,290 Shareholders' equity 25,612 29,210 31,142 33,311 35,373 37,854 40,652 43,725 Minority interests 233 976 922 805 796 526 223 (112) Total equity & liabilities 38,520 44,612 49,434 57,843 62,372 68,148 76,327 85,254 EV 24,476 26,182 23,004 20,459 24,134 23,758 22,638 21,211 Net debt/(cash) (379) 1,598 975 89 4,042 5,413 6,093 6,447 BVPS (CNY) 5.481 4.751 4.894 5.177 5.497 5.883 6.317 6.795

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. 25.6 18.0 45.2 18.9 17.7 13.6 8.5 EBITDA (YoY) n.a. n.a. n.a. n.a. 39.2 17.8 58.2 56.9 Operating profit (YoY) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net profit (YoY) n.a. (0.5) (73.5) 133.9 20.1 10.2 12.0 10.5 Core EPS (fully-diluted) (YoY) n.a. (24.4) (74.4) 131.3 20.0 10.3 12.0 10.5 Gross-profit margin 8.5 3.9 5.3 10.6 11.4 11.1 10.6 10.3 EBITDA margin 0.8 n.a. n.a. 1.5 1.7 1.7 2.4 3.5 Operating-profit margin n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net profit margin 49.1 38.9 8.7 14.1 14.2 13.3 13.1 13.4 ROAE 33.5 15.6 3.8 8.2 9.3 9.6 10.0 10.3 ROAA 22.3 10.3 2.4 4.9 5.3 5.4 5.4 5.4 ROCE n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. ROIC (0.5) (1.9) (4.5) (1.9) (2.1) (2.2) (2.1) (1.7) Net debt to equity net cash 5.5 3.1 0.3 11.4 14.3 15.0 14.7 Effective tax rate 0.0 n.a. n.a. 3.8 4.1 4.1 4.1 4.1 Accounts receivable (days) 59.4 96.8 88.4 77.8 83.5 83.2 84.6 86.4 Current ratio (x) 4.6 3.5 2.2 1.5 1.3 1.3 1.4 1.5 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 28.6 30.1 51.1 38.8 32.3 32.3 32.3 32.3 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

 Company profile GAC is engaged in the manufacturing of vehicles and parts, as well as automobile finance and insurance and related services. It sells passenger vehicles under the Trumpchi marque, passenger and commercial vehicles under Gonow, SUVs under Changfeng Motor, and buses under GAC Bus. GAC has also formed JVs with a number of foreign brands, including Honda, Toyota, Mitsubishi and Fiat to sell passenger vehicles. It sells commercial vehicles through its GAC Bus and GAC Hino businesses.

- 88 - Consumer Discretionary / China 2238 HK 18 June 2015

Slowing profit growth on sedan market share erosion As a result of the recent price cutting by Japanese brands and slowing sales volume amid the high operating leverage environment for the auto OEMs, Losing market share to margins for Japanese JVs are likely to come under increasing pressure. As such, we forecast GAC’s net rivals profit to rise by just by 10% YoY to CNY3.5bn for 2015, slowing from 20% YoY growth a year earlier due to the aforementioned potential margin decline. With tougher licence-plate restrictions leading to car buyers shifting to premium For 2016-17, we look for GAC’s net profit to increase by cars, Japanese brands are likely to 12% YoY and 10% YoY, respectively, partly helped by GAC’s pending launch of a number of new SUV models remain under pressure. in 2015-16.

Has failed to fully catch China’s SUV Tough times ahead for Japanese market boom given scarce SUV exposure brands We forecast demand for SUVs in China to rise by a robust 25-40% YoY for 2015-16, possibly eating into Japanese brands losing market share to sedan market share in the overall PV segment. GAC, local and European premium marques however, has a limited range of SUV models, with only A total of 7 cities, including top-tier cities like Beijing, about 23% of its total sales volume for self-owned Shanghai, Guangzhou, Shenzhen and Tianjin, have brands and foreign JVs combined coming from SUVs introduced policies to restrict new car registrations in in 2014. an effort to curb the growth of ownership of private cars in China, and in turn reduce air pollution and While we are positive on the company’s product launch traffic congestion. plans for 2015-16, in which its self-owned GS4, Fiat Cherokee and new Highlander are all scheduled to be The restrictions have led to some front-loaded demand rolled out, these new models are unlikely to offset its in these cities as car buyers had anticipated the losses in the sedan market in the short term, in our restrictions. However, we expect more cities to roll out view. Among GAC’s jointly controlled entities (JCEs), these licence restrictions and foresee this policy we believe GAC Honda and GAC Toyota will continue dampening sales volumes of PVs further in China. to be the 2 largest profit contributors to the company.

In our view, Japanese JV brands, such as Toyota and  GAC: JCE profit contribution (2013-17E) (CNYm) Honda, to which GAC has significant exposure via its 11,000 various JVs, and which focus on mid-range sedans, 236 would be impacted the most over the next few years. 9,000 200 516 1,433 We see this impact as being 2-fold. 7,000 1,246

5,000 3,664 4,250 4,643 First, in lower-tier cities where restrictions have not yet 4,144 4,299 been imposed and where disposable incomes are on the 3,000 3,390 rise, first-time buyers would likely opt for entry-level 1,000 2,750 2,639 2,455 2,652 (58) local brand cars for their value, not mid-level sedans. (109) (1,000) (660) (362) (836) Second, in the higher-tier cities where licence 2013 2014 2015E 2016E 2017E Guangqi Honda GAC Toyota GAC Mitsubishi Others restrictions have been imposed, first-time car buyers, due to their relative affluence, would likely purchase Source: Company, Daiwa forecasts luxury cars, while replacement car buyers in these cities would seek to upgrade to premium European cars, given the marginal extra cost required versus upgrading to a mid-range sedan. The result is the same: the mid-range sedan segment is effectively bypassed.

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Camry Hybrid in April 2010, the E’Z in June 2011, and Guangqi Honda – first foreign JV, the Levin in July 2014. but losing its lustre The Highlander SUV, contrary to its past strong sales Established in July 1998, Guangqi Honda was the first performance, had sold only 5,000 units in the year-to of GAC’s foreign JVs in China, with GAC and Honda March 2015, compared with 150,000 in 2014, as car each taking 50% stakes in the entity. On the back of the buyers have been waiting for the new-generation model popularity of the Honda Accord and Crider in recent to be launched. With the launch of the new-generation years, Guangqi Honda has become one of the major Highlander in April 2015, we assume this vehicle will players in China’s PV industry. resume a normalised sales-volume level of 6,000- 7,000 units per month for the rest of the year. We However, due to the fierce competition in the sedan expect demand for high-end SUVs to continue to be segment, and our view that mid-range sedans stand to strong, with few competitors in China in this niche lose market share over the next few years to luxury market. European cars and SUVs, we expect sales momentum of GAC’s high-end models, including the new GAC’s new mid-range sedan, Levin, was launched in generation Accord, Odyssey and Crosstour, to be weak, August 2014. We expect more volume contribution as first-time buyers in lower-tier cities opt for low-end from the model and look for it to be one of the key cars or local brands, and replacement car buyers in volume drivers for GAC Toyota in 2015. higher-tier cities prefer luxury models and SUVs.  GAC Toyota: sales volume and growth (2013-17E) We forecast GAC Honda to post sales volume of (units) (YoY%) 600,000 25% 518,000 in 2015, slowing to 8% YoY growth for 2015, from 38% YoY for 2013 and 10% YoY for 2014. The 500,000 20% Honda Vezel, GAC’s new compact SUV model launched 400,000 in October 2014, should help offset part of the volume 15% 300,000 slowdown in 2015, in our opinion. However, margins 10% across the board could be under pressure given GAC’s 200,000 recent aggressive price discounting and its weaker- 100,000 5% than-peer product mix (only 1 SUV model). 0 0% 2013 2014 2015E 2016E 2017E  GAC Honda: sales volume and growth (2013-17E) Sales volume (LHS) Growth (RHS) (units) (YoY%) Source: Company, Daiwa forecasts 700,000 40% 600,000 35% 500,000 30% GAC Mitsubishi – SUV plays 25% 400,000 20% 300,000 GAC Mitsubishi is a JV formed by GAC and Mitsubishi 15% 200,000 Motors (MMC)/Mitsubishi Corporation (MC) in 10% September 2012. GAC, MMC and MC, respectively, hold 100,000 5% 50%, 33% and 17% of the shares in GAC Mitsubishi. 0 0% 2013 2014 2015E 2016E 2017E The JV rolled out its first Mitsubishi ASX in October Sales volume (LHS) Growth (RHS) Source: Company, Daiwa forecasts 2012, and the Pajero in September 2013. Riding on China’s strong demand in the SUV segment, sales volume for the ASX saw a significant increase of 53% GAC Toyota – the pillar of GAC’s YoY in 2014, and as a result, GAC Mitsubishi returned to the black in 2014 from being loss-making in 2013. business We forecast the net margin for GAC Mitsubishi to GAC Toyota was founded in September 2004 as a improve from 2.7% in 2014 to 5% in 2015. The JV plans 50/50 joint venture between GAC and Toyota. It began to continue to expand its SUV product line, although production in May 2006 with the Camry model, one of what the new model pipeline will contain and when the the world’s most renowned and top-selling Toyota timeline for launch are still uncertain. We forecast the models. The company then began producing the Yaris JV’s earnings contribution to increase from CNY200m in May 2008, the Highlander SUV in May 2009, the in 2014, to CNY537m in 2015. - 90 - Consumer Discretionary / China 2238 HK 18 June 2015

 GAC Mitsubishi: sales volume and growth (2013-17E) We note that the loss posted by the company’s self- (units) (YoY%) owned brand dropped significantly in 2013-14 from 120,000 50% more than a CNY1.4bn loss in 2012, thanks to a margin 100,000 improvement as a result of strong sales volume of its 40% SUV model, the GS5. Despite our upbeat SUV demand 80,000 30% growth forecast of 35% YoY for 2015 for the segment, we 60,000 expect GS5 volumes to be flat in 2015/16 as the model is 20% 40,000 becoming mature (it was first launched back in 2012).

10% 20,000 GAC launched its new sporty sedan model, the GA6, in 0 0% December last year, which is expected to trigger higher 2013 2014 2015E 2016E 2017E depreciation and margin erosion as a result of a Sales volume (LHS) Growth (RHS) relatively low utilisation rate during its early stage of Source: Company, Daiwa forecasts production. We expect the existing SUV GS5, sedan GA6 and the new compact SUV GS3 to be the key volume drivers in 2015/16. GAC Fiat – entry-level plays We forecast GAC’s local brands business to record a Headquartered in Changsha, GAC Fiat is a 50/50 JV CNY983m loss in 2015, following a loss of CNY827m in formed by Fiat and GAC in March 2010. GAC’s first 2014, due to the strong competition among low-end product was a medium-sized sedan, Vaiggio, launched sedans. And we see the blended gross margin for GAC’s in September 2012. It launched its second similar local brand dropping to 10.5%/9.9% in 2015/16 from model, Ottimo, in 1Q14. We believe GAC Fiat’s model 10.7% in 2014. will further strengthen GAC’s presence in the small to medium car segment and allow GAC to target first-time  GAC: self-owned brand – sales volume and growth (2013-17E) buyers. (units) (YoY%) 250,000 60% However, given GAC Fiat’s low utilisation of about 48.6% for 2015 (on our forecasts), as the brand just 200,000 50% started production in 2012, we expect the JV to 40% 150,000 continue to record small but narrowing losses of 30% CNY453m for 2015 and CNY135m for 2016. 100,000 20%  GAC Fiat: sales volume and growth (2013-17E) 50,000 10% (units) (YoY%) 0 0% 80,000 350% 2013 2014 2015E 2016E 2017E 70,000 300% Sales volume (LHS) Growth (RHS) 60,000 250% Source: Company, Daiwa forecasts 50,000 200% 40,000 150% 30,000 Valuation and recommendation 20,000 100% 10,000 50% We set a 12-month target price of HKD6.2, based on an 0 0% 8.5x PER applied to the average of our 2015-16E EPS, 2013 2014 2015E 2016E 2017E which is at the low end of the target PER range of 8.5- Sales volume (LHS) Growth RHS) 12.0x that we apply to the auto OEMs under our Source: Company, Daiwa forecasts coverage. Our target price implies 16% downside from current levels. GAC – self-owned brand We expect GAC to continue to register negative free cash GAC’s local branded vehicle business is operated under flow of CNY2-3bn per year over our forecast horizon on Guangzhou Automobile (GAMC). It had capacity of continual R&D and production capacity expansion. 200,000 units at the end of 2014, but was only Dividends received from its JVs are unlikely to see operating at about a 54% utilisation rate, on our significant growth on the sluggish Japanese brand estimates. performance. We forecast net gearing to rise by 3pp to 14% by the end of 2015, from 11% at the end of 2014.

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We see potential for a further derating of GAC shares due to the likelihood of increasing investor concerns Background information over Japanese cars continuing to lose market share to premium European brands and other local brand rivals Headquartered in Guangzhou and listed on the Hong under strengthening licensing restrictions and Kong Stock Exchange in August 2010 through the intensifying competition in the sedan market. privatisation of Denway Motor, GAC is the 6th largest auto manufacturer in China.  GAC: PER valuation 2015-16 EPS average (CNY) 0.58 The company is engaged in the manufacturing of PER (x) 8.5x vehicles and parts, as well as automobile finance and Exchange rate, 1HKD = x CNY 0.80 insurance and related services. It sells PVs under the Equity value/share (HKD/share) 6.2 Current price (HKD) 7.37 Trumpchi brand, both passenger and commercial Potential share price upside/downside (%) -16% vehicles under Gonow, and buses under GAC Bus. Implied target 16E PER (x) 8.1 Source: Companies, Daiwa forecasts GAC has also formed a number of JVs with foreign brands, including Honda, Toyota, Mitsubishi and Fiat  GAC: PER bands to sell PVs. It sells commercial vehicles through its (PER) 40 GAC Bus and GAC Hino businesses. 35  GAC: PV sales volume mix by vehicle type (2014) 30 25 20 SUV 23.0% 15 10 5 0 MPV 5.2% Jul-12 Jul-13 Jul-14 Jan-12 Jan-13 Jan-14 Jan-15 Mar-12 Mar-13 Mar-14 Mar-15 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 May-12 May-13 May-14 May-15 Trading PER Average + 1SD -1 SD Source: Company, Daiwa forecasts Sedan 71.8%

Risks Source: Company

The main industry-specific upside risks to our call on

GAC include better-than expected auto industry demand and the loosening of licensing restrictions in first-tier cities.

The depreciation of the Yen implies lower prices of imported components for GAC’s Japanese JVs. If the

Yen continues to depreciate, this would imply upside potential for the earnings of GAC Honda and GAC Toyota, which are currently the main profit contributors to the company.

Other company-specific upside risks include better- than-expected sales volume from newly launched SUV models, like the Vezel, and narrowing losses for its self- owned brands, which would imply upside potential for our earnings forecasts.

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 GAC: management profile Mr. Zhang Fangyou Chairman and party secretary of the company. Mr. Zhang joined GAC in 1997, has served as the chairman of GAIG since 2000 and has been the chairman of the company since June 2005. Currently, Mr. Zhang is the chairman and party secretary of GAIG and the chairman of Denway, China Lounge, GAC (HK), and Guangqi Honda. Mr. Zeng Qinghong Vice chairman, general manager, supervisor of the Executive Committee of the company. Mr. Zeng first joined the company in 1997. He has served as the deputy chairman and general manager of the company since June 2005. Currently, Mr. Zeng is the vice-chairman and general manager of GAIG, chairman of GAC Toyota, and deputy chairman of Denway, China Lounge, GAC (HK) and GAC Toyota Engine. Mr. Yuan Vice chairman and vice chairman of the Executive Committee of the company. Mr. Yuan joined GAC in 1997 and has served as a director of the company since 2005. He served Zhongrong as the deputy general manager of the company from 2005 to June 2013. Currently, Mr. Yuan is a director and deputy general manager of GAIG, chairman of GAMC, Urtrust Insurance and GAC Gonow. Mr. Yao Yiming Deputy party secretary of the company. Mr. Yao has been a director of GAC since 25 March 2015, and acted as deputy general manager of the company from July 2008 to February 2015, and deputy director of the company’s Executive Committee from June 2013 to February 2015. He is also the chairman of GAC Component, and a director of China Lounge and Guangqi Honda. Mr. Feng Xingya Standing deputy general manager of the company and deputy director of the Executive Committee. He has been a director of the company since 25 March 2015. He is also chairman of GAC Fiat Chrysler, Guangzhou Guang Ai Insurance Brokers Limited and director of GAC Mitsubishi Motor and GAC Toyota. Mr. Liu Huilian Director and chairman of the company’s labour union from 21 June 2012 to 5 February 2015 and now retired. Mr. Liu joined the company in 2001 and has been a director since 2005. Currently, Mr. Liu is a director of GAIG. Prior to this, he held positions as director of the general manager office of Guangzhou Peugeot Automobile company, deputy general manager of Guangzhou Sedan and chairman of the labour union of Guangqi Honda. Ms. Lu Sa Executive director, deputy general manager, a company secretary and secretary of the board, deputy director of the Executive Committee of the company. Ms. Lu joined the company in March 2000 as secretary to the chairman, and has served as the secretary to the board and office director of the board since June 2005 and became an executive director and secretary to the board in August 2008. Currently, Ms. Lu is also a chairman of GAC Toyota, GAC Changfeng, GAC Commercial and GAC Capital, and a director of China Lounge and Denway. Mr. Wei Xiaoqin Director and the deputy party secretary of the company from 21 June 2012 to 5 February 2015 and now retired. Mr. Wei joined the company in 2000. Mr. Li Tun Director of the company from 21 June 2012 to 16 September 2014. Mr. Li is currently the chairman of the labour union of Guangqi Toyota, a director of Guangqi Honda and director of GAC Component. He joined the company in 1999, except for the period from 2001 to 2007 during which he was the deputy general manager of the sales division of Guangqi Honda. Mr. Chen Maoshan Chairman of the labour union of the company. Mr. Chen has been a director of the company since 25 March 2015. Mr. Chen acted as general manager of the company from June 2012 to 3 June 2013, and has been a deputy director of the Executive Committee of the company since June 2013. Mr. Wu Song Deputy director of the Executive Committee of the company. Mr. Wu has been a director of the company since 25 March 2015. Mr. Wu acted as deputy general manager of the company from 2007 to June 2013. He is currently also the director, general manager of Guangzhou Automobile Group Motor and a director of GAC FIAT Frat Chrysler and GAC Gonow. Mr. Wu joined the company in October 2003 and has held positions as deputy managing director of Guangzhou Wuyang-Honda, director of GAC Toyota and director and deputy general manager of GAC Toyota Engine. Source: Company

 GAC: milestones of development Year Event 1997 The company was established as Guangzhou Auto Group? (GAG) owned by the Guangzhou State-Owned Assets Administration Bureau. 1998 GAG entered into a JV agreement with Honda for the purpose of manufacturing PVs. Guangqi Honda was incorporated on 13 May 1998. 2004 The company entered into a joint venture agreement with Toyota for the establishment of GAC Toyota which manufactures and sells PVs and related auto parts. 2005 The company was converted into a joint stock limited company and its name was changed to Guangzhou Automobile Group Co. Ltd (GAC) 2006 The GAC Automotive Engineering Institute founded 2007 The company and Hino established GAC Hino for the manufacture and sale of GAC Hino commercial vehicles and related auto parts. 2008 GAMC established for the purpose of developing a proprietary brand of PVs and expanding production capacity and the portfolio of the PVs. 2009 The company purchased from Changfeng Group 29% of the total share capital of GAC Changfeng and became the largest shareholder of GAC Changfeng. 2010 The company entered into a JV agreement with Fiat for the establishment of GAC Fiat which manufactures PVs and related auto parts. 2010 GAC was listed on Hong Kong Stock Exchange Main Board (Code 2238.HK). 2010 GAMC launched its first model under the "Trumpchi" brand. 2010 GAC Gonow Auto was founded. 2012 GAMC launched its first SUV, "GS5". 2012 GAC was listed on the Shanghai Stock Exchange (Code 601238.HK). 2012 GAC Mitsubishi was founded for the manufacture and sale of GAC Mitsubishi PVs and related auto parts. 2013 GAC signed an agreement with China Auto Parts & Accessories Corp and Zhongxing Auto to jointly develop the automotive industry in Yichang, Hubei Province. 2014 GAC ZX Auto launched its first sedan in Yichang. Source: Company

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 GAC: organisational chart Guangzhou State-Owned Assets Administration Bureau

100%

Guangzhou Automobile Industry Group A shareholders H shareholders 58.8% 8.0% 33.2%

Guangzhou Automobile Group (2238.HK)

50% 50% 50% 50% 50% 50% 50% 30% 25% 30% 100% 100% 51% GAC Fiat GAC GAC Bus GAC GAC HinoGAC GAC Motor GAC ToyotaGAC GAC Gonow GAC Sofinco GAC Mitsubishi GAC Wuyang-Honda Guangqi Honda GAC Toyota Engine Toyota GAC Shanghai Engine Hino Honda Automobile (China)

Source: Company

 Guanqi Honda: Crider Sedan  Guanqi Honda: Fit Sedan

Source: Company Source: Company

 Guanqi Honda: City Sedan  Guanqi Honda: Accord Sedan

Source: Company Source: Company

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 Guanqi Honda: Vezel SUV  Guanqi Honda: Odyssey MPV

Source: Company Source: Company

 GAC Toyota: Levin Sedan  GAC Toyota: Camry Sedan

Source: Company Source: Company

 GAC Toyota: YARiS L SUV  GAC Toyota: Highlander SUV

Source: Company Source: Company

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 GAC Toyota: EZ MPV  GAC Mitsubishi: ASX SUV

Source: Company Source: Company

 GAC Fiat: Viaggio Sedan  GAMC: Trumpchi GA3 Sedan

Source: Company Source: Company

 GAMC: Trumpchi GA5 Sedan  GAMC: Trumpchi GA6 Sedan

Source: Company Source: Company

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 GAMC: Trumpchi GS5 SUV  GAC ZX C3 SUV

Source: Company Source: Company

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- 98 - Consumer Discretionary / China 2238 HK 18 June 2015

- 99 - Consumer Discretionary / China 2238 HK 18 June 2015

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Banking; Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Iris PARK (82) 2 787 9165 [email protected] Regional Deputy Head of Asia Pacific Research Consumer/Retail Rohan DALZIELL (852) 2848 4938 [email protected] Jun Yong BANG (82) 2 787 9168 [email protected] Regional Head of Product Management Oil; Chemicals; Tyres Kevin LAI (852) 2848 4926 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Regional); Banking; Insurance (Taiwan) TAIWAN Junjie TANG (852) 2773 8736 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Macro Economics (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Jonas KAN (852) 2848 4439 [email protected] (Regional) Head of Hong Kong and China Property Steven TSENG (886) 2 8758 6252 [email protected] Cynthia CHAN (852) 2773 8243 [email protected] IT/Technology Hardware (PC Hardware) Property (China) Christine WANG (886) 2 8758 6249 [email protected] Leon QI (852) 2532 4381 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Banking (Hong Kong/China); Broker (China); Insurance (China) Kylie HUANG (886) 2 8758 6248 [email protected] Anson CHAN (852) 2532 4350 [email protected] IT/Technology Hardware (Handsets and Components) Consumer (Hong Kong/China) Helen CHIEN (886) 2 8758 6254 [email protected] Jamie SOO (852) 2773 8529 [email protected] Small/Mid Cap Gaming and Leisure (Hong Kong/China) Dennis IP (852) 2848 4068 [email protected] INDIA Power; Utilities; Renewables and Environment (Hong Kong/China) Punit SRIVASTAVA (91) 22 6622 1013 [email protected] John CHOI (852) 2773 8730 [email protected] Head of India Research; Strategy; Banking/Finance Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Saurabh MEHTA (91) 22 6622 1009 [email protected] Becky HAN (852) 2848 4464 [email protected] Capital Goods; Utilities Small/Mid Cap (Regional) Kelvin LAU (852) 2848 4467 [email protected] SINGAPORE Head of Transportation (Hong Kong/China); Transportation (Regional) Ramakrishna MARUVADA (65) 6499 6543 [email protected] Brian LAM (852) 2532 4341 [email protected] Head of Singapore Research; Telecommunications (China/ASEAN/India) Transportation – Aviation (Hong Kong/China); Railway; Construction and Engineering Royston TAN (65) 6321 3086 [email protected] (China) Oil and Gas; Capital Goods Jibo MA (852) 2848 4489 [email protected] David LUM (65) 6329 2102 [email protected] Head of Custom Products Group Property and REITs Thomas HO (852) 2773 8716 [email protected] Evon TAN (65) 6499 6546 [email protected] Custom Products Group Property and REITs Jame OSMAN (65) 6321 3092 [email protected] PHILIPPINES Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer Bianca SOLEMA (63) 2 737 3023 [email protected] (Singapore)

Utilities and Energy

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- 101 - Consumer Discretionary / China 2238 HK 18 June 2015

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Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 61.0% Hold** 26.1% Sell*** 12.9% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2015. * comprised of Daiwa’s Buy and Outperform ratings. - 103 - Consumer Discretionary / China 2238 HK 18 June 2015

** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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