Consumer Discretionary 22 March 2016

Fuyao Industry Group (3606 HK) Glass Industr y Group

Target price: HKD20.00 Share price (21 Mar): HKD16.90 | Up/downside: +18.3%

Initiation: the world’s only pure automotive glass player Brian Lam (852) 2532 4341  Leading market shares and the only pure supplier of automotive glass [email protected]  Benefiting from purchase tax cut, lower gas tariff and CNY depreciation Kelvin Lau (852) 2848 4467  Initiating with Buy (1) call and TP of HKD20, based on 13x 2016E PER [email protected]

Investment case: Fuyao has a leading 63% share of the China market for Share price performance nd automotive glass (72% of the OEM market), and the 2 -largest share globally (HKD) (%) (20%). It is the only supplier in the world to focus solely on glass for autos, 23 120 giving it strong bargaining power and better profitability than its peers. We 20 110 forecast net-profit growth of 25% YoY for 2016, due to the factors below. 18 100 15 90

13 80 China passenger vehicle sales demand being driven by purchase tax Mar-15 Jun-15 Sep-15 Dec-15 cut. The State Council announced a cut in the purchase tax, from 10% to Fuyao Glas (LHS) Relative to HSI (RHS) 5%, for cars with engines of 1.6L or less on 29 September 2015. We estimate that the policy has boosted the sales of 68% of all the models in 12-month range 13.56-22.50 China since then. As a result, we forecast 2016 sales volume growth of Market cap (USDbn) 5.46 12% YoY for China, vs. the consensus growth forecast of 6% YoY. 3m avg daily turnover (USDm) 3.54 Shares outstanding (m) 2,509

Major shareholder Mr. Cho Tak Wong (17.4%) Lower COGS on natural gas tariff cuts in China. In November 2015, the 3 NDRC announced a 28% (CNY0.7/m ) cut in natural gas prices. However, Financial summary (CNY) the extent of the cut was smaller than expected, given the 60% decline in Year to 31 Dec 16E 17E 18E crude oil since the peak in mid-2014. We expect the price of gas to be cut Revenue (m) 15,023 16,501 18,126 by a further 20% to CNY1.45/m3 in 2Q16, which is line with the published Operating profit (m) 4,163 4,784 5,289 Net profit (m) 3,244 3,729 4,119 view of Daiwa’s Dennis Ip. As energy costs account for about 50%/10% of Core EPS (fully-diluted) 1.293 1.486 1.642 the cost of sales for float/automotive-, we estimate a EPS change (%) 18.0 14.9 10.5 further 20% tariff cut would boost Fuyao’s 2016 net profit by CNY200m. Daiwa vs Cons. EPS (%) 7.5 10.5 7.5 PER (x) 10.9 9.5 8.6 Dividend yield (%) 5.5 6.3 7.0 Benefiting from CNY depreciation. Our economics team forecasts the CNY DPS 0.776 0.892 0.985 to depreciate by 13% against the USD to 7.5 by end-2016, which would PBR (x) 2.0 1.8 1.7 increase Fuyao’s price competitiveness overseas. We therefore look for its EV/EBITDA (x) 6.7 5.8 5.2 ROE (%) 19.0 20.0 20.1 overseas revenue to rise by 15% YoY, on capacity expansion and greater price Source: FactSet, Daiwa forecasts competitiveness. We estimate that for every 1% depreciation in the CNY, it would lead to an FX gain of CNY110m for Fuyao.

Catalysts: With the cost of energy accounting for 50%/10% of the cost of sales for and automotive glass, we believe a further 20% natural gas tariff cut in 2Q16 would act as a share-price catalyst.

Valuation: We initiate coverage of Fuyao with a Buy (1) rating and 12- month TP of HKD20, based on a 2016E PER of 13x, which is in line with the average of its global auto-parts peers (13.1x, Bloomberg). We forecast a payout ratio at 60%, suggesting a 6% dividend yield for 2016E at the current share price. Fuyao is one of only a few dual-listed companies (A and H shares) to have a very narrow valuation gap.

Risks: The main risks to our call include: 1) weaker-than-expected auto sales in China and internationally, and 2) unexpected regulatory and political risks as the company expands its business overseas.

See important disclosures, including any required research certifications, beginning on page 23

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Table of contents

Investment thesis ...... 6 Highly concentrated autos-glass market ...... 6 Competitive landscape ...... 7 Benefits from natural gas tariff cuts ...... 9 Gaining overseas market share via capacity expansion ...... 10 Benefiting from ongoing CNY depreciation ...... 10 Financial forecasts ...... 12 We forecast 25% YoY net profit growth for 2016 ...... 12 Full-year 2015 net earnings beat consensus by 3% ...... 14 Valuation and recommendation ...... 15 Risks to our call ...... 17 Company background ...... 18 Background ...... 18 Products ...... 19 Company history ...... 19

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Fuyao: net profit and net-profit growth We forecast Fuyao to report net-profit growth of 25% YoY (CNYm) (YoY %) 4,500 26% 30% to CNY3.2bn for 2016, driven by: 1) the cut in the purchase 25% 4,000 tax for cars with engines of 1.6L or less in China, 2) 25% 3,500 market-share gains in the US as a result of capacity 3,000 17% 20% 16% 15% 10% expansion, 3) a further cut in natural gas tariffs (which 2,500 15% account for about 20% of the company’s cost of sales) in 2,000 1% 3,729 4,119 1,500 3,244 10% China in 2Q16, and 4) FX gains from CNY depreciation. 2,605 1,000 1,917 2,219 Given the high base in 2016, we forecast 10-15% YoY 1,524 5% increases in net profit for 2017-18, driven by growth of its 500 0 0% overseas markets. 2012 2013 2014 2015 2016E 2017E 2018E Net profit (LHS) YoY Growth (RHS)

Source: Company, Daiwa forecasts

Valuation Fuyao: 12-month PER bands

The stock is trading currently at PERs of 11x for 2016E (PER) (PER) and 10x for 2017E. It is one of the few dual-listed 17 17 companies (A and H shares) that has a very narrow 16 16 15 15 valuation gap. We assign a 12-month target price of 14 14 HKD20.0, which is based on a 2016E PER of 13x. Due to 13 13 the stock’s short listing history in Hong Kong, we 12 12 benchmark our target PER with the average 13.1x of its 11 11 10 10 global auto-parts peers, rather than with the stock’s own 9 9

historical average PER. 8 8

Jul-15

Oct-15 Apr-15 Apr-15 Oct-15

Jun-15 Jun-15 Jan-16

Feb-16 Mar-16

Aug-15 Aug-15 Sep-15 Nov-15 Dec-15 Dec-15 May-15 PER +1 SD Average PER -1 SD Source: Bloomberg, Daiwa forecasts

Earnings revisions Fuyao: Bloomberg consensus EPS forecast revisions

The consensus has not made significant revisions to (CNY) Fuyao’s earnings for 2016 over the past 6 months. We 1.50 believe the announcement of the next gas tariff cut and 1.40 stronger-than-expected autos sales volume growth, driven 1.30 by the purchase tax cut, would trigger the next round of 1.20 upward earnings revisions. Our 2016 EPS is 8% above the 1.10 Bloomberg-consensus forecast. 1.00 0.90

0.80

Jul-15

Apr-15 Oct-15

Jun-15 Jan-16

Mar-16 Feb-16

Aug-15 Sep-15 Nov-15 Dec-15 May-15 2016E 2017E

Source Bloomberg

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales volume - Auto glass (unit) 67 73 82 91 92 103 113 125 Sales volume - Auto glass (YoY %) 13.9 5.8 12.2 12.4 5.0 10.7 9.8 9.8 Sales volume - Float glass (unit) 921 1,089 954 885 1,044 1,169 1,286 1,415 Sales volume - Float glass (YoY %) 5.3 18.2 (12.4) (7.2) 18.0 12.0 10.0 10.0

Profit and loss (CNYm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Domestic revenue 6,506 6,911 7,823 8,598 9,068 9,765 10,396 10,876 International revenue 3,047 3,336 3,678 4,330 4,505 5,258 6,105 7,250 Other Revenue 137 (0) 0 (0) 0 (0) 0 0 Total Revenue 9,689 10,247 11,501 12,928 13,573 15,023 16,501 18,126 Other income (75) 23 (11) 13 521 577 633 696 COGS (6,147) (6,420) (6,831) (7,566) (7,939) (8,205) (9,015) (9,904) SG&A (1,546) (1,778) (2,173) (2,531) (2,901) (3,231) (3,336) (3,629) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 1,922 2,073 2,486 2,845 3,255 4,163 4,784 5,289 Net-interest inc./(exp.) (188) (224) (199) (227) (171) (257) (294) (329) Assoc/forex/extraord./others 38 13 92 21 (42) 6 6 7 Pre-tax profit 1,772 1,862 2,379 2,638 3,042 3,912 4,496 4,967 Tax (260) (338) (462) (422) (435) (665) (764) (844) Min. int./pref. div./others 0 0 0 2 (2) (3) (3) (3) Net profit (reported) 1,513 1,524 1,917 2,219 2,605 3,244 3,729 4,119 Net profit (adjusted) 1,513 1,524 1,917 2,219 2,605 3,244 3,729 4,119 EPS (reported)(CNY) 0.755 0.761 0.957 1.108 1.096 1.293 1.486 1.642 EPS (adjusted)(CNY) 0.755 0.761 0.957 1.108 1.096 1.293 1.486 1.642 EPS (adjusted fully-diluted)(CNY) 0.755 0.761 0.957 1.108 1.096 1.293 1.486 1.642 DPS (CNY) 0.400 0.500 0.500 0.750 0.750 0.776 0.892 0.985 EBIT 1,922 2,073 2,486 2,845 3,255 4,163 4,784 5,289 EBITDA 2,669 2,907 3,391 3,748 4,287 5,235 6,152 6,854

Cash flow (CNYm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 1,772 1,862 2,379 2,638 3,042 3,912 4,496 4,967 Depreciation and amortisation 747 834 905 903 1,033 1,071 1,368 1,565 Tax paid (260) (346) (382) (435) (470) (665) (764) (844) Change in working capital (951) (152) (197) (171) (505) (358) (335) (368) Other operational CF items 154 227 113 194 (99) 272 307 343 Cash flow from operations 1,462 2,426 2,817 3,131 3,000 4,232 5,072 5,663 Capex (1,110) (1,504) (1,881) (2,793) (3,256) (3,042) (3,083) (3,126) Net (acquisitions)/disposals 42 23 296 73 49 0 0 0 Other investing CF items 13 99 167 110 204 0 0 0 Cash flow from investing (1,055) (1,383) (1,418) (2,611) (3,002) (3,042) (3,083) (3,126) Change in debt 1,548 (380) (186) 741 298 646 662 678 Net share issues/(repurchases) 0 0 0 0 6,524 0 0 0 Dividends paid (1,301) (801) (1,001) (1,001) (1,502) (1,881) (1,947) (2,237) Other financing CF items 0 (183) (209) (242) (211) (277) (313) (350) Cash flow from financing 247 (1,364) (1,396) (503) 5,108 (1,513) (1,598) (1,909) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 654 (320) 3 17 5,106 (322) 391 628 Free cash flow 352 922 936 337 (255) 1,191 1,989 2,537 Source: FactSet, Daiwa forecasts

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Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 808 487 490 499 5,905 5,583 5,974 6,602 Inventory 1,892 1,907 1,877 2,169 2,495 2,579 2,833 3,113 Accounts receivable 2,251 2,647 3,215 3,549 3,784 4,188 4,600 5,053 Other current assets 38 24 430 413 334 334 334 334 Total current assets 4,988 5,065 6,012 6,630 12,518 12,684 13,741 15,102 Fixed assets 5,930 7,142 7,416 8,823 10,807 12,658 14,262 15,717 Goodwill & intangibles 1,121 644 891 1,032 1,221 1,340 1,451 1,557 Other non-current assets 173 309 364 407 296 302 308 314 Total assets 12,212 13,160 14,683 16,891 24,842 26,983 29,762 32,690 Short-term debt 2,734 3,126 2,899 3,336 3,871 4,417 4,974 5,542 Accounts payable 1,975 1,825 2,374 2,795 2,941 3,040 3,339 3,669 Other current liabilities 102 209 307 320 291 322 354 389 Total current liabilities 4,811 5,160 5,581 6,451 7,103 7,779 8,667 9,600 Long-term debt 1,122 880 918 1,213 848 948 1,053 1,163 Other non-current liabilities 48 128 323 410 461 461 461 461 Total liabilities 5,981 6,169 6,822 8,073 8,412 9,188 10,181 11,224 Share capital 2,003 2,003 2,003 2,003 2,509 2,509 2,509 2,509 Reserves/R.E./others 4,229 4,985 5,855 6,811 13,915 15,278 17,060 18,941 Shareholders' equity 6,232 6,988 7,858 8,814 16,423 17,786 19,568 21,450 Minority interests 0 4 3 4 6 9 12 16 Total equity & liabilities 12,212 13,160 14,683 16,891 24,842 26,983 29,762 32,690 EV 38,433 38,883 38,664 39,357 34,239 35,204 35,472 35,519 Net debt/(cash) 3,048 3,519 3,326 4,049 (1,186) (218) 53 104 BVPS (CNY) 3.111 3.489 3.923 4.400 6.547 7.090 7.800 8.550

Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) 13.9 5.8 12.2 12.4 5.0 10.7 9.8 9.8 EBITDA (YoY) (4.6) 8.9 16.6 10.5 14.4 22.1 17.5 11.4 Operating profit (YoY) (10.0) 7.9 19.9 14.4 14.4 27.9 14.9 10.6 Net profit (YoY) (15.4) 0.8 25.8 15.8 17.4 24.6 14.9 10.5 Core EPS (fully-diluted) (YoY) (15.4) 0.8 25.8 15.8 (1.1) 18.0 14.9 10.5 Gross-profit margin 36.6 37.4 40.6 41.5 41.5 45.4 45.4 45.4 EBITDA margin 27.5 28.4 29.5 29.0 31.6 34.8 37.3 37.8 Operating-profit margin 19.8 20.2 21.6 22.0 24.0 27.7 29.0 29.2 Net profit margin 15.6 14.9 16.7 17.2 19.2 21.6 22.6 22.7 ROAE 25.1 23.1 25.8 26.6 20.6 19.0 20.0 20.1 ROAA 13.3 12.0 13.8 14.1 12.5 12.5 13.1 13.2 ROCE 21.5 19.7 21.9 22.7 18.9 18.8 19.6 19.7 ROIC 19.3 17.1 18.5 19.9 19.8 21.1 21.3 21.3 Net debt to equity 48.9 50.4 42.3 45.9 net cash net cash 0.3 0.5 Effective tax rate 14.7 18.1 19.4 16.0 14.3 17.0 17.0 17.0 Accounts receivable (days) 80.2 87.2 93.0 95.5 98.6 96.8 97.2 97.2 Current ratio (x) 1.0 1.0 1.1 1.0 1.8 1.6 1.6 1.6 Net interest cover (x) 10.2 9.3 12.5 12.5 19.1 16.2 16.3 16.1 Net dividend payout 53.0 65.7 52.2 67.7 68.4 60.0 60.0 60.0 Free cash flow yield 1.0 2.6 2.6 1.0 n.a. 3.4 5.6 7.2 Source: FactSet, Daiwa forecasts

Company profile

Fuyao Glass is the largest automotive glass manufacturer in China and the second-largest in the world. It has around a 63% share of China’s locally manufactured automotive glass, a 72% share of China’s passenger vehicle glass OEM market, and a 20% share of the global automotive glass market, (in terms of sales volume). In 2014, about one-third of its revenue was derived from overseas, and two-thirds from China.

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Investment thesis Highly concentrated autos-glass market China’s automotive glass market likely to outpace global demand growth China’s automotive The automotive-glass market can be divided into 2 segments: the OEM market for new glass demand to see a vehicles, and the after-sales replacement glass (ARG) market for replacement purposes. CAGR of 8.5% for 15- According to the Roland Berger consultancy, global automotive-glass demand for the OEM 18E, outpacing global and ARG segments combined should increase to 528m sq m by 2018, representing a demand for automotive CAGR of 4.9% over the 2013-18 period (the following chart shows Roland Berger’s glass, according to forecasts for automotive-glass demand). Roland Berger Global automotive-glass demand (100 mn sq. m.) (100 mn sq. m.) 6 6 5.28 4.99 5 4.73 5 4.44 1.05 4.15 4.22 0.97 3.96 0.93 4 3.56 3.73 0.90 4 0.76 0.84 0.87 0.74 3 2.94 0.71 3 0.69 4.23 2 3.80 4.02 2 3.31 3.35 3.54 2.85 2.99 3.20 1 2.25 1

0 0 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E OEM ARG

Source: Roland Berger forecasts

We expect China’s automotive-glass demand to outpace that of the global market, benefiting from the country’s supportive policies (including the purchase tax cut) for the automotive industry. China’s demand for automotive glass increased by a CAGR of 12.6% over 2009-13, and Roland Berger forecasts a CAGR of 8.5% for 2015-18 (the following chart shows Roland Berger’s historical and projected demand for automotive glass in China).

China automotive glass demand (10,000 sq. m.) (100,00 sq. m.) 16,000 15,061 16,000 13,939 14,000 12,850 1,734 14,000 11,800 1,575 12,000 10,715 1,425 12,000 9,645 1,277 10,000 8,612 1,134 10,000 7,939 8,141 997 8,000 648 748 859 8,000 6,005 13,327 6,000 12,364 6,000 542 10,523 11,425 8,648 9,581 4,000 7,291 7,393 7,753 4,000 5,463 2,000 2,000 0 0 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E OEM ARG

Source: Roland Berger forecasts

Concentrated automotive-glass market China’s automotive-glass market is highly concentrated, with the top-5 manufacturers accounting for around 89% of China’s automotive-glass sales. China imports a small quantity of automotive glass each year, primarily for use in imported vehicle models and prototype vehicles. Excluding imported automotive glass, the top-5 manufacturers accounted for 95% of China’s automotive-glass sales in 2013.

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

Global market share of the top automotive-glass manufacturers China market share of the top automotive-glass manufacturers (2013) (2013)

3% 2%

AGC 13% 7% 12% AGC 22% Fuyao Fuyao 5% 9% 5% NSG NSG 4% Saint Gobain Saint Gobain

16% Fuyao: Xinyi Xinyi 20% Fuyao: Guardian 63% Shanghai Yaopi

19% Others Others

Source: Roland Berger Source: Roland Berger

Competitive landscape Fuyao is the only automotive-glass-focused supplier globally Fuyao is the only Fuyao has the largest market share in China, at 63%, in terms of automotive-glass automotive glass- revenue (or a 72% share of the OEM market), and the 2nd-largest player globally, with a focused supplier market share of 20% for 2013. However, it is the only leading glass manufacturer globally globally, which gives it to focus solely on automotive-glass production, while its glass supplier peers have varying scale economies in the degrees of exposure to solar glass, construction glass, etc. production process Fuyao has the broadest geographic coverage in China, with its 12 automotive-glass plants spread over 8 provinces. This network enables the company to deliver glass to the autos OEMs in a cost-effective and just-in-time manner. In addition, its high self-sufficiency in making float glass, (which is the primary raw material for automotive-glass production) ensures the company can provide a stable supply of automotive glass.

Fuyao: geographic coverage of its automotive glass factories

Source: Company Comprehensive customer base compared with those of its peers The company is one of the very few automotive-glass manufacturers in China to have obtained product certification from autos manufacturers in Europe, the US, Japan and

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

Korea, the Four Major Vehicle Series. Therefore, it has the broadest customer base among all its peers in China, including all of China’s top-10 passenger vehicle manufacturers, as well as the other well-known autos manufacturers such as BMW, Mercedes, Bentley, Rolls- Royce and Porsche.

Fuyao has obtained Compared with its peers, Fuyao has better profitability and is the only glass supplier to production certification focus solely on the automotive-glass segment. About 96% of Fuyao’s 2015 revenue was from Europe, the US, derived from automotive glass, while its float glass production is mainly for automotive Japan and Korea, giving grade glass, making the company self-sufficient. With the completion of its US and Russian it broad customer base production plants over the next 2 years, Fuyao stands to gain further market share overseas, in our opinion.

The following table shows Fuyao’s customer relationships with its closest peers (the top-3 automotive-glass manufacturers and the top-10 passenger vehicle OEMs in China).

Customer base comparison of the top-3 automotive glass manufacturers in China Fuyao AGC Saint Gobain SGM X X X FAW VW X X SVW X X Beijing Hyundai X X X Dongfeng Nissan X X X Chevrolet X FAW Toyota X X Changan Ford X X Geely X X Great Wall X X

Source: Roland Berger

A snapshot of Fuyao’s peers Asahi Glass (5201 JP, JPY545, Hold [3]): the company’s glass segment accounted for the largest proportion of its 2014 revenue, at 49%, while the remainder came from its other business operations, including electronics, chemicals and brick-product . Within the glass segment, automotive glass accounted for about 45%. Asahi also manufactures solar glass and architectural glass. However, its glass segment is not that profitable, generating only a 2% EBIT margin for 2015. For both 2012-13, its glass segment was slightly loss-making.

Nippon Sheet (5202 JP, JPY71, Outperform [2]): Nippon Sheet is the most focused glass manufacturer next to Fuyao among the global peers, with its automotive glass contributing 50% of its 2014 revenue. It also produces construction glass and functional glass. However, in terms of profitability, its automotive-glass segment recorded only a 3% EBIT margin for 2014. Our Japan analyst, Yoshimasa Takashina, expects the company’s architectural glass operations to perform well in 2016, benefiting from strong demand and favourable pricing, more than offsetting a potential lacklustre performance of its automotive-glass and technical glass businesses.

Central Glass (4044 JP, Not rated): Central Glass is involved in manufacturing glass and chemicals. It is the 3rd-largest glass manufacturer in Japan after Asahi Glass and Nippon Sheet. Its glass segment has been making a slight loss for the past 3 years, with most of its profit coming from its chemical operations unit.

Saint Gobain (SGO FP, Not rated): Saint Gobain, a France-based producer, has diversified its products into construction and high-performance materials and packaging. In 2014, its flat glass business accounted for 13% of the company’s total revenue.

Xinyi Glass (868 HK, Not rated): About 33% of ’s revenue was generated from automotive glass in 2014. It also produces construction glass and solar glass. The company’s autos segment focuses on the after-sales replacement market, which has lower technology requirements than the OEM market on which Fuyao focuses.

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Fuyao: key metrics vs. those of its peers Price Trading PER (x) Gross margin Net margin EPS growth EPS CAGR PEG 21-Mar-2016 Currency 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E (%) (x) Fuyao Glass* 16.9 HKD 10.9 9.5 8.6 45.4% 45.4% 45.4% 21.6% 22.6% 22.7% 18.0% 14.9% 10.5% 12.7 0.9 Asahi Glass 599 JPY 23.4 17.5 15.6 25.2% 25.4% 25.4% 2.2% 2.9% 3.2% (30.9%) 33.4% 12.3% 22.4 1.0 Central Glass 598 JPY 12.1 11.3 10.8 23.7% 23.9% 24.0% 4.5% 4.6% 4.7% (0.5%) 6.7% 4.5% 5.6 2.2 Nippon Sheet 82 JPY (12.3) 35.1 13.5 24.1% 24.9% 25.3% (1.2%) 0.3% 0.8% n/a n/a 160.4% n/a n/a Saint Gobain 37.69 EUR 15.4 13.0 12.2 25.9% 28.1% n/a 3.4% 3.9% 3.8% 15.1% 18.6% 5.9% 12.1 1.3 Source: *Daiwa forecasts, Bloomberg

Entry barriers The automotive-glass manufacturers must obtain various national safety and quality certifications for their autos products in those countries where they sell products. Fuyao is one of few suppliers to be accepted by the global OEMs and certified by the Four Major Vehicle Series, due to its advanced technology for automotive safety-glass production. The capital-intensive nature and sales network requirements of this segment also keep new players out of the market.

China autos demand boosted by purchase tax cut We forecast 12% YoY China PV sales growth for 2016 China’s State Council announced a cut in the purchase tax, from 10% to 5%, for cars with Fuyao stands to benefit engines of 1.6L or less on 29 September 2015. This policy came into effect on 1 October from the rising demand 2015 and will last until 31 December 2016. We estimate the policy will boost the sales of for autos in China on the 68% of all the models in China. As a result, we forecast 2016 sales volume growth in China back of the purchase tax of 12% YoY (versus the consensus forecast of about 6% YoY growth), after the 7% YoY cut rise for 2015.

Dominant 63% share of the China market Fuyao has a leading 63% share of China’s locally manufactured automotive-glass market, and a 72% share of China’s passenger vehicle glass OEM market. We believe the company will maintain its leading share of the China market given its stronger-than-peer bargaining power, on the back of its leadership market position and longstanding cooperation with the major autos OEMs in China.

China PV sales projections (Quarterly sales, m units) (YoY %) 7 25%

6 20% 15% 5 10% 4 5% 3 0% 2 (5%) 1 (10%) 0 (15%) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16E 2Q16E 3Q16E 4Q16E 1Q17E 2Q17E 3Q17E 4Q17E China PV Sales Volume (LHS) YoY Growth (RHS)

Source: CAM, Daiwa forecasts

Benefits from natural gas tariff cuts In November 2015, the NDRC announced a CNY0.7/m3 cut in the non-residential gas tariff to CNY1.82/m3, effective on 20 November 2015. Given the prevailing weakness in oil prices, we see room for the price of non-residential city-gate gas to be cut further to CNY1.45/m3 for 2Q16, representing a further 20% tariff cut. Energy costs (natural gas and heavy oil) account for about 45-50% of the cost of sales of Fuyao’s float-glass production, and 10% of the cost of sales for its automotive-glass production. As such, we estimate that a 20% cut in natural gas tariffs would lead to a 6-8% increase (or CNY200-250m) in Fuyao’s 2016E net profit.

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

China: natural gas price trend Crude oil price (CNY per m3) (CNY per m3) (USD) (USD) 4.0 4.0 120 120 3.8 3.8 100 100 3.6 80 80 3.4 3.6 60 60 3.2 3.4 3.0 40 40 3.2 2.8 20 20

2.6 3.0 0 0

Jul-15 Jul-11 Jul-12 Jul-13 Jul-14

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15

May-15 May-10 May-11 May-12 May-13 May-14 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Source: CEIC Source: Bloomberg

Gaining overseas market share via capacity expansion Overseas revenue CAGR of 17% over 2015-18E Capacity expansion in We forecast Fuyao’s overseas revenue to rise at a CAGR of 17% over 2015-18, and its the US and Russia domestic revenue to increase at a 6% CAGR, driven mainly by the company’s overseas capacity expansion. We forecast the company’s overseas revenue contribution to expand to 40% of total revenue by 2018, from 33% for 2014.

Strong overseas revenue growth supported by overseas capacity expansion The company is planning aggressive overseas production capacity expansion. By the end of 2017, we estimate its overseas production plants (mainly in the US and Russia) would account for 15% and 22% of the company's total automotive-glass and float-glass production capacity, respectively. We expect the company to incur capex of CNY3bn for each of 2016-17 for the construction of the following capacity:

 450,000 tonnes of float-glass production capacity in Russia by the end of 2017: the new auto-grade float-glass production plant will be built near its Russian automotive-glass production facility. The company expects the plant to be completed by the end of 2017.  150,000 tonnes of float-glass capacity additions for each of 4Q15 and 3Q16: in August 2014, the company bought 2 float-glass production lines in Illinois, the US, for a consideration of USD56m. The plants’ auto-grade float-glass production is being upgraded, and commercial production of float glass started in part in 4Q15, with a second phase due to commence operations in 3Q16.  Automotive-glass production capacity of 12.1m sq m in Ohio, US, at the beginning of 2016  An additional 8.1m sq m of capacity in Kaluga, Russia, at the end of 2016

Benefiting from ongoing CNY depreciation The company would benefit from further CNY depreciation given its increasing overseas revenue mix. Our economics team forecasts the CNY to continue to depreciate against the USD, by 13% to 7.5 by the end of 2016, from 6.5% in 2015. We forecast the company’s overseas revenue to account for 35% of its total revenue for 2016E, up from 32% for 2013. We estimate a further 13% depreciation in the CNY:USD would boost Fuyao’s overseas revenue growth and its price competitiveness overseas. We estimate that for every 1% depreciation in the CNY, Fuyao would register an FX gain of CNY110m.

10

Fuyao Glass Industry Group (3606 HK): 22 March 2016

CNY depreciation (CNY per 1USD) (CNY per 1USD) 8.5 8.5

8.0 8.0

7.5 7.5

7.0 7.0

6.5 6.5

6.0 6.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Dec-16 E

Source: Bloomberg, Daiwa forecasts

11

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Financial forecasts We forecast 25% YoY net profit growth for 2016 Strong earnings growth for 2016E, helped by a likely lower natural gas cost, along with the purchase tax cut and overseas capacity expansion Higher overseas revenue Following the completion of the company’s automotive-glass production capacity of 12.1m mix following the start of sq m in Ohio, US, at the beginning of 2016, and an additional 8.1m sq m in capacity in production in the US and Kaluga, Russia, at the end of 2016, we forecast the company’s overseas revenue to Russia in 2016 account for 35% of its total revenue for 2016, increasing to 40% for 2018E.

We forecast Fuyao’s domestic revenue proportion to fall to 60% for 2018E, from 67% for 2014, once the US and Russia plants are operating fully. Despite the likely lower revenue proportion YoY from the China market for 2016, we forecast the company’s domestic automotive-glass demand to grow by 12% YoY for 2016E, on the back of the purchase tax cut (from 10% to 5% for cars with engines of 1.6L or less), which came into effect on 1 October 2015.

Domestic automotive- As a result, we forecast Fuyao’s overall revenue to see a CAGR of 10% for 2015-18E, glass market supported backed by market-share gains and the start of the new production capacity in the US and by the PV purchase tax Russia, and rising PV demand from China. With the expiration of some of its subsidiaries’ cut income tax benefits in 2016, we assume the company’s effective tax rate for 2016 will return to a normalised level of 17% for 2016, from 14% for 2015.

Accordingly, we forecast Fuyao’s net profit to rise by 25%, 15% and 10% YoY for 2015- 18E, respectively. On our forecasts, its net-profit CAGR of 16% outperforms its top-line CAGR of 11% for the same period, as a result of a 2pp rise in the gross margin, to 45% for 2016E from 42% for 2014, supported by likely lower natural gas costs.

Fuyao: revenue projection by region Fuyao: revenue mix by region (CNY m) (CNY m) (Mix %) (Mix %) 20,000 20,000 100% 100%

32% 16,000 16,000 80% 33% 33% 35% 37% 40% 80% 7,250 6,105 12,000 5,258 12,000 60% 60% 4,330 4,505 3,678 8,000 8,000 40% 40% 68% 67% 67% 65% 63% 60% 9,765 10,396 10,876 4,000 7,823 8,598 9,068 4,000 20% 20%

0 0 0% 0% 2013 2014 2015 2016E 2017E 2018E 2013 2014 2015 2016E 2017E 2018E Domestic sales International sales Domestic sales International sales

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

Fuyao: revenue projection by product Fuyao: revenue mix by product (CNY m) (CNY m) (Mix %) (Mix %) 24,000 120% 100% 3% 3% 3% 3% 3% 2% 100% 21,000 534 16% 14% 15% 15% 15% 16% 509 3,334 100% 80% 80% 18,000 485 3,031 462 2,756 15,000 487 2,485 80% 429 2,130 60% 60% 12,000 2,239 60% 9,000 17,626 16,024 40% 80% 83% 82% 82% 82% 82% 40% 13,138 14,567 6,000 10,912 12,439 40% 3,000 20% 20% 20% 0 (2,079) (2,128) (2,511) (2,784) (3,063) (3,369) (3,000) 0% 0% 0% 2013 2014 2015 2016E 2017E 2018E 2013 2014 2015 2016E 2017E 2018E Automotive glass Float glass Others Less: intragroup elimination Automotive glass Float glass Others

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts Note: Less: intragroup elimination = primarily includes intra-group sales of float glass

12

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Solid balance sheet and cash flow We look for Fuyao to be We forecast Fuyao’s capital expenditure to range from CNY3-3.1bn pa for 2016-18E, with net cash in 2016E, vs. its most of it likely to be earmarked for overseas capacity expansion. Some of the company’s net gearing of 46% in capex requirements will be funded by its H-share IPO proceeds (CNY6.7bnh in 2015) as 2014 well as cash flow generated from operating activities. Fuyao has moved into a net cash position in 2015, compared with its net gearing of 46% as of 2014. Also, we forecast its ROE to be 19% for 2016, down from 27% in 2014 due to the impact of deleveraging. And we assume a dividend payout ratio of 60%, representing a dividend per share of CNY0.78 for 2016E. At the current share price, the implied dividend yield for 2016E is 6%. In our view, Fuyao’s healthy balance sheet will enable it to expand its business and seize new overseas businesses opportunities as they present themselves.

Fuyao: FCF and debt/equity ratio (USDm) (Net debt / equity ratio,%) 3,000 50%

2,500 40%

2,000 30%

1,500 20%

1,000 10%

500 0%

0 (10%) 2013 2014 2015 2016E 2017E 2018E Free Cash Flow (LHS) Net debt/ equity ratio (RHS)

Source: Company, Daiwa forecasts

Raw material and energy account for big proportion of cost of sales Float glass and PVB layers are the main raw materials used in automotive glass production. In 2014, float glass accounted for 33% of Fuyao’s production cost for automotive glass. Separately, PVB layers accounted for 13% of the company’s cost of sales for automotive glass, while other raw materials accounted for 18%. Excluding the energy consumed in the production of float glass, energy costs accounted for about 10% of Fuyao’s automotive glass cost of sales in 2014.

For the production of float glass, the company sourced internally about 76% of the float glass used in its automotive glass sold in 2014. Having converted 2 construction-grade float glass production lines in Tongliao, Inner Mongolia, into float glass production lines at end-2014, Fuyao should achieve a float glass self-sufficiency rate of more than 90% in 2015-17E (vs. around 80% currently), in our view, backed by the potential natural gas price cut in China (energy costs accounted for about 45% of the company’s cost of sales for float glass production in 2014). Hence, assuming a 20% natural gas price cut this year, we forecast Fuyao’s gross margins to widen by 4pp to 45% in 2016.

Fuyao: automotive glass cost of sales structure (2014) Fuyao: float glass cost of sales structure (2014)

13% Raw material - Float Glass Raw material 24% 28% Raw material - PVB layers 34% 12% Raw material - Others Energy cost 4% Energy cost Labour cost 10% Labour cost Manufacturing and others Manufacturing and others 13% 45% 18%

Source: Company data Source: Company data

13

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Full-year 2015 net earnings beat consensus by 3% Fuyao Glass reported net profit growth of 17% to CNY2.6bn in 2015, beating the market’s estimate by about 3%. Revenue came in at CNY13.6bn, up 5% YoY, on a 1% sales volume increase for automobile glass. Fuyao’s ASP for automotive glass was up 4% YoY to CNY142.8 per sq m. Also, the company raised its dividend payout to 72%, or CNY0.75 per share, representing a 5% dividend yield at the current share price.

Fuyao: income statement (In CNY mn except otherwise indicated) 2012 2013 2014 2015 2016E 2017E 2018E Revenue 10,247 11,501 12,928 13,573 15,023 16,501 18,126 YoY growth (RHS) 6% 12% 12% 5% 11% 10% 10%

Rev by region:

Domestic sales 6,911 7,823 8,598 9,068 9,765 10,396 10,876 International sales 3,336 3,678 4,330 4,505 5,258 6,105 7,250 Rev Mix by regions

Domestic sales 67% 68% 67% 67% 65% 63% 60% International sales 33% 32% 33% 33% 35% 37% 40%

Rev by product:

Automotive glass 9,515 10,912 12,439 13,138 14,567 16,024 17,626 Float glass 2,272 2,239 2,130 2,485 2,756 3,031 3,334 Others 342 429 487 462 485 509 534 Less: intragroup elimination (1,881) (2,079) (2,128) (2,511) (2,784) (3,063) (3,369)

Rev Mix by product:

Automotive glass 78% 80% 83% 82% 82% 82% 82% Float glass 19% 16% 14% 15% 15% 15% 16% Others 3% 3% 3% 3% 3% 3% 2% Less: intragroup elimination -18% -18% -16% -19% -19% -19% -19%

COGS (6,420) (6,831) (7,566) (7,939) (8,205) (9,015) (9,904) Gross profit 3,828 4,671 5,363 5,635 6,818 7,487 8,222 YoY growth 8% 22% 15% 5% 21% 10% 10% Gross margin 37.4% 40.6% 41.5% 41.5% 45.4% 45.4% 45.4%

SG&A + Op. income (1,778) (2,173) (2,531) (2,901) (3,231) (3,336) (3,629) Other operating income/expense 23 (11) 13 521 577 633 696 EBIT 2,073 2,486 2,845 3,255 4,163 4,784 5,289 YoY growth 8% 20% 14% 14% 28% 15% 11% EBIT margin 20.2% 21.6% 22.0% 24.0% 27.7% 29.0% 29.2%

Interest income 2 3 14 20 21 19 21 Interest expense (226) (202) (241) (191) (277) (313) (350) Profit/loss from assets sales (8) 66 (10) (47) - - - Profit/loss from associates 22 26 31 6 6 6 7 Other non-operating income (expense) ------Pretax income 1,862 2,379 2,638 3,042 3,912 4,496 4,967 YoY growth 5% 28% 11% 15% 29% 15% 10% Pretax income margin 18.2% 20.7% 20.4% 22.4% 26.0% 27.2% 27.4% Income tax (338) (462) (422) (435) (665) (764) (844) Effective tax rate (%) 18.1% 19.4% 16.0% 14.3% 17.0% 17.0% 17.0% Minority interest (I/S item) 0 0 2 (2) (3) (3) (3) Net income, post-exceptionals 1,524 1,917 2,219 2,605 3,244 3,729 4,119 YoY growth 1% 26% 16% 17% 25% 15% 10% Net margin 14.9% 16.7% 17.2% 19.2% 21.6% 22.6% 22.7%

Post-exceptional items ------Net income (LHS) 1,524 1,917 2,219 2,605 3,244 3,729 4,119 YoY growth 1% 26% 16% 17% 25% 15% 10% Net margin 14.9% 16.7% 17.2% 19.2% 21.6% 22.6% 22.7% SG&A/revenue -17.3% -18.9% -19.6% -21.4% -21.5% -20.2% -20.0%

Source: Company, Daiwa forecasts

14

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Valuation and recommendation We see scope for Fuyao We initiate coverage of Fuyao Glass with a Buy (1) rating and 12-month target price of to trade at the higher HKD20, based on a 2016E PER of 13x, representing 18% potential upside from the current end of its peers’ range, share price. Over the past 5 years, Fuyao Glass has maintained a dividend payout of more ie, 13-15x, given its than 50% and we expect it to be in a position to do the same for 2016 given its healthy dominance in China and balance-sheet position; we assume a dividend payout of 60% (CNY0.79), which suggests likely market-share gains a 6% dividend yield for 2016 at the current share price. from capacity expansion overseas Global glass manufacturers are trading currently at an average 2016E PER of 13x, based on the Bloomberg-consensus forecasts, in line with our target multiple for Fuyao Glass. We are comfortable with our target multiple given the company’s leading position in the automotive glass business and potentially stronger-than-peers’ earnings CAGR, which we forecast at 16% for 2015-18E (premised on a potential cut in the price of natural gas in China, increased demand for cars following the purchase tax cut in China, and further market-share gains resulting from its overseas capacity expansion).

Fuyao (3606 HK): PER bands Fuyao (3606 HK): PBR bands (PER) (PER) (PBR) (PBR) 17 17 2.9 2.9 16 16 2.7 2.7 15 15 2.5 2.5 14 14 13 13 2.3 2.3 12 12 2.1 2.1 11 11 1.9 1.9 10 10 9 9 1.7 1.7

8 8 1.5 1.5

Jul-15

Jul-15

Apr-15 Oct-15

Apr-15 Oct-15

Jun-15 Jan-16

Jun-15 Jan-16

Feb-16 Mar-16

Feb-16 Mar-16

Aug-15 Sep-15 Nov-15 Dec-15

Dec-15 Aug-15 Sep-15 Nov-15

May-15 May-15 PER +1 SD Average PER -1 SD PBR +1 SD Average PBR -1 SD Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Fuyao (600660 CH): PER bands Fuyao (600660 CH): PBR bands (PER) (PER) (PBR) (PBR) 17 17 3.5 3.5

15 15 3.0 3.0

13 13 2.5 2.5

11 11 2.0 2.0

9 9 1.5 1.5

7 7 1.0 1.0

5 5 0.5 0.5

Jun-12 Jun-13 Jun-14 Jun-15

Mar-13 Mar-14 Mar-15 Mar-16

Sep-13 Sep-12 Dec-12 Dec-13 Sep-14 Dec-14 Sep-15 Dec-15

Jun-12 Jun-13 Jun-14 Jun-15

Mar-13 Mar-14 Mar-15 Mar-16

Dec-12 Dec-13 Dec-14 Dec-15

Sep-13 Sep-12 Sep-14 Sep-15 PER +1 SD Average PER -1 SD PBR +1 SD Average PBR -1 SD Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

15

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Auto parts: valuation comparisons Market Name Bloomberg Trading Share price cap Rating PER (x) PBR (x) EV/EBITDA(x) Div yield (%) ROE (%) Code currency 21-Mar-16 USDm FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E China H-share listed Nexteer Automotive Group Ltd * 1316 HK HKD 8.11 2613 Buy 10.8 9.7 2.5 2.1 5.2 4.4 1.9 2.1 26.0 23.8 Fuyao Glass Industry Group-H * 3606 HK HKD 16.90 5552 Buy 10.9 9.5 2.0 1.8 6.7 5.8 5.5 6.3 19.0 20.0 Minth Group Ltd 425 HK HKD 15.00 2142 NR 9.5 8.4 1.4 1.2 n.a. n.a. 4.0 4.5 15.1 15.4 Johnson Electric Holdings ** 179 HK HKD 24.35 2760 NR 13.5 12.2 1.3 1.2 7.2 6.1 2.1 2.3 10.3 10.7 Xinyi Glass Holdings Ltd 868 HK HKD 5.17 2575 NR 9.1 7.5 1.5 1.3 8.5 7.4 5.1 6.2 16.6 18.3 Weichai Power Co Ltd-H 2338 HK HKD 8.80 4961 NR 15.1 12.1 0.8 0.8 6.1 5.5 1.4 1.5 5.7 6.7 China A-share listed Huayu Automotive Systems -A 600741 CH CNY 14.44 7024 NR 7.4 6.7 1.2 1.1 5.2 4.8 4.1 4.4 18.4 17.8 Weifu High-Technology Grp-A 000581 CH CNY 18.98 2819 NR 10.6 9.5 1.5 1.3 14.7 13.6 2.3 2.5 14.7 14.7 Songz Automobile Air Con-A 002454 CH CNY 15.40 1005 NR 16.9 14.5 2.2 2.0 12.3 10.8 1.6 1.6 13.5 14.4 Ningbo Huaxiang Electronic-A 002048 CH CNY 17.40 1445 NR 18.1 14.1 1.8 1.6 n.a. n.a. 0.6 0.6 10.7 12.2 Japan Jtekt Corp ** 6473 JP JPY 1464.00 4504 NR 9.7 9.4 1.0 0.9 4.6 4.5 2.8 3.0 10.7 10.4 Nsk Ltd *, ** 6471 JP JPY 1012.00 5000 Outperform 8.3 9.0 1.1 1.0 5.1 5.3 3.4 3.4 13.9 11.4 Ntn Corp ** 6472 JP JPY 357.00 1704 NR 11.9 7.7 0.7 0.7 5.5 5.7 2.8 3.5 6.6 9.1 Denso Corp *, ** 6902 JP JPY 4312.00 34165 Outperform 13.4 11.9 1.0 1.0 5.8 5.3 2.8 3.0 7.7 8.3 Aisin Seiki Co Ltd *, ** 7259 JP JPY 4300.00 11356 Outperform 12.8 11.6 1.0 1.0 4.5 4.1 2.4 2.6 8.0 8.4 Toyota Industries Corp *, ** 6201 JP JPY 4840.00 14134 Hold 7.9 11.2 0.6 0.6 9.9 9.7 2.5 2.7 7.7 5.5 Asahi Glass Co Ltd 5201 JP JPY 599.00 6371 NR 23.4 17.5 0.6 0.6 5.3 5.1 3.0 3.0 2.7 3.6 Central Glass Co Ltd ** 4044 JP JPY 598.00 1152 NR 12.1 11.3 0.8 0.7 6.9 6.3 1.7 1.8 6.7 6.7 Co Ltd ** 5202 JP JPY 82.00 664 NR n.a. 35.1 0.5 0.5 8.0 7.3 n.a n.a n.a 0.3 S.Korea Hyundai Mobis Co Ltd * 012330 KS KRW 251500.00 21094 Outperform 7.2 6.8 0.8 0.8 5.6 5.3 1.6 1.8 12.3 11.8 Mando Corp * 204320 KS KRW 158500.00 1283 Buy 8.8 7.6 1.1 1.0 4.8 4.5 3.1 3.3 13.2 13.8 Hyundai Wia Corp * 011210 KS KRW 108000.00 2531 Buy 6.9 6.1 0.8 0.7 4.2 3.8 1.0 1.1 12.3 12.4 Hanon Systems * 018880 KS KRW 9290.00 4273 Buy 16.2 14.2 2.5 2.3 n.a. n.a. 2.4 2.7 16.6 16.7 Halla Holdings Corp 060980 KS KRW 52300.00 487 NR 7.5 6.6 0.6 0.5 5.1 4.6 2.0 2.2 8.2 8.2 US Dana Holding Corp DAN US USD 13.89 2088 NR 8.2 7.1 2.7 2.4 4.3 4.1 1.7 1.7 31.3 31.9 Johnson Controls Inc *** JCI US USD 38.82 25190 NR 10.3 9.5 2.1 1.9 8.3 7.3 2.9 3.2 20.1 21.1 Delphi Automotive Plc DLPH US USD 72.36 20049 NR 12.0 10.3 6.3 4.7 8.4 7.5 1.6 1.7 59.0 50.9 Autoliv Inc ALV US USD 113.60 9941 NR 16.8 15.3 2.7 2.5 8.1 7.6 2.1 2.2 16.5 16.7 Visteon Corp VC US USD 78.60 3050 NR 22.3 18.0 23.8 10.8 2.5 2.3 n.a n.a 117.5 n.a BorgWarner Inc BWA US USD 37.79 8285 NR 11.6 10.5 2.2 1.9 6.9 6.5 1.4 1.5 19.3 19.8 Others Motherson Sumi Systems ** MSS IN INR 254.05 5050 NR 26.2 19.4 7.9 6.3 10.2 8.2 1.3 1.8 33.2 34.8 Tong Yang Industry 1319 TT TWD 47.25 864 NR 13.9 11.4 1.4 1.4 9.1 6.3 3.2 3.8 9.9 11.8 Continental AG CON GR EUR 196.23 44168 NR 12.8 11.9 2.6 2.3 6.5 6.2 2.2 2.4 21.7 20.2 Valeo Sa FR FP EUR 133.55 11979 NR 12.8 11.5 2.5 2.1 5.5 5.0 2.4 2.7 21.6 20.4 Compagnie De Saint Gobain SGO FP EUR 37.69 23894 NR 15.4 13.0 1.1 1.0 6.5 5.8 3.3 3.4 7.1 8.3 Magna International Inc MG CN CAD 55.98 17170 NR 8.4 7.3 1.5 1.3 4.8 4.4 2.2 2.4 21.9 21.8 Total Weighted average 12.7 11.0 2.2 1.8 6.5 5.9 2.5 2.7 18.8 17.0 High 26.2 35.1 23.8 10.8 14.7 13.6 5.5 6.3 117.5 50.9 Low 6.9 6.1 0.5 0.5 2.5 2.3 0.6 0.6 2.7 0.3 Median 11.9 10.8 1.4 1.2 6.1 5.7 2.3 2.6 13.9 13.8 Source: Bloomberg, *Daiwa forecasts Note: **Mar year-end, *** Sep year-end 2015 for North America and Europe stocks

16

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Risks to our call Weaker-than-expected automotive sales The automotive-glass manufacturing business is directly related to automotive sales and production, which are highly cyclical and depend on the health of the economy and strength of consumer spending. Slower-than-expected auto sales in the China (Fuyao’s largest market) and the US (increasing exposure) would therefore have a negative impact on the company’s financial performance. In the event of automotive demand weakening and OEMs lowering car prices, Fuyao’s ASP would likely come under pressure.

Execution risk overseas As the company expands its business internationally, where it has limited experience and brand equity, it may be exposed to risks associated with regulatory and political environments that differ from those of its domestic market.

No minimum purchase obligations The company generally signs contracts with automotive OEMs that feature quality requirements but not minimum purchase obligations. Hence, a decline in the production requirements of its major OEM customers could weigh on Fuyao’s business. In 2014, Fuyao’s top 5 customers collectively contributed 17% of its revenue and its largest customer contributed 6.4% of its revenue.

Competition risk Many leading international automotive-glass manufacturers have established manufacturing facilities in China, such as Asahi, NSG and Saint-Gobain. Growing competition, especially from companies in regions of the world where energy and other costs are lower than Fuyao’s, could result in lower selling prices and/or reduce demand for some of Fuyao’s products.

Energy price risk Natural gas accounts for a large proportion of Fuyao’s cost of sales. The natural gas price internationally is closely related to the crude oil price internationally. Hence, a rebound in the price of crude oil or natural gas could have a significant impact on the company’s profitability.

17

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Company background Background Fuyao is China’s No. 1 Founded in 1987, Fuyao Glass is a leading automotive glass manufacturer, with the largest automotive glass market share of 63% by automotive glass sales revenue (72% share of the OEM market) manufacturer and the in China, and the second-largest player globally (20% in 2014). Among the world’s leading only automotive glass automotive glass manufacturers, including Japan’s Asahi Glass and Nippon Sheet and specialist among the France’s Saint Gobain, Fuyao is the only glass supplier that specialises in automotive world’s leading glass. manufacturers Fuyao Glass is also one of the few automotive glass manufacturers that have been qualified by the global OEMs and certified by the Big 4 automobile manufacturing groups. Indeed, the Fuyao’s major customers include the world’s top 20 automobile manufacturers by volume and China’s top 10 passenger vehicle manufacturers by volume. We believe Fuyao’s longstanding business relationships (averaging more than 10 years) with its top 10 customers are testament to the quality of its service and advanced manufacturing capabilities.

Fuyao: revenue breakdown by product type (2015)

CNY 462m; 3%

CNY 2,485m; 15% Automotive glass

Float glass

CNY 13,138m; rev mix 82% Others

Source: Company

Fuyao: shareholding structure

Ms. Chan Fung Mr. Cho Tak Ying Wong

99.99% 0.01% 100% 100% Chopline Limited

Heren Other holders of Other holders Yaohua Home Bridge Sanyi Charitable H-shares of A-shares Foundation

20.16% 50.85% 1.37% 0.48% 15.57% 0.01% 11.56%

Fuyao Glass

Source: Company

18

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Products Fuyao: types of glass products Segment Product Type Details

Float Glass n/a Float glass is the primary raw material for manufacturing automotive glass and architectural glass. There are four grades of float glass, namely optical grade, automotive grade, construction-use grade and regular. In general, the quality of automotive grade float glass is the second highest among these four types. All float glass products that the company manufactures are of automotive grade.

Laminated Laminated glass is made of two or more layers of float glass with PVB interlayers bonded between them. The PVB Glass layers prevent objects that strike the glass from penetrating the glass and prevent the glass from shattering into Automotive sharp pieces. Laminated glass is mainly used in automobile windshields. Glass Tempered Tempered glass is produced by heating float glass to softening point and rapidly cooling the surface uniformly with Glass air to increase its strength. Tempered glass breaks into small pieces without sharp edges when struck by an object, thereby reducing injury to passengers. Tempered glass is mainly used in side and rear windows of vehicles.

Encapsulated Produced by injecting polymer or plastic material on glass rim to enhance its function and aesthetics. glass Panorama Made of one or multiple glass panels to provide passengers with an uninterrupted view of the sky and fill the cabin sunroof glass with natural light and air. HUD glass It can be projected with speedometer and other importing driving and navigational information on the windshield thereby enabling the driver to concentrate on the road ahead. IR-cut glass It controls heat transfer through glass by using a special film coating on the inner surfaces of laminated glass to reflect infrared rays, thereby not only increasing passenger comfort but also improving fuel efficiency by reducing Other air-conditioning load. functional and value-added UV-cut glass It reduces UV rays entering the vehicle to protect passengers from sunburn and car interiors from deterioration. automotive glass: Wire heated It provides defogging and defrosting functions through embedded heating fine wires in the PVB interlayer of glass laminated glass. Semi-tempered Produced by bonding two layers of semi-tempered glass with PVB interlayers, thereby increasing its strength laminated compared with normal tempered or laminated glass. glass Antenna glass It allows wireless signals to pass through the vehicle by printing silver paste on the glass surface or by embedding copper wires in the PVB interlayers of laminated glass. Hydrophobic It has high water repellence and durability, thereby improving visibility in wet weather. glass Acoustic glass It reduces noise entering the windows through the insertion of a special layer within the laminated glass.

Source: Company

Company history Fuyao: development milestones Year Event

June 1987 Fuyao was established as a Sino-foreign equity joint venture in Fuqing, China. July 1989 Fuyao began selling automotive glass to Guangzhou Peugeot, signifying Fuyao's expansion into the OEM automotive glass market. June 1993 Fuyao's A shares were listed on the Shanghai Stock Exchange. December 1994 Fuyao established a subsidiary in Fuqing to double its annual production capacity by 1996. Began exporting automotive glass in North America. September 2000 Fuyao established Fuyao Changchun in Changchun, Jilin Province, its first step towards building a nationwide manufacturing network in China. October 2002 Fuyao began selling to Hyundai Mobis, marking its first agreement to sell OEM automotive glass to an overseas automobile manufacturer. May 2005 Fuyao entered into an agreement with Audi AG Ingolstadt in Germany to sell automotive glass used in the windshields of Audi C6. June 2011 Fuyao entered into an investment agreement to set up an automotive glass production project in Kaluga Oblast, Russia. August 2014 Construction of Phase I of the automotive glass production facility in Kaluga Oblast, Russia was completed. September 2014 Fuyao acquired from PPG a float glass manufacturing facility located in Mt. Zion, Illinois, United States, as well as certain assets and related liabilities. March 2015 Fuyao was listed on the Stock Exchange of Hong Kong.

Source: Company

19

Fuyao Glass Industry Group (3606 HK): 22 March 2016

Fuyao: management profile Management Profile

Mr. Cho Tak`` Wong Mr. Cho Tak Wong has served as Fuyao's Executive Director and Chairman of the Board since August 1999. He is also one of Fuyao's major founders, operators and investors. Mr. Cho Tak Wong currently also serves as a director of a majority of Fuyao's subsidiaries and has several positions in many organisations. Mr. Cho was Fuyao's Managing Director from December 1994 to August 1999, Fuyao's vice chairman from May 1988 to December 1994, and Fuyao's president from June 1987 to September 2003. Mr. Tso Fai Mr. Tso Fai has served as Fuyao's Executive Director since August 1998 and Fuyao's president since September 2006. He is also a director of a majority of Fuyao's subsidiaries and serves several positions in many organisations. He joined Fuyao in November 1989. Mr. Tso received a master’s degree in business administration from Baker College in the United States in December 2005. Mr. Tso obtained the qualification of senior economist as approved by Province in December 2012. Mr. Tso Fai is the son of Mr. Cho Tak Wong. Mr. Bai Zhaohua Mr. Bai Zhaohua has served as Fuyao's Executive Director since December 2006 and vice president since August 1999. He currently also serves as a director of a majority of Fuyao's subsidiaries. Mr. Bai joined Fuyao in November 1995, and was formerly Fuyao's Director from August 1999 to July 2001. Mr. Bai served as president of Fujian Yaohua Automotive Parts Co., Ltd. from June 1998 to August 1999. Mr. Chen Xiangming Mr. Chen Xiangming has served as Fuyao's Executive Director since February 2003, Board Secretary since October 2012 and Joint Company Secretary since October 30, 2014. He currently also serves as a director of a majority of Fuyao's subsidiaries. He joined Fuyao in February 1994. Mr. Chen obtained the qualification as an accountant of the PRC in December 1996 and the qualification as a senior economist qualification from Fujian Province in December 2012. Mr. He Shimeng Mr. He Shimeng has served as Fuyao's vice president since August 1999. He served as the general manager of production department from March 1995 to November 1999, and the deputy manager of Fuyao's sales department from August 1994 to February 1995. Mr. He graduated from the Naval University of Engineering in the PRC in June 2001 with a college diploma, majoring in management engineering. Mr. He is the brother-in-law of Mr. Cho Tak Wong and the uncle of Mr. Tso Fai. Mr. Chen Juli Mr. Chen Juli has served as Fuyao's vice president since February 2002. He joined Fuyao in July 1989. Mr. Chen has also served as president of Fuyao Hong Kong since September 1997, and president of Fuyao Group Hong Kong since March 2010. Mr. Chen also served as Fuyao's Director from December 1994 to July 2001. Mr. Chen graduated from Beijing University of Aeronautics and Astronautics in July 1989. Mr. Chen Jicheng Mr. Chen Jicheng has served as Fuyao's vice president since February 2011 and the general manager of Fuyao's commerce department since November 2004. He joined Fuyao in October 2003 and received executive master of business administration degrees from Tsinghua University in Beijing and INSEAD Business School in France in January 2015, respectively. Mr. Zuo Min Mr. Zuo Min has served as Fuyao's chief financial officer since November 2014. He first joined Fuyao in July 1989. Mr. Zuo received a master’s degree in business administration from Xiamen University in January 2000. He graduated from Fudan University with a doctorate-equivalent qualification in accounting in June 2008.

Source: Company

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

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] SK KIM (82) 2 787 9173 [email protected] Regional Head of Product Management IT/Electronics – Semiconductor/Display and Tech Hardware 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 Junjie TANG (852) 2773 8736 [email protected] Kevin JIN (82) 2 787 9168 [email protected] Macro Economics (China) Small/Mid Cap Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property TAIWAN Cynthia CHAN (852) 2773 8243 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Property (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Leon QI (852) 2532 4381 [email protected] (Regional) Banking (Hong Kong/China); Broker (China); Insurance (China) Christie CHIEN (886) 2 8758 6257 [email protected] Anson CHAN (852) 2532 4350 [email protected] Banking; Insurance (Taiwan); Macro Economics (Regional) Consumer (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Jamie SOO (852) 2773 8529 [email protected] IT/Technology Hardware (PC Hardware) Gaming and Leisure (Hong Kong/China) Christine WANG (886) 2 8758 6249 [email protected] Dennis IP (852) 2848 4068 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Power; Utilities; Renewables and Environment (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] John CHOI (852) 2773 8730 [email protected] IT/Technology Hardware (Handsets and Components) Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Helen CHIEN (886) 2 8758 6254 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Small/Mid Cap Head of Automobiles; Transportation and Industrial (Hong Kong/China) Brian LAM (852) 2532 4341 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Transportation – Railway; Construction and Engineering (China) Jibo MA (852) 2848 4489 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Custom Products Group Thomas HO (852) 2773 8716 [email protected] Capital Goods; Utilities

Custom Products Group SINGAPORE Ramakrishna MARUVADA (65) 6499 6543 [email protected] PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Head of Singapore Research; Telecommunications (China/ASEAN/India) Utilities and Energy Royston TAN (65) 6321 3086 [email protected]

Oil and Gas; Capital Goods David LUM (65) 6329 2102 [email protected] Banking; Property and REITs Shane GOH (65) 64996546 [email protected] Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

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Fuyao Glass Industry Group (3606 HK): 22 March 2016

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