July 23, 2015

Autos (NEUTRAL) Sector Salad days in coming to an end

Update WHAT’S THE STORY? Event: On a recent trip to China we visited BAIC (partner to Hyundai Motor: HMC), China’s SUV leader Great Wall, and four local dealerships. Impact: We expect auto demand in China to bounce back in 4Q as price cuts wind down, the economy picks up, and seasonality kicks in around September holidays (Mid-Autumn Festival). In the longer term, China’s auto industry should consolidate around 5-10 firms. Benchmarking Toyota, Great Wall is investing heavily in its Baoding complex and moving aggressively to become an iconic Chinese company. BAIC, however, is reluctant to cut ASPs at its JV with HMC, as it has a fast-growing second JV with Mercedes-Benz. Action: HMC may not change its pricing policy in China as soon as some had hoped, as BAIC does not agree on the need for price cuts. Meanwhile, aggressive pricing by Japanese automakers bodes ill for an immediate recovery in HMC/Kia’s sales. Over the longer term, however, HMC/Kia should remain among the top-five players in China, backed by their strengths in quality and cost control. Though Chinese auto demand is correcting, this should prove temporary; the market’s growth potential is intact. Still, we Esther Yim advise tempering expectations for excess profit at the Korean automakers, as vehicle Analyst prices in China are approaching the global average. Finally, ongoing changes in the [email protected] 822 2020 7727 competitive landscape shed light on Great Wall’s growth potential.

Hyunryul Cho Research Associate THE QUICK VIEW [email protected] Chinese auto demand to stay weak in 2H: Auto demand in China shrank 3.2% y-y in June, the first 822 2020 7762 decline since Dec 2008. The China Association of Automobile Manufacturers has slashed its full-year demand growth forecast from 7% to 3%. We see three factors behind weakening Chinese auto demand.

 First, consumer sentiment has waned amid an economic slowdown, anti-corruption policies, and a rise in stock  AT A GLANCE market volatility.

Hyundai Motor (005380 KS, KRW138,000)  Second, auto demand is correcting following disproportionate growth over 2000-2014. From late-2012 to 2014, growth in demand was the result of consumers rushing to buy cars before authorities imposed limits on KRW190,000(+37.7%) license plate issuances. Target price  Third, auto demand and carmakers’ market shares until 2014 were calculated using wholesale data. This drove

Kia Motors (000270 KS, KRW42,300) carmakers to compete by increasing production. Then, with dealerships complaining about growing inventories, carmakers started releasing retail sales figures this year. KRW60,000(+41.8%) Target price Growth potential intact: We believe the correction in China’s auto demand will prove temporary, as vehicle ownership per thousand people is still around 50. Hyundai Mobis (012330 KS, KRW201,000)  Positives: Positives include that: 1) real estate transactions have been recovering since May; 2) the government’s determination to buoy the economy should have a positive impact from 2H; and 3) auto demand KRW250,000(+24.4%) is still growing strongly in small inland cities. Target price  Demand to rebound as early as 4Q: BAIC and Great Wall believe auto demand will recover in 4Q15 or 1Q16 as vehicle ASP cuts wind down in 3Q15, the economy visibly improves, and auto demand shows seasonal strength around September (Mid-Autumn Festival) and February (Lunar New Year). Prices converging on global average: We advise tempering expectations for excess profit at Korean carmakers.  Vehicle prices to fall: Considering the market’s size and intensity of competition, it is only natural that vehicle prices will fall from high levels. HMC’s Santa Fe costs 40% more in China than in Korea.  Market to consolidate around 5-10 players: Top Chinese automakers should grow strong, while smaller local players are forced out of the market. HMC/Kia need more time to adjust price policy: HMC may not change its pricing policy in China as soon as some had hoped, as BAIC does not see the need for price cuts. Kia keeps its price policy identical to HMC’s.  BAIC: BAIC is resistant to ASP cuts at BHMC, as it has a fast-growing second JV ( Automotive) with Mercedes-Benz.  Japanese carmakers: Toyota dealers now offer incentives equal to 10% of prices. Aggressive pricing since 2H14 has brought actual prices of Japanese cars below rival HMC models.  HMC/Kia to stay among top five: Highly regarded for cost-control and quality, HMC/Kia should remain in the top five. That said, they do need to shake up their segment mix and focus on introducing new technology.

Samsung Securities (Korea) www.samsungpop.com

July 23, 2015 Autos

 CONTENTS

1. China auto industry converging p2 on average 2. HMC/Kia well-received in China p7 3. Company visits: Great Wall p11 and BAIC Motor

1. China auto industry converging on average

Auto demand to recover from 4Q Auto demand in China shrank 3.2% y-y in June, the first decline since Dec 2008. In 1H, the nation’s light-vehicle demand rose a mere 5% y-y to 10.1m vehicles, prompting the China Association of Automobile Manufacturers to slash its full-year demand growth forecast from 7% to 3%. Concerns over Chinese auto demand are weighing on the stock prices of not only Hyundai Motor (HMC) and Kia Motors—which generate much of their sales volume from China—but all global automakers, including VW, the top player in China. The world’s top players are competing over China, which buys more than 20m vehicles pa, accounting for 25% of global demand. In June, China sales at HMC and Kia dropped by 30.8% and 26.5% y-y, respectively. VW’s China sales fell 17% y-y last month.

China: Monthly auto demand and growth Global automakers: Share-price performances

('000 units) (% y-y) (%) 2,500 50 0 40 (0.1) (0.6) 2,000 (5) (2.2) 30 (3.0) (3.2) (5.2) 20 (6.6) (6.9) 1,500 (10) (7.9) 10 (9.0) 1,000 0 (15) (14.3) (10) (14.8) 500 (20) (20) 0 (30) (21.5) (25) Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Kia VW GM PSA Ford HMC BMW Honda Toyota Daimler Renault

Demand (LHS) Growth (RHS) Average

Source: KARI, Samsung Securities Note: Jun 1-Jul 21 Source: Bloomberg, Samsung Securities We see three factors behind the weakness in Chinese auto demand. First, consumer sentiment has waned amid an economic slowdown, anti-corruption policies, and a rise in stock market volatility. China’s GDP reportedly grew 7% in 2Q, but the credibility of that figure has been questioned. After a steep run-up in 1Q, China’s stock market began plunging in 2Q and has yet to show signs of stabilizing despite government measures. JV automakers are suffering from the dual thorns of the government’s: 1) determination to fight corruption—in part, by reducing the government’s fleet of vehicles; and 2) push to have consumers buy local brands. Second, auto demand is correcting following disproportionate growth over 2000-2014. After China permitted foreign firms to enter the auto market in 2000, auto demand grew at a 17.8% CAGR until 2014. Even during late 2008, when the global financial crisis hit, the nation’s auto demand grew an explosive 30% on the back of government subsidies for small cars. And in 2012, when the real economy weakened due to dwindling real estate transactions, auto demand continued to swell as consumers rushed to buy cars before authorities imposed limits on license plate issuances in 2013 to combat pollution and congestion. Eight large cities have license plate issuance limits, and, contrary to expectations, no more cities adopted limits after Shenzhen did so in late 2014.

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July 23, 2015 Autos

Third, auto demand and carmakers’ market shares until 2014 were calculated using wholesale data. This drove carmakers to compete by increasing production regardless of actual retail sales, resulting in bulging inventories. In late 2014, dealerships complained about this and demanded greater incentives from carmakers. In 2015, carmakers began announcing retail sales figures and working on reducing inventories.

China’s auto market: Inventories China’s auto market: Price cuts Automaker Details Announced price cuts of CNY10,000-54,000 ('000 vehicles) GM Shanghai (KRW1.8m-9.5m) on 40 models 600 Cut prices on some models (including mid-sized sedans) VW Shanghai by up to CNY10,000 500 Reinforced promotional efforts, cut prices, Honda/Ford and covered excise taxes 400 Cut prices on its H2 and H6 models 300 Great Wall by CNY5,000 and CNY6,000, respectively Cut price on its main sedan, C30, by more than 10% 200 Source: Press, Samsung Securities 100

0

(100)

(200) Jan 11 Jan 12 Jan 13 Jan 14 Jan 15

Note: Excluding commercial vehicles Source: Auto Data Bowl, Samsung Securities BAIC and Great Wall say China’s auto demand should correct for a while, but recover in 4Q15 or 1Q16, as: 1) vehicle ASP cuts should wind down in 3Q15; 2) the government’s resolve to strengthen the economy should pay off from 2H; and 3) auto demand is seasonally strong around September (Mid-Autumn Festival) and February (Lunar New Year) holidays. That real estate transactions have been rising since May also bodes well. If they keep climbing, the real economy should benefit. Auto demand is highly correlated with real estate transactions.

China: Housing transaction volume growth vs auto demand growth

(% y-y) 70 60 50 40 30 20 10 0 (10) (20) (30) Jan 11 Jan 12 Jan 13 Jan 14 Jan 15

Housing transaction volume Auto demand

Source: National Bureau of Statistics of China, KARI, Samsung Securities

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China’s auto market converging to global average We believe the correction in China’s auto demand will prove temporary, as vehicle ownership per thousand people is still around 50. That said, we advise tempering expectations for excess profit at Korean automakers, as price competition looks inevitable in a market that is exiting its high-growth phase but crowded by all of the world’s top players. Vehicle prices in China have been much higher than in the US and Korea. HMC’s Santa Fe, for example, is priced at KRW39m-54m in China, 40% above its Korean price tag of KRW28m-37m. Such high ASPs have given HMC’s China plants fat operating margins of 14%—or 17% if including technology royalty income. High ASPs are also the source of high operating margins at Chinese players. Great Wall boasts a double-digit operating margin not because it uses low-grade components or enjoys government support, but because its ASPs, though 30-50% lower than rival JV models, are still high in absolute terms. Great Wall’s best-selling model, the H6, sells for CNY99,800-162,800 (or KRW18.5m-30.1m), which is comparable to the price tag HMC’s Tucson (same segment) sports in Korea. Given that HMC sells 600,000-700,000 units of the Tucson in Korea annually for an operating margin of 12-13%, Chinese automakers’ profitability levels should raise no eyebrows. This is not to say that vehicle prices in China will fall to US or Korean levels, as ASPs in any given market are determined by the market’s size and intensity of competition, and China’s real estate and durable goods prices are also high. Still, automakers operating in China should be unable to keep profitability at levels that have enjoyed through 2014.

Sonata and Santa Fe: Prices in major markets (KRWm) Sonata In won terms* Santa Fe In won terms* Korea Lowest 23.97 30.06 MSRP 22.45 28.17 Taxes 1.52 1.89 Highest 34.02 39.43 MSRP 31.90 36.98 Taxes 2.12 2.45 US Lowest (USD) 23,054 25.70 27,196 30.32 MSRP 21,150 23.58 24,950 27.82 Taxes 1,904 2.12 2,246 2.50 Highest (USD) 36,542 40.74 35,970 40.11 MSRP 33,525 37.38 33,000 36.80 Taxes 3,017 3.36 2,970 3.31 China Lowest (CNY) 190,240 35.37 228,232 42.43 MSRP 174,800 32.50 209,800 39.00 Taxes 15,440 2.87 18,432 3.43 Highest (CNY) 271,650 50.50 315,069 58.57 MSRP 249,800 46.44 289,800 53.87 Taxes 21,850 4.06 25,269 4.70 Source: Company data, Samsung Securities

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Operating performances: vs Great Wall (KRWb) Beijing Hyundai Great Wall 2013 2014 2013 2014 Sales 19,433 19,756 9,746 10,313 Operating profit 2,745 2,695 1,700 1,560 Net profit 1,937 1,925 1,375 1,468 Margins (%) Operating profit 14.1 13.6 17.4 15.1 Net profit 10.0 9.7 14.1 14.2 Source: Company data, Samsung Securities

Korean automakers/parts makers: Portion of net profit derived from China

(%) 80 70 60 50 40 30 20 10 0 Kia Wia PHA HMC Mobis HVCC Mando Ilji Woory Sejong Hitech SL Corp Industrial Industrial Sungwoo Technology

Source: Company data, Samsung Securities We expect the Chinese auto industry to consolidate around 5-10 players, as slowing demand whips up competition and tighter environmental regulations drive up R&D costs. In the US market, the top players dominate a combined market share of 78%. In Japan, the big three control 67%. In China, some 100 automakers have the combined capacity to produce 40m vehicles pa, double that of current demand. Smaller automakers producing 20,000-30,000 vehicles pa have so far survived on government subsidies, but may no longer be able to compete now that top players are cutting ASPs. Already, the top-10 firms control 86% of the Chinese market, and a merger between the number-two and number- four players—Dongfeng and FAW—is looking increasingly likely.

Top-10 Chinese automakers: Market share trends (%) Company JVs 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015* 1 SAIC GM and VW 17.0 17.7 18.7 19.8 20.4 21.8 23.1 23.1 23.5 23.4 2 , Honda, PSA, and Kia 12.9 12.9 12.9 13.9 13.8 15.1 14.4 14.6 14.9 14.1 3 , Mazda, Suzuki, and PSA 9.8 9.8 9.8 13.7 13.1 10.8 10.1 10.0 10.8 12.1 4 FAW VW, Toyota, Mazda, and GM (commercial vehicles) 16.2 16.3 16.3 14.3 12.4 12.4 12.3 11.9 12.0 11.3 5 BAIC HMC and Daimler 9.5 7.9 7.9 9.1 8.0 7.9 8.3 9.1 9.5 9.6 6 GAC Honda, Toyota, Fiat, and Mitsubishi 4.9 5.8 5.8 4.4 4.4 4.0 3.5 4.4 4.9 4.3 7 Great Wall 1.2 1.4 1.4 1.7 2.3 2.7 3.3 3.4 3.1 3.6 8 Brilliance BMW 2.9 3.4 3.4 2.6 2.9 3.1 3.3 3.5 3.4 3.2 9 Volvo (subsidiary) 2.8 2.52.5 2.42.4 2.42.6 2.51.9 2.4 10 JAC 2.4 2.4 2.4 2.4 2.3 2.4 2.2 2.1 1.7 2.2 Total 79.6 80.1 81.1 84.3 82.1 82.6 83.1 84.6 85.6 86.2 Note: * January-May Source: Auto Data Bowl, Samsung Securities On the top-10 list, Chinese automakers with strong local-brand power—Great Wall, Geely, and Changan—should continue to grow briskly. Around the world, most governments support local automakers bulking up, as they are aware of the vast ramifications the auto sector has on employment and related value chains. When the Chinese auto market was in a fledgling state, JV brands enjoyed rapid growth thanks to their strong global brand equity. Now, however, the landscape is shifting, with auto demand dividing into two distinct groups—premium and lower-end—as smaller, inland cities are replacing larger, coastal metropolises as the drivers of demand growth. We believe Chinese automakers employing a value-for-money strategy will enjoy structural growth.

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July 23, 2015 Autos

China: Vehicle ownership and disposable income, by province

(Vehicles) Eastern Central Western (CNY'000) 300 45 240 40 35 180 30 120 25 60 20 0 15 Jilin Tibet Hebei Anhui Tianjin Hubei Henan Beijing Shanxi Fujian Jiangxi Hainan Hunan Gansu Ningxia Yunnan Qinghai Jiangsu Xinjiang Shaanxi Guizhou Liaoning Sichuan Guangxi Zhejiang Shanghai Shandong Chongqing Guangdong Heilongjiang Inner Mongolia

Vehicles per thousand people (LHS) Disposable income (RHS)

Source: CEIC, Samsung Securities

China: Double peaks projected for income and consumption

Second- to fourth-tier cities First-tier: city (Mil people)

300 Games Housing Premium cars

250 Education Cafés Luxury housing Childrens’ Fashion Luxury items Home /cosmetics 200 appliances products Movies Food Tour/leisure Premium home Small-and appliances 150 mid-sized cars Shoes Sports Golf Household 100 Mid-low price goods clothing Culture 50 2015 2020 0 1,500 3,000 5,000 8,000 10,000 12,000 15,000 (USD per capita)

Source: National Bureau of Statistics of China, Samsung Securities

China: Light-vehicle market breakdown China: SUV market breakdown

(%) (%) 100 100 90 90 80 80 48.4 52.5 53.4 53.6 70 55.3 58.2 55.3 70 61.9 66.8 71.0 66.3 66.6 60 60 50 50 40 40 30 30 51.6 47.5 46.6 46.4 20 44.7 41.8 44.7 20 38.1 33.2 29.0 33.7 33.4 10 10 0 0 2010 2011 2012 2013 2014 2015* 2010 2011 2012 2013 2014 2015*

Local automakers JVs Local automakers JVs

Note: * January-May Note: * January- May Source: Auto Data Bowl, Samsung Securities Source: Auto Data Bowl, Samsung Securities

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 CONTENTS

1. China auto industry converging p2 on average 2. HMC/Kia well-received in China p7 3. Company visits: Great Wall p11 and BAIC Motor

2. HMC/Kia well-received in China

HMC/Kia’s sales unlikely to recover soon HMC needs to alter its price policy in China, where auto demand is slowing and local players emerging as viable contenders, backed by competitive prices. However, HMC may not change its pricing policy in China as soon as some had hoped, as BAIC does not agree on the need for price cuts. Kia, although partnered with Dongfeng, keeps its price policy identical to HMC’s. Japanese automakers, on the other hand, have priced their vehicles aggressively, making their cars cheaper than comparable HMC/Kia models—which bodes ill for an immediate recovery in HMC/Kia’s sales. To minimize margin squeeze at current ASPs, the Korean automakers are likely to cut output and minimize inventory. If sales at the BAIC-HMC JV (Beijing HMC: BHMC) continue to fall, BAIC should agree to price cuts, as the JV contributes 71% to its sales and 80% to its operating profit. If HMC can alter its pricing policy by 4Q (when demand should rebound and the firm roll out new cars—eg, a redesigned Tucson), sales may recover.

China: Auto sales growth, Jan-May 2015

(%) 60 Local makers JV makers 49.8 50 40

30 22.0 20.3 16.2 20 11.1 9.1 10 5.8 (0.2) (0.3) (2.4) (6.9) 0 (10) JAC GAC FAW BAIC SAIC Geely Brilliance Dongfeng Great Wall Changan (JV) Changan (local)

Source: Auto Data Bowl, Samsung Securities

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HMC: Retail sales volume and shipments in China Kia: Retail sales volume and shipments in China

('000 vehicles) ('000 vehicles) 130 70

120 65 60 110 55 100 50 90 45 80 40

70 35 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15

Retail sales Shipments Retail sales Shipments

Source: Company data, Samsung Securities Source: Company data, Samsung Securities China’s top two players VW and GM announced price cuts in April and May, respectively, prompting other JV brands to turn to aggressive pricing, too. Toyota dealers now offer incentives equal to 10% of vehicle prices. China’s SUV leader Great Wall announced price cuts in June. Although HMC/Kia hiked incentives, they remain equivalent to 5% of vehicle price tags. Japanese automakers’ aggressive pricing since 2H14 has brought the actual prices of their vehicles below competing HMC/Kia models.

Chinese market: Prices of HMC’s Langdong vs prices of competing Japanese models

(CNY) 170,000

160,000

150,000

140,000

130,000

120,000

110,000

100,000 Langdong Old Corolla New Corolla Axela Crider Levin Tilda

Source: Autohome, Samsung Securities BAIC is resistant to ASP cuts at BHMC, as it has a fast-growing second JV (Beijing Benz Automotive: BBAC) with Mercedes-Benz. BAIC thinks highly of BHMC’s quality management and cost controls, and it not worried about utilization—which is still above 90% despite having slipped below once or twice. The Chinese firm is skeptical whether ASP cuts will help sales recover, as VW’s ASP cut failed to boost sales, due to demand concentrating on SUVs. BBAC’s sales grew 59.8% y-y to 103,000 vehicles in 1H, in stark contrast to sale at other luxury brands, BMW and Audi, which fell. BAIC, which turned BBAC into a consolidated subsidiary in 2012 by increasing its stake by 1%, saw sales slip 1.2% y-y to 762,000 vehicles in 1H despite strong growth at BBAC.

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China: German brands’ ytd* sales growth (including imports) China: BAIC’s ytd* sales growth (excluding imports)

(% y-y) (% y-y) 35 32.9 70 59.8 30 60

25 50 40 20 30 15 20 10 10 5 1.1 0 0 (10) (3.4) (7.7) (5) (1.8) (20) Benz BMW Audi Beijing Benz Beijing Motor Beijing Hyundai (BBAC) (BHMC)

Note: *Jan-May 2015 Note: *Jan-Jun 2015 Source: Auto Data Bowl, Samsung Securities Source: Company data, Samsung Securities

HMC/Kia to stay in upper ranks over long-term Both BAIC and Great Wall are optimistic about HMC/Kia’s longer-term growth potential, and they view the Korean firms’ cost controls and quality management as their biggest strengths. BAIC said HMC is the only automaker that can earn a net margin of 10% even at an ASP of CNY100,000 in China. Great Wall, impressed with HMC’s dramatic rise from newcomer to a global top-five player, said it is benchmarking the Korean firm’s quality management and cost-control practices. HMC/Kia ranked high in the J.D. Power 2014 Initial Quality Study (IQS), Automotive Performance Execution and Layout (APEAL), and Customer Satisfaction of after-sales Index Study (CSIS). Of particular note, HMC has topped the Sales Satisfaction Index Study (SSIS) for the past two years. BAIC and Great Wall attribute HMC/Kia’s Chinese market share losses this year to the firms rolling out relatively few new models at a time when demand is weakening. HMC/Kia’s high sales growth had been driven by their introducing new models and entering new segments. However, since they diversified into the small-SUV segment in 2014, HMC/Kia have been rolling out updates of existing models. The Chinese firms we spoke with believe HMC/Kia’s recent weakness will prove to be temporary given the Korean firms strengths—ie, brand image as a producer of high-quality mass-market cars, and extensive sale network across the mainland. They added that they believe stock market concerns over HMC/Kia’s Chinese sales are overblown. On the other hand, they were rather skeptical about Japanese automakers’ long-term growth prospects in light of those firms’ conservative investments in the Chinese market (and despite their sales beginning to recover this year on low 2014 base and aggressive pricing).

Chinese market: Initial Quality Study (IQS) (Rank) 2009 2014 Brand Score Brand Score 1 DF Honda 88 GAC Toyota 82 2 GAC Honda 90 Beijing Hyundai 85 3 Beijing Hyundai 91 DF Honda 86 4 DF Yueda Kia 94 DF Yueda Kia 86 5 FAW Toyota 101 GAC Honda 87 6 GAC Toyota 104 94 7 SAIC Buick 107 DF Nissan 97 8 DF Nissan 108 FAW Toyota 97 9 Changan Ford 127 DF Peugeot 99 10 FAW VW 128 GAC Chuan Qi 99 Source: J.D. Power, Samsung Securities

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Chinese market: Sales Satisfaction Index of vehicles Study (SSIS) (Rank) 2009 2014 Brand Score Brand Score 1 DF Peugeot 842 BHMC 772 2 SAIC Buick 835 DF Citroen 772 3 FAW VW 835 DF Nissan 765 4 DF Nissan 834 DF Yueda Kia 746 5 SAIC Chevrolet 831 SAIC VW 746 6 Skoda 831 Changan Ford 738 7 GAC Honda 829 DF Peugeot 737 8 SAIC VW 829 FAW Mazda 721 9 DF Honda 827 692 10 BHMC 823 GAC Honda 690 Source: J.D. Power, Samsung Securities

Chinese market: Customer Satisfaction of after-sales Index (CSIS) (Rank) 2009 2014 Brand Score Brand Score 1 GAC Honda 870 DF Peugeot 906 2 SAIC 846 GAC Honda 906 3 DF Honda 845 DF Citroen 898 4 DF Nissan 839 DF Yueda Kia 890 5 DF Citroen 838 BHMC 876 6 SAIC Chevrolet 838 Chery 874 7 GAC Toyota 835 DF Honda 872 8 SAIC Buick 834 SAIC Chevrolet 872 9 FAW Toyota 831 DF Nissan 870 10 BHMC 824 FAW 863 Source: J.D. Power, Samsung Securities

Ytd* sales growth in China (including exports): Korean vs Japanese automakers

(% y-y)

20 16.9

15

10

5 2.1 0.6 0

(5) (3.6)

(10)

(15) (13.0) Honda Kia Toyota HMC Nissan

Note: *January-May Source: Auto Data Bowl, Samsung Securities BHMC plans to bring its fourth and fifth China plants online over late 2016-2017, increasing its annual output by 600,000-800,000 vehicles. Kia’s China capacity is scheduled to expand by 150,000 vehicles in 2016. To secure growth over the longer term, HMC/Kia need to: 1) increase the number of China-only models they offer; 2) make the introduction of new technology a priority; and 2) revisit their strategy of offering new models alongside older ones—which has so far boosted sales. Meanwhile, we believe their parts vendors, including affiliates such as Hyundai Mobis, should reduce their dependence on the Korean automakers and secure new customers (including Chinese firms). (For more details, see our Apr 27 report China’s up-and-comers.)

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 CONTENTS

1. China auto industry converging p2 on average 2. HMC/Kia well-received in China p7 3. Company visits: Great Wall p11 and BAIC Motor

3. Company visits: Great Wall and BAIC Motor

Great Wall dreaming of becoming China’s Toyota Great Wall shares have fallen 40% from their April high (as of Jul 20), hurt by concerns of a third-party rights offering, slowing auto demand, and price competition. Given the recent volatility in China’s markets, they are unlikely to rebound in the near future, but we remain bullish on the company for its medium- to long-term growth momentum.

Great Wall: Shares before and after third-party offering Before After Shares Ownership (%) Shares Ownership (%) A shares Existing shares 2,009,243,000 66.04 2,009,243,000 58.59 Estimated issuance 387,007,600 11.28 H shares 1,033,180,000 33.96 1,033,180,000 30.13 Total 3,042,423,000 100.00 3,429,430,600 100.00 Source: Company data, Samsung Securities

Great Wall: Expected use of proceeds from third-party offering (CNYm) Total investment Issuance proceeds to be applied* EV R&D 5,080 5,080 EV smart transmission systems (0.5m units) 4,142 4,000 EV motor and management devices (0.5m units) 1,762 1,700 EV driving battery systems (1m packs) 1,044 1,000 Smart vehicle R&D 5,033 5,020 Total 17,061 16,800 Note: * Issuance expected to involve up to 387m shares (CNY16.8b) Source: Company data, Samsung Securities We recently visited Great Wall, speaking to its IR team and touring its headquarters, plants, and R&D center in Baoding. With a population of 11m, Baoding is China’s seventh largest metropolis, and we came away from our visit most impressed with the planning the city and Great Wall are putting into the development of an automotive industrial complex. The city is 20 times as large as Ulsan, where Hyundai Motor (HMC) has its plants, and 28 square kilometers of land has been earmarked for automotive production (more than 55 times as much as HMC has in Ulsan). Much like Nagoya and Toyota, Great Wall and Baoding are working in concert to establish an auto-production value chain. Parts affiliates are opening plants nearby, and around 6,000 people now work in Great Wall’s research center (it can accommodate 10,000), with more than 100 previously having worked at foreign carmakers. The company is building apartment complexes, schools, and parks for employees and residents. The investments may seem excessive in relation to Great Wall’s 2014 sales volume of 800,000 units—in comparison, HMC and Kia Motors sold a combined 8m vehicles last year and had 10,000 R&D personnel in Korea—but an argument can be made that they are reasonable, given the size and growth potential of the Chinese market, and Great Wall’s chances of becoming the country’s representative carmaker.

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Great Wall: Overall capacity

Baoding plant Capacity:400,000 units pa Model: Wingle, H5, H1, M4, C30 Chengde Zhangjiakou

Xushui first plant Beijing Qinhuangdao Opened: Nov 2011 Tangshan Capacity: 250,000 units pa Tianjin first plant Tianjin Model: H8, H9, Coupe C Langfang Opened: Aug 2011 Capacity: 250,000 units pa Baoding Model: H6 Xushui second plant Opened: Jul 2015 Cangzhou Tianjin second plant Capacity: 250,000 units pa Shijiazhuang Opened: Jul 2013 Model: H7 Capacity: 250,000 units pa Hengshui Xingtai Model: H6, H2, C50

Handan

Source: Company data, Samsung Securities

Great Wall: Baoding R&D center

Source: Company data, Samsung Securities

Great Wall: Baoding complex plans

Source: Company data, Samsung Securities

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By the time a country has gone through its first motorization period, a leading automaker usually has emerged within it—Great Wall has the chance to become this, as well as a global brand. The company is reshaping China’s auto market by specializing in the rapidly growing SUV segment. Its brand specializes in SUVs (the Great Wall brand focuses on sedans), offering seven models priced at CNY60,000-300,000. Most foreign-domestic joint ventures in Japan offer only one or two SUV models and are unprepared to exploit the growing popularity of SUVs. (See our Jun 4 report “Great Wall’s growth backed by internalized core technologies”.)

Great Wall: Full SUV lineup

M4 H5 H9

H8 H4 H2 H6 Coupe c H7

60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 Retail price (CNY’000) Source: Company data, Samsung Securities Designated a high-tech firm by Beijing, Great Wall is subject to only a 15% tax rate, and because it has internalized many core technologies, it does not pay fees to outside firms for technologies. In contrast, JVs pay 25% of their profits as taxes and largely depend on their foreign partners for components and technology. For this reason, it is hard for them to receive a high-tech designation. In response to JVs cutting prices and seasonally weak summer demand, Great Wall lowered prices on some models in June. If conditions allow, however, the firm hopes to raise prices again after September. While its domestic sales remain solid, exports have suffered from a strong yuan and weak demand in emerging markets (particularly Russia). Exports are unlikely to rebound soon, but we believe the company, over time, will realize its vision of becoming a global SUV maker, and rising exports will drive its shares higher.

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Q&A with Great Wall Q. Can you comment on the demand outlook? A. Auto demand began to weaken in April and should remain lackluster through August. Slowing GDP growth has been influencing sales volumes, but demand should start rebounding from September as the traditionally off-peak summer season comes to an end, with support provided by holidays in October and in 4Q before the New Year. Q. Why have you been cutting prices? A. Great Wall has cut prices to maintain sales volume in response to seasonally weak auto demand in April-May and signs of an economic slowdown. Luxury brands cut prices last year and JV brands followed suit earlier this year. The company intends to cut prices over June-September, then raise them again depending on market conditions. Q. How will you sustain 13-14% operating margins when ASPs of some models are up to 50% less than those of JV brands? A. Three factors will allow this: 1) cost management—wholly-owned subsidiaries supply 50-60% of our components; 2) a low R&D burden—unlike JVs, we do not have to pay technology fees; and 3) pricing—while some of our models are priced lower, on average our ASPs are slightly higher than those of local brands, while our cost levels are similar. Q. Does Great Wall receive subsidies as a local brand when buying raw materials from Chinese steelmakers or investing in R&D? A. Great Wall does not receive subsidies but we do get some tax benefits. We are classified as a high-tech firm, and thus subject to a tax rate of only 15% (vs 25% for other firms). This benefit lasts for three years, after which we can reapply for it. Q. Why are price cuts failing to boost JVs’ sales volume? A. Volkswagen’s sales volume has not recovered since price cuts in April because passenger car demand has not picked up. SUV sales have expanded steadily, however, and Great Wall expects SUVs to become mainstream. Q. What countermeasures are planned if JVs release low-priced cars? A. JV brands are likely to start offering low-end autos in the near future, but Great Wall will keep launching new models. JVs will not be able to maintain the same quality in their mass-market models that they offer in luxury cars. Q. What is the possibility of local brands outpacing JVs in total market share? A. JVs control the Chinese market now, but local brands have been gaining presence in SUVs. Consumers are starting to pay more attention to quality-vs-price (ie, value), focusing more on the practical aspects of a car than brand power. Great Wall has a positive outlook on and Geely Automobile. Q. Why is HMC’s sales volume shrinking? A. HMC and European automakers have seen sales volume decline. Only the Japanese are enjoying solid growth. Korean players have less brand power than their European and Japanese rivals among Chinese consumers—the rankings go in the order of Europe, Japan, Korea and China. On quality, HMC ranks quite high. Q. What is the future for SUV segment? A. Like their US counterparts, Chinese consumers favor large cars because the country’s territory is vast. They had liked passenger cars, but their preference is changing to SUVs (drawn to their rising height and perceived safety). SUVs now account for 25% of demand and the figure is likely to soon exceed 30%. SUVs are popular among young people and many well-designed models should hit the market. Q. Could China’s pickup truck segment grow as much as the US pickup market? A. This is unlikely. Pickups are not suitable for large cities.

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Q. Could infrastructure projects (eg, the One Belt, One Road initiative) lead to new pickup truck exports? A. Yes. Southeast Asia now accounts for a low portion of our exports, most of which go to the Middle East. Q. How are forex rates affecting exports, and how is factory construction in Russia proceeding? A. Exports accounted for less than 5% of sales in 1H. Great Wall intends to keep exporting and maintain overseas distribution channels, and will look to boost exports by improving its sales model. Meanwhile, construction of a factory in Russia began this year and should be completed in 2017 at the earliest. The firm is also eying Brazil, India, and South Africa, but has no plans to build factories yet. Q. What are Great Wall’s views on EVs and alternative vehicle? A. EVs are the way of the future, but infrastructure and battery development has a long way to go. Initially, hybrids should be mainstream. We are investing in smart car R&D, but commercialization is still far off. Great Wall plans to deal with changing consumer needs with its current and electric vehicle lineups. We plan to roll out an EV (ie, a hybrid) in 2017, but it is difficult to set a sales volume target at this time. Q. Can you comment on the plans for a rights offering and target investors? A. No decision has been made. Plans will be discussed at a general shareholders meeting in September, with any agreement requiring approval by the China Securities Regulatory Commission. The issuance should be wrapped up by December. Q. Will Great Wall provide 10,000 vehicles to A-shareholders? A. Not real cars, but models, and only to shareholders who test drive. The move is in line with government efforts to boost stock prices after the market’s recent correction. Q. How will rights offering proceeds be spent, and what are your plans to internalize EV technology? A. Our EV operation has just taken off, so details are lacking. The company is still deciding whether to internalize technology or form a strategic alliance for it. Q. Do you agree with the consensus view that Changan, Geely, and Great Wall will lead the Chinese market over the long term? A. Yes. Great Wall is strong in SUVs; Geely has an edge in passenger vehicles. Changan is controlled by a state-owned firm and has a JV brand, making it difficult to compare to the others. Its CS35 and CS75 models look good. Q. Which JV brands are likely to come out on top? A. All are doing well, with VW-related ones doing best in sales and customer evaluations. Q. What impact do you expect from political disputes with Japan? A. Territorial disputes have kept the relationship between China and Japan fragile. In terms of quality, Japanese firms rank high but slightly behind European firms. Japanese players seem to have done well in 1H15, mainly due to the low base of 1H14. Q. What parts are sourced in-house and outsourced? How has Great Wall accumulated engine technology so quickly? A. Great Wall manufactures core parts such as engines and transmissions. We acquired a local engine maker in the early 2000s. Our headquarters and main factories are located in Hebei Province, where there are few parts-manufacturing factories, so we source in-house parts that would otherwise incur high logistics costs. Manual transmissions are made in-house; automatic transmissions are outsourced. The outsourcing portion should increase as more new technology is utilized.

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BAIC enjoying high growth Beijing Corporation (BAIC) is HMC’s partner in China, and the BAIC Group is China’s fifth largest automotive player, with a market share of 9.3%. Founded in 1958, the group entered into a 50:50 JV with Beijing Jeep Corporation in 1983, a 50:50 JV with HMC in 2002 (BHMC), and a 50:50 JV with the Daimler Group in 2005. In Nov 2013, it increased its stake in the latter (Beijing Benz Automotive, or BBAC), thus bringing the unit under consolidated accounting. That year the group also took up a 49% stake in Beijing Mercedes-Benz Sales Service, and in doing so secured a license to use the Mercedes-Benz E-Class LWB V212 platform without having to pay royalties. BBAC listed on the Hong Kong Exchange at end-2014 and now has a market cap of KRW10t.

BAIC: Ownership structure

Beijing State-owned Asset Management and Benyuan Jinghong Beijing Energy Investment Administration Center

4.6% 3.7% 3.5%

Other H-share public BAIC Group Shougang Daimler AG shareholder

45.6% 13.7% 10.2% 18.8%

BAIC Motor (1958 HK)

Passenger Vehicle Passenger Vehicle Finance & service

BAIC Motor powertrain BAIC Group Finance Beijing Mercedes-Benz Sales service (49%) (99%) (20%)

Beijing Benz Automotive Beijing Beinei Engine parts Beijing Shougang (51%) and components (99%) Cold-roll Sheet (20%)

Beijing Hyundai Motor Beijing Hainachuan Investment (49%) (78%)

Beijing Motor Sales (100%)

Source: Company data, Samsung Securities

BAIC: Ownership breakdown Shares Ownership (%) BAIC Group 3,415,643,691 45.0 Beijing Shougang (000959 CH) 1,028,748,707 13.5 Benyuan Jinghong 342,138,918 4.5 Other domestic investors 708,116,184 9.3 Daimler 765,818,182 10.1 Other 1,334,872,500 17.6 Total 7,595,338,182 100.0 Source: Company data, Samsung Securities

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BAIC appears satisfied with collaboration with HMC and BHMC’s growth, and thinks high of HMC’s quality management and ability to control costs. BAIC attributes BHMC’s net margin of more than 10%—despite its vehicles being sold at an ASP of CNY100,000 less than those of other JVs—to strong cost control. It displayed little concern over a drop in sales volume this year, saying BHMC need only sell 1m units per year (it is targeting 1.16m this year) to maintain a utilization rate of 100%, and said it prefers to maintain profitability over cutting prices to increase volume. BAIC expects BHMC sales volume to continue deteriorating through 2016, when the subsidiary expects to finish building its fourth and fifth plants in China. BAIC and BHMC are currently negotiating prices, but no decisions have been made. In 2014, BHMC accounted for 71% of BAIC’s total auto sales, suggesting that if BHMC sales volume continues to drop, BAIC will agree to ASP cuts. BHMC plans to increase capacity from 1.05m units in 2014 to 1.65m units in 2016, and dealers from 800 in 2012 to 1,000 in 2015. BHMC now sells 12 models, and should roll out a 13th (an upgraded Tucson small SUV) in Oct 2015.

BAIC: Sales volume BAIC: Sales volume, by brand

('000 vehicles) (%)

2,500 100 3.2 8.3 8.6 9.2 12.5 14.2 1,953 90 15.0 2,000 1,792 80 20.0 1,581 22.2 24.3 70 1,349 1,500 60 1,041 50 96.8 1,000 858 91.7 40 76.4 70.8 30 65.2 61.5 500 20 10 0 2011 2012 2013 2014 2015E 2016E 0 2011 2012 2013 2014 2015E 2016E

Beijing Hyundai Beijing Motor Beijing Benz Beijing Hyundai Beijing Motor Beijing Benz

Source: Company data, Samsung Securities Source: Company data, Samsung Securities

BAIC: Net profit, by brand

(CNYm) 8,000 5,987 5,712 6,000 3,835 4,000 1,295 2,000 941 784

0

(2,000) (1,359) (4,000) (2,496) (4,056) (6,000) Beijing Beijing Beijing Beijing Beijing Beijing Beijing Beijing Beijing Hyundai Benz Motor Hyundai Benz Motor Hyundai Benz Motor

2012 2013 2014

Source: Company data, Samsung Securities

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Beijing Hyundai: Product lineup Model Release date Segment Price (CNY'000) Engine YF Sonata Apr 2011 Mid-sized sedan 181.9-225.9 2.0L / 2.4L LF Sonata Mar 2015 Mid-sized sedan 174.8-249.8 2.0L / 2.4L Sonata Monica Aug 2009 Mid-sized sedan 116.8-139.8 2.0L Mistra Nov 2013 Mid-sized sedan 129.8-189.8 1.8L / 2.0L Elantra Dec 2003 Compact sedan 89.8-98.8 1.6L Yuedong Apr 2008 Compact sedan 99.8-128.8 1.6L Langdong Jul 2012 Compact sedan 105.8-149.8 1.6L Verna Aug 2010 Compact sedan 73.9-106.9 1.4L / 1.6L ix35 Apr 2010 SUV 169.8-242.8 2.0L / 2.4L Santa Fe Dec 2012 SUV 209.8-289.8 2.0L / 2.4L Tucson Jun 2005 SUV 165.8-203.8 2.0L ix25 Oct 2014 SUV 119.8-186.8 1.6L / 2.0L Source: Autohome, Samsung Securities

Beijing Hyundai: Annual metrics (CNYm) 2011 2012 2013 2014 Sales volume ('000 units) 740 860 1031 1120 Sales 68,711 77,312 103,167 108,902 Operating profit 9,108 10,037 14,575 14,856 Net profit 6,832 7,470 10,799 11,050 Margins (%) Operating profit 13.3 13.0 14.1 13.6 Net profit 9.9 9.7 10.5 10.1 Source: Company data, Samsung Securities BAIC expects BBAC to grow faster than BHMC over the next two to three years. While the Mercedes-Benz Group has been conservative in marketing in China, it has responded to weak sales of late by investing and cooperating more with BAIC. In 2014, Mercedes-Benz controlled 17.5% of China’s luxury segment, far behind Audi’s 36.9% and BMW’s 27.9%. Considering Mercedes-Benz’s global presence, BAIC’s expectations are likely not excessive. Indeed, BBAC plans to launch the New C-Class, as well as the SUVs GLA and GLC in 2015, and its 1H15 sales volume jumped 59.8% y-y to 103,000 vehicles. BBAC plans to increase capacity from 250,000 units in 2014 to 420,000 units by end-2015, and dealer numbers from 262 in 2012 to 570 in 2017.

German luxury brands: China market share (excluding imports)* German luxury brands: China market share (including imports)*

(%) (%) 100 100 90 90 80 80 42.4 43.7 44.7 44.0 70 56.1 55.1 56.0 54.7 70 60 60 50 50 31.5 40 40 35.2 35.5 34.6 30 23.6 27.1 28.2 29.8 30 20 20 26.2 10 20.3 17.4 15.8 15.5 10 21.1 19.8 21.4 0 0 2011 2012 2013 2014 2011 2012 2013 2014

Beijing Benz BMW Brilliance FAW Audi Benz BMW Audi

Note: * Volume-based Note: * Volume-based Source: CAAM, Samsung Securities Source: CAAM, Samsung Securities

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German luxury brands: China portion of global sales volume

(%) 35 31.2 30.9 30 27.9 24.0 23.8 25 21.9 19.7 20 17.4 15.7 14.9 14.4 14.9 15

10

5

0 Benz BMW Audi Benz BMW Audi Benz BMW Audi Benz BMW Audi 2011 2012 2013 2014

Source: Company data, Samsung Securities

German automakers: Medium-term capacity expansion plans in China (Units) End-2013 capacity Medium-term capacity targets Mercedes-Benz 120,000 420,000 units by 2015 BMW 300,000 400,000 units by 2016 Audi 400,000 700,000 units by 2017 Source: Company data, Samsung Securities

Beijing Benz: Product lineup Model Release date Segment Price (CNY'000) Engines E-Class 2010 Mid- to large-sized sedan 398.0-798.0 2.0T / 3.0T / 3.5L C-Class 2Q15 Mid-sized sedan 314.8-489.0 1.6T / 2.0T GLK Oct 12 SUV 378.0-558.0 2.0T / 3.0L GLA 2Q15 SUV 269.8-398.0 1.6T / 2.0T Source: Autohome, Samsung Securities

Beijing Benz: Annual metrics (CNYm) 2011 2012 2013 2014 Sales volume ('000 units) 93 103 116 145 Sales 28,688 29,673 33,220 43,372 Operating profit 3,882 2,563 2,032 3,080 Net profit 3,479 1,911 1,507 2,313 Margins (%) Operating profit 13.5 8.6 6.1 7.1 Net profit 12.1 6.4 4.5 5.3 Source: Company data, Samsung Securities BAIC’s own brand operations (ie, Senova, BJ, and Wevan) are losing money, selling only around 300,000 vehicles annually. The Senova brand (formed when BAIC acquired two Saab platforms in 2009) produces mid-range and luxury vehicles. BJ (launched in 2012) focuses on low-end models, while Wevan concentrates on the low-end crossover and multi-purpose segments. BAIC also has hybrid and EV lineups. In all, it produces 14 models under its own brands, and it plans to add two more in 2H15. BAIC intends to raise own-brand production capacity from 450,000 units in 2014 to 800,000 units in 2016, and dealers from 253 in 2012 to more than 500 in 2015. Chinese carmakers operating their own brand generally break even when sales volume reaches 500,000 units. New models are boosting BAIC’s own-brand volume, but it is too early to forecast when the firm will achieve profitability. The company seeks to improve profitability by integrating platforms (centering on Senova’s), raising utilization (by rolling out new models), and internalizing core parts (such as engines and transmissions).

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Beijing Benz: Product lineup Model Release date Segment Price (CNY'000) Engines Senova D80 1H15 Mid- to large-sized sedan 204.8-268.8 1.8T / 2.0T / 2.3T D70 May 13 Mid-sized sedan 139.8-215.8 1.8T / 2.0T / 2.3T D60 1H15 Mid-sized sedan 119.8-168.8 1.8T D50 Apr 14 Compact sedan 74.8-119.8 1.5L D20 Nov 14 Small sedan 48.8-82.8 1.3L / 1.5L BJ E-Series Mar 12 Small sedan 58.8-87.8 1.3L / 1.5L BJ40 Dec 13 SUV 146.8-176.8 2.4L Wevan 306 Mar 11 CUV 36.8-46.8 1.2L / 1.3L 307 Oct 13 CUV 44.8-51.8 1.2L M20 Oct 13 MPV 46.8-56.8 1.5L 205 Nov 12 CUV 29.8-40.8 1.0L / 1.3L 007 1H15 SUV 89.8-109.8 2.0L / 2.0T Source: Autohome, Samsung Securities

Beijing Motor: Capacity overview (CNYm) Location Operation date Capacity (units) Total investment Existing facilities Beijing plant Beijing Mar 2013 150,000 Zhuzhou plant #1 Zhuzhou Jun 2013 200,000 Guangzhou plant Guangzhou Apr 2014 100,000 Powertrain plant Beijing Dec 2012 100,000 Engine plant Zhuzhou Jun 2013 100,000 Expansion plans Beijing plant expansion Beijing Dec 2015 150,000 2,585 Zhuzhou plant #2 Zhuzhou Dec 2016 200,000 3,500 Powertrain plant expansion Beijing Jun 2016 200,000 4,020 Source: Company data, Samsung Securities

Beijing Motor: Annual metrics (CNYm) 2011 2012 2013 2014 Sales volume ('000 units) 10 67 202 316 Sales 1,916 3,520 6,84714,924 Operating profit (619) 151 (2,751) (2,142) Net profit (919) (314) (3,257) (2,644) Margins (%) Operating profit (32.3) 4.3 (40.2) (14.4) Net profit (48.0) (8.9) (47.6) (17.7) Source: Company data, Samsung Securities

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BAIC’s subsidiaries include financial units, an engine maker, a transmission manufacturer, and Beijing Hainachuan Automotive Parts (BHAP), a holding company that owns 30 parts makers with more product diversity than Hyundai Mobis. It recently established a JV with chassis maker Hwashin, and will to supply BHMC’s fourth and fifth plants in China. Until now, Hainachuan has supplied just over 10% of BHMC’s needs— losing out to Korean parts makers that boast superior quality. BAIC hopes its parts makers will make further inroads with BHMC once the two new plants come online.

BHAP: Sales and growth

(CNYb) 35

30

25

20

15 30.0

10 19.2 15.0 5 9.0 4.2 5.7 0 2008 2009 2010 2011 2012 … 2015E

Source: Company data, Samsung Securities

BHAP: Overview Shareholders BAIC Group (60%) Beijing Industrial Development Investment Management (40%) Major clients BAIC, Mercedes-Benz, VW, BMW, Ford, Honda, Toyota, Mahindra, FAW, and SAIC Major subsidiaries Inalfa Roof Systems, JV with Beinei, Visteon, and Johnson Controls Source: Company data, Samsung Securities

BHAP: Main products Division Products Chassis and powertrains Transfer cases, brakes, axles, transmissions, suspension Bodies Body welding, noise dampeners, body sealers, airbag systems, steering wheels Thermal systems A/C, radiators Electronic parts Wire harnesses, access boxes, central power locks, antennas Seats Seat modules, seat cover assemblies Interior/exterior Cockpits, door trim, head-lining modules, bumpers, seatbelts Source: Company data, Samsung Securities

Hyundai Mobis: Module sales to BHMC Hyundai Mobis: Module sales to DYK

(KRWt) (%) (KRWt) (%)

8.0 50 4.0 32 7.5 3.5 31 7.0 45 6.5 3.0 30 6.0 40 2.5 29 5.5 2.0 28 5.0 35 1.5 27 4.5 4.0 30 1.0 26 2010 2012 2013 2014 2010 2012 2013 2014

BHMC-bound module sales (LHS) DYK-bound module sales (LHS) Portion of BHMC sales (RHS) Portion of DYK sales (RHS)

Source: Company data, Samsung Securities Source: Company data, Samsung Securities

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Hyundai Mobis: Module sales, by region Hyundai Mobis: Aftermarket sales, by region

Other: 3% Other: 12%

Korea: 29%

Korea: 34% China: 14% China: 37%

EU: 17%

US: 20% EU: 11% US: 23%

Source: Company data, Samsung Securities Source: Company data, Samsung Securities

Huayu Auto: Financial statement (CNYm) 2011 2012 2013 2014 2015E 2016E Sales 1,916 3,520 12,782 56,370 82,235 101,878 Gross profit 27 (168) 415 8,983 14,161 18,827 Operating profit (693) (979) (2,789) 660 4,687 7,444 Pretax income 2,784 3,785 3,065 6,698 10,364 13,118 Net profit 2,598 3,417 2,714 4,511 6,470 8,391 Margins (%) Operating profit (36.2) (27.8) (21.8) 1.2 5.7 7.3 Net profit 135.6 97.1 21.2 8.0 7.9 8.2 Total assets 21,801 31,782 85,396 109,859 Current assets 4,461 9,094 33,763 44,319 Non-current assets 17,340 22,688 51,633 65,540 Cash and cash equivalents 1,388 2,931 16,794 21,923 Total liabilities 10,501 15,770 54,342 67,890 Current liabilities 7,677 7,288 36,920 51,500 Non-current liabilities 2,825 8,482 17,423 16,390 Borrowings 6,331 11,925 23,663 31,147 Cash flow from operations (748) (2,496) 969 7,246 Cash flow from investments (4,996) (8,470) (493) (14,926) Capex (3,312) (4,675) (5,749) (9,055) Cash flow from financing 4,325 12,040 13,251 12,813 Free cash flow (4,060) (7,172) (4,780) (1,809) Valuation (x) P/E 10.3 7.1 5.7 P/B 1.6 1.2 1.1 Source: Bloomberg, Samsung Securities

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Q&A with BAIC Q. Why is demand in China falling? A. The auto industry has ups and downs. Demand in China needed a correction after more than 10 years of robust growth. It has been affected by China’s economy and stock market, but in the long term is bound to grow. BAIC expects demand to resume growing in 2016 (most in the market expect 4Q15). Demand probably should have corrected in 2008 after the global financial crisis, but government stimulus stopped this. From a big picture perspective, a pullback this year is a good thing. More than 100 companies are licensed to make cars in China, and production capacity hit 40m units last year, compared to demand of 20m units—clearly there is too much capacity. In the US, three local and three Japanese firms lead the market. Two or three companies dominate in both Korea and Japan. Given its sheer size, the Chinese market should be dominated by 5-10 makers. Q. Are government-supported automakers restructuring? A. Automakers that local governments have supported have begun restructuring. BAIC acquired three firms last year. Q. Why were HMC’s sales weak in 1H15? A. BHMC sales have consistently beaten expectations since 2002, and BAIC does not see this year’s performance as weak. BHMC’s car sales fell 7.5% y-y in 2Q, which we attribute to two things. First, all JVs with foreign firms are losing market share. Second, BHMC sold 1.12m cars in 2014 and set a 2015 target of 1.16m (vs production capacity of 1.05m). HMC has made it a priority to achieve its sales goal but BAIC emphasizes profitability and cash flow. VW and GM have cut prices but their sales have yet to recover, and they have had to spend a lot on promotions. BHMC should be able to remain number four in the market even focusing on profitability. Q. Any chance of price cuts? A. China focuses on earnings; Korea is preoccupied by sales targets. That VW has lost market share suggests price cuts are no panacea. The fallout of cutting prices is that consumers now expect prices to keep declining, likely hurting sales further. Car sales in 1H actually bode well for China’s local brands. Sales rose in fourth- to sixth-tier cities while falling in first- to third-tier cities (where consumers tend to focus on JV brands, and appear to be waiting for further price cuts). The correction should force small, local brands out. Q. What do JV brands need to do to survive? A. It is too pessimistic to worry about JV brand makers being forced out. HMC needs to ponder how to become even stronger, not how to survive. China is the world’s largest auto market and has the potential to grow further. HMC’s production facilities are a bit aged and running at or over capacity. How it uses its fourth and fifth factories will be key. HMC’s ability to control costs has been the key to its success thus far in China. Q. Which JV poses the biggest threat? A. Ford, given its product lineup in China and execution capabilities. Q. How are Japanese players doing? A. Japanese players likely rebounded overall in 2Q, but largely do not have a far-sighted strategy for China. Only Nissan has a long-term strategy. Q. Does BHAP supply BHMC? A. BHAP now supplies BHMC with 10% of its parts needs and is going to try to supply more for the fourth and fifth factories.

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Q. What is your view of Chinese government policy? A. At a recent forum, China’s top-ten local brands appealed to the government for support. BAIC has yet to earn a return from investing in its own brands, in which Chinese consumers seem to have little interest. The administration’s purchases of local brands for government vehicles have helped, but such purchases have declined sharply since when. Only EVs now have government support. Q. What is BAIC’s vision for EVs? A. EVs are being strategically pursued at the state level and thus should become mainstream. BAIC leads China’s EV segment in retail sales and government vehicle purchases. Q. Could low-speed EVs be used for a car-sharing business model? A. Low-speed EVs have a top speed of 80km/hour and range of 80km (both much less than typical EVs) but have the potential for wide use in suburban areas and small cities. EV production was once banned due to safety issues, but the government is now encouraging production. Meanwhile, in large cities, EV demand outweighs production because of auto-purchasing restrictions, but infrastructure is the biggest challenge. Q. Where are rechargeable batteries sourced from? A. BAIC uses batteries from a JV. When it comes to boosting EV penetration, battery technology is another issue to be addressed. Suppliers could differ depending on whether batteries are charged or replaced, and if they are replaced, what types would be standard. It would be some time before EVs become mainstream. Q. Any prospect of Chinese cars becoming cheaper? A. China is expensive. A house in Beijing costs as much as a mansion in the US. While weaker demand brings down prices, Chinese car prices are unlikely to fall to US levels in the near term. Q. How are Great Wall and Geely making cars so cheaply? A. Great Wall has strengths in cost and quality control. All successful brands in China seem to have copied HMC and its excellent cost-saving capabilities. HMC is the only brand with an average MSRP of CNY100,000 and net margin of 10%. Great Wall has succeeded in its SUV focus, but now must contend with increasing competition. Q. Mercedes-Benz or HMC—which one has more growth potential? A. BAIC believes Benz has more growth potential than HMC over the next two to three years. Mercedes-Benz is a respected, successful brand around the world, and an aggressive growth strategy in China implemented since last year has helped it outperform rivals. In the past, Mercedes-Benz has struggled in China because of weak distribution channels and sour relationships with its Chinese partners, but BAIC and Daimler are strengthening ties. Demand for this year’s models is outstripping supply even without incentives.

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 Compliance Notice

- During the three months prior to Jul 22, 2015, Samsung Securities had not participated in any securities issuance (including DRs, CBs, and IPOs) by companies covered in this report. - As of Jul 22, 2015, Samsung Securities' holdings of shares and debt instruments convertible into shares of each company covered in this report would not, if such debt instruments were converted, exceed 1% of each company's outstanding shares. - As of Jul 22, 2015, the covering analyst(s) did not own any shares, or debt instruments convertible into shares, of any company covered in this report. - This material has not been distributed to institutional investors or other third parties prior to its publication. - This report has been prepared without any undue external influence or interference, and accurately reflects the views of the analyst(s) covering the company or companies herein. - All material presented in this report, unless specifically indicated otherwise, is under copyright to Samsung Securities. - Neither the material nor its content (including copies) may be altered in any form, or by any means transmitted, copied, or distributed to another party, without prior express written permission from Samsung Securities. - This memorandum is based upon information available to the public. While we have taken all reasonable care to ensure its reliability, we do not guarantee its accuracy or completeness. This memorandum is not intended to be an offer, or a solicitation of any offer, to buy or sell the securities mentioned herein. Samsung Securities shall not be liable whatsoever for any loss, direct or consequential, arising from the use of this memorandum or its contents. Statements made regarding affiliates of Samsung Securities are also based upon publicly available information and do not necessarily represent the views of management at such affiliates. - During the twelve months prior to Mar 31, 2015, 72.6% of our ratings were BUY, 27.4% HOLD, and 0.0% SELL.

 Target price changes in past two years

Hyundai Motor Kia Motors

(KRW) (KRW) 350,000 90,000 80,000 300,000 70,000 250,000 60,000 200,000 50,000

150,000 40,000 30,000 100,000 20,000 50,000 10,000 0 0 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15

Hyundai Mobis

(KRW) 400,000

350,000

300,000

250,000 200,000 150,000

100,000

50,000

0 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15

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 Rating changes in past two years

Hyundai Motor Date 2013/7/24 2014/1/15 3/25 5/12 5/19 7/7 9/28 2015/1/22 6/4 Recommendation BUY BUY★★★ BUY BUY BUY BUY BUY BUY BUY Target price (KRW) 265,000 290,000 290,000 300,000 290,000 280,000 250,000 230,000 190,000 Kia Motors Date 2013/7/24 7/26 2014/1/15 3/17 5/12 5/19 7/7 8/3 9/28 2015/1/25 5/11 6/4 Recommendation BUY BUY BUY BUY BUY BUY BUY BUY★★★ BUY BUY BUY BUY Target price (KRW) 68,000 70,000 65,000 69,000 80,000 69,000 70,000 77,000 70,000 60,000 65,000 60,000 Hyundai Mobis Date 2013/7/26 2014/1/15 7/7 9/28 10/26 2015/4/6 4/26 6/4 Recommendation BUY BUY★★★ BUY★★★ BUY BUY★★★ BUY BUY BUY Target price (KRW) 295,000 380,000 360,000 330,000 330,000 330,000 300,000 250,000 Samsung Securities uses the following investment ratings. Company BUY★★★ Expected to increase in value by 30% or more within 12 months and is highly attractive within sector BUY Expected to increase in value by 10% or more within 12 months HOLD Expected to increase/decrease in value by less than 10% within 12 months SELL Expected to decrease in value by 10% or more within 12 months SELL★★★ Expected to decrease in value by 30% or more within 12 months

Industry OVERWEIGHT Expected to outperform market by 5% or more within 12 months NEUTRAL Expected to outperform/underperform market by less than 5% within 12 months UNDERWEIGHT Expected to underperform market by 5% or more within 12 months

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July 23, 2015 Autos

Global Disclosures & Disclaimers General This research report is for information purposes only. It is not and should not be construed as an offer or solicitation of an offer to purchase or sell any securities or other financial instruments or to participate in any trading strategy. This report does not provide individually tailored investment advice. This report does not take into account individual client circumstances, objectives, or needs and is not intended as recommendations of particular securities, financial instruments or strategies to any particular client. The securities and other financial instruments discussed in this report may not be suitable for all investors. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein and investors should seek the advice of a financial adviser. This report may not be altered, reproduced, distributed, transmitted or published in whole or in part for any purpose. 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