Xiezhong International | 3663.HK

Rating NOT RATED Entering a new era with Beijing Automotive Current price HK$1. 33

Well established HVAC system supplier in the PRC Company Report Xiezhong is a manufacturer of automotive heating, ventilation and cooling (“HVAC”) systems. It has 19.1%/9.9% share in the PRC 14 Aug 2014 heavy truck and SUV/pickup truck HVAC system market, while sales of sedan HVAC system boosted from RMB9mn in 2011 to RMB152mn in 2013. Lewis Pang Invested by Beijing Automotive Group in June 2014 [email protected] On 4 June 2014, 1) Hainachuan, 2) family of Xiezhong’s Chairman (852) 2235 7847 and 3) family of Xiezhong’s Executive Director agreed to purchase 33.16%/8.09%/1.50% shares from previous institutional shareholders at HK$0.90 per share. Hainachuan is 60% owned by Trading data Beijing Automotive Group. Beijing Automotive Group sold >2mn 52-Week Range (HK$) 4.20/0.72 units of automobiles in 2013, while Xiezhong supplied ~150,000 3 Mth Avg Daily Vol (m) 4.4 HVAC systems to them. We believe it is likely for Beijing Automotive No of Shares (m) 800 Group to give more orders to Xiezhong after the investment. Market Cap (HK$m) 1,064 Cooperation and potential asset injection from Hainachuan Major Shareholders (%) Family of Mr. Chen Hainachuan is primarily focus on automotive parts industry and (37.90%) expected to achieve RMB26bn sales in 2014. It could potentially Beijing Hainachuan inject some of its assets into Xiezhong, in our view. For instance, (33.2%) Hainachuan operates a JV with HVCC, the second largest global Auditors KPMG automotive HVAC system manufacturers. Moreover, Hainachuan Result Due 1H14: Aug has a more globalized customer network, which could help Xiezhong to expand its customer base. Company description Supplier of Beijing Automotive Group’s electric vehicle Listed in 2012, Xiezhong International Xiezhong started supplying electric vehicle HVAC systems to Beijing (“Xiezhong”) is mainly engaged in the Automotive Group since 2010, and it entered into strategic cooperation agreement with Beijing Automotive Group on 31 July manufacturing of automotive heating, ventilation 2014 to further strengthen the relationship. Xiezhong has been and cooling (“HVAC”) systems. Xiezhong offers acting as the sole HVAC supplier of some of the Beijing New Energy its HVAC system products to a wide range of Automobile’s new energy vehicle models such as E150EV. automobiles, including 1) SUVs and pickup trucks, 2) sedans, 3) heavy trucks, 4) vans, 5) Beijing New Energy Automobile targeted to sell 20,000 and 100,000 construction machineries and 6) others (mainly electric vehicles in 2014 and 2018 respectively. We are cautiously light trucks and buses). Xiezhong also sells 7) optimistic toward its sales outlook, given 1) the competitive price HVAC components to auto manufacturers. point of E150EV (~RMB85,000 after subsidy and retail discount), 2) Beijing should be one of the most active cities in promoting new energy vehicles, and 3) the exemption of purchase tax for new Price chart energy vehicle effective from 1 September 2014. Support from Beijing Automotive likely to boost future earnings Xiezhong is now trading at 13X/11X PER in FY14E/15E respectively according to Bloomberg consensus, broadly in-line with peers average. We believe Xiezhong has entered a new growth era with the support from Beijing Automotive Group, which has not yet been factoring into the current earnings forecast. We suggest investors to keep an eye on Xiezhong.

RMB million FY11A FY12A FY13A FY14E FY15E

Revenue 620 590 728 920 1,122 Net Profit 86 68 59 67 77 EPS (RMB) 0.143 0.096 0.074 0.083 0.096 P/E ( x) 7.4 11.1 14.2 12.8 11.2 Sources: Bloomberg

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Well established HVAC system supplier in the PRC

Supply HVAC systems to a wide range of automobiles Xiezhong International (“Xiezhong”) is mainly engaged in the manufacturing of automotive heating, ventilation and cooling (“HVAC”) systems. Xiezhong offers its HVAC system products to a wide range of automobiles, including 1) SUVs and pickup trucks, 2) sedans, 3) heavy trucks, 4) vans, 5) construction machineries and 6) other vehicles (mainly light trucks and buses). Xiezhong also sells 7) HVAC components to auto manufacturers.

Exhibit 1: FY13 revenue breakdown

Source: Xiezhong

Exhibit 2: Structure of HVAC products

Source: Xiezhong

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Established position in heavy truck and SUV/pickup truck market Established in 2002, Xiezhong has built a strong position in the PRC heavy truck as well as SUV/ pickup truck HVAC system market, with 19.1% and 9.9% market share in terms of 2011 sales volume, as well as >10 years cooperating history with some of the key customers including Beiqi Foton Motor (600166 CH), Liaoning SG Automotive (600303 CH) and Sinotruk (3808 HK). Leverage on its proven track record in PRC commercial vehicle market, Xiezhong started to explore the opportunities in sedan HVAC system market since 2012.

Increasing contribution from sedan HVAC system products Xiezhong achieved encouraging results in sedan market in the past two years. Its sedan HVAC system was supplied to various auto manufacturers including Beijing Automotive and Brilliance Auto (1114 HK), with sales contribution boosted from RMB9mn in 2011 to RMB152mn in 2013. While the strategy to venture into sedan market brought negative effect to GPM in short term, as Xiezhong needed to accept some low margin trial orders (~15-20% GPM for sedan HVAC system in 2012-13 versus a Group GPM of 27-28% during 2009-11), we believe it would bear fruit for the long term growth as sedans contributed >50% of auto production volume in the PRC.

Exhibit 3: Customer base of Xiezhong

Source: Xiezhong

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Promising opportunity after Beijing Automotive Group’s investment

Substantial shareholding structure change in June 2014 Xiezhong announced a series of shares transaction agreements on 4 June 2014. Based on these agreements, 1) Beijing Hainachuan Automotive Parts Co., Ltd., (“Hainachuan”) 2) family of Mr. Chen Cunyou (Chairman of Xiezhong) and 3) family of Mr. Ge Hongbin (Executive Director of Xiezhong) agreed to purchase 33.16%/8.09%/1.50% shares from previous institutional shareholders (CITIC Capital China Partners, CDH China Fund III, CDH China Growth Capital Fund II and Fang Brothers Holdings Ltd.) at the price of HK$0.90 per share.

Exhibit 4: Change in Xiezhong shareholding structure

% of shareholdings

Shareholders Immediately after the After the general offer and all share Before the transaction transaction in June transfer based on the Share in June 2014 2014 Incentive Plan is completed

Beijing Hainachuan Automotive Parts Co., 0.0% 33.2% 33.2% Ltd. Family of Mr. Chen (Chairman of 29.9% 38.0% 37.9% Xiezhong) Family of Mr. Ge (executive Director of 0.4% 1.9% 2.3% Xiezhong) CITIC Capital China 22.6% 0.6% 0.0% Partners

CDH China Fund III 11.5% 0.3% 0.0%

CDH China Growth 5.5% 0.1% 0.0% Capital Fund II Fang Brothers 4.4% 0.1% 0.0% Holdings Ltd.

Public 25.9% 25.9% 26.7%

100.0% 100.0% 100.0%

Source: Xiezhong, CIRL

Entering a new era with the investment from Hainachuan, a 60% owned subsidiary of Beijing Automotive Group With the change in shareholding structure, we believe Xiezhong has entered into a new era of development. First of all, the overhang of institutional shareholders disposing stake has been removed. More importantly, the investment from Hainachuan, a 60% owned subsidiary of Beijing Automotive Group focusing on the automotive parts industry, should brought tremendous opportunity to Xiezhong, including 1) more orders from Beijing Automotive Group, 2) cooperation and potential asset injection from Hainachuan, as well as 3) closer cooperation with Beijing Automotive Group in new areas such as HVAC system for new energy automobile.

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Likely more orders from Beijing Automotive Group With the self owned brands including Foton, Senova and Weiwang, as well as the joint ventures Beijing Hyundai Motor and Beijing Benz Automotive, Beijing Automotive Group sold >2mn units of automobiles in 2013. Before the equity investment, Beijing Automotive Group was already the largest customers of Xiezhong, contributing ~30% sales volume of Xiezhong (~150,000 units) in 2013. We believe Beijing Automotive Group would potentially allocate more orders to Xiezhong in the future.

Exhibit 5: Major self owned and JV brands of Beijing Automotive Group

Source: Beijing Automotive Group

Potential asset injection from Hainachuan Established in 2008, Hainachuan is 60%/40% owned by Beijing Automotive Group and Beijing State-Owned Assets Management Co., Ltd. After years of development, Hainachuan has turned into a large scale automotive part supplier covering a wide range of products including seat protecting, heat exchange, electronic module, chassis braking systems, roof systems as well as bodies and other systems. The company targeted to achieve RMB26bn sales in 2014.

Hainachuan has planned to go public since 2011. However, there are 46 business units under Hainachuan, of which 15 of them are 100% owned subsidiaries, 12 are JVs with international enterprises and the remaining 19 units are JVs with domestic companies. Such relatively complicated structure makes it difficult to get listed. According to management of Hainachuan, the company would consider providing some resources to Xiezhong in order to create synergy.

Hainachuan operates a JV with HVCC, #2 global HVAC system manufacturer For instance, Hainachuan operates a JV with Halla Visteon Climate Control Corp. (“HVCC”) in Beijing. HVCC is the second largest global automotive HVAC system manufactures with 13% market share. The Hainachuan–HVCC JV sold >1mn units of HVAC systems in 2013, according to our estimation. While there is no clear intention or roadmap for asset injection at this moment, we believe it could significantly boost the sales as well as technical capability of Xiezhong if such injection takes place.

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Exhibit 6: HVCC provides a “full-line” HVAC system products as well as energy saving solution

Source: HVCC

Xiezhong would benefit from the customer network of Hainachuan Moreover, Hainachuan has a more globalized customer network in comparison to Xiezhong. With the help of Hainachuan, it would be easier for Xiezhong to penetrate into the supply chain of other auto manufacturers. The two existing production bases of Xiezhong (located in Nanjing of Jiangsu Province and Fushun of Liaoning Province respectively) have a maximum annual capacity of >1mn units (versus ~500,000 units sales in 2013), hence capacity would not be a constraint in the next 2-3 years.

Exhibit 7: Hainachuan has a more globalized customer network

Source: Hainachuan

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Supply HVAC system to Beijing Automotive Group’s electric vehicle

Started supplying electric vehicle HVAC systems to Beijing Automotive Group since 2010, entered into strategic cooperation agreement in 2014 Xiezhong would also establish an even closer cooperation with Beijing Automotive Group in new business areas such as HVAC system for new energy vehicle. Xiezhong began to supply electric vehicle HVAC systems to Beijing Automotive Group in 2010. To further strengthen the relationship with Beijing Automotive Group in the new energy vehicle area, Xiezhong signed a strategic cooperation agreement with Beijing New Energy Automobile, subsidiary of Beijing Automotive Group, on 31 July 2014.

Exhibit 8: Xiezhong signed a strategic cooperation agreement with Beijing Automotive Group

Source: Takung.cn

Xiezhong is actively participating in Beijing New Energy Automobile’s R&D process when developing a new electric vehicle model, in order to provide the best HVAC system solution for each model. Since travel distance per charge is an important concern for electric vehicle customers, the energy efficiency of the HVAC system is more important for electric vehicle than for traditional vehicle. With the in-depth involvement in early R&D stage, Xiezhong is able to act as the sole HVAC supplier of some new energy vehicle models of Beijing New Energy Automobile such as E150EV.

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Beijing New Energy Automobile targeted to sell 20,000 electric vehicles in 2014 Beijing Automotive Group accelerated its development in new energy automobile in recent years through a series of cooperation and acquisition, which included purchasing 25.02% shares of Atieva in Feb 2014. Atieva is a US based new energy automobile core system provider, which took part in the R&D of pure electric vehicle and hybrid electric vehicle of TESLA, Chevrolet and Audi.

Beijing New Energy Automobile targeted to sell 20,000 and 100,000 electric vehicles in 2014 and 2018 respectively, and E150EV model is expected to be the major contributor in 2014. While the 2014 sales target could be relatively too aggressive given Beijing New Energy Automobile only received orders for 1,000 units in 1H14, we are cautiously optimistic toward its sales outlook given 1) its competitive price point, with government subsidy of RMB95,000 and retail discount of RMB51,000, E150EV is selling at ~RMB85,000 per unit before purchase tax, 2) its extensive network in Beijing, which should be one of the most active cities in promoting new energy vehicles, and 3) the exemption of purchase tax for new energy vehicle effective from 1 September 2014.

Exhibit 9: Beijing Automotive Group’s E150EV electric vehicle is selling at ~RMB85,000 only

Source: JD.com

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Valuation

Support from Beijing Automotive Group likely to boost future earnings Xiezhong is now trading at 13X/11X PER in FY14E/15E respectively according to Bloomberg consensus, broadly in-line with the average valuation level of international as well as HK-listed peers. While the size of Xiezhong is smaller than most of its peers, we believe it has entered a new growth era with the support from Beijing Automotive Group, which has not yet been factoring into the current earnings forecast. We suggest investors to keep an eye on Xiezhong.

Exhibit 10: Peers comparison

Ticker Mkt cap Price P/E(x) P/B(x) Dividend yield (%)

(HKD mn) (HKD) FY13A FY14E FY15E FY13A FY14E FY15E FY13A FY14E International auto parts manufacturers CONTINENTAL AG CON GR 322,372 1,611.81 16.3 12.0 10.8 3.3 2.8 2.3 1.6 2.0 DENSO CORP 6902 JP 307,082 347.35 16.3 12.8 13.2 1.5 1.4 1.3 1.7 2.3 JOHNSON CONTROLS JCI US 247,660 371.82 27.9 15.2 13.0 2.7 2.5 2.3 1.6 1.8 HYUNDAI MOBIS 012330 KS 217,261 2,231.92 14.5 7.9 7.3 1.9 1.2 1.1 0.6 0.7 MAGNA INTL MG CN 184,005 859.84 16.2 12.8 11.0 2.5 2.5 2.3 1.2 1.4 DELPHI AUTOMOTIV DLPH US 157,487 525.60 17.4 13.3 11.6 7.1 5.7 4.2 1.0 1.5 MICHELIN ML FP 153,687 824.11 13.1 10.4 9.1 1.5 1.5 1.3 3.1 3.5 BORGWARNER INC BWA US 109,166 477.93 22.6 18.3 15.5 3.9 3.4 2.9 0.0 0.6 AISIN SEIKI CO 7259 JP 88,826 301.44 11.7 12.3 11.7 1.2 1.2 1.0 2.3 2.4 AUTOLIV INC ALV US 72,502 780.92 19.8 16.4 14.3 2.4 2.3 2.1 2.0 2.1 VALEO SA FR FP 71,619 901.29 15.3 12.1 10.5 2.8 2.4 2.1 1.9 2.4 HALLA VISTEON CL 018880 KS 40,342 377.88 34.0 16.3 14.3 3.8 3.2 2.7 1.8 2.0 Average 18.1 12.3 11.2 3.2 2.7 2.2 1.3 1.6

HK-listed auto parts manufacturers WEICHAI POWER-H 2338 HK 57,436 34.85 15.4 12.2 11.3 2.0 1.7 1.5 0.9 1.2 MINTH GROUP LTD 425 HK 16,948 15.50 13.7 11.8 10.1 1.8 1.6 1.5 3.0 3.1 XINGDA INTL 1899 HK 4,773 3.13 9.1 7.9 6.8 0.7 0.7 0.7 5.2 5.3 EVA PRECISION 838 HK 2,958 1.76 53.3 21.0 14.3 1.4 1.3 1.3 0.6 1.4 CHINA METAL INTE 319 HK 2,892 2.88 9.1 N/A N/A 1.1 N/A N/A 4.9 N/A Average 20.1 13.2 10.6 1.4 1.3 1.2 2.9 2.7

Hosa 3663 HK 1,064 1.33 14.2 12.8 11.2 1.1 1.1 1.0 2.1 1.8 Source: Bloomberg, CIRL

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Exhibit 11: Financial statement

Income statement Year to Dec (RMB mn) FY09A FY10A FY11A FY12A FY13A Total revenue 347 546 620 590 728 - HVAC system: Pickup Trucks and SUVs 181 255 287 265 227 - HVAC system: Sedans 0 0 9 54 152 - HVAC system: Heavy Trucks 120 150 127 68 115 - HVAC system: Vans 0 0 47 88 102 - HVAC system: Construction Machineries 10 33 58 41 40 - HVAC system: Other Vehicles 16 84 34 23 19 - HVAC Compnents 19 24 59 51 74 Gross profit 97 151 172 156 170 SG&A (41) (56) (63) (76) (94) Other Income / expenses 3 5 5 9 11 Net finance costs (1) (2) (6) (7) (9) Profit/(losses) from JV 0 (2) (0) (0) (0) Profit before tax 58 97 109 81 77 Tax expenses (9) (16) (22) (13) (18) Minority interest (15) (1) (1) (0) (0) Net profit 34 79 86 68 59

Ratio Year to Dec FY09A FY10A FY11A FY12A FY13A Margin GPM 28.0% 27.7% 27.8% 26.4% 23.3% EBIT margin 17.1% 18.1% 18.5% 15.0% 11.8% Profit margin 9.8% 14.6% 13.9% 11.5% 8.1%

Cost ratio SG&A to sales 11.7% 10.2% 10.1% 12.9% 12.9% Effective tax rate 15.6% 16.7% 19.8% 15.8% 22.8% * Xiezhong started providing sales figures of sedans and vans HVAC system in 2011

Source: Bloomberg, Xiezhong

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Rating Policy

Rating Definition Buy Outperform HSI by 15% Stock Rating Neutral Between -15% ~ 15% of the HSI Sell Underperform HSI by -15% Accumulate Outperform HSI by 10% Sector Rating Neutral Between -10% ~ 10% of the HSI Reduce Underperform HSI by -10%

Analysts List

Antony Cheng Research Director (852) 2235 7127 [email protected] Hayman Chiu Senior Research Analyst (852) 2235 7677 [email protected] Kenneth Li Senior Research Analyst (852) 2235 7619 [email protected] Lewis Pang Senior Research Analyst (852) 2235 7847 [email protected] Susanna Chui Research Analyst (852) 2235 7131 [email protected]

Analyst Certification I, Lewis Pang hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was / were, is / are or will be directly or indirectly, related to the specific recommendations or views expressed in this report / note.

Disclaimer This report has been prepared by the Cinda International Research Limited. Although the information and opinions contained in this report have been compiled or arrived at from sources believed to be reliable, Cinda International cannot and does not warrant the accuracy or completeness of any such information and analysis. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Recipients should understand and comprehend the investment objectives and its related risks, and where necessary consult their own financial advisers prior to any investment decision. The report may contain some forward-looking estimates and forecasts derived from the assumptions of the future political and economic conditions with inherently unpredictable and mutable situation, so uncertainty may contain. Any opinions expressed in this report are subject to change without notice. The report is published solely for information purposes, it does not constitute any advertisement and should not be construed as an offer to buy or sell securities. Cinda International will not accept any liability whatsoever for any direct or consequential loss arising from any use of the materials contained in this report. This document is for the use of intended recipients only, the whole or a part of this report should not be reproduced to others.

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