Electric Vehicles Visit to China: Game on Visit to China: Game on We recently visited the electric vehicle (EV) supply chain and key influencers in Industry Report China. Among our observations was a significant change in the Chinese government’s EV policy since our last visit in October 2015. Last year, policymakers September 12, 2016 were focused on expanding the EV market through a wide range of incentives . Now, the government appears more focused on curbing th e overly generous Mirae Asset Daewoo Co., Ltd. subsidy programs (which have led to oversupply concerns, similar to the solar power industry), emphasizing the need to create an environment where EV makers [Electric Vehicles ] are able to foster competitiveness on their own. Yeon -ju Park The changes in policy will solidify the market dominance of leading players (e.g., +822 -768 -3061 [email protected] BYD) and encourage switching over to nickel-cobalt-manganese (NCM) lithium ion batteries for cost reduction. Major players, including BYD, are likely to deliver Young Ryu steady growth via cost reduction, while new entrants should struggle. +822 -768 -4138 [email protected] In the most recent round of certifications in June, Korean battery suppliers failed to Jae -hwan Huh obtain certification in the country (making EVs using those companies’ batteries +822 -768 -3054 ineligible for subsidies). Views on this were mixed. On the on e hand, demand for [email protected] Korean batteries has been high due to their lower cost, and a number of Chinese automakers that have already completed the development of new models using Yeon -hwan Choo Korean batteries may need to alter these models by installing other types of +822 -768 -3002 batteries—a process that could take about one year. On the other hand, if the [email protected] Chinese government continues to exclude LG Chem and Samsung SDI from its list Chul -joong Kim of approved battery suppliers (to avoid having foreign suppliers dominate the +822 -768 -4162 market), this may give Chin ese battery makers a chance to gear up their [email protected] competitiveness and enter the market over the medium term. In -gu Lee Industry outlook and investment strategy Shanghai Office [email protected] Despite the government’s decision to reduce subsidies, we forecast the EV market to continue expanding thanks to technological advances and cost reductions driven by economies-of-scale effects. In the process, major players, such as BYD and Tesla, will likely maintain their competitiveness over peers. Due to tight supply, we believe NCM suppliers will benefit fro m EV makers’ efforts to reduce battery costs. Although the cathode materials market was initially expected to experience oversupply due to the entry of Chinese makers, many Chinese makers have failed to produce high-quality NCM (i.e., NCM with high nickel content), benefitting Korean makers and some top-tier Chinese makers. Of note, cobalt prices are likely to climb on robust demand stemming from NCM. We think there is still a technological gap between Korean and Chinese battery suppliers. As already evidenced by cathode materials, leaders tend to maintain their competitiveness over other players as technology develops. We believe Korean equipment makers, including P&T, will continue to benefit from Chinese battery manufacturers’ capacity expansion. September 12, 2016 Electric Vehicles C O N T E N T S China trip takeaways 4 1. Game on 4 2. Meeting summaries 8 Industry outlook and investment strategies 16 1. EV and battery market outlook 16 2. Government focus on innovation and the EV market 20 3. Materials market outlook 28 4. Equipment market outlook 33 5. Charging market outlook 36 6. Global supply chain 42 LG Chem (051910 KS) 45 Samsung SDI (006400 KS) 48 Iljin Materials (020150 KS) 51 People & Technology (137400 KQ) 54 Mirae Asset Daewoo Research 2 September 12, 2016 Electric Vehicles Table 1. Status of major players in the EV supply chain (Wbn, x, %) Company Ticker Mkt. cap P/E (17F) P/B (17F) Investment points and risks Tesla TSLA US 32,038 125.3 10.5 Likely to lead EV popularization with the launch of the Model 3 at end -2017; Boasts superior competitiveness in EV design and battery technology Risks: Concerns over the acquisition of SolarCity; Potential delay to Model 3 launch BYD 1211 HK 25,039 23.0 2.4 Highest global EV sales volume; Growth to continue via government support and vertical integration Risks: Slowdown in Chinese EV market growth; Fall in EV sales volume stemming from subsidy cuts Huayou Cobalt 603799 CH 3,133 110.5 7.2 EV battery-use cobalt producer; Cobalt demand to rise on a switch to NCM batteries Risks: Slowdown in Chinese EV market growth Beijing Easpring 300073 CH 1,808 68.1 7.3 EV battery -use c athode/anode materials producer ; To benefit from 1) a switch to NCM batteries and 2) rising lithium prices Risks: Slowdown in Chinese EV market growth ; Fall in EV sales volume stemming from subsidy cuts LG Chem 051910 KS 16,468 10.2 1.2 To benefit from EV market growth as a leading EV maker; Concerns related to t he firm appear to have been priced in, given the recent share price decline Risks: Short-term earnings could slow on won appreciation Samsung SDI 006400 KS 7,048 27.1 0.6 Global EV market to grow full-swing starting in 2017 Risks: Short -term earnings momentum to fall on Galaxy Note 7 battery recall and Chinese subsidy issues Iljin Materials 020150 KS 641 17.2 2.1 High competitive edge in the I2B (for rechargeable batteries) business ; Customer diversification is underway Risks: Galaxy Note 7 battery recall P&T 137400 KS 82 7.8 1.2 Rising revenue from local Chinese rechargeable battery producers; Cost reduction stemming from the internalization of equipment parts at the Xian factory Risks: Intense competition with Chinese makers; Delay to orders arising from changes in customers ’ capex plans Source: Bloomberg, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 3 September 12, 2016 Electric Vehicles China trip takeaways 1. Game on Last week, we visited major companies in the Chinese EV supply chain in addition to government officials. Here, we highlight key takeaways. First, we noted a significant change in the Chinese government’s EV policy since our last visit in October 2015. Last year, the Chinese government was focused on expanding the EV market through a wide range of subsidies. Now, government officials are pointing out the limits of the subsidies-oriented growth strategy. The change in the government’s stance appears to stem from the following: 1) EV subsidies are estimated to have increased to RMB50bn in 2015 (vs. the initial projection of RMB18bn); and 2) the EV market is seeing oversupply due to overly generous subsidy programs, as with the solar power industry. Indeed, in early 2016 the government announced a plan to gradually reduce subsidies, and will likely release an additional subsidy reduction plan related to mini-buses in September. The government is also expected to announce the results of its investigation into subsidy fraud this month. These policy changes underscore the government’s commitment to making Chinese EV makers competitive even in the absence of subsidy programs. Policymakers with whom we met during our trip emphasized that it is important to create a competitive environment where EV makers are able to foster competitiveness on their own, by improving battery performance and expanding charging infrastructure rather than relying on subsidies. We project Chinese EV sales volume to increase sharply in 4Q. Although Chinese EV sales volume climbed YoY in 1H16, growth slowed from 2H15 due to the government’s delayed subsidy payments (pending the results of the fraud investigation), dampening EV makers’ sales campaigns. However, once the results of the investigation are announced and uncertainties dissipate, EV sales volume is likely to expand markedly, as consumers are likely to rush to purchase EVs before the 20% cut in subsidies (for pure EVs) scheduled for 2017. Figure 1. EV sales trend in China Figure 2. Chinese EV subsidy plan (based on battery-only EVs) (units) (2016=100) 120,000 EV (commercial) 100 EV (bus) 100,000 EV (passenger) 80 PHEV (bus) 80,000 PHEV (passenger) 60 60,000 40 40,000 20 20,000 0 0 1/15 4/15 7/15 10/15 1/16 4/16 2016 2017-2018 2019-2020 Source: Industry data, Mirae Asset Daewoo Research Source: Press release, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 4 September 12, 2016 Electric Vehicles In the medium to long term, the policy changes will likely create an environment where EV makers are able to foster competitiveness on their own, thus 1) solidifying the market dominance of leading players (e.g., BYD) and 2) accelerating the adoption of high- performance cathode materials, including NCM. Starting in 2017, the Chinese government is set to cut EV subsidies by 20% for pure EVs and 10% for plug-in hybrid electric vehicles (PHEVs). Given that subsidies currently account for 40% of EV sales prices, the subsidy cut will likely lead to an 8% rise in EV prices. As such, EV makers will need to lower their production costs by more than 8% to overcome the impact of the subsidy cut and increase sales volume. We believe cutting costs is more challenging for second-tier makers than for top-tier makers, including BYD. BYD plans to lower production costs by 10% each year through 2020. For the BYD Song, a plug-in hybrid compact SUV to be released in 1H17, total production cost is estimated at RMB200,000-210,000 (vs.