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Geely Automobile Holdings (175 HK)– BUY HKD12.00 Key Trends in China’S PV Market Over the Next Three Years: 1

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Geely Automobile Holdings (175 HK)– BUY HKD12.00 Key Trends in China’S PV Market Over the Next Three Years: 1 Sector Initiation Hong Kong ! 5 May 2017 Consumer Cyclical | Automobiles & Components Neutral Automobiles & Components Stocks Covered: 3 Competition In The New Era Ratings (Buy/Neutral/Sell): 1 / 2 / 0 We expect growth in China’s PV market to slow to 5%/3% in 2017/2018 Top Pick Target Price respectively, due to diminishing effects of purchase tax cuts. We see three Geely Automobile Holdings (175 HK)– BUY HKD12.00 key trends in China’s PV market over the next three years: 1. Local brands to expand market share; 2. EV sales to grow at a higher pace vs fuel cars; 3. SUVs to continue to lead the market. China’s PV sales and growth rate on the uptrend Our sector Top Pick is Geely on its improved model portfolio and good synergy with Volvo. We also initiate coverage on BYD and GWM with NEUTRAL recommendations. Our sector call is NEUTRAL. We initiate coverage on China’s auto manufacturers with a NEUTRAL weighting. We expect passenger vehicles and minibus (collectively known as PV) sales in 2017/2018 to grow by 5%/3% respectively, slowing from 7%/15% registered in 2015/2016 respectively. This is as due to the diminishing effects of purchase tax discounts on cars with 1.6L displacement and below, to 25% starting 2017 from 50% in Oct 2015. Note that part of 2017’s PV sales were pre- sold in 2016, and part of PV sales in 2018 would be partially pre-sold in 2017. Solid growth expected in various segments, such as sport utility vehicles (SUVs), electric vehicles (EVs), smart vehicles, cars with displacements above 1.6L, premium brands, price-insensitive auto buyers, and in areas such as lower- Source: China Passenger Car Association (CPCA) tier cities. Hence we value auto manufacturers based on their respective special competitive advantages as highlighted above. Since new auto models are Sales growth for local brands leading the pack usually planed 5-8 years ahead, we believe companies with a good sense of the market, flexibility and efficiency would be well prepared. Also, the soft market helps to eliminate uncompetitive players, which would improve industry concentration and market share expansion for key players, in our view: i. Prefer market leaders of local brands, as we see creativity and upgrades in local brands driving the growth in smart cars and renewable energy vehicles. We like local brand manufacturers with execution ability and efficiency, and are in tune with Chinese consumers’ preferences and government policies – BYD’s EVs, Geely Automobile’s (Geely) Lynk & Co, and Great Wall Motor’s (GWM) WEY. Due to the joint venture (JV) structure of mass market manufactures and local governments’ protection of local brands against JV brands, we see relatively slower application of creativity and improvements in JV brands vs local brands; ii. EV sales continue to be strong, driven by government policies and Source: CPCA subsidies. We expect Chinese EV sales – PV and commercial vehicles (CV) – to reach 2,035,000 units in 2020, and grow at CAGR of 40% with a penetration rate of 6% in the overall market, driven by government Table Of Contents subsidies, the 5L cap on fuel consumption per 100km by 2020, plate Peer Comparison 2 lottery/bidding, and tail number restrictions; Investment Thesis 3 Mild Growth Prospects Ahead 5 iii. SUVs’ solid growth to continue. We forecast a CAGR of 13.2% for SUV Local Brands – New Era For Market Leaders 8 sales in China up to 2020, which would result in SUV sales reaching 48% of EV Sales Stay Strong On Government Policies 9 overall PV sales by then, driven by the Government’s second-child policy, SUVs: The Growth Continues 14 Geely Automobile Holdings 17 and higher demand for SUVs in third- or lower-tier cities. Great Wall Motor 29 Our sector Top Pick is Geely, for its strong 2016 model portfolio, successful BYD 40 launches of Boyue, GC, and the new Emgrand, as well as margin improvement driven by synergies with Volvo (VOLVB SS, NR). We also initiate coverage on BYD with a NEUTRAL call – we like its strength in EVs and rapid shift into the mono rail market but we are cautious on the drop in its EV gross margins and mono rail execution. We initiate coverage on GWM with a NEUTRAL rating – we like its solid leadership in the SUV market, which should remain stable, but we are concerned over its margin deterioration. % Upside P/E (x) P/B (x) Yield (%) Analyst Company Name Rating Price Target (Downside) Dec-18F Dec-18F Dec-18F Zhuang Dan Geely Automobile Holdings BUY HKD10.22 HKD12.00 17.4 8.8 2.0 1.1 BYD Co Ltd NEUTRAL HKD44.00 HKD40.40 (8.2) 18.5 1.6 0.8 +852 2103 9414 Great Wall Motor Co NEUTRAL HKD8.11 HKD8.13 0.2 5.4 1.0 5.6 [email protected] Source: Company data, RHB See important disclosures at the end of this report 1 Powered by the EFA Platform Automobiles & Components Hong Kong Sector Initiation 5 May 2017 Figure 1: Peer comparison I Note: Data as of 4 May 2017 Source: RHB, Bloomberg See important disclosures at the end of this report 2 Automobiles & Components Hong Kong Sector Initiation 5 May 2017 Figure 2: Peer comparison II Note: Data as of 4 May 2017 Source: RHB, Bloomberg See important disclosures at the end of this report 3 Automobiles & Components Hong Kong Sector Initiation 5 May 2017 Investment Thesis Mild growth prospects ahead We expect growth in China’s PV market to slow to 5% and 3% in 2017 and 2018 respectively from 15% in 2016, due to the diminishing effects of purchase tax cuts. The tax rate on small-engine vehicles with engine sizes of up to 1.6L has been raised to 7.5% in 2017 from 5% in 2016, albeit still below the normal 10%. In other words, the purchase tax cuts have been reduced to 2.5% in 2017, from 5% in 2016. The purchase tax cuts on small-engine vehicles would be reduced further to 0% in 2018. Figure 3: Purchase tax cuts and tax rates for small-engine vehicles Effective period Purchase tax cuts Tax rates 1 Oct 2015-31 Dec 2016 Reduced to 5% from 10% 5% 1 Jan 2017-31 Dec 2017 Reduced to 2.5% from 5% 7.5% From 1 Jan 2018 To reduce to 0% from 2.5% 10% Source: Ministry of Finance (MoF) 1Q17 auto sales grew 5.1% YoY. For the next three quarters, we expect PV sales to grow at 4.3%, 2.3% and 5.4% YoY in 2Q17, 3Q17 and 4Q17 respectively: i. +4.3% YoY growth projected for 2Q17 to be supported by the low comparison base in 2Q16; ii. +2.3% YoY growth projected for 3Q17 is relatively softer, given the higher comparison base in 3Q16, and the seasonally slower Jul-Aug period for auto sales; iii. +5.4% YoY growth for 4Q17F, as we believe sales demand in 2017 would mostly be back-loaded towards year-end, considering consumers’ purchases before the Lunar New Year and pre-consumption ahead of 2018. Figure 4: China’s PV sales and forecasts Figure 5: China’s PV sales – quarterly growth Source: CPCA, RHB Source: CPCA, RHB Prefer market leaders of local brands over mass-market JV brands We prefer market leaders of local brands, such as Geely, GWM, and BYD, over Dongfeng Motor Group (DFM) (489 HK, NR) and Changan Auto (Changan) (000625 CH, NR). Over the past few years, local brands have expanded their market share to 41% in 2016 from 32% in 2009, due to: i. More rapid increases in demand for autos in lower tier cities, where local brands win on low prices; ii. Improved brand image and product upgrades by local brands, which have drawn consumers away from JV brands. See important disclosures at the end of this report 4 Automobiles & Components Hong Kong Sector Initiation 5 May 2017 Although we expect some market share squeeze from lower-priced autos – mainly from local brands in 2017 as price-sensitive buyers would have pre-purchased in 2016 – we view this positively as it would actually eliminate uncompetitive local players and improve industry concentration, as well as support market share expansion for key players which are stronger, such as GWM, Geely and BYD. We believe Geely and GWM have strong new car pipelines coming up, which would boost their respective sales. The improvement in quality has gradually changed the image of local brands whilst we believe local brands have managed to ride on government policies and subsidies, thereby benefiting from the growth in the EV market. EV sales continue to be solid, driven by government policies and subsidies We expect Chinese EV (PV and CV) sales to reach 2,035,000 units in 2020, or a 4-year CAGR of 40% and a penetration rate of 6% in the total autos market, as guided by the Energy Saving and New Energy Vehicles Development Plan set by the state council and announced in 2012. For 2017, we expect Chinese EV sales to reach 682,657 units, representing a 40% and 13% growth in PV and CV respectively. We believe EV sales would be underpinned by the Chinese Government’s efforts in boosting EV sales, due to: i. Severe air pollution; ii. Reduced dependency on imported oil – at the end of 2015, China's car ownership reached 172m, or +11.5% YoY. China's oil dependency increased to 60.6% in 2015, from 36% in 2003. iii. Support for growth in local auto sales.
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