China / Hong Kong Industry Focus China Auto Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 29 May 2019 Premium segment takes the lead HSI: 27,236 • Lineup of new premium car models (BMW) and ANALYST tight supply (Lexus) to support performance of Rachel MIU +852 36684191 [email protected] auto dealerships in 2H19 • Prefer BMW auto dealership proxies to ride on Recommendation & valuation new model cycle - Grand Baoxin, China Yongda, China ZhengTong and China Meidong Company Price T arget Recom F Y19F Mk t Price PE Cap • Brilliance’s valuation is attractive, given strong HK$ HK$ x US$m earnings led by solid BMW sales growth Auto Dealers China Yongda Automobiles Svs. 6.45 7.50 BUY 6.3 584 Premium car segment outperforming the overall auto market; 3669 HK margin pressure on auto dealerships easing. The premium auto China Zhengtong Auto Svs.* 3.16 6.30 BUY 4.2 990 segment is benefitting from lower import tariffs and new 1728 HK Grand Baoxin Auto Group 2.47 n.a. NR 8.0 893 models, which are supporting consumer upgrading and driving 1293 HK mid-term sales growth. Volume sales of German premium cars China Meidong Auto Hdg. 4.56 n.a. NR 10.6 670 (Audi-BMW-Benz combined) rose c.5% y-o-y in 4M19, with 1268 HK BMW leading the growth at 12%. There were some short-term disruptions to supplies as Porsche had adjusted production to Company Price T arget Recom F Y19F Mk t Price PE Cap comply with the National Fuel VI standard. Sales have also yet Local$ Local$ x US$m to reflect the positive impact from lower VAT after automakers Auto manufacturers revised down their price lists recently. As a result, growth in the Brilliance China 7.47 10.30 BUY 4.5 4,802 premium car market was modest for 4M19, but still better 1114 HK than the overall PV market which had shrunk by 14.7% YTD. We estimate the premium car market to grow at 8% this year. Source: Thomson Reuters, DBS Bank (Hong Kong) Limited (“DBS HK”), Bloomberg Finance L.P The auto dealership market has stabilised in 1Q19 compared to 2H18, as demand remains firm and downward pressure on GP *China ZhengTong TP under review. margin has eased slightly. Volume sales growth comparison (Jan-Apr 2019) Brilliance stands out among premium automaker peers. The BMW JV vehicle shipment grew 29% y-o-y from Jan-Apr 2019, ahead of peers. Besides, the Mercedes Benz product cycle is Y-o-Y (%) ageing and could affect future sales performance. The new 15 BMW 3 series will be ready in 2H19, an important volume 10 driver. Brilliance’s current valuation is attractive and we believe the company’s ownership reform has largely been factored into 5 its share price. We believe market will refocus on the JV 0 operations and its ability to generate future growth. -5 Auto dealership sector valuation. Following the recent broad -10 market sell-down, the auto dealership sector is trading at c.6x FY20F PE. This provides an opportunity for investors to -15 accumulate some of the BMW related auto names. The -20 attractive lineup of new BMW models is positive for the BMW BMW Lexus Mercedes Audi Premium Overall dealerships. Also, the special incentives from BMW in 1Q/2Q19 Benz market PV market should mitigate some pressure off dealers’ GP margins. Source: Companies; CEIC Note: Units sales including imports ed- JS/ sa-CS / JY Industry Focus China Auto Sector Takeaways from company visits China ZhengTong (1728 HK) China ZhengTong is among the top 3 BMW auto dealerships in We spoke to several auto dealerships recently on the 2019 China. In 2019, the company target to achieve around 10% outlook and their key concerns. In summary, the volume sales volume sales growth and BMW, Volvo and Porsche are some of momentum has remained encouraging YTD, trending along the important revenue drivers. The new car sales GP margin is with the key premium brands they represent. While the trade expected to norrmalise to around 5% this year, compared to war has some impact on demand, the auto dealerships believe 6.7% in 2018, as the company anticipates lower special a balanced demand-supply equilibrium should help to protect incentives from the automakers. China ZhengTong key margins. The special incentives from BMW in 1Q/2Q19 and advantages over its peers are 1) it is expected to benefit from lowering of vehicle price lists by automakers (due to cut in the Guangdong vehicle stimulus policy given its presence in the VAT) do help their new car sales business. The main concern is southern region; and 2) it operates an auto finance unit which the trade war impact on the health of the overall economy. is riding on the rapid industry expansion. As the credit market is improving and interest rate coming down, it should be Below are the key takeaways from the meetings. positive on the auto finance operations. Its major subsidiary, Wuhan ZhengTong posted 1Q19 earnings improvement from China Meidong (1268 HK) 4Q18, but lower than 1Q18 on high base and trade war Premium car sales growth is fine YTD, and margins have impact. Our FY19/20F earnings and TP are under review. stabilised for certain brands, compared to 4Q18. In 1Q19, the 4S store business was decent, with volume growth in the key premium brands they represent, such as BMW, Lexus, and Porsche. New car sales GP margin was reasonable, and the special bonus from BMW in 1Q/2Q19 helps to mitigate the margin pressure. In 4Q18, BMW GP margin was quite modest compared to other premium brands. For Porsche, the GP margin is expected to hover at 9%, compared to 10.5% in 1H18. Also, premium automakers such as BMW have lowered vehicle prices on some of their car models by 2-3% to reflect the 3ppts cut in VAT, enhancing its market competitiveness. The company expects 1H19 performance to be better than 2H18. In FY19, revenue is expected to increase by about 30%, coming from store expansion (acquired six BMW stores in 2018 which should start to contribute to sales) and projected volume growth (estimated to increase by over 20% y-o-y). By end 2019, the sales network is expected to reach 59 dealership stores, up from 49 in 2018. China Meidong adopts a single city single store strategy, largely in the tier 3-4 Chinese cities. China Yongda Auto (3669 HK) New car sales GP margins have stabilised in 1Q19 compared to 2H18. Any further improvement in GP margin will depend on the demand situation. Since April 2019, sales momentum has remained decent, especially with the increase in deliveries from Porsche. The company expects its quarterly performance to improve from the trough level in 2H18, coming from the delivery of new car models as well as VAT cut. For 2019, China Yongda expects volume and new car sales revenue to grow at around 10% y-o-y. New car sales GP margin is expected to be flat in 2019 but may post some slight improvement if market competition eased. China Yongda has the largest exposure to the BMW brand. In 2018, it accounted for about 9% of total BMW volume sales in China. At end December 2018, China Yongda had 53 BMW outlets, of which 42 units are 4S stores. Page 2 Industry Focus China Auto Sector Premium car sales outperformed Our view • Premium car sales outperformed the overall PV market in (%) recent years on consumption upgrading 40.0 • Trade war has affected overall car sales, but the impact on 30.0 premium car segment was smaller 20.0 • Key premium volume drivers include car models from BMW, 10.0 Lexus and Volvo 0.0 -10.0 -20.0 -30.0 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18 May-14 May-15 May-16 May-17 May-18 Premium YoY % PV YoY % Source: CEIC, companies Premium car market sales projections Our view • Consumption upgrade and low penetration rate is '000 % supporting premium car sales growth 3,500 25 • Estimate premium car sales to expand by 8-10% for FY19- 3,000 20 20F 2,500 • Positive drivers are lower import tariffs on non-US made 15 2,000 cars, VAT cuts (automakers passing on cost savings to 1,500 10 consumers through lower vehicle prices) and new model 1,000 launches 5 500 • Relaxation of auto sales quota in Guangdong is expected to 0 0 be positive on high-end and premium car sales 2013 2014 2015 2016 2017 2018 2019F 2020F ABB Others Y-o-Y chg. (RHS) Source: Companies; DBS HK Note: ABB: Audi, BMW, Mercedes Benz, Others: other premium brands Volume sales growth comparison (Jan-Apr 2019) Our view • BMW volume sales outperformed peers and the overall PV Y-o-Y (%) market, attributable to new model pipeline 15 • Several new models planned for 2019 launch, including 10 BMW X7, BMW 3 series, BMW series and BMW 7 series 5 (facelift) to drive sales 0 • Beneficial to BMW auto dealerships such as Grand Baoxin, China Yongda, China ZhengTong, China Meidong etc. -5 -10 -15 -20 BMW Lexus Mercedes Audi Premium Overall Benz market PV market Source: Companies; CEIC Note: Units sales including imports Page 3 Industry Focus China Auto Sector Inventory days of Sino-foreign and imported brands Our view • Inventory levels were at healthy range of 1.7-1.8 months at Y-o-Y (%) end April 2019 for imported vehicles and Sino-foreign JV 15 brands, given that the industry is in a traditionally lull period 10 • Certain imported brands have very low inventory, such as 5 Lexus, as the automaker has controlled production to protect brand value and profit margins 0 -5 -10 -15 -20 BMW Lexus Mercedes Audi Premium Overall Benz market PV market Source: CADA Vehicle import volumes Our view • Changes in vehicle import tariffs have affected trade flow, unit as importers had waited for new tariff rates to take effect in 180,000 2H18 160,000 • Tariff rate on non-US made imported vehicles is 15%, down 140,000 120,000 from 25% previously 100,000 • Lexus overtook Mercedes Benz as the top imported brand in 80,000 4M19, due to the preferential tariff rate 60,000 40,000 20,000 0 Jul Jan Sep Nov Mar May 2016 2017 2018 2019 Source: CEIC China Yongda quarterly performance Our view • Improving net margin trend from trough level in 2H18 Rmb m (%) • Expect better 2H19 profitability as 1H19 is affected by high 500 4.0 450 base.