China / Hong Kong Company Guide

Guangzhou Automobile Group Version 4 | Bloomberg: 2238 HK Equity | 601238 CH Equity | Reuters: 2238.HK | 601238.SS

Refer to important disclosures at the end of this report DBS Group Research . Equity 29 August 2016

H: BUY Robust SUV sales Last Traded Price (H): HK$10.66 (HSI : 22,910) Strong earnings catalysts from self brand and Japanese JVs; BUY the H- Price Target 12-mth (H): HK$12.20 (14% upside) (Prev HK$11.60) share. Guangzhou Automobile (GAC) has been actively revamping its new model pipeline in recent years to beef up its market A: HOLD competitiveness. Its Trumpchi brand has strong earnings upside Last Traded Price (A): RMB23.66 (CSI300 Index : 3,307) potential, with the support of the GS4 SUV model. In 1H16, Trumpchi Price Target 12-mth (A): RMB23.90 (1% upside) (Prev RMB23.20) chalked up some 160k units of sales, of which the bulk is from GS4 Potential Catalyst: Strong sales momentum model. This model is challenging market leader Great Wall Motors’ Where we differ: Our FY16/17 EPS slighlty higher than consensus Havel H6. The Japanese JVs are also posting a strong turnaround in

Analyst earnings. The strong reception of the GAC-Toyota Highlander (SUV) for Rachel MIU +852 2863 8843 [email protected] instance has given the Japanese JVs a good run in 1H16. A total of some 10 new models from its various JV brands (Guangqi-Honda, GAC- What’s New Toyota, GAC-Mitsubishi and GAC Fiat-Chrysler) will help to strengthen  Strong earnings outlook for Trumpchi SUV sales GAC’s earnings outlook. and Japanese JVs  Interim earnings ahead of our expectations Capacity expansion to support growth. GAC is expanding production capacity at its JVs and self-owned brand to cater to new vehicle roll-  Raised FY16/17 earnings estimates by 13%/8% on outs in the coming few years. GAC will be adding about 20% new higher sales volume and GP margins capacity at the major operating units to gradually meet the higher  Maintain BUY with higher TP of HK$12.20, pegged anticipated demand. Funding is not an issue as the company has to 10x PE on FY16 earnings strong cash generation ability.

Price Relative Valuation: We revised up FY16/17F earnings by c.13%/8% on a strong new product pipeline. Our new HK$12.20 TP (H-share) is based on 10x PE (FY16 earnings). We believe improving contributions from its JVs and self-owned brand are critical for share price performance. We have a HOLD rating on the A-share as the valuation is expensive. As we enter 4Q16, there could be some share price volatility arising from the high base comparison in 4Q15.

Forecasts and Valuation (H Shares) Key Risks to Our View: Margin compression. Rapid expansion in production capacity in the FY Dec (RMB m) 2014A 2015A 2016F 2017F Turnover 22,383 29,418 45,980 51,664 industry could intensify market competition and drag down product EBITDA 4,473 6,213 9,336 10,434 prices, affecting vehicle sales margins and earnings. Pre-tax Profit 3,066 4,386 7,275 8,279 Net Profit 3,194 4,212 6,869 7,766 Weak controls at new auto JVs. In recent years, GAC has entered into Net Pft (Pre Ex) 3,194 4,212 6,869 7,766 Net Profit Gth (Pre-ex) (%) 20.4 31.9 63.1 13.0 several new business arrangements with its foreign partners to localise EPS (RMB) 0.50 0.65 1.04 1.17 some new models in China. For instance, Jeep's localisation strategy EPS (HK$) 0.58 0.76 1.21 1.36 may fail if the company is unable to implement the right strategy to EPS Gth (%) 20.4 31.9 58.5 13.0 scale up its operations, leading to massive losses. Diluted EPS (HK$) 0.58 0.76 1.21 1.36 DPS (HK$) 0.19 0.23 0.36 0.41 At A Glance BV Per Share (HK$) 6.41 6.99 8.42 9.40 Issued Capital - H shares (m shs) 2,213 PE (X) 18.5 14.0 8.8 7.8 - Non H shares (m shs) 4,222 P/Cash Flow (X) 169.4 15.2 17.3 14.1 H shs as a % of Total 34 P/Free CF (X) nm nm 120.6 46.5 Total Mkt. Cap (HK$m/US$m) 140,004 / 18,053 EV/EBITDA (X) 10.3 8.9 5.4 4.6 Major Shareholders Net Div Yield (%) 1.7 2.2 3.4 3.8 Guangzhou Automobile (%) 57.6 P/Book Value (X) 1.7 1.5 1.3 1.1 Major H Shareholders (%) Net Debt/Equity (X) CASH CASH CASH CASH Westwood Global Investments, LLC (%) 10.2 ROAE (%) 9.3 11.4 15.9 15.3 Guangzhou Auto Industry Group (%) 9.1 Earnings Rev (%): 13 8 BlackRock, Inc. (%) 6.1 Consensus EPS (RMB) 1.00 1.13 Templeton Asset Management (%) 6.0 Other Broker Recs: B: 16 S: 6 H: 3 H Shares-Free Float (%) 68.7 Source of all data on this page: Company, DBSV, Thomson Reuters, 3m Avg. Daily Val. (US$m) 18.6 ICB Industry : Consumer Goods / Automobiles & Parts HKEX

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Company Guide

Guangzhou Automobile Group

WHAT’S NEW The second profit driver came from its two major Japanese JVs, Interim earnings above our expectation which had contributed to the sharp increase in JCE profits. Guangqi-Honda posted sales growth of 12.4% to 273,083 Strong interim earnings driven by JVs and self-brand: 1H16 net units, translating to revenue expansion of 9.1% to Rmb31.6bn. earnings jumped 128% y-o-y to about Rmb4bn, coming from GAC-Toyota also made 8% higher volume sales at 208,752 Trumpchi’s strong profits and high contributions from the units and revenue rose 14.7% to Rmb29bn. In total, these two Japanese JVs. JVs contributed about Rmb2.6bn to net profit.

The self brand business recorded 87% increase in turnover to Operating cash inflow surged sharply: The strong interim profit Rmb21.4bn, thanks to robust GS4 model SUV sales. As a result, has lifted operating cash inflow to Rmb2.9bn, up sharply from gross profit more than doubled to Rmb3.7bn, translating to an outflow of Rmb194m in 1H15. The strong cash generation excellent GP margin of 17.1%, up from 9.4% in the same ability will help to support future business expansion. period last year. In 1H16, Trumpchi has chalked up almost

160k unit sales, growing by 144% y-o-y.

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Company Guide Guangzhou Automobile Group

Results summary

Y-o-Y chg. (RMBm) 1H15 1H16 (%) Revenue 11,450 21,429 87.2% Cost of sales (10,375) (17,755) 71.1% Gross profit 1,075 3,674 241.8% Selling and distribution costs (713) (1,263) 77.3% Administrative expenses (631) (1,054) 67.2% Interest income 113 178 56.7% Other expenses, net 432 88 -79.6% Operating profit 277 1,623 486.3% Finance costs (447) (410) -8.1% Interest income 56 49 -13.3% Share of asso & JCE profits 1,916 3,164 65.1% Profit before tax 1,802 4,425 145.5% Income tax expense (81) (411) 405.7% Minority Interest 28 (33) n.m. PATMI 1,750 3,982 127.6% EPS (RMB) 0.27 0.62 127.6%

Margin A naly sis (%) ppts chg. Gross Profit Margin 9.4 17.1 7.8 Operating Profit Margin 2.4 7.6 5.2 Net Profit Margin 15.3 18.6 3.3

Sales volume - including JCEs (1,000 units) Passenger vehicles 567.8 731.1 28.8% Commerical v ehicles 1.5 0.8 -44.7% Total v olume 569.3 731.9 28.6%

JCEs revenue performance Guangqi Honda 28,997 31,639 9.1% GAC Toyota 24,997 28,679 14.7% GAC Fiat-Chrysler 1,722 10,678 520.1% GAC Mitsubishi 3,339 3,704 10.9% GAC Hino 535 298 -44.3% GAC Sofinco 943 977 3.6% Wuyang-Honda 2,835 2,554 -9.9% Total 63,368 78,529 23.9%

Source: Company, DBS Vickers

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Company Guide

Guangzhou Automobile Group

CRITICAL DATA POINTS TO WATCH Passenger vehicle (units)

Earnings Drivers: New JVs and vehicle roll-outs. GAC has been active in setting up new JVs to enhance its product offerings and improving market competitiveness. Under the various Sino-foreign JVs with Honda and Toyota, the company is planning to refresh its vehicle models. Also, the new JV with Fiat Chrysler Auto (FCA) will be launching new SUV products to ride on the industry uptrend. During the start-up phase of the FCA JV, we expect GAC to report some initial losses until the

production scale is ramped up to a reasonable size. GAC-FCA is expanding its range of SUV models under the JEEP brand Commercial vehicle (units) and the new Guangzhou plant is scheduled to commence operations this year.

Profit margin improvements. The Japanese JVs have been actively managing their production output and this has greatly reduced inventory pressure at the dealers’ channels. This has helped to stabilise car prices and protect profit margins, as inventory is kept at a healthy level of 1-1.5 months. Going forward, with a disciplined approach to production output, we anticipate profit margins at its JCEs and self-owned brand to improve. Total veh sales at GAC level

Trumpchi brand's steady development. Trumpchi has been one of the more successful local brands with a SOE background to have gained strong consumer support. Strong commitment in R&D and widening of vehicle range are key growth engines. GAC plans to grow Trumpchi into a large auto self-brand. Within three short years, the company has expanded its range of vehicle types, especially in the SUV segment. For instance, its GS4 SUV sales have jumped multiple folds since it started sales in 2H15 Gross profits and GP margins Benefitting from vehicle purchase tax cuts. The company has RMB m % a relatively large exposure to the 1.6L-and-below car segment, 10,000 18.0 16.0 especially for its Trumpchi brand. We estimate that about 20- 8,000 14.0 12.0 30% of volume sales from GAC’s two Japanese JVs will 6,000 10.0 benefit from the tax benefits. 4,000 8.0 6.0 2,000 4.0 2.0 0 0.0 FY13 FY14 FY15 FY16F FY17F Gross profit (LHS) Gross margin (RHS)

JCE profit contributions RMB m 6,000

5,000

4,000

3,000

2,000

1,000

0 FY13 FY14 FY15 FY16F FY17F

Source: Company, DBS Vickers ASIAN INSIGHTS VICKERS SECURITIES

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Company Guide Guangzhou Automobile Group

Leverage & Asset Turnover (x) Balance Sheet: Maintaining a healthy balance sheet. GAC reported a major increase in net cash flow from operations in 1H16. We expect the company to report small positive free cash flows in the coming 2-3 years as it is still growing the business. However, it has a strong net cash balance to support these capex spending. The company is boosting its capital base via an A-share CB issuance to support business growth.

Capital Expenditure Share Price Drivers: Healthy monthly vehicle sales. A steady increase in monthly vehicle sales will give the market a positive signal of its earnings ability. The new car models in the pipeline will help to strengthen its market positioning and to drive earnings.

Key Risks: Major deceleration of economic growth. Concerns of economic growth deceleration could affect buying sentiment on cars. A slowdown in disposable income growth and a weaker property ROE market could also dampen sales.

Industry overcapacity. Overcapacity could drive down prices of cars, due to rising competition from other car makers. Under- utilisation of production capacity may be a drag on return of investment.

Anti-trust probe. Automakers are facing pressure to lower ASPs of spare parts, which could affect future margin performance.

Forward PE Band

Company Background: Guangzhou Automobile Group Company, Ltd. (GAC) manufactures, sells, and services automobiles. The Company is also involved in automobile parts and components, and auto financing and related services for both domestic and overseas markets. It manufactures Toyota, Honda, Mitsubishi and Fiat cars under partnerships with its foreign partners.

PB Band

Source: Company, DBS Vickers

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Company Guide

Guangzhou Automobile Group

Key Assumptions FY Dec 2013A 2014A 2015A 2016F 2017F Passenger vehicle (units) 127,100.0 140,662.0 206,538.0 321,915.0 370,202.3 Commercial vehicle 884.0 3,791.0 1,945.0 1,556.0 1,633.8 (units) Total veh sales at GAC 127,984.0 144,453.0 208,483.0 323,471.0 371,836.1 level Source: Company, DBS Vickers

Segmental Breakdown (RMB m)

FY Dec 2013A 2014A 2015A 2016F 2017F Revenues (RMB m) Guangqi Honda 58,437 59,809 69,397 80,695 86,989 GAC Toyota 52,386 53,879 54,663 62,535 66,800 GAC Mitsubishi 5,909 7,478 6,144 6,515 7,238 GAC Fiat 5,052 6,814 4,822 15,913 18,380 Unit Sales (delete RMBm) Guangqi Honda 435,480 480,060 580,068 661,278 727,405 GAC Toyota 303,088 374,108 403,088 443,397 483,303 GAC Mitsubishi 43,035 63,199 56,318 59,134 65,047 GAC Fiat 48,375 68,090 39,488 118,464 130,310

Source: Company, DBS Vickers

Income Statement (RMB m) FY Dec 2013A 2014A 2015A 2016F 2017F Revenue 18,824 22,383 29,418 45,980 51,664 Cost of Goods Sold (16,830) (19,831) (25,975) (39,083) (43,398) Gross Profit 1,994 2,552 3,444 6,897 8,266 Other Opng (Exp)/Inc (3,217) (3,361) (3,468) (5,152) (5,940) Operating Profit (1,222) (809) (25) 1,745 2,326 Other Non Opg (Exp)/Inc 0 0 0 0 0 Associates & JV Inc 4,020 4,181 4,720 5,814 6,173 Net Interest (Exp)/Inc (169) (307) (310) (283) (221) Dividend Income 0 0 0 0 0 Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 2,629 3,066 4,386 7,275 8,279 Tax (101) (131) (400) (655) (786) Minority Interest 125 259 226 249 273 Preference Dividend 0 0 0 0 0 Net Profit 2,654 3,194 4,212 6,869 7,766 Net Profit before Except. 2,654 3,194 4,212 6,869 7,766 EBITDA 3,749 4,473 6,213 9,336 10,434 Growth Revenue Gth (%) 45.2 18.9 31.4 56.3 12.4 EBITDA Gth (%) 101.5 19.3 38.9 50.3 11.8 Opg Profit Gth (%) 15.4 33.8 97.0 N/A 33.3 Net Profit Gth (%) 134.0 20.4 31.9 63.1 13.0 Margins & Ratio Gross Margins (%) 10.6 11.4 11.7 15.0 16.0 Opg Profit Margin (%) (6.5) (3.6) (0.1) 3.8 4.5 Net Profit Margin (%) 14.1 14.3 14.3 14.9 15.0 ROAE (%) 8.2 9.3 11.4 15.9 15.3 ROA (%) 4.9 5.3 6.5 9.4 9.3 ROCE (%) (2.6) (1.7) 0.0 2.8 3.2 Div Payout Ratio (%) 38.8 32.2 30.6 30.0 30.0 Net Interest Cover (x) (7.2) (2.6) (0.1) 6.2 10.5 Source: Company, DBS Vickers

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Company Guide Guangzhou Automobile Group

Interim Income Statement (RMB m) FY Dec 1H2014 2H2014 1H2015 2H2015 1H2016

Revenue 10,766 11,617 11,450 17,969 21,429 Cost of Goods Sold (9,705) (10,126) (10,375) (15,600) (17,755) Gross Profit 1,061 1,491 1,075 2,369 3,674 Other Oper. (Exp)/Inc (1,180) (2,180) (912) (2,557) (2,230) Operating Profit (119) (689) 163 (188) 1,445 Other Non Opg (Exp)/Inc 600 489 519 652 540 Associates & JV Inc 1,576 1,637 1,453 2,224 2,673 Net Interest (Exp)/Inc (252) (176) (333) (105) (233) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 1,806 1,260 1,802 2,583 4,425 Tax (92) (38) (81) (319) (411) Minority Interest 12 247 28 198 (33) Net Profit 1,725 1,469 1,750 2,462 3,982 Net profit bef Except. 1,725 1,469 1,750 2,462 3,982

Growth Revenue Gth (%) 30.5 9.8 6.3 54.7 87.2 Opg Profit Gth (%) 75.6 6.1 N/A 72.7 784.9 Net Profit Gth (%) 41.5 2.4 1.4 67.6 127.6

Margins Gross Margins (%) 9.9 12.8 9.4 13.2 17.1 Opg Profit Margins (%) (1.1) (5.9) 1.4 (1.0) 6.7 Net Profit Margins (%) 16.0 12.6 15.3 13.7 18.6 Source: Company, DBS Vickers

Balance Sheet (RMB m) FY Dec 2013A 2014A 2015A 2016F 2017F

Net Fixed Assets 7,366 8,544 10,581 12,650 14,643 Invts in Associates & JVs 18,425 18,693 18,478 21,351 23,774 Other LT Assets 5,539 8,341 10,262 9,415 8,488 Cash & ST Invts 19,040 18,371 16,472 22,848 25,908 Inventory 2,036 2,661 1,927 2,023 2,125 Debtors 4,725 5,516 8,727 10,036 11,541 Other Current Assets 713 338 772 772 772 Total Assets 57,843 62,463 67,220 79,096 87,251

ST Debt 9,397 41 4,279 4,279 4,279 Creditors 8,637 10,651 14,077 15,766 17,658 Other Current Liab 25 9,541 300 935 1,702 LT Debt 4,775 4,769 7,649 8,149 8,349 Other LT Liabilities 893 1,212 1,424 1,424 1,424 Shareholder’s Equity 33,311 35,453 38,647 47,947 53,518 Minority Interests 805 796 845 596 323 Total Cap. & Liab. 57,843 62,463 67,220 79,096 87,251

Non-Cash Wkg. Capital (1,188) (11,676) (2,951) (3,870) (4,922) Net Cash/(Debt) 4,868 13,560 4,544 10,421 13,280 Debtors Turn (avg days) 77.8 83.5 88.4 74.5 76.2 Creditors Turn (avg days) 172.5 187.9 184.5 146.0 147.1 Inventory Turn (avg days) 39.5 45.8 34.2 19.3 18.3 Asset Turnover (x) 0.4 0.4 0.5 0.6 0.6 Current Ratio (x) 1.5 1.3 1.5 1.7 1.7 Quick Ratio (x) 1.3 1.2 1.4 1.6 1.6 Net Debt/Equity (X) CASH CASH CASH CASH CASH Net Debt/Equity ex MI (X) CASH CASH CASH CASH CASH Capex to Debt (%) 13.4 73.0 36.2 24.1 23.8 Z-Score (X) 2.5 2.4 2.5 2.6 2.6 Source: Company, DBS Vickers

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Company Guide

Guangzhou Automobile Group

Cash Flow Statement (RMB m) FY Dec 2013A 2014A 2015A 2016F 2017F

Pre-Tax Profit 2,629 3,066 4,386 7,275 8,279 Dep. & Amort. 951 1,100 1,517 1,778 1,934 Tax Paid (172) (85) (91) (20) (20) Assoc. & JV Inc/(loss) (4,020) (4,181) (4,720) (5,814) (6,173) (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. 566 593 2,629 284 285 Other Operating CF 594 (144) 170 0 0 Net Operating CF 548 348 3,891 3,503 4,305 Capital Exp.(net) (1,904) (3,513) (4,322) (3,000) (3,000) Other Invts.(net) 0 0 0 0 0 Invts in Assoc. & JV (1,333) (288) (2,109) 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF 3,946 547 7,173 2,941 3,750 Net Investing CF 708 (3,254) 742 (59) 750 Div Paid 0 0 0 0 0 Chg in Gross Debt 4,041 28 (2,469) 500 200 Capital Issues (507) (923) (814) 2,432 (2,195) Other Financing CF (22) (14) (89) 0 0 Net Financing CF 3,512 (909) (3,372) 2,932 (1,995) Currency Adjustments 0 (2) 14 0 0 Chg in Cash 4,767 (3,816) 1,274 6,376 3,059 Opg CFPS (RMB) 0.00 (0.04) 0.20 0.49 0.61 Free CFPS (RMB) (0.21) (0.49) (0.07) 0.08 0.20

Source: Company, DBS Vickers

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Company Guide Guangzhou Automobile Group

H Share - Target Price & Ratings History

S.No. Date Closing 12-mth Rating HK$ Price Target 12.0 7 Price 4 5&6 11.0 3 1: 2-Nov-15 HK$6.82 HK$8.30 Buy 10.0 1 2 2: 1-Feb-16 HK$6.74 HK$7.50 Buy 3: 18-Mar-16 HK$7.58 HK$7.50 Buy 9.0 4: 11-Apr-16 HK$8.57 HK$9.80 Buy 8.0 5: 28-Apr-16 HK$8.90 HK$10.60 Buy 7.0 6: 28-Apr-16 HK$8.90 HK$10.60 Buy 6.0 7: 1-Aug-16 HK$10.30 HK$11.60 Buy 5.0 4.0 Jul-16 Jan-16 Jun-16 Oct-15 Feb-16 Sep-15 Apr-16 Dec-15 Nov-15 Mar-16 Aug-15 Aug-16 May-16

Source: DBS Vickers Analyst: Rachel MIU

A Share - Target Price & Ratings History

S.No. Date Closing Target Rating RMB Price Price 30.0 1: 2-Nov-15 RMB20.86 RMB10.50 Fully Valued 123 45&6 7 25.0 2: 1-Feb-16 RMB19.69 RMB15.80 Fully Valued 3: 18-Mar-16 RMB19.40 RMB15.80 Fully Valued 20.0 4: 11-Apr-16 RMB20.73 RMB18.20 Fully Valued 5: 28-Apr-16 RMB21.50 RMB19.00 Fully Valued 15.0 6: 28-Apr-16 RMB21.50 RMB19.00 Fully Valued 10.0 7 1-Aug-16 RMB23.82 RMB23.2 Hold

5.0

0.0 Jan-16 Jun-16 Nov-15 Mar-16 Aug-15 Aug-16

Source: DBS Vickers Analyst: Rachel MIU

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Company Guide

Guangzhou Automobile Group

DBSV recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

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The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd., DBSVS and DBSVHK, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the “DBS Group”)) do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies.

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Company Guide Guangzhou Automobile Group

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Other In any other jurisdictions, except if otherwise restricted by laws or regulations, this report is intended only for jurisdictions qualified, professional, institutional or sophisticated investors as defined in the laws and regulations of such jurisdictions.

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ASIAN INSIGHTS VICKERS SECURITIES

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