Corporate China Dongfeng Motor Group Company Limited Credit Report Ratings Overview Issuer Rating ▪ Pengyuan International has affirmed Dongfeng Motor Group Company LT Issuer Credit Rating A Limited’s (DFMG) global scale long-term issuer credit rating (LTICR) at ‘A’. The outlook is stable. Outlook Stable ▪ The Company’s issuer credit rating is supported by its leading position in China as amongst the largest commercial vehicle (CV) manufacturers, its successful joint ventures (JVs) with Nissan and Honda that provide consistently high dividend pay-out, and the consequently strong leverage Contents and profitability profile. The rating is, however, constrained by the earnings drag from some other loss-making passenger vehicle (PV) Business Profile ..................................... 3 businesses, ongoing research and development (R&D) needs and uncertainties in the JV structures. Financial Profile ..................................... 6 Liquidity .................................................. 7 Rating Outlook Government Support .............................. 7 ▪ The rating outlook is stable, which reflects our expectation that DFMG’s Company Background ........................... 8 CV business and its two highly profitable JVs (with Nissan and Honda) Peer Comparison ................................... 8 will continue to deliver stable financial support while the Company’s moderately strong tie with the government, through the parent Dongfeng Rating Scores Summary .......................10 Motor Corporation (DFMC), will sustain and that the State-owned Asset Related Criteria .....................................10 Supervision and Administration Commission of the State Council (SASAC) will continue to support DFMC, thus DFMG. ▪ We would consider downgrading DFMG’s issuer credit rating if 1) Nissan and/or Honda raise(s) the stake in their respective JVs with DFMG; 2) there is a substantial drop in Nissan and Honda JVs’ profitability that makes the high dividend pay-out policy unsustainable; 3) the profitability of the CV business deteriorates materially; and 4) the loss in its own brand and/or PSA JV’s PV business worsens, possibly due to further investment Contacts in new energy vehicle (NEV) initiatives. ▪ We would consider upgrading DFMG’s issuer credit rating if 1) the loss- making situation of its own brand and PSA JV’s PV business significantly Primary Analyst improves; and 2) there is a rapid increase in auto financing business’s Name Vincent Ha, CFA profit contribution. Title Senior Director Direct +852 3615 8307 Email [email protected] Financial Summary Secondary Analyst Table 1: Financial Ratios 2019A 2020A 2021F 2022F 2023F Name Jonathan Tai, CFA Debt/EBITDA 0.9x 0.8x 1.1x 1.2x 1.4x Title Analyst EBITDA interest coverage 25.7x 15.1x 14.0x 14.1x 13.8x Direct +852 3615 8276 Gross debt/Capital 25% 31% 31% 32% 32% Email [email protected] FFO/Debt 114% 133% 82% 74% 61% OCF/Debt 105% 220% 44% 53% 33% FCF/Debt 64% 175% 12% 26% 11% EBITDA margin 15% 14% 14% 14% 14% ROIC 15% 11% 12% 12% 12% Sources: Company, Pengyuan International 7 May 2021 Page | 1 RA02050200017 Corporate China Key Rating Drivers Credit Strengths ▪ Leading position in China’s vehicle manufacturing industry. DFMG is the third largest vehicle original equipment manufacturer (OEM) in China with a volume-based market share of 11% in 2020, behind Shanghai Auto’s (SAIC) 22% and First Auto’s (FAW) 15%. Founded in 1969 as Second Auto Works with a focus on CVs, the Company is still amongst China’s largest CV OEMs with 11% market share in 2020. In that year, DFMG managed to record 18.5% year-on-year (YoY) increase in CV sales volume, in line with the industry growth in China, despite the coronavirus pandemic. With 2.3 million units of aggregate sales from various brands in 2020, the Company is also one of the leading PV OEMs in China. Last but not least, DFMG’s economy of scale also implies strong bargaining power along the supply chain for effective cost control. ▪ Robust cash inflow from JVs with Nissan and Honda. DFMG’s largest earnings contributors are the two 50-50 JVs, namely Dongfeng Motor Company Limited (DFL, a JV with Nissan) and Dongfeng Honda Automobile Company Limited (DHAC, a JV with Honda). In 2020, these two JVs accounted for 80% of DFMG’s total vehicles sold (vs. 60% in 2016) while their earnings contribution made up 91% of the Company’s net profit (vs. 74% in 2016). High dividend pay-out ratios from DFL and DHAC also provide strong cash inflow for DFMG over the years. To elaborate, the Company was entitled to an average of RMB10.7 billion dividends from DFL and DHAC each year between 2016 and 2020. Considering the well-diversified product line-ups, good brand image of Dongfeng Nissan and Dongfeng Honda, and their sales resilience even in 2020 amid the pandemic, we believe that these two JVs will continue to achieve healthy earnings going forward. ▪ Robust leverage and profitability profile. Despite the losses from other businesses such as its own brand PV business and the PSA JV, DFMG has a strong overall leverage and profitability profile bolstered by the profitability of the CV business, auto financing business and the DFL/DHAC JVs. To elaborate, the Company has an average adjusted EBITDA margin of 12% in 2016-20 after including dividends from JVs and associates. While DFMG’s leverage appears to be on the rise from a net cash position before 2018, partly due to investments on R&Ds, development of its own brand business and expansion of auto financing services, the debt-to-equity ratio is expected to stay below 20% in the foreseeable future, let alone the fact that DFL and DHAC are both in strong net cash position. Credit Weaknesses ▪ Uncertainties in future JV ownership structure. Since DFMG’s profitability mainly hinges on its lucrative JVs, the Company is exposed to the risk of reduction in JV stake and even termination of JV agreements. To elaborate, China did not allow foreign vehicle OEMs to own more than 50% of any local OEM entity and hence that led to set-ups of many Sino-foreign OEM JVs. However, the rule was scrapped for NEV OEMs in 2018, for CV OEMs in 2020 and will be scrapped for PV OEMs by 2022. DFMG’s key OEM JV partners, namely Nissan, Honda, Stellantis and Volvo AB, have hitherto expressed no intention in changing the stake-holding status quo. However, the possibility of buying back stake by the JV partners cannot be fully ruled out, especially considering the high profitability in DFL and DHAC. If this happens, DFMG’s financial profile could be negatively impacted. ▪ Profit drag from loss-making businesses. Apart from the profitable CVs and the Japanese OEM JV businesses, DFMG also has its own brand PV business and the Dongfeng Peugeot Citroen Automobile Company Limited (DPCA) JV, which are both incurring losses. To elaborate, the Company’s own brand PV business and Dongfeng Peugeot Citroen Automobile Sales Company Limited (the selling arm of DPCA) made operating losses of RMB3.5 billion, RMB3.9 billion and RMB4.3 billion, respectively, in 2018, 2019 and 2020 amid dwindling sales, while DPCA contributed to RMB885 million, RMB1.3 billion and RMB1.0 billion losses, respectively, in 2018, 2019 and 2020. Apparently, both DFMG’s own local brands and DPCA have not gained traction in China’s PV market and we do not expect the loss-making trend to revert in the foreseeable future given a lack of popular new models. ▪ More R&D investments on the way. According to DFMG, the Company will accelerate the development for NEV business, including the development of NEVs and intelligent connectivity vehicles. DFMG has established a new standalone NEV brand Voyah and we think that more financial resources will be put aside for R&D. Since the Company’s current NEV sales contribution is less than its peers such as SAIC and BYD, let alone the competitions from NEV start- ups, the catching-up efforts could lead to a rise in cash expenditure and rising leverage, in our view. 7 May 2021 Page | 2 RA02050200017 Corporate China Table 2: Key Credit Metrics (RMB mn) 2019A 2020A 2021F 2022F 2023F Financials and Profitability Revenue 101,087 107,964 117,222 122,807 128,008 EBITDA 15,550 14,964 15,978 17,327 18,134 EBITDA margin 15% 14% 14% 14% 14% Return on assets (ROA) 6% 4% 4% 4% 5% Return on invested capital (ROIC) 15% 11% 12% 12% 12% Cash Flow Measures Funds from operations (FFO) 15,567 15,050 14,201 15,205 15,821 Operating cash flows (OCF) 14,413 24,977 7,700 10,952 8,600 Free cash flow (FCF) 8,709 19,789 2,024 5,276 2,924 Discretionary cash flow (DCF) 5,378 16,331 -2,862 -544 -3,287 Capital expenditure 5,704 5,188 5,676 5,676 5,676 Balance Sheet Measures Cash and liquid investments 35,243 55,757 54,944 56,898 56,567 Excess cash 31,697 51,441 50,354 52,146 51,668 Total debt 45,411 62,771 67,771 72,771 77,771 Adjusted debt 13,714 11,330 17,417 20,625 26,103 Total capitalisation 179,379 203,897 216,000 228,487 241,473 Leverage Measures Debt/EBITDA 0.9x 0.8x 1.1x 1.2x 1.4x EBITDA/Interest expense 25.7x 15.1x 14.0x 14.1x 13.8x Gross debt/Capitalisation 25% 31% 31% 32% 32% FFO/Debt 114% 133% 82% 74% 61% OCF/Debt 105% 220% 44% 53% 33% FCF/Debt 64% 175% 12% 26% 11% DCF/Debt 39% 144% -16% -3% -13% Debt/Equity 10% 8% 12% 13% 16% FFO/Cash interest expense 99x 49x 12x 12x 12x Sources: Company, Pengyuan International Business Profile Consistently amongst the top 3 vehicle OEMs in China with strengths in CV and Japanese JVs Headquartered in Wuhan, Hubei, DFMG mainly engages in the R&D, manufacturing and sales of CVs, PVs, engines and other auto parts.