Dongfeng Motor (489.HK) – Initiation of Coverage 10 January 2013 Dongfeng Motor (489.HK) Automobile Sector 10 January 2013 Research Idea: Moving Up the Gears Target Price HK$15.00 We rate Dongfeng Motor (DFG) a Buy with 12-month target price of 12m Rating Buy HK$15.00. Its sales have dropped since Q3 2012 amid Sino-Japan tensions, 16% upside but we expect a recovery to pre-protest levels in Q1 2013 and growth to DFG – Price Chart (HK$) persist backed by a strong brand lineup. As one of the nation’s leading 22 Bull, HK$20.90 20 automakers, DFG is a good proxy for a secular sector growth story. 18 16 Base, HK$15.00 Three reasons to Buy: 14 12 10 . Sino-Japanese tensions have eased. DF Honda’s sales rebounded to 8 pre-protest levels while DF Nissan’s rebounded to 80% of pre-protest 6 Bear, HK$6.40 Jan12 May12 Sep12 Jan13 May13 Sep13 Jan14 levels in December, well above expectations. Consumer concerns about damage to vehicles should be offset by Sino-Japan auto JVs Price (HK$) 12.96 guaranteeing to repair damage caused during the recent unrest. We Mkt cap – HK$m (US$m) 112,354 (14,494) expect DFG’s sales volume growth to rebound from down 0.8% to +11% in FY13. Free float – % (H-share) 100.00 3M avg. t/o– HK$m (US$m) 299.5 (38.6) . Strong brand lineup can facilitate market-share gains. DFG has Major shareholder (%) three JVs and a comprehensive range of well-received models, which should help minimize sales fluctuations. It is launching economy sedans DFMC 66.86 and JV own brands, which can help gain market share from local brands, Sources: Bloomberg and Sun Hung Kai Financial while the new Infiniti can capture rapid growth in the premium market. Compelling valuation for a market leader. The shares trade at 9X P/E. We are optimistic about an earnings rebound in FY13 and solid growth over the next few years, in view of the company’s strong lineup of models and as Sino-Japan tensions fade. DFG is one of China’s leading automakers and hence a good proxy for the nation’s compelling long-term growth story. Catalysts: Proposed Renault JV; Japanese auto brands regaining market share in China faster than expected; DFG’s domestic-brand business grow exceeding expectations Valuation: DFG’s shares trade at 9X FY13E P/E, below the sector average 1H12 revenues: RMB68bn of 12X. But since the company is one of China’s leading automakers, we Others believe it should trade at least at par with its peers. We initiate coverage with 1% a Buy rating and 12-month target price of HK$15.00 based on 10.4X forward RESEARCH INSTITUTIONAL P/E, for 16% upside. Commercial vehi cles We forecast EPS of RMB0.915, RMB1.15 and RMB1.43 for FY12-FY14E for 22% growth of -25% y/y, 25% and 24% y/y. Risks: Weak PV sales; Slow recovery in CV business; Greater-than-expected losses for domestic-brand business. Passenger vehicles Figure 1: DFG – Earnings Summary 77% Year end 31 Dec. FY10 FY11 FY12E FY13E Revenue – RMB m 122,395 131,441 124,564 141,366 Gross margin – % 21.5 20.1 17.6 18.5 EBIT margin – % 11.9 10.9 8.9 9.8 Net profit – RMB m 10,981 10,481 7,881 9,881 Eva Yip, CFA Net-profit growth – % 75.7 (4.6) (24.8) 25.4 +852 3929-6159 EPS – RMB fen 127.4 121.6 91.5 114.7 [email protected] EPS growth – % 75.7 (4.6) (24.8) 25.4 P/E – X 8.3 8.7 11.5 9.2 Dividend yield – % 1.7 1.7 1.2 1.4 Reports available at: http://www.shkresearch.com P/B – X 2.4 2.0 1.7 1.5 http://www.thomsonreuters.com Issued shares - millions 8,616 8,616 8,616 8,616 http://www.capitaliq.com Sources: Bloomberg and Sun Hung Kai Financial http://www.themarkets.com Bloomberg Code: <shkr> Sun Hung Kai Financial Institutional Research 1 Dongfeng Motor (489.HK) – Initiation of Coverage 10 January 2013 Valuation and Recommendation DFG’s shares trade at 9X FY13E P/E, below the sector average of 12X. But since the company is one of China’s leading automakers, we believe it should trade at least at par with its peers. Historically, the shares have traded at 9X-12X during the middle of the industry cycle and below their long-term mean of 8X during a downcycle. We believe the coming industry rebound justifies a valuation of around 10X. The company has a comprehensive range of well-received models, which should help ensure solid earnings growth over the next few years. As one of the nation’s leading automakers, DFG is also a good proxy for what we believe is a secular growth story. We believe the stock’s current discount to domestic-only brands is not justified in view of its JV exposure and burgeoning own-brand business. We rate DFG a Buy with 12-month target price of HK$15.00 based on 10.4X forward P/E, for 16% upside. Figure 2: Valuation scenario Target Upside/ FY13E EPS Scenario price (HK$) downside (%) Key assumptions (RMB) 15% PV growth, PV ASP back to FY11 level, with 21% PV GPM Bull 20.90 61 10% CV sales growth 1.33 12.5X FY13E P/E 12% PV growth, 3% PV ASP growth, 19.5% PV GPM Base 15.00 16 1.15 10.4X FY13E P/E 6% PV growth on prolong weak Japanese car sales, -3% ASP fall with 17% PV Bear 6.40 (51) GPM and no recovery in CV segment 0.85 6X FY13E P/E Source: Sun Hung Kai Financial Our estimates vs. consensus Our FY12 revenue and EPS are below consensus. We believe the market is still too optimistic about ASP and profitability that plunge sharply in 2H12. Our FY13 revenue is in line with consensus and FY14 numbers slightly above consensus. Sun Hung Kai Financial Institutional Research 2 Dongfeng Motor (489.HK) – Initiation of Coverage 10 January 2013 Investment Thesis Sino-Japan tensions to fade Japanese brands contributed 60% of DFG’s PV sales volumes in FY11 and FY12 and have long been popular in China, reflected in their 20% market share. Sino-Japan JVs’ sales have been hit hard since September amid rising tensions, but we believe the worst is over. Figure 3: Japanese auto brands have long been popular in China (L); DFG’s sales by JV (R) (%) ('000 units) 60 1,600 50 1,400 40 1,200 1,000 30 800 20 600 10 400 0 200 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 0 FY08 FY09 FY10 FY11 FY12E Chinese brands Japanese brands German brands American brands South Korea brands Other brands DF Nissan DF PSA DF Honda Sources: The Company, WIND and Sun Hung Kai Financial From our conversations with management, we gather that DF Honda’s sales are already above pre-crisis levels while DF Nissan’s sales rebounded to 80% of pre-protest levels in December, well above management expectations. Inventories had also fallen from peaks of 86 days for DF Nissan and 55 days for DF Honda in September, to 1½ months in December. Recovery has been helped by Sino-Japan JVs easing their sales targets for auto dealers. As a result dealers have not had to slash prices to clear inventory, which would have tarnished their brand image. In addition the JVs have offered to repair any of their cars damaged during the protests until 31 Dec 2014. The company usually makes warranty provisions for these expenses, included in other expenses on the income statement, based on sales volumes and historical levels of returns. We believe the company has enough provisions to cover upcoming repair expenses since actual repair expenses have typically been less than warranty provisions in recent years. Management also does not expect much impact on operating expenses. Figure 4: DF Nissan’s marketing initiatives to revive consumer confidence Sources: The Company Sun Hung Kai Financial Institutional Research 3 Dongfeng Motor (489.HK) – Initiation of Coverage 10 January 2013 Steady sales growth to persist DFG’s key models have consistently sold more than 12k units per month. This is likely attributable to its strong JV partners, with Honda and Nissan in particular introducing cars each year that meet or exceed consumer expectations. As a result, DFG has outperformed the industry during difficult times and has been able to adapt to changing consumer preferences. Figure 5: DFG’s sales growth vs. the industry (%) 50 45 40 35 30 25 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 DFG Industry Sources: WIND and Sun Hung Kai Financial DFG will continue its aggressive launch strategy this year with new-generation models for all its brands (excluding upgrades/facelifts). Its JVs plan to introduce seven new models next year: Concept-S MPV from DF Honda, three from DF PSA, and three from DF Nissan, including the long-anticipated Teana. DF PSA will introduce two compact economy sedan models, which should help it gain market share from domestic brands. In 2014, DFG will produce two Infiniti models in China, which should strengthen its hand in the fast-growing premium PV market. Figure 6: DFG’s upcoming new car models DF Nissan DF Honda DF PSA 2013 Teana Concept-S Citroen sedan Livina Peugeot sedan Venucia Peugeot 3008 (extend from Dec 2012) Sources: The Company and Sun Hung Kai Financial Local brands could drive growth in lower-tier cities Domestic automakers have operated JVs with foreign automakers for years but still have limited access to technology and not a single Chinese brand is competitive globally.