Korea Consumer Discretionary 23 June 2016 Korea Automobiles and Components Sector Electric vehicles and smart cars: reinventing the wheel Apple and Tesla’s aggressive moves towards EVs and smart cars herald a new era and should give parts makers’ shares a leg up We revise up our EV and smart-car forecasts on more stringent regulations, government support and falling component prices Sung Yop Chung Mando and Hanon (both Buys [1]) are our top picks; we also like HMC (82) 2 787 9157 (Buy [1]) on a 6-month view [email protected] See important disclosures, including any required research certifications, beginning on page 134 Korea Automobiles and Components Sector: 23 June 2016 Table of contents EVs and smart cars: changing the landscape ....................................................... 7 Reality check: what are the obstacles? ................................................................ 13 Our forecasts for EVs and smart cars: what’s new ............................................. 18 Electric vehicles: strong drivers ahead ................................................................ 22 Smart cars: faster-than-expected growth should provide impetus .................... 32 EVs and smart cars: auto and ICT parts makers to lead the pack ..................... 46 Valuations and recommendations ........................................................................ 56 Appendix ................................................................................................................. 69 Company Section Mando Corp ................................................................................................................... 73 Hanon Systems .............................................................................................................. 81 Hyundai Motor ................................................................................................................ 90 Hyundai Mobis ............................................................................................................. 101 Kia Motors .................................................................................................................... 110 Hyundai Wia Corp ........................................................................................................ 120 S&T Motiv ..................................................................................................................... 125 Woory Industrial ........................................................................................................... 127 Korea Consumer Discretionary 23 June 2016 Korea Automobiles and Components Sector Electric vehicles and smart cars: reinventing the wheel Apple and Tesla’s aggressive moves towards EVs and smart cars herald a new era and should give parts makers’ shares a leg up We revise up our EV and smart-car forecasts on more stringent regulations, government support and falling component prices Sung Yop Chung Mando and Hanon (both Buys [1]) are our top picks; we also like HMC (82) 2 787 9157 (Buy [1]) on a 6-month view [email protected] What's new: Tesla’s unveiling of its first mass-market electric vehicle (EV), Key stock calls the Model 3, along with Apple’s more aggressive stance on developing EVs New Prev. with smart-car functions, are rapidly changing the car industry landscape. Mando Corp (204320 KS) Rating Buy Buy We are revising up our global EV shipment forecasts for 2016-30 and our Target 300,000 260,000 market forecasts for smart cars for 2016-25. In turn, we now see a stronger Upside p 34.5% earnings growth trajectory for auto parts makers over the next 3 years. Hanon Systems (018880 KS) Rating Buy Buy What's the impact: Upward revisions to EV and smart-car market Target 15,000 13,000 forecasts. We now see stronger growth drivers for EVs globally, backed Upside p 32.7% by: 1) a more stringent regulatory environment for fuel-economy and Hyundai Motor (005380 KS) Rating Buy Buy emission control standards, 2) a stronger shipment growth trajectory from Target 170,000 170,000 China, and 3) a faster-than-expected decline in EV battery prices. As such, Upside p 21.4% we are raising our EV demand forecast globally to 2,600,000 units by 2020 Source: Daiwa forecasts (2015-20E CAGR of 36.9%) from 750,000 units (CAGR of 28.3%). For smart cars, we now expect the automotive electronics market to reach USD341.3bn by 2020 (2015-20E CAGR of 8.4%) from USD323.1bn (CAGR of 7.3%), on: 1) more stringent safety measures, 2) a faster rise in electronic content per vehicle for advanced driver assistance systems (ADAS), connectivity and infotainment, and 3) information and communication technology (ICT) players’ focus on uncovering new growth angles. We expect auto parts’ makers to lead the pack and enjoy higher profitability vs. OEMs over the long term, through their competency in key components for EVs and smart cars as well as their system-supplying capabilities. While the end-customer (auto OEMs and ICT players) market is fragmented, there are only a few players globally with these capabilities. As such, auto parts makers have been recording higher operating profit than OEMs, and we expect this trend to continue over the next 3 years. What we recommend: We look for Mando Corp (Mando) and Hanon Systems (Hanon) to lead the way in earnings visibility and expansion of trading multiples, on their strong competitive edge as system suppliers for thermal energy management and ADAS capabilities. We lift our 12-month DCF/PER-based TPs for Mando to KRW300,000 (from KRW260,000) and for Hanon to KRW15,000 (from KRW13,000). On a 6-month view, we also like HMC for its rising presence in SUVs, alongside favourable trends in developed-markets (DM) and emerging-market (EM) currencies. And we take another look at Woory Industrials (not rated) and S&T Motive (not rated), both small-cap suppliers of EV components. How we differ: We are above the market on 2016-18E EPS for the sector, as we think it has yet to factor in Hanon and Mando’s product-mix improvements. See important disclosures, including any required research certifications, beginning on page 134 Korea Automobiles and Components Sector: 23 June 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook EV shipment outlook We now expect faster growth in shipments of both EVs and ('000 units) 27,976 the size of the smart-car (autonomous cars that contain 30,000 features like infotainment, connectivity, and ADAS) market 25,000 22,9194,697 19,140 up to 2020. Our new forecasts call for EV demand to reach 20,000 4,361 16,056 4,146 14,189 2,600,000 units by 2020 (2015-20E CAGR of 36.9%), vs. 15,000 13,295 11,094 3,951 11,824 750,000 units (2015-2020E CAGR of 18.3%) previously. 9,367 3,651 10,000 8,025 9,854 6,052 6,781 3,317 For smart cars, we now forecast the market size for 4,558 5,113 3,043 8,211 3,231 3,870 2,865 6,843 2,813 2,731 5,702 5,000 1,667 2,156 2,363 2,552 4,752 9,090 automotive electronics to reach USD341.3bn by 2020 1,893 2,045 2,188 3,960 6,733 1,803 1,911 3,000 3,300 3,894 5,140 1,573 1,610 1,800 2,300 2,600 2,075 2,801 (2015-20E CAGR of 8.4%) from USD323.1bn (2015-20E 0 1,5611051.1 3181.6 5406 1,00010 1,30020 25 70 150 500 750 1,200 1,572 CAGR of 7.3%). Apart from governments implementing 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E more stringent measures for fuel economy, emissions FCEV EV HEV control standards and safety, we expect the tug-of-war Source: Wards auto, PWC, Daiwa forecasts between auto OEMs and ICT players to provide more impetus for auto parts makers globally. Valuation Global OEMs vs. EV and smart-car suppliers Since Apple’s (AAPL, USD95.5, Buy [1]) more aggressive (EPS CAGR, %) 35.0 Tung Thih move towards EVs with smart-car features through its Project Titan, and Tesla’s (TSLA, USD196.7, Not Rated) 30.0 Hota Ind. unveiling of its first mass-market EV, the Model 3, the 25.0 GS Yuasa Visteon BYD share prices of EV and smart-car components names have 20.0 staged a strong rebound. We expect their valuation Hella 15.0 Delphi Smart-car parts Ev-parts avg. VW Mando avg. (21.4 , 15.3) premium to global OEMs to widen over 2016, as the Nexteer Valeo (14.7, 13.0) 10.0 Nissan Siemens Autoliv Bloomberg consensus calls for an operating margin of Borg W. OEMs avg. Conti. LG 8.9% on average for 2016 (vs. 6.8% for the global OEMs). 5.0 HMC (6.8, 6.1) Denso Chem Daimler (PER, x) 0.0 Ford JTEKT We look for Hanon and Mando to trade on a par with global 0.0 5.0 10.0 15.0 20.0 25.0 30.0 EV and smart-car component makers over the next 12 Source: Bloomberg, Daiwa months, at average 2016E PERs of 21.4x and 14.7x, respectively, on several potential orders for thermal energy management and ADAS products on the horizon. Earnings revisions Korea automakers and components: earnings forecast revisions (Daiwa vs. Bloomberg) Our 2016-18E EPS for Hanon and Mando are higher than (KRW) the Bloomberg-consensus figures, as we believe the street 40,000 35,000 has yet to incorporate their product mix improvements over 30,000 the past 2-3 years, whereby they now offer a greater 25,000 proportion of high-margin thermal energy management 20,000 systems (Hanon) and high-margin electronic products 15,000 10,000 (Mando) and cost-cutting measures for both companies. 5,000 0 Our 2016-18E EPS for HMC are also higher, because we BBG Daiwa BBG Daiwa BBG Daiwa BBG Daiwa BBG Daiwa BBG Daiwa think the consensus has yet to factor in the company’s HMC Kia Hyundai Mando Hyundai Wia Hanon Mobis