China / Hong Kong Company Guide Guangzhou Automobile Group Version 6 | 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 7 May 2019 Japanese JCEs leading growth H: BUY Last Traded Price (H) ( 7 May 2019):HK$8.14(HSI : 29,363) More clarity on JVs future strategy. Guangzhou Auto (GAC) and its Price Target 12-mth (H):HK$9.60 (17.9% upside) (Prev HK$17.86) Japanese JCE partners have agreed on key priorities to grow the business. The medium-term plans include capacity expansion and new A: HOLD model development (both traditional and new energy vehicles). Last Traded Price (A) ( 7 May 2019):RMB11.61(CSI300 Index : 3,721) Price Target 12-mth (A):RMB11.30 (2.7% downside) (Prev RMB21.71) Another key factor is that both partners have agreed to maintain the current shareholding structure, hence removing uncertainties. The Analyst Rachel MIU+852 36684191 [email protected] Japanese auto brands have gained market share from 15.6% in December 2016 to 19% in February 2019 aided by their product What’s New range, pricing, and proactive business strategy. Despite the tough • More clarity on development of Japanese JCEs, key 1Q19 auto market, GAC’s Japanese JCEs managed to chalk up strong earnings driver in the future volume sales growth and decent profit contributions to the group. • Self-brand going through short-term adjustment and Where we differ? We expect normalisation of Trumpchi sales to have should start to normalise in 2H19 a meaningful impact on earnings, on anticipation of a recovery in • Maintain BUY, TP revised down slightly to HK$9.60 the PV market in 2H19. Apart from the overall weakness of the Chinese passenger vehicle market, destocking in preparation of Price Relative launch of new models had also affected Trumpchi’s 1Q19 performance. The self-brand accounted for 25% of FY18 total volume sales but this fell to 18% in 1Q19. Share price catalyst. Successful launch of 14 new and refresh car models should drive up GAC’s share price. Based on 1Q19 sales data, the Japanese JCEs are expected to produce decent earnings growth, based on the number of new models planned. Valuation: We cut FY19F earnings by 16% to factor in lower gross margins assumptions. We pegged our new HK$9.60 TP at 7x FY19F earnings (previously 7x FY18F PE). Forecasts and Valuation (H Shares) FY Dec (RMBm) 2017A 2018A 2019F 2020F Key Risks to Our View: Turnover 71,575 72,380 76,659 83,207 Margin compression. Rapid expansion in production capacity in the EBITDA 14,642 14,814 15,983 17,413 Pre-tax Profit 12,194 11,863 13,211 14,567 industry could intensify market competition and drag down product Net Profit 11,005 10,900 12,180 13,334 prices, affecting vehicle sales margins and earnings. Net Profit Gth (Pre-ex) (%) 75.0 (1.0) 11.7 9.5 EPS (RMB) 1.20 1.07 1.19 1.31 Weak controls at new auto JCEs. GAC has several JCEs with its EPS (HK$) 1.39 1.24 1.38 1.51 foreign partners and managing these operations require EPS Gth (%) 22.9 (11.1) 11.7 9.5 management’s full attention. Any misguided investment could lead Diluted EPS (HK$) 1.39 1.24 1.38 1.51 to substantial losses. DPS (HK$) 0.61 0.44 0.48 0.53 BV Per Share (HK$) 11.27 8.70 9.62 10.62 At A Glance PE (X) 5.8 6.6 5.9 5.4 Issued Capital - H shares (m shs) 3,099 P/Cash Flow (X) 4.4 nm 7.2 8.7 - Non H shrs (m shs) 7,134 P/Free CF (X) 7.6 nm 4358.4 nm H shs as a % of Total 30 EV/EBITDA (X) 1.8 2.9 2.7 2.6 Total Mkt Cap (HK$m/US$m) 117,334 / 14,976 Net Div Yield (%) 7.6 5.4 5.9 6.5 Major Shareholders (%) P/Book Value (X) 0.7 0.9 0.8 0.8 Guangzhou Automobile Industry Group Co., Ltd. 72.8 Net Debt/Equity (X) CASH CASH CASH CASH Guangzhou Huiyin Tianyue Equity ROAE(%) 19.4 14.9 15.1 15.0 Investment Fund Management Co., Ltd. 5.9 Major H Shareholders (As % of H shares) 0 Earnings Rev (%): (16) New Guangzhou Automobile Industry Group Co., Ltd. 9.4 Consensus EPS (RMB) 1.16 1.29 Schroder Investment Management Ltd. (SIM) 5.9 Other Broker Recs: B:29 S:2 H:5 H Shares-Free Float (%) 84.6 Source of all data on this page: Company, DBS Bank (Hong Kong) Limited 3m Avg. Daily Val. (US$m) 28.39 (“DBS HK”), Thomson Reuters ICB Industry: Consumer Goods / Automobiles & Parts Bloomberg ESG disclosure score (2017)^ 43.0 - Environmental / Social / Governance 34.1 / 52.6 / 53.6 ^ refer to back page for more information ed-JS/ sa- CS / DL Company Guide Guangzhou Automobile Group WHAT’S NEW sales growth. To further enhance its market position, GAC is Moving ahead amid market challenges working with internet companies on mobility development. The company is working with Tencent and Guangzhou Public Major Japanese JCEs the main earnings growth driver; foreign Transport Group to roll out around 10,000 vehicles in ownership structure intact. Toyota and Honda recorded Guangzhou under phase one of the mobility service provider strong volume sales growth of 11% and 46% y-o-y in 1Q19 development plans. Demand for mobility and ridesharing respectively, ahead of the industry passenger vehicle (PV) services is a rising trend globally and GAC is ready to market trend of a 6.9% contraction. This explains the JVs’ penetrate this market. The JV partners are committing 1Q19 profit contribution rose c.5% y-o-y to Rmb2.5bn. Rmb1bn of investment into the business. Steady new product rollouts, quick response to consumer preference, and new models enabled the Japanese JCEs to Financial health remains decent. Operating cashflows was outperform the overall PV market, despite market challenges. negative at Rmb6bn in 1Q19, due to lower profits and higher In fact, the Japanese automakers in China have managed to level of cash tied up in working capital. Capex also increased raise market share by about 3ppts since early 2018 to reach as the company expanded its business scale and is carrying c.20% at end March 2019. This should be positive on GAC’s out new product development. As a result, net cash balance future development. GAC-Toyota and GAC-Honda JVs have was down by Rmb1bn from December 2018 to Rmb19bn recorded market share expansion since 2012. during the quarter. We believe this situation could be temporary as the business improves in 2H19. GAC-Toyota have agreed to invest some US$1.64bn to expand NEV production capacity as well as US$605.19m into Early adoption of national VI standard in Guangzhou and the production of Toyota New Global Architecture (TNGA) Shenzhen. We believe this move could have some bearing on engine series. The NEV project is scheduled to complete by GAC’s near-term sales performance, as the company will 2022 under two phases and will have a total production have to destock to prepare for the new fuel standard capacity of 400,000 units per year. When the TNGA engine implementation. China intends to implement the stringent plant is ready for production in 2021, it will have annual National VI fuel standard by 1 July 2023 but certain cities will output of 432,000 units. adopt the new fuel standard starting this year, such as Shenzhen and Guangzhou. So far, the Japanese JCE partners have decided to keep the existing ownership structure intact, thus removing the near- New energy vehicle (NEV) strategy gathering pace. To further term uncertainty on JCE earnings. The PV market will be fully enhance the NEV segment, GAC’s NEV brand - Aion - has liberalised in 2022. two new models planned. The NEV strategy will be undertaken at its new Rmb4.7bn facility in Guangzhou. The Self-brand’s weak performance could be temporary. The plans including annual production output of 200,000 units weak Chinese auto market and keen competition have when fully operational and two new models every year to dragged Guangzhou Auto Group Co (GAC)’s 1Q19 broaden the NEV product offerings. GAC achieved NEV performance. Its Trumpchi brand had to adjust production to revenue of Rmb2.3bn in FY18 on sales of 20,000 units and clear inventories and as a result, 1Q19 total volume sales fell targets to raise volume sales to 50,000 units this year. 41% y-o-y to 88,000 units, leading to a 26% decline in revenue to Rmb14.4bn. GP declined 63% to Rmb1.8bn on Earnings revision post weak 1Q19 results: We cut FY19F lower volume sales, and GP margin slipped to 12.8% vs earnings by c.16%, after adjusting down our profit margin 25.5% in 1Q18. With the sharp drop in gross profit, net assumptions. Our new TP is HK$9.60, rolled over to FY19F earnings fell 28% to Rmb2.8bn. earnings and pegged to unchanged 7x PE (previously 7x PE on FY18F earnings). The overall vehicle market is expected to New models to drive 2019 volume sales. The various pick up in 2H19, and the company is lining up its new models operating units are rolling out 14 new and facelift models to to ride on this industry trend. However, given market drive sales, despite the tough market conditions.