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 ASIAN INSIGHTS VICKERS SECURITIES ed-JS/ sa- AH 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. ASIAN INSIGHTS VICKERS SECURITIES Page 2 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 ASIAN INSIGHTS VICKERS SECURITIES Page 3 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.