China autos and auto parts EQUITY: AUTOS & AUTO PARTS New wheels and new drivers Global Markets Research 9 July 2014 Replacement, financing, and favourable seasonality to fuel sales growth upgrade in 2H14F Anchor themes We raise our 2014F PV sales volume growth forecast to 13% from 12% We remain constructive on the Defying market concerns over a slowdown in the beginning of the year, 2H14F outlook for new auto including a real estate market slowdown and more new car sales restrictions, sales, underpinned by growing new passenger vehicle (PV) sales volume grew at 11% YTD, which beats replacement demand and consensus of 8-10% at end-2013. We attribute such resilience to the availability of auto financing. We emergence of replacement demand, auto financing, and rising affordability in prefer SUVs, entry-level luxury, lower-tier cities. As a result, we raise our PV sales volume growth forecast for and OEMs with strong new 2014F and 2015F to 12.9% and 11.4% (from 12.1% and 11.0%), respectively. model pipelines. Any risk of a significant slowdown in 2H14F should be well-contained, owing to these structurally positive factors, as well as further macro policy easing, as Nomura vs consensus projected by the Nomura economics team, in our view. We expect the Street to Our 2014F new PV sales start raising its forecasts around the interim results season in August. volume growth forecast of 13% Key beneficiaries of these positive trends will be SUVs (partly replacement- y-y is above consensus of 10%. demand driven), entry-level luxury models (thanks to rising affordability and availability of auto financing), and OEMs with strong new model pipelines (to Research analysts capture the peak-season demand from September onwards), in our view. Replacement demand is starting to make a real positive impact China Autos & Auto Parts Replacement demand is an increasingly critical driver for China’s auto Benjamin Lo - NIHK demand, contributing more than first-time buyers to PV sales growth by 2015F, [email protected] we estimate. This might explain why slower property sales this year have not +852 2252 6220 led to a visible and negative impact on PV sales, since replacement demand Joseph Wong - NIHK [email protected] should be less affected by property sales, as opposed to first-time buyers who +852 2252 6111 typically purchase their cars after buying their homes, in our view. Auto financing will help fuel growth in lower-tier cities In China, approximately 20% of car buyers utilise auto financing, compared with typically 70% in overseas matured markets. We believe more financing packages will help fuel auto penetration, especially in lower-tier cities. Stock picks: SAIC (OEM top pick) and Nexteer (auto parts top pick) In view of our positive sector view and the favourable seasonality in 2H, we expect the sector P/E (now 8.8x) to be re-rated towards 10-11x. We initiate coverage of SAIC (OEM top pick) and Nexteer (auto parts top pick) with Buy, both offering c40% upside potential. Among the rest, we favour GAC (Buy), Dongfeng (upgrade to Buy) and Brilliance (upgrade to Neutral) going into the interim results season in August for their likely strong 1H numbers, but around results, recommend switching into Great Wall (Buy) and Geely (upgrade to Buy) on our expected 2H recovery. We have no Reduce-rated stocks. Fig. 1: Stock for action 2014F 2015F 2014F Market Cap Price TP Up/downside EPS EPS 2014F 2015F 2014F 2014F Div yld Ticker Rating (USDm) (HKD) (HKD) (%) Growth Growth PER (x) PER (x) PBR (x) ROE (%) Brilliance 1114 HK NEUTRAL ↑ 10,012 15.44 15.1 ↑ -2.2% 29% 13% 14.2 12.6 3.7 29.2% 1.1% Dongfeng 489 HK BUY ↑ 15,853 14.26 16.6 ↑ 16.4% 17% 17% 7.9 6.8 1.4 18.2% 1.9% Geely 175 HK BUY ↑ 3,373 2.97 3.76 ↑ 26.6% -23% 30% 10.1 7.8 1.1 12.1% 1.2% Great Wall 2333 HK BUY 12,872 31.65 40.0 ↓ 26.4% 13% 29% 8.2 6.3 2.2 29.6% 3.2% GAC 2238 HK BUY 8,005 9.59 11.5 ↑ 19.9% 61% 28% 11.5 8.9 1.3 12.2% 2.2% SAIC Motor 600104 Ch BUY 27,650 CNY15.56 CNY21.2 36.2% 11% 11% 6.2 5.6 1.1 15.8% 8.6% Johnson 179 HK NEUTRAL 3,297 7.14 6.90 ↓ -3.4% 4% 7% 15.2 14.2 1.7 12.0% 1.7% Minth 425 HK BUY 2,194 15.56 18.6 ↑ 19.5% 14% 16% 12.2 10.5 1.6 14.3% 3.3% Nexteer 1316 HK BUY 1,769 5.49 7.50 36.6% 11% 27% 10.9 8.6 2.0 19.6% 1.8% Source: Bloomberg, Nomura estimates. Initiating coverage for SAIC Motor and Nexteer. Pricing as of 4 July 2014. Note: For Johnson Electric, "14F" here refers to the fiscal year ending in March 2015. See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | China autos and auto parts 9 July 2014 Contents 4 Summary of our new ratings, TPs and estimates; initiate coverage on SAIC and Nexteer 5 PV sales volume growth - 5M14 at 11%; we raise our FY14F forecast to above-consensus 13% 7 Replacement demand: A long-term underpinning growth factor 9 Auto financing – fuelling further auto penetration in China 13 Valuations: Sector P/E likely to head higher from August onwards 14 Seasonality factor 18 Investment risks 22 Appendix 1 – New models in 2H14 24 Appendix 2 – Market share trends 24 Luxury segment – Germany’s big 3 still the dominant force 26 Mid-size segment 27 Compact and subcompact segments – Competition remains intense 28 SUV segment 29 Appendix 3 - China auto parts industry 29 Overview 30 Competitive landscape 31 Future development 32 Appendix 4 – Global auto market outlook 33 Brilliance China 37 Dongfeng Motor 41 Geely Automobile 45 Great Wall Motor 2 Nomura | China autos and auto parts 9 July 2014 49 Guangzhou Auto 53 SAIC Motor 63 Johnson Electric Holdings 67 Minth Group 71 Nexteer Automotive 92 Appendix A-1 3 Nomura | China autos and auto parts 9 July 2014 Summary of our new ratings, TPs and estimates; initiate coverage on SAIC and Nexteer We update and revise our estimates and target prices for all auto stocks under our coverage universe in this report in view of the release of the latest sales volume data as well as the themes discussed herein. Additional details can be found in the individual company reports in the companies section. The two figures below summarise our estimate revisions and valuation methodologies. We have more detailed discussions on valuations for the sector and for each of the companies under our coverage in the valuation section and the company sections of this report. Regarding our ratings, we upgrade Dongfeng and Geely to Buy, and Brilliance to Neutral. We maintain our Buy rating on GAC and Great Wall. We also initiate coverage on two companies, SAIC and Nexteer, with Buy ratings. There is no Reduce rating in our coverage universe. Fig. 2: Summary of revisions to our ratings, TPs and EPS forecasts Current Previous % change 2014F EPS 2015F EPS TP 2014F EPS 2015F EPS TP 2014F 2015F Ticker Rating (old rating) TP (HKD) (loc) (loc) (HKD) (loc) (loc) (HKD) EPS EPS OEM Brilliance 1114 HK NEUTRAL (REDUCE) 15.1 0.87 0.98 9.3 0.78 0.87 62.4% 11.0% 12.2% Dongfeng 489 HK BUY (NEUTRAL) 16.6 1.43 1.68 12.4 1.16 1.27 33.9% 23.6% 31.7% Geely 175 HK BUY (NEUTRAL) 3.76 0.23 0.30 3.4 0.27 0.30 4.7% -15.0% 0.9% Great Wall 2333 HK BUY (BUY) 40.0 3.07 3.96 47.2 3.41 4.16 -15.3% -10.0% -4.9% GAC 2238 HK BUY (BUY) 11.5 0.66 0.85 10.5 0.69 0.88 9.5% -3.8% -3.5% SAIC Motor 600104 CH BUY (NR) CNY21.2 2.51 2.79 n.a. n.a. n.a. n.a. n.a. n.a. Auto parts Johnson Electric 179 HK NEUTRAL (NEUTRAL) 6.9 0.06 0.06 7.3 0.06 0.06 -5.5% -0.2% -0.2% Minth Group 425 HK BUY (BUY) 18.6 1.02 1.18 18.2 1.07 1.19 2.2% -4.9% -1.0% Nexteer 1316 HK BUY (NR) 7.5 0.06 0.08 n.a. n.a. n.a. n.a. n.a. n.a. Source: Bloomberg, Nomura estimates Note: For Johnson Electric, "14F" here refers to the fiscal year ending in March 2015 Fig. 3: Summary of valuation methodology Company Ticker Rating TP (HKD) Valuation methodalogy Nomura comments OEM Brilliance 1114 HK Neutral 15.1 13.0x mid 15F P/E (representing LT Given our concern on Brilliance's growth and valuation headwinds have alleviated, we average) rebased our target multiple back to LT average. Dongfeng Motor 489 HK Buy 16.6 8.5x mid 15F P/E Despite a near-term pick-up in earnings growth, we still assign LT-average as our (DFM) (representing long-term average) target P/E multiple, as we do not see a multi-year re-rating story yet. Geely 175 HK Buy 3.76 1.3x P/B 2015F BVPS (representing - We raised our TP to reflect the roll-forward 2015F BVPS, allowing us to look past the 1 SD below historical mean) restructuring disruption in 2014F and hence better reflect the potential recovery Great Wall Motor 2333 HK Buy 40.0 9x mid 15F P/E We assign a lower target P/E (from LT average of 11x to -1 SD below mean) given the (GWM) (representing -1 SD below LT H8 uncertainty.