China Auto Sector ： Why size matters more than ever

See important disclosures, including any required research certifications, beginning on page 33 ■ What's new Our on-the-ground research indicates that China’s car buyers increasingly prefer larger vehicles and are prepared to pay a premium for them. We believe this willingness to pay a higher price, in terms of ASP/m³, will enhance earnings visibility for auto makers which offer large-platform vehicles with a volume of more than 9m³. The shift towards larger and heavier vehicles calls for more efficient engines. According to our analysis, Great Wall’s (GWM) newly launched H8 and Geely Automobile’s forthcoming EX8 will surpass rival models in price/quality, and have better-performing engines in terms of hp/cc than those of the joint-venture/OEMs. We believe that both companies are strongly placed to position their products in a sweet spot of the domestic market. ■ What's the impact In our view, the H8 and EX8 will tick the boxes for many prospective car buyers, as they are large in size, have powerful and efficient engines, and are relatively cheap in terms of ASP/m³. We think these attributes will give the H8 and EX8 a 2- to 3-year window in which to tap the growing demand, as: 1) most domestic brands do not yet have the technology to match the engines of GWM and Geely, and 2) the joint-venture/OEMs likely will not establish lower-end domestic brands to use their large-car platforms out of fear of diluting their own brand equity. As a result, we believe GWM and Geely will continue to set the pace amid market consolidation. ■ What we recommend We revise up our earnings forecasts for GWM by 3.9% for 2015, and our 6-month target price to HKD69.59 (previously HKD67.16). For Geely, we revise up earnings by 3.7% for 2014E and 4.5% for 2015E, while our target price remains HKD5.84. Both stocks remain Buys. On valuation grounds, we upgrade Dongfeng Motor Group (DFM) to Buy (from Outperform). For Guangzhou Automobile Group (GAC), we revise up earnings for 2013-14E by 32% and 19%, respectively, mainly due to cost control and platform integration; our target price rises to HKD6.61 (previously HKD5.05). However, we reaffirm our Sell rating for GAC, as we believe its local brands continue to lack a competitive edge. On a 6-month view, we prefer GWM over Geely, as we think GWM’s H8 will be a more immediate share-price catalyst. By 4Q14, however, we expect investors’ sentiment to favour Geely, as the Geely-Volvo CMA platform should by then be nearing launch (likely around 1H15). We have yet to factor the new platform into our earnings forecasts for Geely. The key risk to our Positive view of the sector would be an economic hard landing. Secondary risks would be higher dealer inventories and delays on product launches. ■ How we differ Our EPS forecasts are higher than those of the Bloomberg consensus by 22% (2014) and 58% (2015) for GWM and 25% and 38% for Geely. Backed by their lead in engine technology, both should see stronger sales of large models and better earnings visibility than the market expects. 7 January 2014 Why size matters more than ever • Great Wall's H8 and Geely's EX8 should have the growing market for larger SUVs to themselves for 2 to 3 years • Both companies have an edge over their domestic rivals in engine quality (hp/cc), price (ASP/m3), and earnings-growth visibility • Recent share-price weakness offers attractive entry point. Our top picks are Great Wall and Geely; we also updgrade DFM to Buy China Auto Sector Key stock calls Source: Daiwa forecasts. Consumer Discretionary / ChinaPositive(unchanged)NeutralNegativeJeff Chung(852) 2773 8783jeff.chung@hk.daiwacm.comLi Xiong(852) 2773 8829li.xiong@hk.daiwacm.comNewPrev.Great Wall Motor (2333 HK)RatingBuyBuyTarget69.5967.16Upside60.9%Geely Automobile (175 HK)RatingBuyBuyTarget5.845.84Upside70.8%Dongfeng Motor Group (489 HK)RatingBuyOutperformTarget13.9913.56Upside20.6%Brilliance China Automotive (1114 HK)RatingHoldHoldTarget12.8913.73Upside1.3%Guangzhou Automobile Group (2238 HK)RatingSellSellTarget6.615.05Downside20.5% China Auto Sector 7 January 2014 - 2 - Source: Daiwa forecasts Sector stocks: key indicators ShareCompany NameStock codePriceNewPrev.NewPrev.% chgNewPrev.% chgNewPrev.% chgBrilliance China Automotive1114 HK12.72HoldHold12.8913.73(6.1%)0.6750.675(0.0%)0.8580.858(0.0%)Dongfeng Motor Group489 HK11.60BuyOutperform13.9913.563.2%1.2821.2730.7%1.4381.4022.6%Geely Automobile175 HK3.42BuyBuy5.845.840.0%0.3430.343(0.2%)0.4530.4363.7%Great Wall Motor2333 HK43.25BuyBuy69.5967.163.6%2.8032.825(0.8%)4.1824.1790.1%Guangzhou Automobile Group2238 HK8.31SellSell6.615.0530.9%0.4920.37331.9%0.6100.51219.2%RatingTarget price (local curr.)FY1EPS (local curr.)FY2 China Auto Sector 7 January 2014 - 3 - Why size matters more than ever ................................................................................................ 4 GWM’s and Geely’s new models look set to sell well ..........................................