China Autos Sector. Running on fumes in 2016; refill needed for 2017

Transcription

1 China Consumer Discretionary 4 January 2016 China Autos Sector Running on fumes in 2016; refill needed for 2017 Positive investor sentiment on the sector should persist in 1Q-3Q16, but concerns are likely to resurface as we get closer to 2017 We prefer domestic brands to foreign brands, but expect SUV margins to continue to deteriorate over our forecast period Positive on Geely, BAIC and DFM; negative on GWM; initiating on DFM with an Outperform (2) and Brilliance with an Underperform (4) Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com See important disclosures, including any required research certifications, beginning on page 103

2 China Autos Sector: 4 January 2016 Table of contents Running on fumes in 2016; refill needed for Tax cut should boost sales volume growth in Strong industry pipeline in Domestic brands should keep outpacing foreign brands...10 Accelerating investment in NEVs in Balance sheets remain healthy...18 Hard to see any recovery for CVs...18 Valuations and recommendations Not that cheap anymore...20 Recommendations...20 Risks to our Neutral sector view...21 Company Section Geely Automobile...23 BAIC Motor...32 BYD...41 Dongfeng Motor Group...52 Guangzhou Automobile Group...71 Brilliance China Automotive...78 Great Wall Motor...93

3 China Consumer Discretionary 4 January 2016 China Autos Sector Running on fumes in 2016; refill needed for 2017 Positive investor sentiment on the sector should persist in 1Q-3Q16, but concerns are likely to resurface as we get closer to 2017 We prefer domestic brands to foreign brands, but expect SUV margins to continue to deteriorate over our forecast period Positive on Geely, BAIC and DFM; negative on GWM; initiating on DFM with an Outperform (2) and Brilliance with an Underperform (4) Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com What's new: We expect investor sentiment on the China Autos Sector to stay strong in 1Q-3Q16 on robust new PV sales resulting from the purchase tax cut and a rich pipeline. However, we believe new PV sales growth will slow in 4Q16, due to the high base in 4Q15 and because, as we step into 2H16, we expect concerns on new-car unit sales to resurface in In light of this, we maintain our Neutral rating on the sector. What's the impact: Strong sales volume growth in 1Q-3Q16E but YoY decline in 2017E. We expect a 12% YoY rise in new passenger vehicle (PV) sales volume in 1Q-3Q16 due to the tax policy and a strong pipeline (see p. 8-9). We expect the YoY growth to be strongest in 2Q16-3Q16, up 17-18% YoY, but for it to slow to flat YoY in 4Q16. In 2017, we expect newcar unit sales to fall by 3% YoY, due to the high base effect and because our base case assumes the end of the supportive tax rate ie, that the purchase tax cut won t be extended beyond end-2016 and the tax will actually rise again to 10% in Meanwhile, we expect strong SUV sales volume growth, but see SUV margins continuing to deteriorate due to rising competition. Growth opportunities remain, in lower-tier cities and NEVs. While overall car ownership in China s lower-tier cities remains low, we stick with our view that this offers local OEMs good sales-volume growth opportunities. In addition, we expect local OEMs to produce more NEV models over our forecast period, prompted by China s commitment to NEV infrastructure investment from On this theme, we see the key players as Geely (175 HK, HKD4.23, Buy [1]) and BYD (1211 HK, HKD42.40, Outperform [2]). Meanwhile, for luxury brands, we reiterate our view that overall sales performance will outperform the broader China autos market, at least in What we recommend: Geely is still our top pick, due to its strong pipeline in 2016 and what we view as its long-term rerating story. We also expect strong sales-volume growth in 2016E for BAIC Motor (1958 HK, HKD7.77, Buy [1]) and Dongfeng Motor (DFM) (489 HK, HKD10.64, Outperform [2]), as they also both have rich pipelines. But we remain negative on Great Wall (GWM) (2333 HK, HKD9.14, Underperform [4]) as it has failed in its bid to upgrade its brand and its 2016 pipeline looks unexciting. The outlook for Brilliance China (1114 HK, HKD9.84, Underperform [4]) also looks uninspiring. The major risks to our Neutral sector view would be if new car sales were either weaker or stronger than expected. Key stock calls New Prev. Geely Automobile (175 HK) Rating Buy Buy Target Upside p 15.8% BAIC Motor (1958 HK) Rating Buy Buy Target Upside p 21% Dongfeng Motor Group (489 HK) Rating Outperform Target Upside p 14.7% Great Wall Motor (2333 HK) Rating Underperform Underperform Target Downside q 8.1% Brilliance China Automotive (1114 HK) Rating Underperform Target 8.90 Downside q 9.6% Source: Daiwa forecasts China Autos sector: TP valuation summary Company Target price (HKD) Target PER 2016E Geely x BAIC Motor x BYD SOTP Great Wall x GAC x Dongfeng Motor x Brilliance China x Source: Daiwa How we differ: We are one of only a few firms to expect a YoY decline in PV sales in 2017, making us more cautious than the market. See important disclosures, including any required research certifications, beginning on page 103

4 China Autos Sector: 4 January 2016 Sector stocks: key indicators EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg BAIC Motor 1958 HK 7.77 Buy Buy % % % Brilliance China Automotive 1114 HK 9.84 Underperform BYD 1211 HK Outperform Outperform (16.1%) (1.3%) (15.8%) Dongfeng Motor Group 489 HK Outperform Geely Automobile 175 HK 4.23 Buy Buy % % % Great Wall Motor 2333 HK 9.14 Underperform Underperform (5.6%) % % Guangzhou Automobile Group 2238 HK 6.94 Hold Hold % % % Source: Bloomberg, Daiwa forecasts China Autos Sector: key assumptions Sales Volume (units, YoY %) E 2016E 2017E E 2016E 2017E Geely 549, , , , , % -24.0% 19.6% 20.0% 7.4% Beijing Brand 202, , , , , % 53.0% 1.3% 33.9% 14.3% Beijing Benz 116, , , , , % 25.4% 71.0% 30.0% 15.0% Beijing Hyundai 1,031,000 1,120,000 1,042,000 1,152,000 1,226, % 8.7% -7.0% 10.6% 6.4% GAC Honda 435, , , , , % 10.3% 18.8% 14.0% 1.7% GAC Toyota 303, , , , , % 23.4% 9.4% 7.3% 0.0% GWM 771, , , , , % -4.9% 9.6% 6.4% 10.6% BYD - Conventional 470, , , , , % -20.6% 3.5% 2.4% 7.0% BYD - NEV 3,000 21,000 68, , , % 563.9% 226.8% 79.9% 21.2% Dongfeng Nissan 926, , ,000 1,144,000 1,202, % 2.8% 3.0% 16.7% 5.0% Dongfeng PSA 550, , , , , % 28.0% -0.7% 1.9% -3.0% Dongfeng Honda 321, , , , , % -4.1% 29.1% 15.1% -0.7% Brilliance BMW 207, , , , , % 34.7% 4.2% 14.6% 11.4% ASP (CNY, YoY %) E 2016E 2017E E 2016E 2017E Geely 52,246 52,024 56,706 61,243 65, % 1.8% 9.0% 8.0% 7.0% Beijing Brand 33,852 40,178 36,160 33,267 32, % 18.7% -10.0% -8.0% -3.0% Beijing Benz 286, , , , , % 5.5% 4.0% 0.0% 0.0% Beijing Hyundai 100,084 97,938 93,530 90,725 88, % -2.1% -4.5% -3.0% -3.0% GAC Honda 134, , , , , % 10.2% 12.0% 10.0% 8.0% GAC Toyota 172, , , , , % 23.4% 12.0% 8.0% 8.0% GWM 69,809 80,964 85,822 89,254 91, % 16.0% 6.0% 4.0% 2.0% BYD - Conventional 53,568 66,680 80,016 96, , % 24.5% 20.0% 20.0% 10.0% BYD - NEV 488, , , , ,435 n/a -29.2% -5.0% -5.0% -5.0% Dongfeng Nissan 138, , , , ,866 n/a -7.4% -2.0% -1.0% -2.0% Dongfeng PSA 96,326 91,840 90,003 88,203 85,557 n/a -4.7% -2.0% -2.0% -3.0% Dongfeng Honda 149, , , , ,183 n/a -11.1% -2.0% -2.0% -3.0% Brilliance BMW 353, , , , , % -4.1% -4.0% 0.0% 0.0% Net profit (CNY m, YoY %) E 2016E 2017E E 2016E 2017E Geely 2,663 1,431 2,604 3,366 3, % -46.3% 82.0% 29.3% 15.7% BAIC 2,714 4,511 5,057 6,324 7, % 66.2% 12.1% 25.1% 14.2% GAC 2,653 3,185 3,891 4,533 4, % 20.1% 22.2% 16.5% 3.0% GWM 8,224 8,042 8,497 8,624 8, % -2.2% 5.7% 1.5% 3.8% BYD ,327 2,512 3, % -84.5% % 89.2% 46.3% Dongfeng 10,528 12,845 12,021 13,201 13, % 22.0% -6.4% 9.8% 3.0% Brilliance 3,374 5,403 3,340 3,873 4, % 60.1% -38.2% 15.9% 13.7% Gross margin (%, YoY pp.) E 2016E 2017E E 2016E 2017E Geely 20.1% 18.2% 18.3% 18.2% 18.2% 1.6 (1.9) 0.1 (0.1) (0.0) BAIC 3.2% 15.9% 17.4% 18.5% 18.7% GAC 10.6% 11.4% 11.6% 11.6% 11.7% GWM 25.9% 25.0% 23.3% 22.1% 21.2% 1.9 (0.9) (1.6) (1.2) (1.0) BYD 13.1% 13.8% 13.9% 13.8% 14.5% (0.1) 0.7 Dongfeng 12.6% 13.2% 12.0% 12.0% 12.0% (1.2) - (0.0) Brilliance 11.2% 10.2% 7.0% 7.5% 8.0% (0.5) (1.0) (3.2) Net margin (%, YoY pp.) E 2016E 2017E E 2016E 2017E Geely 9.3% 6.6% 9.2% 9.2% 9.2% 1.0 (2.7) 2.6 (0.0) 0.1 BAIC 21.2% 8.0% 5.7% 5.5% 5.5% (75.9) (13.2) (2.4) (0.2) (0.0) GAC 14.1% 14.2% 13.5% 10.1% 9.4% (0.7) (3.4) (0.8) GWM 15.0% 13.3% 12.1% 11.1% 10.3% 1.3 (1.7) (1.2) (1.0) (0.9) BYD 1.1% 0.2% 1.6% 2.3% 3.0% 0.9 (0.3) 2.4 (0.9) 0.7 Dongfeng 28.3% 15.9% 9.7% 11.4% 12.4% (121.0) (12.4) (6.2) Brilliance 55.3% 98.0% 65.7% 69.9% 80.0% (32.3) Source: Companies, Daiwa forecasts 4

5 China Autos Sector: 4 January 2016 Running on fumes in 2016; refill needed for 2017 We are positive on the purchase tax cut, but expect the impact to be much milder than that for the 2009 cut Tax cut should boost sales volume growth in 2016 Raising our 2016 sales volume growth forecast, but cutting it for 2017 On 29 September 2015, China s State Council announced new measures to support the automotive industry. As well as its policies to support new-energy vehicles (NEV), it also implemented a cut in the purchase tax, from 10% to 5%, for cars with engines of 1.6L or less. This policy came into effect on 1 October 2015 and will last until 31 December China: details of automotive stimulus policies Subject Policy details Cars with engines of <=1.6L Purchase tax reduced from 10% to 5% NEVs Restriction on new NEV car sales removed in all cities Old cars with excessive emissions To be replaced by NEVs by 2017 Source: State Council We estimate that the 2015 tax cut policy will boost the sales of 68% of all the models in the China market. However, we expect the impact in 2016 to be much milder than when a similar policy was implemented in We now forecast 2016 sales volume growth of 12% YoY, compared with our previous forecast of 4% YoY. However, this still would be far below the 50% YoY increase in 2009, due to differences in the macro environment (see following table). China: impact of stimulus policy on automotive sector, 2009 vs E Daiwa s GDP growth forecast 9.2% 6.5% Daiwa s M2 Growth 28.4% 10.5% China PV market size, sales (m units) YoY growth 52.9% 11.6% China new PV sales market size as a % of the US s PV market 114.5% 163.1% SUV sales as a % of PV sales 8.8% 35.6% Other stimulus policies Subsidies to farmers in rural areas Removal of purchase restrictions on NEVs; Provide subsidies to encourage the replacement of old models that with high emissions Source: State Council, Daiwa forecasts We currently assume no extension in the purchase tax cut after the end of 2016; we see it increasing to 10% in 2017, and this is our base case In 2009, apart from the purchase tax being cut from 10% to 5%, other supportive policies were also in place, including the CNY4tn stimulus package, which helped to boost the country s economic growth through infrastructure investment, and by encouraging the replacement of vehicles in rural areas (boosting both the PV and CV segments). Also, the new car sales base was much smaller then, and China was seeing higher GDP growth. Further, compared to 2009, we have been seeing a gradual slowdown in the China economy since Daiwa s economics team forecasts GDP growth to slow to 6.9% in 2015 and 6.5% in Given the backdrop of a slowing China economy, we believe this could curb demand and consumption of PVs, and thus, even with the boost of the purchase tax cut, we expect a 12% YoY increase in PV sales in 2016, after a 7% YoY rise in Meanwhile, our base case assumes that the current tax-cut policy will not be extended into 2017, and that the rate will go back up to 10% then. Accordingly, we expect PV sales to decline by 3% YoY in 2017, given the high base in From our sensitivity analysis, we do see a chance of the government first raising the purchase tax to 7.5% in 2017, and then 10% in 2018, as was the case in If this were to happen, we estimate that the new car sales volume would be flat YoY in

6 E 2016 E 2017 E 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 E 1Q16 E 2Q16 E 3Q16 E 4Q16 E 1Q17 E 2Q17 E 3Q17 E 4Q17 E China Autos Sector: 4 January China PV sales scenario analysis Purchase tax on new cars China PV sales YoY change Base case: Full reversal of the tax cut 10% 3% decline Alternative case: gradual increase in the tax cut in 2 tranches 7.5% Flat Source: Daiwa forecasts China: PV sales estimates by quarter (Quarterly sales, m units) (YoY %) 7 25 % 6 20 % 5 15 % 10 % 4 5% 3 0% 2 (5%) 1 (10%) 0 (15%) China PV S ales Volume (LHS) YoY Growth (RHS) Source: CAM, Daiwa forecasts China: PV sales estimates by year (Yearly sales, m units) (YoY %) % % % % % % 9.7% 11.6% 15 % 7.1% 7.0% 10% 10 5% 5.2% -3.3% 5 0% (5%) 0 (10%) E 2016 E 2017 E China PV S ales Volume (LHS) YoY Growth (RHS) Source: CAM, Daiwa forecasts Strong SUV pipeline in 2016 We expect SUVs sales volume growth of 10-30% YoY in Strong industry pipeline in 2016 We expect strong SUV segment sales growth, but see margins continuing to deteriorate due to fierce competition Apart from the purchase tax reduction, we think overall industry sales volume growth in 2016 will be driven by a strong pipeline, as many new models are being launched over the 2H15-1H16 period. We estimate that around 91 new models will be launched by the major brands, much higher than the 30 or so new models in 2H14-1H15. Of these new launches, SUVs should remain the major driver, with one-third of the new models launched in 2H15-1H16 being these types of vehicles. We estimate that SUVs will account for around 50% of total new model sales volume over this period. In November 2015 YTD, SUVs saw 54% YoY sales volume growth. We forecast a 54% YoY increase in SUV sales volume in 2015, as we assume a total of 1.5m SUVs will be sold in China in November-December. We estimate that SUVs will account for 30% of total PV sales volume in 2015, which is below the US number of 40% (see the following chart). And as we believe purchasing patterns in China will follow those in the US, we see room for further growth in 2016, with many new SUV models arriving over the same period. In 2016, we forecast SUV sales volume growth to remain strong, although it is likely to start to slow, to 33% YoY (from 54% in 2015). And, based on expected weak sales volume growth for the other segments in 2016, we look for new SUV sales to account for 35% of total new car sales for the year. But we look for the pace of SUV sales growth to slow as we move into 2017, to 10% YoY, by which time, SUVs should account for 41% of total new-car sales. SUV penetration rate in US and China 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: Wards, CAM, Daiwa forecasts US: SUV and Cross Utility Vehicle to PV sales China: SUV to PV sales 6

7 China Autos Sector: 4 January 2016 Margin erosion to continue in On the margin side, as we expect competition to intensify in 2016, we look for SUV margins (net and gross) to continue on their declining trend in , although the overall gross margin should remain above the 20% level, which is better than the margin on sedans. We expect the automotive OEMs that have reported high gross margins over the period, such as Great Wall, to experience margin erosion in 2016 and even in 2017 due to the high base. 7

8 China Autos Sector: 4 January 2016 H-share listed OEM: model pipeline for 2H Other OEMs: model pipeline for 2H Company Model Type Launch date Geely Emgrand EV* Sedan 2H15 NL-3 SUV 2H15 Compact SUVs SUV 2016 Emgrand Cross Vehicle Cross 2016 Emgrand 4-door Sedan Sedan 2016 BAIC Beijing Benz C350eL* PHEV Sedan 2H15 GLC SUV 2016 New E-class Sedan 2016 Beijing Hyundai Tucson* SUV 2H15 Elantra Lingdong Sedan 2016 (Mar) Sonata PHEV ver. PHEV Sedan 2016 Equus Sedan 2016 Beijing Brand Senova X25* SUV 2H15 Senova X55 SUV 2H15 (Dec) Senova X35 SUV 2H15 (Dec) EV-260 EV Sedan 2016 BJ40 5-door ver SUV 2016 BJ80 SUV 2016 BYD Song* PHEV SUV 2H15 Yuan PHEV SUV 2H15 Qin EV EV Sedan 2016 Great Wall C30-classic (Facelift)* Sedan 2H15 Haval H1 Red badge* SUV 2H15 Haval H7 SUV 2016 A new SUV smaller than H2 SUV 2016 Haval H6 Blue badge SUV 2016 Haval H5 Blue badge SUV 2016 Facelift of H8 SUV 2016 GAC GAC Honda New City* Sedan 2H15 Crider (Facelift) Sedan 2H15 (Dec) Crosstour (Facelift) Sedan 2H15 (Dec) Acura SUV SUV 2016 GAC Toyota Levin HEV* Hybrid Sedan 2H15 Lingzhi EV EV Sedan 2016 GAC Fiat-Chrysler Cherokee SUV 2H15 GAC Mitsubishi Outlander PHEV PHEV SUV 2016 GAMC GS4 EV EV SUV 2016 GA3S PHEV PHEV Sedan 2016 Brilliance Brilliance BMW 3-series (Facelift)* Sedan 2H15 2-series Sedan 2016 X1 SUV 2016 Dongfeng Dongfeng Peugeot-Citroën Citroën C5* Sedan 2H15 Peugeot 3008 (Facelift) SUV 2016 Dongfeng Nissan Venucia R50X* Sedan 2H15 Venucia T70X* SUV 2H15 Lannia* Sedan 2H15 Murano* SUV 2H15 Qashqai* SUV 2H15 Maxima Sedan 2016 Infiniti QX30 SUV 2016 Dongfeng Honda Greiz* Sedan 2H15 Civic Sedan 2016 Elysion MPV 2016 (Jan) Dongfeng Renault Kadjar SUV 2016 (Mar) Dongfeng Passenger Vehicle Fengshen A60* Sedan 2H15 Fengshen AX3 SUV 2H15 Dongfeng Liuzhou Motor S500* MPV 2H15 Source: Companies, various media Note: *Already launched Company Model Type Launch date Changan Changan Ford Focus* Sedan 2H15 Explorer* SUV 2H15 Taurus Sedan 2H15 Tourneo MPV 2016 Changan PSA DS 5* Sedan 2H15 DS 4S Sedan 2016 Changan Suzuki S.Cross* SUV 2H15 Swift* Sedan 2H15 Vitara* SUV 2H15 Changan Motor CS15 SUV 2016 Jiangling Landwind X7* SUV 2H15 SAIC Shanghai Volkswagen Skoda Yeti* SUV 2H15 Skoda Octavia* Sedan 2H15 Skoda Superb* Sedan 2H15 Gran Lavida Sedan 2H15 Passat (Facelift) Sedan 2016 Touran L MPV 2016 Shanghai GM Buick Verano Sedan 2016 Shanghai GM Chevrolet Trax* SUV 2H15 Malibu* Sedan 2H15 Lova RV MPV 2H15 Shanghai GM Cadillac ATS-L (Facelift)* Sedan 2H15 CT6-40T Sedan 2H15 SAIC Motor Roewe 360* Sedan 2H15 MG5* Sedan 2H15 MG3 SW* SUV 2H15 Roewe E950 PHEV Sedan 2016 FAW Car Besturn B70* Sedan 2H15 Besturn X80* SUV 2H15 Besturn B30* Sedan 2H15 FAW Toyota Crown* Sedan 2H15 Prado (Facelift)* SUV 2H15 Land Cruiser (Facelift) SUV 2H15 FAW Volkswagen FAW Volkswagen CC* Sedan 2H15 Golf GTI* Sedan 2H15 Bora Sedan 2H15 Golf SportsVan Sedan 2016 Magotan Sedan 2016 FAW Volkswagen Audi Q7* SUV 2H15 A6 (Facelift) Sedan 2016 Chery Chery Tiggo 5* SUV 2H15 Arrizo 5 Sedan 2016 Chery Jaguar Land Rover Discovery Sport SUV 2H15 Dongfeng Yueda KIA K5* Sedan 2H15 KX5 SUV 2016 Zotye SR7 SUV 2H15 Z700 Sedan 2H15 Source: Companies, various media Note: *Already launched 8

9 China Autos Sector: 4 January 2016 H-share listed OEMs: model pipeline for 2H14-1H15 Company Model Type Launch date Geely EC7 Sedan Jul-2014 GC9 Sedan Apr-2015 Vision Sedan Nov-2014 GWM H2 SUV Jul-2014 H5 SUV Nov-2014 H1 SUV Nov-2014 H9 SUV Nov-2014 H8 SUV Apr-2015 BAIC Beijing Brand Senova D20 Sedan Nov-2014 Senova X65 SUV Feb-2015 Wevan 007 SUV Jan-2015 Senova CC Sedan Apr-2015 BJ 40 SUV Apr-2015 EV-200 EV Sedan Mar-2015 Beijing Benz C-class Sedan Aug-2014 GLA SUV Aug-2014 Beijing Hyundai Verna (facelift) Sedan Mar-2015 Elantra Langdong (facelift) Sedan Oct-2014 ix 25 SUV Oct-2014 ix 35 (facelift) SUV Jan-2015 Sonata 9 Sedan Mar-2015 GAC GAC Honda Accord (facelift) Sedan Mar-2015 Vezel SUV Oct-2014 GAC Toyota Camry Sedan Jan-2015 Levin Sedan Jul-2014 EZ MPV Dec-2014 GAC Fiat Viaggio Sedan Nov-2014 GAC Mitsubishi ASX (facelift) SUV Aug-2014 GAMC GA5 EV Sedan Nov-2014 GA6 Sedan Dec-2014 GS4 SUV Apr-2015 Brilliance Brilliance BMW X1 (facelift) Oct-2014 Dongfeng Dongfeng Nissan Venucia R30 Sedan Jul-2014 Venucia E30 Sedan Sep-2014 Sunny (facelift) Sedan Feb-2015 Teana (facelift) Sedan Apr-2015 March Sedan Nov-2014 Venucia T70 SUV Jan-2015 Q50L Sedan Nov-2014 QX50 SUV Mar-2015 Dongfeng Honda Spirior Sedan Nov-2014 CR-V (facelift) SUV Apr-2015 XR-V SUV Nov-2015 Dongfeng PSA 308S Sedan Mar Sedan Jan-2015 C3-XR SUV Dec-2014 DS6 SUV Oct-2014 Source: Companies, various media Other OEMs: model pipeline for 2H14-1H15 Company Model Type Launch date Changan Changan Ford Edge SUV May-2015 Escort Sedan Jan-2015 Kuga (facelift) SUV Jan-2015 Changan Suzuki Alivio Sedan Dec-2014 Changan Mazda Mazda 3 Sedan Sep-14 Changan Motor Eado Sedan Mar-15 Yuexiang V7 Sedan Nov-14 SAIC Shanghai Volkswagen Skoda Fabia Sedan Apr-15 Tiguan SUV Jul-14 Lamando Sedan Jan-15 Touran (facelift) MPV Aug-14 Shanghai GM Buick Envision SUV Oct-2014 Excelle GT Sedan Mar-2015 Shanghai GM Chevrolet Sail Sedan Mar-2015 Shanghai GM Cadillac ATS-L Sedan Aug-2014 SAIC Motor Roewe 350 Sedan Jun-15 FAW Car FAW Mazda CX-7 SUV Jul-2014 FAW Toyota Crown Sedan Mar-2015 FAW Volkswagen Sagrita (facelift) Sedan Mar-2015 Dongfeng Yueda KIA K2 Sedan Nov-14 K4 Sedan Sep-2014 KX3 SUV Mar-2015 Sportage R SUV Sep-15 Chery Tiggo 3 Sedab Nov-2014 Zotye Z500 Sedan Nov-14 Z100 EV Sedan Oct-14 Source: Companies, various media 9

10 China Autos Sector: 4 January 2016 China Autos Sector: key SUV model 4S store price trends (4S Price, CNY) 350, , , , ,000 (4S Price, CNY) 350, , , , , ,000 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct ,000 BAIC Hyundai IX35 GAC Honday CR-V SAIC VW Tiguan FAW VW Audi Q3 GWM H6 Source: CAM Note: 4S refers to Sale, Spare parts, Service, and Survey Sedan sales expected to remain weak, with flat YoY sales volume in 2016 and a 10% YoY decline in 2017 China sedan sales expected to be flat YoY in 2016 For sedans, on the other hand, we expect sales volume growth to remain weak in 2016, although better than our forecast of a 6% YoY decline in Due to the purchase tax cut, sedan sales should increase by 2% YoY in But in 2017, when we expect the purchase tax to be raised again, and based on the high base effect we foresee from 2016, we look for sedan sales to return to a downward trend and decline by 10% YoY. We saw this declining trend in 2015 until the purchase tax cut was implemented in October China Autos Sector: PV sales growth estimates by segment (YoY %) (YoY %) 200% 200% 150% 100% 50% 0% -50% E 2016 E 2017 E Sedan MPV SUV Cross Source: CAM, Daiwa forecasts 150% 100% 50% 0% -50% On the margin side, we expect the rate of decline in sedan margins to be slower than that for SUV margins, as the sedan business is a lower-margin business and there are fewer new models competing for business. For an OEM such as Geely, which has been able to successfully upgrade its brand, we expect its sedan gross margin to remain at the current level in Domestic brands should continue to benefit from strong sales growth in low-tier cities Domestic brands should keep outpacing foreign brands Opportunities in lower-tier cities While the overall automobile penetration rate (see tables on page 11) in China is still low, after close analysis, we note that penetration in top-tier cities, such as Beijing and Shenzhen, has already reached cars per thousand people, which is comparable to mature markets like Japan, Korea and Taiwan. However, in lower-tier cities, penetration is still mild at around 100 cars per thousand people. This level of penetration is comparable to developing countries like India, where we see more sales growth opportunities, as they are often the major market for domestic brands as customers there are price-sensitive. We believe this stronger sales growth trend for domestic brands will continue in 2016 and into As such, we continue to prefer domestic brands to foreign JV brands. Among domestic brands, independent brands like Geely and GWM are posting better profitability, on cost control and brand improvement, than domestic brands developed by 10

11 China Autos Sector: 4 January 2016 automakers that rely on JVs with foreign brands. In comparison, the profitability of domestic brands developed by BAIC Motor, Brilliance and Dongfeng, for example, is often weak due to a lack of technological independence or know-how. Their heavy reliance on profit from foreign JV brands means they focus more on foreign brands and less on their own brands. This situation leads to them to strive for more technological transfers from JV partners to capture the best technology at as low a cost as possible. However, expectations to derive technology from a JV partner are becoming more unrealistic, as foreign JV partners often only share old model platforms and their components are usually expensive. Therefore, we are in favour of the long-term development of local brands such as Geely, which has high technological independence. Ownership growth rate against ownership per 1,000 capita (Ownership annualised growth in , %) 40% Gansu 35% 30% Ningxia 25% Hunan Zhejiang 20% 15% Guangdong Tianjin R² = % Shanghai Beijing 5% 0% (Auto Ownership per 1,000 capita in 2010) Source: National Bureau of Statistics of China Automobile ownership: China vs. other countries, by end-2014 City/Region/Country Population (m) Auto Ownership per 1,000 capita China China PV only Beijing Tianjin Zhejiang Shandong Shanghai Guangdong Chongqing Shanxi Sichuan Guizhou USA (PV only)* Japan (PV only)* S. Korea (PV only)* Taiwan (PV only)* Source: National Bureau of Statistics of China, Statista Note: as of end of 2012 Key model comparison: sedan Automotive OEM Model Length (mm) Price range (CNY k) Launch date Launch date of facelift / new options Avg sales units per month in 2015 Geely GC Apr-2015 n.a. 3,090 SAIC Motor Roewe Mar-2012 Jul (Facelift) 158 GAC Toyota Camry Dec-2011 Mar-2015 (Facelift) 10,727 Beijing Benz E-class Jun-2010 Aug-2013 (Facelift) 4,896 Source: Companies, various media Key model comparison: SUV Automotive OEM Model Length (mm) Price range (CNY k) Launch date Launch date of facelift / new options Avg sales units per month in 2015 GWM H k - 159k Oct-2012 May-2015 (Facelift) 29,037 Changan CS Apr-2014 Sep-2015 (new options) 14,551 Dongfeng Honda CR-V Feb-2012 Apr-2015 (Facelift) 11,995 FAW VW Audi Q Mar-2010 Apr-2013 (Facelift) 9,241 Source: Companies, various media Luxury cars still sell well in China, especially Beijing Benz Demand for luxury still strong Among foreign JV brands, we still prefer luxury brands, as we believe rising disposable incomes and licence restrictions in some cities have encouraged customers to skip mid-range cars, such as Korean and Japanese brands, and buy luxury European cars, particularly German-made cars. In 2015, sales of Beijing Benz cars outperformed sales of peers significantly, and in 2016 we expect the outperformance to continue as the pipeline for Beijing Benz in 2016 is strong, with the forthcoming launch of the GLC and new E-class model. On the other hand, we expect sales volume for BMW Brilliance to pick up, as the strong sales growth generated by its 3-series facelift is likely to continue in 2016 and it is due to launch the new X1 SUV and 2-series models in Even though the design for the X1 SUV is yet to be finalised (ie, 5-seater or 7-seater), we believe this SUV model will still be welcomed by customers. For the 2-series, even though we do not think it can replace sales of the 3-series or 5-series, we believe this model will offer customers an additional choice, especially those looking for an entry model luxury brand. 11

12 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 China Autos Sector: 4 January 2016 Overall, we do not see the anti-corruption campaign as having a big negative impact on luxury car sales growth in China, which we see still outperforming the broader China autos market at least in If there is any impact, it would likely be on FAW Audi, which used to be a popular brand favoured by government ministers. Sales of luxury auto brands in China German auto OEM pipeline for 2H (Sales unit) 120, ,000 80,000 60,000 40,000 20,000 0 Source: CAM Luxury brands monthly sales (LHS) China overall PV YoY (RHS) Luxury brands YoY (RHS) (YoY %) 60% 40% 20% 0% (20%) Company Model Type Launch date Beijing Benz C350eL* Hybrid Sedan Nov-2015 GLC SUV 2016 New E-class Sedan 2016 Shanghai Volkswagen Skoda Yeti* SUV Aug-2015 Skoda Octavia* Sedan Aug-2015 Skoda Superb* Sedan Oct-2015 Bora Sedan 2H15 Passat (Facelift) Sedan 2016 Touran L MPV 2016 FAW VW CC* Sedan Oct-2015 Golf GTI* Sedan Nov-2015 Golf SportsVan Sedan 2016 Magotan Sedan 2016 FAW VW Audi Q7 SUV Dec-2015 A6 (Facelift) Sedan 2016 Source: Companies, various media Note: * Already launched German cars are gaining market share from Japanese brands Market shifting away from Korean and Japanese brands Due to their aggressive sales strategies and greater number of entry-level models available in the market, German brands, including Audi and BMW and recently Benz, have been gaining market share over the past few years, with their share having risen from 16.5% in 2011 to 20% in October 2015 YTD. Japanese brands have been losing market share, due to the aggressive sales strategies of German brands as well as rising disposable incomes and licence restrictions in top-tier cities. Given the licence restrictions in several top-tier cities (see the following chart), we expect car buyers to favour luxury brands (such as BMW, Benz and Audi) over mid-range brands (such as Korean and Japanese brands) given the expensive new licence-plate fee and because the total number of new licences is limited depending on the city they are allocated in. This means that if a family can afford a luxury car, it would probably jump straight to it rather than buying an entry-level (ie, domestic brand) or mid-level (ie, Japanese or Korean brand) model, in our view. China new car licence restrictions in various cities Cities Plate issuance through Implementation date Quota (annual) Shanghai Bidding ,000 Beijing Lottery 12/23/ ,000 Guiyang Lottery 7/11/ ,000 Guangzhou Bidding and lottery 6/30/ ,000 Tianjin Bidding and lottery 12/15/ ,000 Hangzhou Bidding and lottery 3/25/ ,000 Shenzhen Bidding and lottery 12/29/ ,000 Luxury brand sales in China (Sales unit) (YoY %) 120,000 60% 100,000 40% 80,000 60,000 20% 40,000 0% 20,000 0 (20%) Source: Local governments, various media reports Source: CAM Luxury brands monthly sales (LHS) China overall PV YoY (RHS) Luxury brands YoY (RHS) 12

13 China Autos Sector: 4 January 2016 The market share for Japanese brands shrank from 20% in 2011 to 16% YTD in October 2015, and we expect it to be flat YoY in 2016 due to rich pipelines from Nissan and Honda in China. However, we remain concerned about 2017 onward, as we expect to see more competition from German cars and even local Chinese brands. Sales volume growth for the Korean brands should recover in 2016, but long-term growth remains a concern Meanwhile, Korean brand market share rose from 8% in 2011 to 9% in 2014, but fell back to 8% in October 2015 YTD, due partly to weak sales volumes for Beijing Hyundai and Dongfeng KIA, as a result of intense competition in the China market and the Korean brands slow pricing adjustments. We look for the sales growth of Beijing Hyundai to recover in 2016 due to its improved product quality and more attractive models being launched, while its overall market share should remain at around 8%. In the longer term, we are concerned about the Korean brands in China as they may be the first victims of the emergence of local brands. Local brands have also lost a lot of market share, which contracted from 42% in 2011 to 38% in 2014, due mainly to the loss in market share from the sedan segment, which declined from 29% in 2011 to 22% in As such, rising disposable incomes led to more second-time buyers shifting to luxury German cars, while the local brands pushed fewer sedan models (and more SUVs) due to declining profitability on sedans. However, with SUVs comprising a growing proportion of the China autos market, the combined market share of the local brands returned to 40% in October 2015 YTD. We expect the market share of the local brands to gradually improve over the next 3 years, in line with the growing proportion of SUVs in new-car sales. Mixed outlook for local brands Among domestic brands, the outlook seems mixed. We see selective brands like Geely continuing to gain market share due to better pipelines in 2016, and GAC Motor s GS4 still selling well. On the other hand, GWM may continue to lose market share to foreign brands, while we believe BAIC Motor s Beijing Brand is unlikely to be profitable in the next 3 years. China PV market share by originating country (Market share, %) 40% 30% 20% 10% 0% Source: CAM China SUV market by originating country (Market share, %) 50% 40% 30% 20% 10% 0% Source: CAM YTD-2015 China Domestic Germany Japan Korea US Others YTD-2015 China Domestic Germany Japan Korea US Others China Sedan market share by originating country (Market share, %) 30% 25% 20% 15% 10% 5% 0% Source: CAM China PV market, market shares of selected domestic brands (Market share, %) 4% 3% 2% 1% 0% Source: CAM YTD-2015 China Domestic Germany Japan Korea US Others YTD-2015 Geely Beijing Motor BYD GWM GAMC Dongfeng proprietary brands Brilliance Jinbei 13

14 China Autos Sector: 4 January 2016 Charging facilities still the major bottleneck Government and OEMs more serious on NEVs for next 5 years 5m NEV ownership should be achievable Accelerating investment in NEVs in Government and OEMs becoming more serious According to the NDRC, by the end of 2014, there were only 780 charging stations which provided 31,000 charging poles to serve more than 120,000 EVs owned in China. The ratio of EVs to charging poles is way below the targeted 1:1 level. According to a 2012 study by TÜV Rheinland regarding major concerns about purchasing EVs, 22% of Chinese interviewees were most concerned about the limited driving range, while 19% worried about the lack of charging facilities. The situation did not improve in 2015, when the major obstacle for the Chinese government to promote EVs was insufficient charging facilities. However, the policy guidelines regarding the development of charging facilities in China for announced on 17 November seemed to indicate a stronger commitment from the government to push the development of NEVs over the next 5 years in order to reduce pollution and prepare for future competition in this global growing segment. Also, the coming 5-year plan for automotive OEMs places a greater focus on EVs for the next 5 years, in order to help China meet fuel efficiency requirements by The government estimates that the total number of NEVs owned will reach about 5m units by the end of 2020, consisting of 4.3m electric PVs, 0.3m electric taxis, 0.2m electric buses and 0.2m electric trucks and other vehicles. We think this target is achievable, as we expect many new model launches over the next 5 years. We expect new-car sales of NEVs to increase by 70% YoY in 2016 and 40% YoY in 2017, and by 20-30% YoY in NEV strategies for major China automotive OEMs Company Plans Geely NEV sales targeted to reach 90% of total sales by 2020, 65% of which would be PHEVs and hybrid EVs while the remaining 35% would be pure EVs. GWM According to market news, GMW's first EV sedan, C30EV, targeted to be launched in The company also aims to launch its first hybrid SUV model in GAC For the next 5 years, GAC will invest CNY2bn to develop NEVs and launch 5 new NEV models including sedans and SUVs. Changan Has invested CNY1bn to develop NEVs since 2001 and plans to invest CNY18bn more in the next 10 years. The company aims to introduce 34 new NEV products to the market over the next decade and targets accumulated NEV sales of 100,000 units and 2,000,000 units by 2020 and 2025, respectively, with NEVs accounting for 10% of total sales. SAIC The company will invest CNY20bn to develop EV products and aims to launch 30 NEV products consisting of 13 pure EV models and 17 hybrid EV models. It targets sales volume of NEVs to reach 600,000 units in 2020, of which 200,000 will be its self-owned brand. Source: cnstock.com China: NEV sales ( E) (units) (YoY % ) 80 0, % 300% 714, % 700, % 600, , , , , ,000 0 Source: CEIC, Daiwa forecasts 63% 38% 8,000 13,000 18,000 75, , , E 20 16E 20 17E NEV sales (LHS) YoY growth (RHS) 70% 40% 25 0% 20 0% 15 0% 10 0% 50 % 0% 14

15 China Autos Sector: 4 January 2016 Summary of fuel-efficiency targets for major markets km/l (mpg) US EU Japan China S. Korea (29.0) 15.8 (37.2) 16.7 (39.3) 11.0 (25.9) 12.3 (28.9) (33.0) 18.0 (42.3) 19.6 (46.1) 14.4 (33.9) 14.8 (34.8) (36.0) 19.7 (46.3) 21.0 (49.4) 15.7 (36.9) 16.7 (39.3) (47.0) 25.8 (60.7) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) (56.0) 30.8 (72.4) ~ 35.0 (82.3) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) 5-YOY (%) US EU Japan China S. Korea % 13.9% 17.4% 30.9% 20.3% % 9.4% 7.1% 9.0% 12.8% % 31.0% 11.4% 35.7% 0.0% % 19.4%~35.7% 0.0% 0.0% 0.0% Improvement (%) US EU Japan China S. Korea % 71.1%~94.4% 19.4% 47.9% 12.8% % 56.3%~77.7% 11.4% 35.7% 0.0% Source: ICCT Note: No official fuel efficiency guidance have been provided for Korea (from 2015), Japan (from 2020), or China (from 2020) Forecast of EVs owned by China Government at end An estimated 5m EVs owned 4.3 Electric passenger vehicles Electric buses Electric taxis Electric Sanitation and logistics vehicles Source: NDRC, Daiwa Better plan for charging network Tackling infrastructure bottleneck To support the ownership of 5m NEVs in China, the government has set a target to build 4.8m distributed charging poles and 120,000 charging stations. Apart from setting a charging pole construction target, the NDRC has also revealed a plan to establish a nationwide charging network to connect the charging facilities. At this stage, the government plans to speed up the construction of charging facilities in the more developed eastern part of the country due to that area s more serious air pollution problem, with the middle and western parts to follow. In the longer term, the government plans to link its charging stations with the expressway network, to build a 4 Vertical, 4 Horizontal inter-city fast-charging network to facilitate the interprovincial use of NEV vehicles. Construction target for charging stations by vehicle usage by Total 120,000 charging stations Source: NDRC, Daiwa Bus-only charging stations Taxi-only charging stations Sanitation and logistics vehicles-only charging station Public charging stations - PVs Inter-city charging stations 15

16 China Autos Sector: 4 January 2016 Target for distributed charging poles by Total 480m distributted charging poles 2.8 Residential area Parking areas in commercial buildings, industrial parks and government buildings, etc. Other public areas Source: NDRC China: construction target for charging facilities for Source: NDRC, Daiwa Plan for nationwide inter-city fast-charging network Source: NDRC Note: red line: charging network built before 2015; blue line: network to be built in

17 China Autos Sector: 4 January 2016 Other supportive measures also important Besides improving the related infrastructure, the government has announced other supportive measures, such as lifting purchase restrictions and traffic controls on NEVs, requiring property developers to reserve spaces to build charging poles in the future. Hence, we believe the problem of inadequate charging poles, one of the biggest concerns for potential EV buyers, will be gradually solved by Latest supportive measures by China Government to promote NEVs Policy Licence & traffic restrictions Charging stations Source: CAAM Details Lift purchase restrictions and traffic controls for NEVs but retain curbs on vehicles with conventional internal combustion engines (ICE). New residential complexes must be built with chargers or reserved spaces for future installations. At least 10% of public parking facilities should be built with chargers or spaces reserved for future installations. Every 2,000 EVs owned should be matched by 1 public charging station. In Beijing, 18% of parking spaces in all new residential complexes should be built for EVs. To build a nationwide charging network for up to 5m electric vehicles by We expect subsidies to be maintained in coming years and scaled back gradually Geely and BYD the potential leading NEV brands Customer subsidies to be phased out According to a notice issued in April 2015 by the Ministry of Industry and Information Technology (MIIT) regarding subsidies on NEVs, the government plans to cut subsidies to customers by 20% in from the 2016 level, and by 40% in from the 2016 level, except for fuel-cell vehicles. As the price of an NEV is still higher than that of a conventional PV, even with the subsidy, we see the cut on subsidies as being only slightly negative for NEV sales, as most of the sales in the near term would focus on corporates or car companies, which are required to buy more NEVs to achieve government fuelconsumption standards. Also, subsidies on EVs and PHEVs are only a small amount compared to the price of an NEV. On the other hand, the local government subsidies on NEV R&D should continue, which would provide incentive and support for OEMS to push more NEV models. We see the current constraint on charging facilities being solved or improved significantly by We expect public transportation and corporates to be the first to switch from more conventional cars to NEVs in the early stages, and therefore expect BYD to benefit more in the near term, while new brands such as Geely should also benefit on EV launches in the long term. China: 2016E NEV subsidies Subsidy (CNY/vehicle) Pure electric driving range (in km), R 100 R < R < 250 R 250 R 50 Pure EV 25,000 45,000 55,000 / Plug-in hybrid electric vehicle / / / 30,000 Source: NDRC China: 2016E fuel-cell vehicle subsidies Vehicle type Subsidy (CNY/vehicle) Fuel-cell PV 200,000 Fuel-cell light CV 300,000 Fuel-cell mid-large CV 500,000 Source: NDRC Price comparison of selected NEV and comparable ICE models Company Model Type Price (Before subsidy, CNY '000) Price (After subsidy, CNY '000)* Comparable ICE model Price range BYD Qin PHEV Geely Vision, BYD F Tang PHEV Changan CS75, FAW Besturn X Song PHEV Soueast Motor DX7, GWM Haval H e6 EV DF Fengxing S500, Chery Arrizo M Denza EV GAC Trumpchi GA5, BAIC Senova D Geely Emgrand EV EV FAW Besturn B30, DF Fengshen A60, Roewe BAIC e-series EV Chery Fulwin 2, Changan CX Dongfeng Nissan Venucia E30 EV Changan CX20, BAIC Senova D Zotye Z100 EV EV Geely Panda, Chery QQ Changan Eado EV EV FAW Besturn B30, DF Fengshen A60, Roewe Chery eq EV Geely Panda, Chery QQ JAC iev4 EV Geely KingKong, Chery E Source: Companies, Autohome, Sohu Auto and Diangdong Note: Subsidies subject to different provincial policies 17

18 China Autos Sector: 4 January 2016 Little possibility of equity-raising unless there is another A-share or H-share market rally Balance sheets remain healthy On the balance-sheet side, the industry is in good shape, with net gearing levels for the A- share and H-share automakers of 23-26% in 2014, appreciably better than levels in Europe and Japan. Therefore, unless we see a major rally in the H-share or A-share markets that prompts companies to raise more capital for future R&D (especially for NEVs), we see a limited possibility of China OEMs raising equity in In terms of 2014 ROEs, China automakers reported ratios of 2-36%, with a weighted average of 15%, and on this measure we expect them to be stable over our forecast horizon. However, although their balance sheets remain strong, we expect dividends to remain low, as we believe the OEMs will seek to preserve cash for R&D and product development. In other words, we do not expect China automakers to be yield plays in the near term. Global major auto OEMs: net debt-to-equity ratio ( ) China H-share listed China A-share listed US net cash net cash net cash net cash net cash Europe net cash Japan Korea Global Global autos OEMs: ROE ( E) (% ) Source: Bloomberg E 20 16E 20 17E China H-share listed China A-share listed US Europe Japa n Korea Source: Bloomberg China: H-share listed auto makers: yield ( E) Name Bloomberg code E 2016E 2017E BAIC 1958 HK n.a. n.a. n.a. n.a GEELY 175 HK DFM 489 HK BYD 1211 HK n.a GAC 2238 HK GWM 2333 HK BRILLIANCE 1114 HK Weighted average Source: Bloomberg Note: Historical yield calculated by DPS/share price on last trading day of corresponding year We expect CV sales volume to decline by 10% YoY in 2016 Hard to see any recovery for CVs We expect trade data in China to remain subdued in Daiwa s Chief Economist Kevin Lai forecasts China s exports to decline by 3.4% YoY and imports to decline by 6.4% YoY in In this context, we believe the overall profitability of the logistics companies, especially the freight forwarding and transportation players, will remain weak in At the same time, with new emissions standards set to come into effect in the near term, and with large replacement orders having been made in 2014, we do not expect commercial vehicle (CV) sales to pick up in 2016 despite the fact they have been weak for 3 years now. Overall, we forecast a 10% YoY decline in CV sales volume in 2016 and a 5% YoY contraction in

19 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 China Autos Sector: 4 January 2016 China: emissions standards for heavy-duty engines Standard China III China IV China V Test Cycle CO HC NMHC CH4 NOx PM Smoke g/kwh 1/m ESC + ELR /0.13** 0.8 ETC /0.21* - ESC + ELR ETC ESC + ELR ETC Source: transportpolicy.net Note: *: Natural gas engines only, **: For engines with a per cylinder displacement of < 0.75 L and rated speed > 3000 rpm China: monthly CV sales and growth (2014 October 2015) (units) (YoY %) 500,000 20% 400, , , , % 0% (10%) (20%) (30%) (40%) Source: CEIC Monthly sales (LHS) YoY growth (RHS) China: yearly CV sales and growth ( ) (units) (YoY %) 4,400,000 4,300,000 4,200,000 4,100,000 4,000,000 3,900,000 3,800,000 3,700,000 3,600,000 3,500,000 Source: CEIC 4,292,933 30% 4,035,386 3,809,841-6% -6% 4,065,346 7% 3,788, CV sales (LHS) YoY Growth (RHS) -7% 35% 30% 25% 20% 15% 10% 5% 0% (5%) (10%) 19

20 China Autos Sector: 4 January 2016 Valuations and recommendations Not that cheap anymore The China Autos Sector has been rerated since the sales recovery in August 2015, with the reduction in purchase tax in October providing a boost. The weighted index for the H- share automakers is trading currently at a 2016E PER of 8x (excluding BYD, which is an outlier as it trades at a significant premium to the other automakers), below its past-3-year range of 7-10x (excluding BYD). However, based on the expected slower EPS growth of the automakers vs. their past 3- year trading average, we see limited scope of a further rerating, particularly as the purchase tax reduction is essentially a one-off event. We look for car sales volume growth to continue to slow from 4Q16 into 2017, with sales volume contracting by 3% YoY in In this context, we expect market sentiment on the sector to weaken as 2017 approaches. Hence, we remain Neutral on the China Autos Sector as a whole, and recommend a selective approach to investment in the OEMs. PER comparison: automakers vs. market 30x 25x 20x 15x 10x 5x 0x Source: Bloomberg E 2016E 2017E Cap-weighted H-share listed auto makers MSCI China Financials Index MSCI China Consumer Discretionary Index MSCI China H Index MSCI China Utilities GICS Sector Index We prefer local brands, with Geely as our top pick Recommendations Top buys: Geely, BAIC and DFM In general, we prefer local brands. However, we would avoid GWM, which we think is set for overall margin deterioration in the face of intense competition and a subdued consumer response to the H8 and H9 models so far. On the other hand, Geely s new model, the GC-9, looks to have been well received and has already hit the company s sales target of 5,000 units/month. In 2016, we expect Geely s new SUV NL-3 (to be launched in December 2015) and NL-4 (to be launched in mid-2016) to have a positive impact on the bottom line, as the GC-9 should cover the fixed costs of the Chunxiao plant, which will also start production of the NL-3 and NL-4 SUVs using the company s A-segment sedan platform. For BAIC, we expect a recovery for Beijing Hyundai on sales of the Tucson and the new Elantra, as well as strong sales performance for Beijing Benz due to the new E-class sedan and GLC, to be share-price drivers in On a longer-term view, however, we are concerned about the competitiveness of the Korean brands in China. For DFM, we believe the company stands to benefit in 2016 from the strong product pipeline of Dongfeng Nissan (including SUV models, such as the Qashqai, Murano and T70X), which should have a full-year impact in terms of sales in Also, the new Lannia sedan has been well received since its launch in October 2015, and we expect it to be another sales volume driver in

21 China Autos Sector: 4 January 2016 We have a cautious outlook on GWM due to intensifying competition and resulting margin erosion Top sell: GWM We remain sceptical on GWM s prospects over our 12-month investment horizon on intense competition for its SUV models. Most of the models that GWM plans to launch in 2016 are SUVs, a segment where many foreign JV brands are offering bigger discounts. Against this backdrop, we think it could be hard for GWM to raise its ASP or sell more expensive models such as the H8 or H9 (or even the H7, which is to be launched in 2016). Separately, we are not confident in GWM s red badge/blue badge differentiation strategy, as we are not convinced that consumers will detect a material difference between the 2 offerings. Risks to our Neutral sector view Weaker- or stronger-than-expected demand The major downside risk to our view on the sector would be weaker-than-expected sales volumes and margins. In this regard, we believe the risk for the foreign JV brands is greater than for the local brands, as we have already seen many foreign JV brands cutting prices. While we expect margins to remain under pressure across the sector, we look for 12% YoY growth in sales volume in If the macro environment turns to be weaker than we expect, there is a risk that sales volumes and margins would fall short of our expectations. On the other hand, if sales volume and margins turn out to be higher than we expect, they would constitute the major upside risks to our call. According to our base-case scenario, the government would raise the purchase tax back to the 10% level in However, if the government were to decide to extend the tax cut to boost the auto industry further, in order to stimulate the slowing economy, the increase in sales volume could beat our expectations. Political risk We believe the major political risk to the sector would be the state of Sino-Japanese relations. In 2012, when political tensions between China and Japan were fueled by a dispute over the Diaoyu Islands, sales of Japanese OEMs, such as GAC and DFM, slowed significantly. If the political relationship between China and Japan were to deteriorate again, we think the sales performance of the Japanese brands would be adversely affected while their domestic competitors would benefit. Separately, political instability in other countries could have a bearing on demand for the China brands, especially as most of the local OEMs are exporting to emerging countries, which tend to be less politically stable than developed markets. Currency risk The depreciation of the Renminbi relative to the Yen and Euro would be negative for foreign JV OEMs such as BAIC, Brilliance, GAC and DFM, as it would raise the price of imported components. In 2014, most of the foreign JV OEMs recorded exchange gains due to the weakening of the Yen and Euro against the Chinese currency. However, Daiwa s Chief Economist Kevin Lai expects the Renminbi to depreciate by 14% YoY against the US dollar by the end of 2016, which serves as our base-case scenario. And in this case, we would expect foreign JV OEMs to be negatively affected. However, if the government decides to defend the CNY or if there are any other sudden events that cause the Euro or Yen to weaken vs. the CNY, the JV OEMs would benefit from a strengthening in this currency, which would pose another upside risk to our call. 21

22 China Autos Sector: 4 January 2016 Global automotive OEMs: valuation comparison Name Bloomberg Trading Share price Rating 12-mth Target PER (x) PBR (x) EV/EBITDA(x) Div yield (%) ROE (%) code currency 28-Dec-15 Price FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E China H-share listed Geely Automobile Holdings Lt * 175 HK HKD 4.23 Buy BAIC Motor Corp Ltd-H * 1958 HK HKD 7.77 Buy BYD Co Ltd-H * 1211 HK HKD Outperform Great Wall Motor Company-H * 2333 HK HKD 9.14 Underperform Guangzhou Automobile Group-H * 2238 HK HKD 6.94 Hold Dongfeng Motor Grp Co Ltd-H * 489 HK HKD Outperform Brilliance China Automotive * 1114 HK HKD 9.84 Underperform n.a. n.a China A-share listed BYD Co Ltd -A CH CNY NR NA Guangzhou Automobile Group-A CH CNY NR NA Great Wall Motor Co Ltd-A CH CNY NR NA Saic Motor Corp Ltd-A CH CNY NR NA Chongqing Changan Automobi-B CH HKD NR NA Faw Car Company Limited-A CH CNY NR NA Anhui Jianghuai Auto Co-A CH CNY NR NA Jiangsu Yueda Investment C-A CH CNY NR NA Tianjin Faw Xiali Automobi-A CH CNY 7.53 NR NA n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Lifan Industry Group Co Lt-A CH CNY NR NA n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Haima Automobile Group Co-A CH CNY 6.24 NR NA n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Shenyang Jinbei Automotive-A CH CNY 7.19 NR NA n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. US Ford Motor Co F US USD NR NA General Motors Co GM US USD NR NA Europe Daimler Ag-Registered Shares DAI GR EUR NR NA Bayerische Motoren Werke AG BMW GR EUR NR NA Volkswagen AG VoW GR EUR NR NA n.a. n.a Fiat Chrysler Automobiles NV FCA IM EUR NR NA n.a. n.a. n.a. n.a Peugeot SA UG FP EUR NR NA Renault SA RNO FP EUR NR NA Japan Honda Motor Co Ltd *, ** 7267 JP JPY Hold 4, Nissan Motor Co Ltd *, ** 7201 JP JPY Hold 1, Toyota Motor Corp *, ** 7203 JP JPY Outperform 8, Korea Hyundai Motor Co * KS KRW 151,000 Buy 190, Kia Motors Corp * KS KRW 52,300 Buy 68, India Tata Motors Ltd ** TTMT IN INR NR NA Mahindra & Mahindra Ltd ** MM IN INR NR NA Total Weighted average High Low Median Source: Bloomberg, *Daiwa forecasts Note: **Mar year-end Pricing as at 28 December

23 Geel y Automobil e China Consumer Discretionary 4 January 2016 Geely Automobile (175 HK) Target price: HKD4.90 (from HKD4.90) Share price (28 Dec): HKD4.23 Up/downside: +15.8% 2016 likely to be another good year We forecast a market-beating 20% YoY rise in 2016 sales volume Strong 2016 pipeline should support consistent model launches We forecast a flat gross margin YoY, better than peers; reiterate Buy (1) Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com What's new: Geely remains our top pick in the China Autos sector due to its strong product pipeline for 2016 and the successful upgrade of its brand via solid sales of the B-segment sedan, the GC-9. We believe 2016 will be another strong year, incorporating full-year sales of the new SUV NL-3 and products from the CMA platform by the end of 2016 or early 2017, which we think will further enhance its brand image and competitiveness in the long run. We reiterate our view that Geely will see a long-term rerating in the coming 3 years. What's the impact: For 2016, we expect Geely to experience another strong year, with a 20% YoY increase in new-car sales, to 600K units, due to a ramp-up in sales of the GC-9, NL-3 and the new Emgrand EV. Also, another SUV, NL-4, is slated for launch in mid Overall, we expect 16% of Geely s sales to come from the SUV segment in 2016E. Separately, Geely plans to launch its CMA platform sharing with Volvo by end-2016, which we think will improve its brand acceptance and lower its production costs and R&D expenses. Although we have reservations about the attainability of Geely s target of deriving 90% of its sales from EVs in 2020, we are confident it would become one of the leading NEV brands in China, given its advanced technology vs. local peers as well as the government s support for local brands on NEV development. Finally, we believe Geely will be better placed to deliver regular new-model launches each year going forward. What we recommend: We apply a target PER of 11x to Geely (on our 2016E EPS), a 20% premium to the stock s past-3-year average PER of 9x. We believe this is justified as: 1) its past-3-year average was affected by an abnormal valuation in 2014, when Geely s operations were affected by the restructuring of its sales network, and 2) it now has a more sustainable growth model compared with previous years, in our view. Therefore, we reiterate our Buy (1) rating with a 12-month TP of HKD4.90. The key risk to our view: slower-than-expected improvements in its net margin and sales-volume growth. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change Net profit change Core EPS (FD) change Source: Daiwa forecasts Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Geely Auto (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 8,801 Major shareholder LI Shu Fu (45.0%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 28,350 36,757 42,242 Operating profit (m) 3,223 4,141 4,759 Net profit (m) 2,604 3,366 3,894 Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E EPS are 2-4% above the consensus forecasts, as we are more optimistic on its new-product launches. We expect Geely s car models to see a robust sales performance. In addition, we think Geely s improving brand image in China will support solid revenue growth over our forecast horizon. See important disclosures, including any required research certifications, beginning on page 103

24 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Geely Automobile (175 HK): 4 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook Following on from weak earnings in 2014 due to the restructuring of its dealer network, Geely s bottom line looks set to get back on the right track, in our opinion. Coupled with forecast margin enhancement, we project net profit growth of 82% YoY for Bottom-line growth should also be solid in E, on our forecasts, as we expect it to gain market share from its competitors, backed by its product pipeline and the tax-cut stimulus. Our forecast E net-profit growth of 16-29% is likely to outperform those of its peers. Geely: net-profit forecasts (CNYm) 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, E 2016E 2017E Net profit (LHS) YoY Growth (RHS) Source: Company, Daiwa forecasts 100% 80% 60% 40% 20% 0% (20%) (40%) (60%) Valuation Geely: 1-year-forward PER (x) We apply a target PER of 11x to our 2016E EPS to value Geely, marking a 20% premium to the stock s past-3-yearaverage PER of 9x, which we believe was distorted by the stock s abnormal valuation in We believe our target PER is justified, as we consider Geely to have a more sustainable growth model today. Therefore, we reiterate our Buy (1) rating and 12-month target price of HKD4.90. (PER) PER +1 SD Average PER -1 SD Source: Company, Daiwa forecasts Earnings revisions Our E EPS are 2-4% above consensus, as we are more optimistic on its new-product launches, on the back of its R&D capability, represented by the success of the GC9. In addition, deeper integration with Volvo also means stronger technical support in the future. Geely: Bloomberg consensus EPS forecast revisions (CNY) Source: Bloomberg 2015E 2016E 24

25 Geely Automobile (175 HK): 4 January 2016 Financial summary Key assumptions Year to 31 Dec E 2016E 2017E Sales volume (unit) 416, , , , , , , ,000 Sales volume (YoY %) (24.0) ASP 48,334 49,726 50,939 52,246 52,024 56,706 61,243 65,530 ASP (YoY %) (0.4) Profit and loss (CNYm) Year to 31 Dec E 2016E 2017E Domestic revenue 18,505 18,924 19,305 21,962 17,646 23,014 29,838 34,291 International revenue 1,594 2,041 5,323 6,745 4,092 5,336 6,919 7,951 Other Revenue (0) (0) (0) Total Revenue 20,099 20,965 24,628 28,708 21,738 28,350 36,757 42,242 Other income , ,016 1,247 1,617 1,859 COGS (16,379) (17,145) (20,069) (22,942) (17,776) (23,162) (30,067) (34,554) SG&A (2,386) (2,459) (2,881) (3,474) (3,083) (3,213) (4,166) (4,787) Other op.expenses Operating profit 2,098 2,352 2,723 3,267 1,896 3,223 4,141 4,759 Net-interest inc./(exp.) (192) (167) (195) (40) (24) (47) (24) 14 Assoc/forex/extraord./others (5) (1) Pre-tax profit 1,900 2,183 2,529 3,304 1,943 3,235 4,182 4,837 Tax (351) (467) (479) (624) (494) (599) (774) (895) Min. int./pref. div./others (181) (172) (10) (17) (19) (32) (42) (48) Net profit (reported) 1,368 1,543 2,040 2,663 1,431 2,604 3,366 3,894 Net profit (adjusted) 1,368 1,543 2,040 2,663 1,431 2,604 3,366 3,894 EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT 2,098 2,352 2,723 3,267 1,896 3,223 4,141 4,759 EBITDA 2,603 2,993 3,583 4,345 2,770 4,168 5,239 6,012 Cash flow (CNYm) Year to 31 Dec E 2016E 2017E Profit before tax 1,900 2,183 2,529 3,304 1,943 3,235 4,182 4,837 Depreciation and amortisation , ,097 1,252 Tax paid (214) (281) (711) (610) (497) (599) (774) (895) Change in working capital (701) (1,647) 1,503 (449) (960) (285) (314) (221) Other operational CF items (5) Cash flow from operations 1,983 1,208 4,438 3,562 2,033 3,350 4,220 4,969 Capex (2,072) (2,197) (1,922) (2,022) (2,421) (2,561) (2,611) (2,663) Net (acquisitions)/disposals 122 (788) (232) Other investing CF items Cash flow from investing (1,346) (2,953) (2,071) (865) (1,468) (2,561) (2,611) (2,663) Change in debt (639) 716 (1,460) (930) (274) (200) (700) (700) Net share issues/(repurchases) Dividends paid (148) (170) (170) (264) (320) (174) (316) (409) Other financing CF items (52) (166) (193) (183) 1,766 (113) (92) (59) Cash flow from financing (732) 393 (1,206) (1,366) 1,172 (487) (1,108) (1,168) Forex effect/others Change in cash (95) (1,352) 1,160 1,330 1, ,138 Free cash flow (90) (989) 2,515 1,540 (388) 789 1,609 2,306 Source: FactSet, Daiwa forecasts 25

26 Geely Automobile (175 HK): 4 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment 4,393 3,030 4,189 5,478 7,203 7,505 8,006 9,144 Inventory 987 1,358 1,822 1,784 1,620 2,110 2,739 3,148 Accounts receivable 9,913 12,215 13,476 14,785 16,385 21,369 27,705 31,840 Other current assets Total current assets 15,684 17,006 19,855 22,251 25,303 31,089 38,566 44,254 Fixed assets 5,467 6,796 7,008 6,209 5,861 6,285 6,693 7,084 Goodwill & intangibles 2,823 3,708 4,282 4,392 5,346 6,537 7,642 8,662 Other non-current assets Total assets 23,974 27,597 31,380 33,599 37,280 44,741 53,796 60,959 Short-term debt 1,097 2,532 1, Accounts payable 10,508 12,114 15,183 16,075 17,017 22,173 28,783 33,078 Other current liabilities Total current liabilities 11,778 14,985 16,693 17,237 17,845 22,843 29,306 33,436 Long-term debt 1, ,820 1,820 1, Other non-current liabilities 1,556 1, Total liabilities 14,897 17,447 18,176 17,370 19,814 24,812 30,775 34,404 Share capital Reserves/R.E./others 7,883 9,443 12,734 15,907 17,127 19,557 22,607 26,092 Shareholders' equity 8,022 9,582 12,887 16,068 17,288 19,718 22,768 26,253 Minority interests 1, Total equity & liabilities 23,974 27,597 31,380 33,599 37,280 44,741 53,796 60,959 EV 30,485 31,992 29,001 26,140 25,960 25,430 24,207 22,354 Net debt/(cash) (1,734) 344 (2,285) (4,512) (4,691) (5,194) (6,394) (8,232) BVPS (CNY) Key ratios (%) Year to 31 Dec E 2016E 2017E Sales (YoY) (24.3) EBITDA (YoY) (36.3) Operating profit (YoY) (42.0) Net profit (YoY) (46.3) Core EPS (fully-diluted) (YoY) (2.5) (46.3) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity net cash 3.6 net cash net cash net cash net cash net cash net cash Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. Net dividend payout Free cash flow yield n.a. n.a n.a Source: FactSet, Daiwa forecasts Company profile Listed on the Hong Kong Stock Exchange in 2003, Geely Automobile is engaged principally in the manufacture and trading of automobiles, automobile parts and related automobile components. Focused on the economy car segment, the company currently has 3 self-owned brands, Gleagle, Emgrand and Englon, with an aggregated 2.1% market share in China s passenger car market. However, over the next 2 years, these 3 brands will gradually be consolidated into a single brand under Geely. 26

27 Geely Automobile (175 HK): 4 January 2016 Promising growth outlook With the launch of 4 new models in the pipeline, we forecast Geely to sell 600k units in 2016 Geely: NL-3 SUV New-era growth strategy for Geely New SUV and EV models the next earnings-growth drivers for 2016E Geely s preliminary sales-volume target for 2016 is 600k units, a rise of 20% YoY and in line with our initial projection. In 2016, Geely plans to launch 4 new models, 2 of which are the NL-3 and NL-4 (launch date to be announced in July/August 2016). Sales of Geely s SUVs should then reach close to 100k units for 2016E, or 16% of its target sales, up from the current 12% for The other 2 new models are a new generation of the EC7 sedan, and a cross-suv. Moreover, the launch of the Emgrand EV at end-2015 could help Geely establish a first-mover advantage in the NEV segment, in our view. Geely: Emgrand EV Source: Company Platform sharing could help Geely launch new models every year and hence increase earnings visibility Source: Company Platform-sharing capability to result in more consistent launch schedule From 2016, Geely plans to adopt a platform-sharing practice for its new models, which means several auto models will share the same design blueprint for drivetrains, chassis, axles and suspension systems. The goal is save development time and lower costs, due to standardised designs and economies of scale. Geely aims to focus on 3 platforms for its product line-up: the FE platform, KC platform, and CMA platform. Indeed, several of its current models were developed under the FE platform or KC platform, eg, the Vision and EC7 are under the FE platform, while the GC9 is under the KC platform. As a result, new models should break even comfortably as existing models already cover the cost of the plant operations for the platform. The CMA platform (based on which Volvo models are built) is set to be unveiled in March/April 2016 and put into operation in 2017, according to Geely s management. Additionally, Geely is developing 2 more brand new platforms: the PE platform for smallersize NEVs and the CV platform for commercial vehicles; it aims to launch the first models using both platforms in As such, we expect Geely to have several model launches each year going forward, as opposed to the more scattershot approach of previous years. This implies to us greater earnings visibility in the coming years. Geely: summary of future platforms Platform name Positioning Current models Future pipeline FE Volume market Vision, EC7 (Xindihao) EC7 (2016 ver.), NL-3, NL-4, a cross-suv KC Higher-end GC9 (Borui) no plan in 2016 CMA Premium/Luxury n.a. Start operation in 2017 PE Small size NEV n.a. First model in 2017 CV Commercial vehicle n.a. First model in 2017 Source: Company 27

28 Geely Automobile (175 HK): 4 January 2016 Blue Geely Action Plan a long-term positive NEV strategy A bold move to establish a market-leading position in the NEV segment GC9 is the first among China domestic brands to see meaningful traction in B-segment sedans On 18 November 2015, Geely announced its long-term EV strategy: the Blue Geely Action Plan. With this plan, it aims to derive 90% of total sales from the NEV segment in 2020, 65% of which should be from hybrids and 35% from pure EVs. Such a development would allow Geely to achieve average fuel consumption of 5.0L/100km sooner than the China Ministry of Industry and Information Technology requires it to. To reach this target, the company aims to have NEV versions of all of its models. Although we have reservations about Geely achieving its sales target for NEVs by 2020, we view this strategy to be positive for Geely in the longer term, as it would help Geely to establish itself as one of the first movers and market leaders for NEV among its customers. More details on the recent EV launch and NEV strategy can be found in Blue Geely Action Plan and test drive of Emgrand EV, 20 November Improving R&D another long-term advantage GC9 breakthrough suggests that Geely is at another level Launched in April 2015, the GC9 is Geely s first B-segment sedan model, with a length of 4956mm and price range of CNY130k-230k. In October 2015, just 6 months after its launch, it accounted for more than 10% of Geely s monthly sales volume, or 4,979 units. Traditionally, the B-segment has been dominated by foreign JVs as cars in this segment tend to carry higher prices compared with small cars and consumers generally favour foreign JVs at such price points. Given the GC9 s unit-sales momentum, its market acceptance is similar to that of cars produced by foreign JVs, and we note that similar models offered by its domestic peers have recorded sales of a few hundred units or fewer. These sales numbers suggest to us that Geely s R&D is appreciably better than its peers, which should be positive for Geely s brand recognition. Geely s GC9 peer comparisons Auto OEM Model Length (mm) Price range (CNY k) Launch date Launch date of facelift / new options Avg. sales units per month in 2015 Geely GC Apr-2015 n.a. 3,090 SAIC Motor Roewe Mar-2012 Jul (Facelift) 158 Lifan Mar-2015 n.a. 586 GAC Motor GA Dec-2014 Mar-2015 (New options) 879 Beijing Hyundai Sonata Mar-2015 n.a. 6,540 GAC Honda Accord Sep-2013 Mar-2015 (Facelift) 8,756 GAC Toyota Camry Dec-2011 Mar-2015 (Facelift) 10,727 DF Nissan Teana Dec-2013 Apr-2014 (New options) 9,068 FAW Car Mazda Mazda 6 Atenza May-2014 Aug-2015 (New options) 3,360 SAIC VW Passat Sep-2011 Aug-2015 (New options) 17,349 SAIC GM Buick Regal Sep-2013 Mar-2015 (New options) 9,194 FAW VW Magotan Jul-2011 Apr-2015 (New options) 12,782 Dongfeng Honda Spirior Nov-2014 Oct-2015 (New options) 1,716 Source: Companies, various media Increasing integration with Volvo means quality upgrade 2015E net margin to improve by 2.6pp YoY to 9.2%, and to remain at that level, at least, in future years Ever since Volvo Cars was bought by Geely s parent holding company, Zhejiang Geely, in 2010, Geely s R&D capability has been improving. The GC9 is one example of this trend. On a 3- to 5-year view, by leveraging technology from Volvo Cars, we believe Geely will be able to source components from quality international suppliers and ultimately deliver better products than those of its peers. Currently, 60% of its suppliers are international (vs. 20% 10 years ago). In addition, management s approach to pricing has helped Geely maintain its net and gross margins. Since 2Q15, there have been multiple price cuts by the auto OEMs, including domestic brands and foreign JVs. However, Geely did not participate in these price wars, as management decided instead to protect its margins. In turn, we project Geely s net margin to come in at 9.2%, up by 2.6pp YoY, for For the years thereafter, we expect Geely s ASP to rise steadily, due to the more upmarket offerings in its pipeline. However, the development of new platforms and models may require some upfront costs. Therefore, we conservatively forecast that its net margin through 2017 will hold at the 2015E level. 28

29 Geely Automobile (175 HK): 4 January 2016 Geely has relatively high exposure to smallengine cars Demand from low-tier cities to benefit Geely Other long-term factors Better positioned than its peers to benefit from the tax cut On 30 September, China s State Council announced plans to cut the purchase tax from 10% to 5% for cars with engine sizes smaller than or equal to 1.6L. The policy, which will be effective from 1 October 2015 until 31 December 2016, should help boost Geely s sales volume, as 79% of its cars have engines in this category, compared with a market average of 68%. Demand from low-tier cities The auto penetration rate in China s top-tier cities is already comparable to that in mature market such as Japan, Korea and Taiwan. However, the overall auto penetration rate in China is still lagging behind these markets. Hence, the growth mainly comes from low-tier cities. As such, we believe there are ample growth opportunities in this market, and we believe the domestic players are poised to capture most of the growth due to their relatively low prices and more extensive sales networks. Therefore, well-known domestic players, such as Geely, are likely to outperform the foreign JVs in general, in our view. 29

30 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Geely Automobile (175 HK): 4 January 2016 Valuation and recommendation Current valuation attractive; we expect PER to go up slightly Our top pick in the sector Our E EPS are 2-4% above the consensus forecasts, as we are more optimistic on its new-product launches on the back of its R&D capability. Based on our 2016 EPS forecast and a PER multiple of 11x, we have a 12-month target price for Geely of HKD4.90. The target multiple marks a 20% premium to the stock s past-3-year average PER of 9x. However, we note that its past-3-year average was brought down by an abnormal valuation in 2014, when Geely s operations were affected by the restructuring of its sales network. In addition, we believe Geely now has a more sustainable growth outlook compared with the past. Therefore, we believe our target PER is justified, and we reiterate our Buy (1) rating with a 12-month TP of HKD4.90. Geely: PER bands (x) (PER) Source: Company, Daiwa forecasts PER +1 SD Average PER -1 SD Risk of slower sales if demand is weaker than we expect Risk of weak SUV sales if competition intensifies further Risks Weaker-than-expected sales of new models and declining exports As mentioned, Geely has launched several new models recently (such as the GC-9, and the new Emgrand EV), and soon plans to launch the NL-3 and NL-4. Therefore, the sales performance of these new models could affect market sentiment on the stock. On the other hand, after declining by 50% YoY in 2014, Geely s exports were weak in 2015 YTD. Its exports through November 2015 were down by 55% YoY, due to ongoing sanctions or political instability in its major export markets (Iran, Egypt and Russia). Although exports accounted for only 6% of its total sales through October 2015, if this sluggishness continues it can be expected to weigh on Geely s sales and profits to some extent. Intensifying competition in the SUV segment SUV unit-sales growth in China has been strong due to changing consumer preferences. In a bid to increase market share, many domestic manufacturers (including Geely), as well as foreign JVs, have launched new competitively-priced SUV models. Other strong competitors include GS4 and Landwind, which have driven up the sales of Guangzhou Automobile Motor (GAMC) and Jiangling Motor by 92% and 63% YoY, respectively. We also expect to see additional SUV models coming to the market in 2016, such as the Kadjar by Dongfeng Renault. However, we remain confident in Geely s product quality and believe its new SUV models can snatch market share from peers, similar to what the company did with the GC9 in the sedan market in

31 Geely Automobile (175 HK): 4 January 2016 Geely NL-3/NL-4 possible competitors Auto OEM Model Length (mm) Price range (CNY k) Launch date Launch date of facelift / new options Avg. sales units per month in 2015 Geely NL-3 not disclosed yet not disclosed yet Jan-2016 Geely NL-4 not disclosed yet not disclosed yet 2016 Dongfeng Renault Kadjar 4449 not disclosed yet Mar-2016 GAMC GS Apr-2015 n.a. 13,930 Landwind X Aug-2015 n.a. 4,898 Changan CS Apr-2014 Sep-2015 (new options) 14,551 GWM H Jul-2014 Sep-2015 (new options) 13,042 SAIC GM Wuling Baojun Jul-2015 n.a. 20,185 BAIC Hyundai Tucson Sep-2015 n.a. 10,054 Dongfeng Nissan Venucia T Jan-2015 Sep-2015 (new options) 4,803 Source: Companies, various media 31

32 BAIC Motor China Consumer Discretionary 4 January 2016 BAIC Motor (1958 HK) Target price: HKD9.40 (from HKD9.40) Share price (28 Dec): HKD7.77 Up/downside: +20.9% 2016: a year of recovery Beijing Benz to see strong sales growth in 2016E due to new models Sales volume for Beijing Hyundai continues to recover from a trough Beijing Brand s losses should shrink in 2016; reiterate Buy (1) rating Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com What's new: We see 2016 being a good year for BAIC, with the likelihood of a continuing sales recovery for Beijing Hyundai and another strong year for Beijing Benz. On the other hand, we expect losses at Beijing Brand, the company s self-owned brand, to diminish in 2016 with new SUV models. BAIC remains our top pick among the foreign JV brands. What's the impact: Beijing Hyundai s strong sales recovery looks set to continue in Beijing Hyundai s sales volume turned around in October, rising by 8% YoY compared to 16% YoY and 5% YoY declines for August and September, respectively. The major driver was the launch of the new Tucson SUV in September, as well as better sales of the Elantra Langdong and Sonata due to higher discounts and new models. With a fullyear impact of the new Tucson and also a new Elantra Langdong launching in 1Q16, the JV looks poised for a significant sales improvement in 2016, especially given the relatively low base from which it is recovering. Beijing Benz likely to maintain strong growth in 2016 with a strong pipeline. Beijing Benz s fast sales-volume growth in 2015 looks set to continue in 2016 with 2 new models, namely the GLC SUV and new E- class sedan, which combined should account for half of its sales volume for the year. In addition, luxury brand sales are likely to outgrow that for the broader China PV market due to the government s purchase quota policy in top-tier cities. Also, Beijing Benz is projected to see the strongest growth in 2016 among the luxury brands due to the favourable timing of its product launches. Losses at Beijing Brand poised to contract. With the launch of the company s new X25, X35 and X55 SUVs in 2016, versus only the X65 launch in 2015, we believe Beijing Brand stands a good chance of reducing its losses, as the SUV is still the brand s most profitable model despite its declining gross margin. We forecast the JV s losses to reduce to CNY2.3bn in 2016E from CNY2.5bn in 2015E. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change Net profit change Core EPS (FD) change Source: Daiwa forecasts Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 BAIC Motor (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 2.36 Shares outstanding (m) 7,508 Major shareholder BAIC Group (45.0%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 89, , ,324 Operating profit (m) 6,234 8,478 10,072 Net profit (m) 5,057 6,324 7,221 Core EPS (fully-diluted) EPS change (%) (4.2) Daiwa vs Cons. EPS (%) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) What we recommend: We reiterate our Buy (1) rating and 12-month TP of HKD9.40, still based on a target PER of 9.5x, which is the industry s past-3- year average. The stock is trading currently at a 2016E PER of 7.7x, and we expect it to be rerated back to close to peers average when we see evidence of the sales recovery at Beijing Hyundai extending into The key risk is weaker-than-expected new car sales. How we differ: Our E EPS are 7-12% higher than consensus, as we are more confident of a sales recovery at Beijing Hyundai, as well as a surge in sales for Beijing Benz. See important disclosures, including any required research certifications, beginning on page 103

33 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 BAIC Motor (1958 HK): 4 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We forecast BAIC to post sales growth of 29% YoY for 2016, after a 59% YoY rise for Firstly, we expect Beijing Benz s sales volume growth to continue, projected to be 30% YoY, supported by new models. Secondly, Beijing Hyundai has been on a recovery track after posting rock-bottom sales growth in July In 2016, we forecast a 10.6% YoY increase in sales volume, benefitting from new product launches and better buying sentiment. Thirdly, Beijing Brand looks likely to reduce its losses incurred. Overall, we forecast BAIC s net profit to increase by 14-25% YoY E. BAIC: net profit forecasts (CNYm) 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, E 2016E Net profit (LHS) YoY Growth (RHS) Source: Company, Daiwa forecasts 80% 60% 40% 20% 0% (20%) (40%) Valuation BAIC: 1-year forward PER (x) BAIC stock is trading currently at a 2016E PER of 7.7x, which is well below the industry s past-3-year average PER of 9.5x, and also below the stock s own average PER of 9x since listing in January With a sales volume recovery for Beijing Hyundai and strong growth for Beijing Benz, we expect BAIC to be rerated back to the industry average PER over the next 12 months. (PER) PER +1 SD Average PER -1 SD Source: Company, Daiwa forecasts Earnings revisions BAIC: Bloomberg-consensus EPS forecast revisions Our E EPS are 7-12% higher than consensus, as we are more confident about a sales recovery for Beijing Hyundai, as well as a surge in sales volume for Beijing Benz. We expect the consensus to start revising up its earnings for BAIC when it sees signs that the sales recovery at Beijing Hyundai is sustainable, as well as continuous strong sales-volume growth for Beijing Benz. (CNY) Source: Bloomberg 2015E 2016E 33

34 BAIC Motor (1958 HK): 4 January 2016 Financial summary Key assumptions Year to 31 Dec E 2016E 2017E Volume - Beijing Brand (unit) n.a. 24,000 78, , , , , ,000 Volume - Mercedes Benz (unit) n.a. 93, , , , , , ,000 Volume - Hyundai (unit) n.a. 740, ,000 1,031,000 1,120,000 1,042,000 1,152,000 1,226,000 Volume growth - Beijing Brand (%) n.a. n.a Volume growth - Mercedes Benz (%) n.a. n.a Volume growth - Hyundai (%) n.a. n.a (7.0) Profit and loss (CNYm) Year to 31 Dec E 2016E 2017E Beijing Motor n.a. 1,916 3,520 6,847 12,434 11,340 13,967 15,488 Beijing Benz n.a. n.a. n.a. 5,934 43,937 78, , ,835 Other Revenue n.a. n.a. n.a Total Revenue n.a. 1,916 3,520 12,782 56,370 89, , ,324 Other income n.a ,418 1, ,213 COGS n.a. (1,888) (3,688) (12,367) (47,387) (73,915) (94,228) (107,633) SG&A n.a. (753) (1,536) (3,520) (9,102) (11,110) (13,826) (15,832) Other op.expenses n.a Operating profit n.a. (627) (972) (2,609) 1,299 6,234 8,478 10,072 Net-interest inc./(exp.) n.a. (82) (158) (474) (533) (635) (708) (660) Assoc/forex/extraord./others n.a. 3,297 4,835 6,147 5,932 4,316 4,879 5,030 Pre-tax profit n.a. 2,588 3,704 3,065 6,698 9,915 12,648 14,442 Tax n.a. (21) (226) (114) (857) (1,983) (2,530) (2,888) Min. int./pref. div./others n.a. 32 (61) (237) (1,331) (2,875) (3,794) (4,333) Net profit (reported) n.a. 2,598 3,417 2,714 4,511 5,057 6,324 7,221 Net profit (adjusted) n.a. 2,598 3,417 2,714 4,511 5,057 6,324 7,221 EPS (reported)(cny) n.a EPS (adjusted)(cny) n.a EPS (adjusted fully-diluted)(cny) n.a DPS (CNY) n.a EBIT n.a. (627) (972) (2,609) 1,299 6,234 8,478 10,072 EBITDA n.a. (474) (779) (1,790) 3,663 9,306 12,362 14,812 Cash flow (CNYm) Year to 31 Dec E 2016E 2017E Profit before tax n.a. 2,588 3,704 3,065 6,698 9,915 12,648 14,442 Depreciation and amortisation n.a ,364 3,072 3,885 4,740 Tax paid n.a. (10) (8) (258) (1,365) (1,983) (2,530) (2,888) Change in working capital n.a. (250) ,282 1,642 5,294 3,442 Other operational CF items n.a. (3,498) (4,750) (6,802) (6,717) (3,341) (3,841) (3,992) Cash flow from operations n.a. (1,017) (624) (2,457) 2,262 9,305 15,457 15,743 Capex n.a. (4,258) (5,659) (7,236) (11,785) (13,102) (14,362) (14,501) Net (acquisitions)/disposals n.a. (800) (328) 3,775 (2,691) Other investing CF items n.a. 2, ,394 4,535 4,357 3,237 3,659 Cash flow from investing n.a. (2,449) (5,690) 2,933 (9,941) (8,745) (11,125) (10,841) Change in debt n.a. 2,549 5,998 7,194 7,396 2,000 2,000 (2,000) Net share issues/(repurchases) n.a. 1,500 3,003 6,132 7, Dividends paid n.a. 0 (1,500) (212) (2,273) (2,279) (2,174) (2,719) Other financing CF items n.a. (2,001) (115) 141 (210) (975) (1,038) (1,038) Cash flow from financing n.a. 2,048 7,386 13,254 12,822 (1,253) (1,212) (5,757) Forex effect/others n.a Change in cash n.a. (1,419) 1,072 13,730 5,143 (693) 3,119 (855) Free cash flow n.a. (5,275) (6,283) (9,692) (9,524) (3,797) 1,094 1,243 Source: FactSet, Daiwa forecasts 34

35 BAIC Motor (1958 HK): 4 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment n.a. 1,818 2,891 16,790 21,923 21,230 24,349 23,494 Inventory n.a ,479 11,068 17,264 22,009 25,140 Accounts receivable n.a ,004 6,422 13,424 17,334 19,849 Other current assets n.a. 2,047 4,841 3,490 4,905 5,510 5,986 6,292 Total current assets n.a. 4,461 9,094 33,763 44,319 57,428 69,678 74,775 Fixed assets n.a. 2,899 7,151 24,755 34,218 44,251 54,759 64,577 Goodwill & intangibles n.a. 4,076 5,025 11,012 13,598 13,596 13,566 13,508 Other non-current assets n.a. 10,365 10,513 15,866 17,723 17,682 19,325 20,695 Total assets n.a. 21,801 31,782 85, , , , ,555 Short-term debt n.a. 3,851 4,008 9,273 18,574 20,025 21,136 21,869 Accounts payable n.a ,493 11,112 14,978 21,435 27,326 31,214 Other current liabilities n.a. 3,354 1,787 16,535 17,948 25,484 32,909 37,682 Total current liabilities n.a. 7,677 7,288 36,920 51,500 66,945 81,371 90,764 Long-term debt n.a. 2,533 8,069 15,122 13,935 15,935 17,935 15,935 Other non-current liabilities n.a ,300 2,455 2,455 2,455 2,455 Total liabilities n.a. 10,501 15,770 54,342 67,890 85, , ,155 Share capital n.a. 5,000 5,462 6,382 7,508 7,508 7,508 7,508 Reserves/R.E./others n.a. 5,859 10,336 17,310 25,847 28,625 32,775 37,276 Shareholders' equity n.a. 10,859 15,798 23,692 33,355 36,133 40,283 44,784 Minority interests n.a ,362 8,614 11,489 15,284 19,616 Total equity & liabilities n.a. 21,801 31,782 85, , , , ,555 EV n.a. 44,101 47,775 51,150 53,965 61,026 63,170 65,720 Net debt/(cash) n.a. 4,566 9,185 7,606 10,586 14,730 14,722 14,310 BVPS (CNY) n.a Key ratios (%) Year to 31 Dec E 2016E 2017E Sales (YoY) n.a. n.a EBITDA (YoY) n.a. n.a. n.a. n.a. n.a Operating profit (YoY) n.a. n.a. n.a. n.a. n.a Net profit (YoY) n.a. n.a (20.6) Core EPS (fully-diluted) (YoY) n.a. n.a (29.2) 45.3 (4.2) Gross-profit margin n.a. 1.4 n.a EBITDA margin n.a. n.a. n.a. n.a Operating-profit margin n.a. n.a. n.a. n.a Net profit margin n.a ROAE n.a ROAA n.a ROCE n.a. n.a. n.a. n.a ROIC n.a. (3.9) (4.4) (7.9) Net debt to equity n.a Effective tax rate n.a Accounts receivable (days) n.a Current ratio (x) n.a Net interest cover (x) n.a. n.a. n.a. n.a Net dividend payout n.a Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a Source: FactSet, Daiwa forecasts Company profile BAIC Motor is the second-largest Hong Kong-listed passenger vehicle manufacturer by volume. The company's manufacturing business operates under 3 brands: self-owned Beijing Motor, 51%- owned Beijing Benz, and 50%-owned JV Beijing Hyundai. BAIC has a diverse product portfolio, including economy and premium cars, small CUVs and sedans, and large SUVs and MPVs. 35

36 BAIC Motor (1958 HK): 4 January unit sales growth poised to accelerate Luxury brands are outperforming the China PV market, with Beijing Benz enjoying the fastest sales growth among them Beijing Benz likely to continue to shine in 2016 Sales growth YTD in 2015 is unrivalled in the luxury segment Year-to-date to November 2015, Beijing Benz s sales had increased by 93% YoY, chiefly because of new model launches last year, namely the C-class sedan and GLA SUV, both of which were available for sale in August This is in contrast to other luxury brands, such as BMW and Audi, which had relatively unattractive pipelines during the period. Another reason was the increase in demand for luxury brands in China on the back of the government s purchase quota scheme, whereby buyers have to bid for the limited number of licences available. In our view, those who could afford it would favour a luxury car because they can only obtain a quota by bidding, and if they can buy only one car, they would likely prefer a luxury car. Luxury brands outgrowing overall market in China PV Beijing Benz: outperforming other luxury brands YTD 2015 (Sales Unit) (YoY %) (YoY %) (YoY %) 120,000 60% 170% 170% 100,000 80,000 40% 120% 120% 60,000 20% 70% 70% 40,000 20,000 0% 20% 20% 0 (20%) -30% -30% Luxury brands monthly sales (LHS) China overall PV YoY (RHS) Luxury brands YoY (RHS) Source: CAM Note: Luxury brands include Benz, BMW, VW Audi, Buick Cadillac, Volvo and Infiniti Source: CAM Beijing Benz BMW Brilliance FAW VW Audi Beijing Benz should maintain fast sales growth in 2016 due to its strong pipeline 2016 new model launches to boost sales further Beijing Benz s product offering remains strong for Two models, namely the GLC SUV and E-class sedan, look likely to become the new sales drivers. The GLC was already launched in late November 2015, and is expected to replace the current GLK SUV, which was launched in Meanwhile, the E-class sedan is expected to be available in early 2016, and features a newer design to the existing E-class, which was launched in 2010 and facelifted in Moreover, domestic luxury brand peers Brilliance BMW and FAW VW Audi are not planning to launch any new generation models of a similar type in 2016, so Beijing Benz should enjoy another year of strong sales growth in Beijing Benz GLC peer comparison mid size luxury SUV Auto OEM Model Length (mm) Price range (CNY 000) Current/Past model launch date New model launch date Beijing Benz GLC Oct-2012 (GLK) Nov-2015 BMW (Import) X Mar-2011 (Launch); Jun-2014 (Facelift) (TBC) FAW VW Audi Q Apr-2010 (Launch); Apr-2013 (Facelift) N/A Source: Companies, various media Beijing Benz E-class peer comparison full size luxury sedan Auto OEM Model Length (mm) Price range (CNY 000) Current/Past model launch date New model launch date Beijing Benz E-class Jun-2010 (Launch); Aug-2013 (Facelift) Early-2016 Brilliance BMW 5-Series Aug-2010 (Launch); Sep-2013 (Facelift) 2017 FAW VW Audi A Mar (TBC, Facelift) Source: Companies, various media 36

37 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 BAIC Motor (1958 HK): 4 January 2016 New model launch and discounts helped Beijing Hyundai s sales volumes to recover in 2H15 Beijing Hyundai to recover in 2016 Coming back after the trough in 2015 Beijing Hyundai s sales volumes have been the weakest in 2015 than they have been for 3 years. In the year to October, its sales volume had declined by 9% YoY, versus 9-20% YoY growth over the past 3 years. In particular, July 2015 seems to mark the trough, when Beijing Hyundai posted a 32% YoY decline in sales volumes. The main reason was the overall sluggish sentiment in the market, coupled with the company s lack of new models in the mass market in 1H15. However, after July, its sales started to pick up again, driven by its new generation Tucson SUV, more discounts being offered and a recovery in China s broad PV market. Beijing Hyundai: sales volumes (Sales Unit) (YoY %) 30% 120,000 20% 100,000 10% 80,000 0% 60,000-10% 40,000-20% 20,000-30% 0-40% Beijing Hyundai: sales portfolio (Sales mix %) 100% 80% 60% 40% 20% 0% 100% 80% 60% 40% 20% 0% Source: CAM Beijing Hyundai sales (LHS) Overall China PV YoY (RHS) Beijing Hyundai YoY (RHS) Verna Elantra Langdong Elantra - Old gens Sonata Other Sedans Tucson Other SUVs Source: CAM New model launches should help Beijing Hyundai s sales bottom out in 2H15 Should outperform the market in 2016 Historically, Beijing Hyundai s sales trend is closely correlated with China s overall PV market, mainly because Beijing Hyundai s product offering has a similar composition to that of the overall market. Examples include its SUV mix and small-engine car mix. With China s overall PV market set to recover in 2016 on the back of the purchase tax cut (see the sector report for a detailed discussion) to 12% YoY according to our forecasts, we expect better buying sentiment overall in the market which would benefit Beijing Hyundai. Also, Beijing Hyundai s new models, including the full-year impact of the Tucson SUV and launch of the Elantra Langdong in 1Q16, which is the latest generation of the Elantra sedan, would provide an incremental source of support for sales growth. Therefore, with the low base in 2015, we forecast Beijing Hyundai s sales growth to reach 10.6% YoY for 2016, higher than the market average of 12% YoY. Beijing Hyundai: close resemblance to the China PV market China PV market Beijing Hyundai Honda Toyota Volkswagen SUV mix 29.0% 26.4% 42.0% 20.7% 13.4% Executive/Luxury model mix 5.8% 6.9% (Sonata) 1.4% (Crosstour) 2.4% (Crown and Land Cruiser) 14.8% (Audi) Small-engine car mix 67.7% 66.5% 19.4% 57.9% 67.6% Source: CAM Note: as of YTD-2015 Beijing Hyundai: new models Model Segment Launch date Tucson SUV Sep-2015 Elantra Langdong Compact Sedan 2016 (Mar) Equus Full size Sedan 2H15 (Dec) Sonata PHEV ver. Plug-in Hybrid Sedan 2016 Source: Company, various media 37

38 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 BAIC Motor (1958 HK): 4 January 2016 New sedan models have been unable to help Beijing Brand in 2015 Beijing Brand should see losses recede in 2016 Sluggish sales in 2015 In 2015, despite Beijing Brand, the self-owned brand of BAIC, launching several new models, sales have been relatively soft, with YTD-November growth of just 3.1% YoY. The main reason was that the new models have been mostly sedans, namely the Senova CC and Senova D80, which failed to provide growth momentum as the sedan segment itself is weak. Thus, sales volume for Beijing Brand s sedan segment has fallen by 23.2% YoY YTD. On the other hand, new models in the SUV segment, namely the Senova X65, have been selling well, giving rise to a 265% increase in sales volume for Beijing Brand s SUV segment in the year to November In addition, the Wevan M20, which is priced as low as CNY33-59,000, has also been a hit, posting YTD growth of 77% YoY. However, according to BAIC s management, Beijing Brand will still incur losses for the company in 2015, with no reduction in the magnitude of losses, due to higher promotional expenses and downward trending ASPs. As such, we forecast Beijing Brand to post a net loss of CNY2.5bn for Beijing Brand: sales volumes (Sales Unit) 40,000 30,000 20,000 (YoY %) 60% 20% Beijing Brand: sales portfolio (Sales mix %) 100% 80% 60% (Sales mix %) 100% 80% 60% 10,000-20% 40% 40% 0-60% 20% 20% 0% 0% Beijing Brand monthly sales (LHS) China overall PV YoY (RHS) Beijing Brand YoY (RHS) Sedan SUV MPV Crossover NEV Source: CAM Source: Company We expect SUV models to help Beijing Brand reduce its losses in 2016 SUV models to improve profitability in 2016E However, in 2016, we believe Beijing Brand should return to better growth, with the help of more new launches in the SUV segment including the X25, X35 and X65. This should offset the weak profitability of its sedan models. Moreover, Beijing Brand s NEV is also projected to maintain high growth. However, the loss from Beijing Brand is likely to continue, as the management revealed that the breakeven sales unit should be around 600k units annually. Given that we are now projecting a 33.9% YoY growth in 2016, or total sales of 420k units, Beijing Brand is still far from breakeven. As such, we estimate a loss of CNY2.3bn in 2016E. Beijing Brand new models Model Segment Launch date Senova X65 Mid-size SUV (4654mm) Mar-2015 Senova X25 Small SUV (4110mm) Nov-2015 Senova X55 Compact SUV (4405mm) Dec-2015 Senova X35 Small SUV Mar-2016 BJ40 5-door ver. Compact/Mid SUV 2H-2016 BJ80 Mid-size SUV (4765mm) 2H-2016 Source: Company, various media 38

39 BAIC Motor (1958 HK): 4 January 2016 Valuation and recommendation PER valuation should at least catch up with peers average, as we project higher-than-peer EPS growth Valuation looks undemanding We reiterate our Buy (1) rating on BAIC and 12-month TP of HKD9.40, based on a target PER of 9.5x, which is the industry s past-3-year average. The stock is trading currently at a 2016E PER of just 7.7x, which we consider to be undemanding given our expectation of a sales recovery at Beijing Hyundai, continuous strong sales growth from Beijing Benz, and a loss reduction at Beijing Brand. Our E EPS are 7-12% higher than the Bloomberg consensus, as we expect more upward earnings revisions in the next 6 months to boost sentiment toward the stock. We believe BAIC should trade at least on a par with the industry s past 3-year average. BAIC: PER bands (PER) Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 PER +1 SD Average PER -1 SD Source: Company, Daiwa forecasts Less exposure to small engine cars may limit the growth of Beijing Benz Risks Stimulus policy not fully benefitting Beijing Benz The tax reduction stimulus policy announced by the State Council in late-september is only applicable to PVs with engine sizes smaller than or equal to 1.6L. However, only 19% of Beijing Benz s sales are derived from this sub-segment, versus the industry average of 67.7%. Therefore, the additional demand induced by this policy may not benefit Beijing Benz as much as its peers, which could lead to downside risk to our forecasts if more-thanexpected buyers care about the 5% tax reduction and choose smaller-sized engine cars than those Benz makes. Beijing Benz: YTD 2015 sales by engine size C-class engine size <=1.6L 27.8% engine size >1.6L 72.2% E-class engine size <=1.6L 0.0% engine size >1.6L 100.0% GLA engine size <=1.6L 63.9% engine size >1.6L 36.1% GLK engine size <=1.6L 0.0% engine size >1.6L 100.0% Beijing Benz total engine size <=1.6L 19.1% engine size >1.6L 80.9% Source: CAM Note: Only 2L and 3L engine size model available for E-class and GLK; same for the upcoming GLC Loss reduction from Beijing Brand remains a question mark Loss reduction at Beijing Brand not certain The losses incurred by Beijing Brand, the proprietary brand of BAIC, have dragged down BAIC s earnings in recent years. In 2014, this segment lost CNY2.4bn. For 2015, management initially targeted the loss to narrow by CNY800m (to around CNY1.6bn). However, the loss now is more likely to be in the region of CNY2.5bn, based on our projections. For 2016, even though we project an increase in sales volume, which we forecast will lead to a scaling up of production and therefore a lower loss of CNY2.3bn, we still see a risk that margin erosion will impact its operation. Such erosion will come about 39

40 BAIC Motor (1958 HK): 4 January 2016 because Beijing Brand plans to launch 3 new models in the SUV segment, where competition is keen and many OEMs have been cutting prices to secure sales. If Beijing Brand has to follow this trend to achieve sales growth, its margins would be hampered and the much-needed reduction in losses may not materialise. 40

41 BYD Hong Kong Consumer Discretionary 4 January 2016 BYD (1211 HK) Target price: HKD47.00 (from HKD56.00) Share price (28 Dec): HKD42.40 Up/downside: +10.8% Beneficiary of accelerating investment in NEVs China likely to accelerate NEV investment in 13 th FYP ( ) BYD would be a beneficiary of policy support But competition from other OEMs set to rise long term; Outperform (2) Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com What's new: We believe the China Government will accelerate its investment in charging facilities nationwide over the next 5 years from 2016, in order to increase the popularity of new energy vehicles (NEVs) in China. However, in the long term, we see more local OEMs entering the NEV market, which would intensify competition in this segment. What's the impact: In our view, the policy guidelines announced by the government on 17 November regarding the development of charging facilities for NEVs in China from 2015 to 2020 set out a detailed target and methodology to improve the current bottleneck of charging facilities in the country. If implemented, the guidelines would be positive for BYD s new-car sales over the next 3 years. However, at the same time, we expect more local OEMs to produce pure electric vehicles (PEVs) in order to lower the blended fuel consumption for their brands to meet government standards by 2020 requiring a 34% improvement in fuel consumption as compared to We are revising up our E revenue after the acceleration in sales volume growth we saw for BYD s NEVs year-to-date to October. However, we are cutting our E EPS by 1-16% as a result of revising down our EBIT margin forecasts for the automobile business from 5-7% to 5-6%, and for the handset business from 6.5% to 5-6% due to increasing competition from NEVs and weakening demand for handsets. As such, we lower our SOTP-based 12-month target price to HKD47 from HKD56. What we recommend: We reiterate our Outperform (2) rating on BYD as we believe the company would benefit from increasing investment in charging facilities. However, we see competition in the NEV segment intensifying as more local OEMs start producing PEVs over the next 5 years. The key risks are weaker-than-expected sales due to more fierce competition and slower-than-expected development of charging facilities. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change Net profit change (1.3) (15.8) (11.7) Core EPS (FD) change (1.3) (15.8) (11.7) Source: Daiwa forecasts Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 BYD (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 2,737 Major shareholder Mr. Wang Chuan-fu (23.1%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 84, , ,240 Operating profit (m) 3,231 4,069 5,500 Net profit (m) 1,327 2,512 3,674 Core EPS (fully-diluted) EPS change (%) n.a Daiwa vs Cons. EPS (%) (36.6) (4.7) 8.3 PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our 2015E EPS is 37% lower than the Bloombergconsensus forecast as we exclude the one-off disposal gain. Our 2016E EPS is 5% lower than consensus, while our 2017E EPS is 8% higher, as we are more optimistic about BYD s NEV sales in 2017 once the charging infrastructure has been improved. See important disclosures, including any required research certifications, beginning on page 103

42 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 BYD (1211 HK): 4 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We look for continued strong EPS growth of 46-76% YoY in , due to the favourable outlook for NEV shipments and low base for BYD s production. We forecast the company s NEV sales volume to rise by 80% YoY in 2016, which is in line with our expectation for market growth for the year. However, we only forecast a 21% YoY increase in BYD s new NEV sales in 2017, lower than market growth of 50% YoY, due to more model launches by competitors. BYD: adj. net profit and growth ( E) (CNYm) 4,000 3,500 3,000 2,500 2,000 1,500 1, E 2015E 2016E 2017E Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts 1600% 1400% 1200% 1000% 800% 600% 400% 200% 0% (200%) Valuation BYD: SOTP valuation We stick with our SOTP valuation methodology for BYD by virtue of its diversified businesses. We apply a 2016E PBR of 1.0x (unchanged) for its rechargeable batteries business, and a new PER of 8.0x (previous 10.0x) for mobile handsets, 6.0x (previous 8.0x) for conventional autos, and 30.0x (unchanged) for its NEV business. We lower the PER for the mobile handset and conventional autos businesses to maintain a discount of 20% among domestic peers due to its weaker brand. (CNYm) Valuation Multiple (x) NAV 16E Rechargeable batteries PBR 1.0x 11,967 Mobile handsets PER 8.0x 11,460 Autos conventional PER 6.0x 4,556 Autos NEVs PER 30.0x 91,579 Sub-total 119,562 - Net debt/cash (6,813) - Minority interest (4,302) Equity value (CNYm) 108,447 Exchange rate, 1HKD = x CNY 0.85 Equity value (HKDm) 127,585 Equity value/share (HKD) Source: Daiwa forecasts Earnings revisions The Bloomberg-consensus forecasts remained quite stable until late September 2015, when forecasts started to be revised up due we believe to the purchasing tax cut which benefits BYD s conventional autos business. With China s government looking like it will speed up construction of NEV infrastructure, we see further upside to 2017 consensus forecasts. BYD: consensus E EPS revisions (CNY) Source: Bloomberg 2015E 2016E 42

43 BYD (1211 HK): 4 January 2016 Financial summary Key assumptions Year to 31 Dec E 2016E 2017E BYD NEV volume (units) n.a. n.a. 3,344 3,142 20,859 68, , ,703 Volume growth - NEV (%) n.a. n.a. n.a. (6.0) Battery shipment (%) n.a (0.8) Handset shipment (%) n.a. (4.8) (12.3) Profit and loss (CNYm) Year to 31 Dec E 2016E 2017E Rechargeable Battery n.a. 4,620 4,675 5,018 4,980 5,030 5,030 5,080 Mobile handset n.a. 19,557 17,155 19,459 24,116 26,528 28,650 30,369 Other Revenue n.a. 22,136 22,551 25,291 26,270 53,282 76,241 88,790 Total Revenue n.a. 46,312 44,381 49,768 55,366 84, , ,240 Other income n.a ,378 1,785 2,017 COGS n.a. (39,445) (39,255) (43,252) (47,743) (73,041) (94,751) (106,193) SG&A n.a. (5,299) (4,717) (5,364) (6,694) (9,945) (12,886) (14,564) Other op.expenses n.a Operating profit n.a. 2,414 1,127 1,803 1,879 3,231 4,069 5,500 Net-interest inc./(exp.) n.a. (687) (812) (947) (1,292) (1,192) (764) (789) Assoc/forex/extraord./others n.a. 1 (25) (24) 287 1, Pre-tax profit n.a. 1, ,689 3,305 4,711 Tax n.a. (132) (78) (56) (134) (516) (463) (659) Min. int./pref. div./others n.a. (210) (132) (223) (306) (443) (331) (377) Net profit (reported) n.a. 1, ,730 2,512 3,674 Net profit (adjusted) n.a. 1, ,327 2,512 3,674 EPS (reported)(cny) n.a EPS (adjusted)(cny) n.a EPS (adjusted fully-diluted)(cny) n.a DPS (CNY) n.a EBIT n.a. 2,414 1,127 1,803 1,879 3,231 4,069 5,500 EBITDA n.a. 5,091 4,383 5,336 6,092 8,049 9,554 11,639 Cash flow (CNYm) Year to 31 Dec E 2016E 2017E Profit before tax n.a. 1, ,689 3,305 4,711 Depreciation and amortisation n.a. 2,678 3,256 3,533 4,212 4,817 5,485 6,139 Tax paid n.a. (344) (299) (246) (192) (516) (463) (659) Change in working capital n.a. 1,179 1,132 (2,913) (6,106) 5,724 1, Other operational CF items n.a ,175 1,230 1,251 (360) 1,386 1,482 Cash flow from operations n.a. 5,985 5,555 2, ,354 11,002 12,121 Capex n.a. (8,942) (7,150) (5,764) (8,578) (8,767) (9,099) (9,449) Net (acquisitions)/disposals n.a. (280) 2, Other investing CF items n.a. 299 (32) (168) Cash flow from investing n.a. (8,923) (4,610) (5,851) (7,901) (8,192) (9,099) (9,449) Change in debt n.a. 3,733 (3,085) 3,232 5,314 2,327 2,327 2,327 Net share issues/(repurchases) n.a. 1, ,342 15, Dividends paid n.a (124) Other financing CF items n.a. (366) 1,868 1,276 (1,262) (1,290) (1,386) (1,482) Cash flow from financing n.a. 4,736 (1,217) 4,508 7,271 16, Forex effect/others n.a Change in cash n.a. 1,798 (271) 1,093 (592) 21,199 2,843 3,518 Free cash flow n.a. (2,958) (1,595) (3,328) (8,540) 4,587 1,902 2,673 Source: FactSet, Daiwa forecasts 43

44 BYD (1211 HK): 4 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment n.a. 3,737 3,487 4,511 3,950 25,149 27,993 31,511 Inventory n.a. 6,596 7,345 8,221 9,978 14,608 18,950 21,239 Accounts receivable n.a. 9,782 9,937 13,135 22,435 25,452 32,976 37,272 Other current assets n.a. 2,665 2,555 4,099 4,471 6,027 7,351 8,107 Total current assets n.a. 22,780 23,324 29,966 40,834 71,236 87,270 98,128 Fixed assets n.a. 30,723 33,659 34,147 36,379 39,935 42,217 44,331 Goodwill & intangibles n.a. 6,689 7,983 9,623 10,821 12,290 13,622 14,817 Other non-current assets n.a. 6,689 5,042 4,279 5,974 5,974 5,974 5,974 Total assets n.a. 66,881 70,008 78,015 94, , , ,251 Short-term debt n.a. 11,342 11,288 16,172 19,173 19,173 19,173 19,173 Accounts payable n.a. 17,236 19,933 22,293 25,851 36,521 47,376 53,097 Other current liabilities n.a. 6,050 6,008 4,879 7,998 12,256 15,880 17,948 Total current liabilities n.a. 34,628 37,228 43,344 53,022 67,950 82,428 90,218 Long-term debt n.a. 7,079 7,341 8,652 10,979 13,306 15,633 17,960 Other non-current liabilities n.a. 1,194 1,294 1,162 1,113 1,113 1,113 1,113 Total liabilities n.a. 42,901 45,863 53,158 65,114 82,369 99, ,291 Share capital n.a. 2,354 2,354 2,354 2,476 2,737 2,737 2,737 Reserves/R.E./others n.a. 18,770 18,843 19,356 22,890 40,358 42,870 46,544 Shareholders' equity n.a. 21,125 21,197 21,710 25,366 43,095 45,607 49,281 Minority interests n.a. 2,856 2,947 3,147 3,529 3,972 4,302 4,679 Total equity & liabilities n.a. 66,881 70,008 78,015 94, , , ,251 EV n.a. 113, , , , , , ,866 Net debt/(cash) n.a. 14,684 15,143 20,313 26,202 7,329 6,813 5,622 BVPS (CNY) n.a Key ratios (%) Year to 31 Dec E 2016E 2017E Sales (YoY) n.a. n.a. (4.2) EBITDA (YoY) n.a. n.a. (13.9) Operating profit (YoY) n.a. n.a. (53.3) Net profit (YoY) n.a. n.a. (94.1) (84.5) 1, Core EPS (fully-diluted) (YoY) n.a. n.a. (94.2) (84.9) 1, Gross-profit margin n.a EBITDA margin n.a Operating-profit margin n.a Net profit margin n.a ROAE n.a ROAA n.a ROCE n.a ROIC n.a Net debt to equity n.a Effective tax rate n.a Accounts receivable (days) n.a Current ratio (x) n.a Net interest cover (x) n.a Net dividend payout n.a Free cash flow yield n.a. n.a. n.a. n.a. n.a Source: FactSet, Daiwa forecasts Company profile Listed in Hong Kong in 2002, BYD is engaged in the R&D, manufacture and distribution of automobiles, rechargeable batteries and mobile phone components. It owns 65% of BYD Electronics (285 HK, Not rated). BYD focuses on autos (especially NEVs), rechargeable batteries (lithium-ion and nickel batteries used in mobile phones and other portable electronic devices), as well as mobile-phone components and its assembly mobile phones business (casings, keypads, mobile-phone designs, etc.). 44

45 BYD (1211 HK): 4 January 2016 Benefits from accelerating investment in NEVs Government to speed up NEV infrastructure investment Benefits from replacement demand from public transport More policy support More charging facilities to be built According to the NDRC, by the end of 2014, there were only 780 charging stations, providing 31,000 charging poles, to serve more than 120,000 EVs owned in China. The ratio of EVs to charging poles is far below the targeted 1:1 level. Therefore, the government recently announced guidelines to develop charging facilities for NEVs in , targeting to build up to 4.8m charging poles and 120,000 charging stations to cater to the expected 5m NEVs in China by Hence, we believe the problem of inadequate charging poles, which is the biggest obstacle for potential EV buyers, would be mostly solved by A more favourable operating environment for NEVs would benefit BYD, which is the leading NEV player focusing on plug-in hybrid electric vehicles (PHEVs). Apart from improving the charging facilities, other supportive measures such as lifting the licence restriction on NEVs, and requiring property developers to reserve spaces to build charging poles in the future, are also included in the document. Also, on 29 September, the government announced a policy requiring that aged public transport vehicles that do not meet emissions standards be replaced by NEVs by Such a policy should help boost the sales volume of BYD s PEV bus, the K9. As such, we look for the sales volume for K9 buses to increase by 30-50% YoY in Chinese government s latest supportive measures to promote NEVs Policies Licence & traffic restrictions Charging stations Source: CAAM Auto stimulus policy details Details Lift purchase restrictions and traffic controls for NEVs but retain curbs on conventional internal combustion engine (ICE) vehicles New residential complexes must be built with chargers or reserved spaces for future installations At least 10% of public parking facilities should be built with chargers or spaces reserved for future installations Every 2,000 EVs owned should be matched by 1 public charging station In Beijing, 18% of parking space at all new residential complexes should be built for EVs To build a nationwide charging network for up to 5m EVs by 2020 Subject Policy details Cars with engine sizes of <=1.6L Purchase tax reduced from 10% to 5% New energy vehicles New car sales restriction removed in all cities Old cars with excessive pollutant emissions To be replaced by NEVs by 2017, especially for public transport Source: PRC State Council We believe lower subsidies from 2017 and a reduction in the purchase tax at end-2016 will lead to buyers bringing forward their purchases to 2016 Policy effect may bring sales forward to 2016 According to a notice issued by the Ministry of Industry and Information Technology (MIIT) in April 2015 regarding subsidies on NEVs, the Chinese Government plans to gradually reduce subsidies for buyers from , except for those on fuel-cell vehicles (FCVs). The government plans to cut subsidies for by 20% from the 2016 level, and by 40% for from the 2016 level, except for those on FCVs. We believe the cuts in subsidies due to kick in by 2017 may urge more buyers to bring forward their purchases to 2016, which would benefit BYD in the near term. Also, at the moment, the purchase tax reduction is valid until the end of 2016, which could urge buyers to purchase BYD s conventional cars in In the year to November, about 60% of BYD s sales comprised models with an engine size of below 1.6L, which would benefit from the purchase tax cut. 45

46 BYD (1211 HK): 4 January 2016 China: subsidies on NEPVs in 2016 Pure electric driving range, R Subsidies (CNY/vehicle) 100 R < R < 250 R 250 R 50 Pure EV 25,000 45,000 55,000 / Plug-in hybrid electric vehicle / / / 30,000 Source: NDRC China: subsidies on FCVs in 2016 Vehicle types Subsidies (CNY/vehicle) Fuel-cell PV 200,000 Fuel-cell light CV 300,000 Fuel-cell mid-large CV 500,000 Source: NDRC BYD: YTD-November sales by engine size Engine size % <1.6L 61% >1.6L 24% EV 15% Source: CAM, Daiwa forecasts Diversified product portfolio should help BYD see broad-based growth Strong product pipeline support for 2016 New products to contribute sales Since May 2015, BYD has launched 4 new NEV models (including facelifts) in total. The company currently owns a diversified NEV portfolio making up sedans, SUVs, MPVs and even coaches with different powertrains, such as EVs and PHEVs. We believe such a diversified product range proves the company s technological know-how in NEV manufacturing, and stands it in good stead to benefit from the growth of NEVs in different segments. BYD: comparison of select NEV models Model Segment Powertrain Pure electric range (km) Battery (kwh) Fuel consumption (L/ 100km) List price ('000 CNY) Launch date F3DM Sedan PHEV Dec-2008 K9 Coach EV N.A. N.A. Sep-2010 Qin Sedan PHEV Dec-2013 Denza Sedan EV N.A. 369 Nov-2014 e6 (facelift) MPV EV N.A May-2015 Tang SUV PHEV Jun-2015 e5 (Surui EV) Sedan EV N.A. N.A. Sep-2015 Song SUV PHEV Aug-2015 Shang MPV PHEV N.A. Nov-2015 Source: Company, MIIT, Baidu Note: list prices exclude subsidies from the government Well-positioned in the SUV segment For 2016, we expect BYD to launch 2 more NEV models, including the Qin EV and PHEV SUV Yuan. The Yuan model is likely to be better received by customers as it belongs to the popular SUV segment, and offers a new choice of mini SUV. As a reference, unit sales of the newly launched Song SUV (August 2015) reached 2.3k in just 3 months after launch, while sales of the Tang SUV remained at 3k for 2 consecutive months since its launch in June. Hence, we assume monthly unit sales of the Yuan SUV will reach 2,000 in 2016, and further ramp up to 2,800/month in BYD: NEV product pipeline in 2016 or later Model Segment Powertrain Pure electric range (km) Battery (kwh) Fuel consumption (L/ 100km) Listed price ('000 CNY) Launch date Yuan SUV PHEV 70 TBC TBC Est. <300k 1H2016 Qin EV Sedan EV N.A. N.A Source: company, MIIT, Baidu 46

47 BYD (1211 HK): 4 January 2016 BYD: Song SUV BYD: Yuan SUV Source: company BYD: Shang MPV Source: PCAuto BYD: Qin EV sedan Source: PCAuto Other vehicles to support longer-term sales-volume and earnings growth BYD: T3 logistics electric vehicle Source: AutoSohu Non-PV segment to contribute in the long run According the company s 7+4 planning, BYD targets 7 markets including PVs, public buses, inter-city transportation, taxis, sanitation vehicles, logistics trucks and construction vehicles, and 4 markets for special-duty vehicles, including warehouses, airports, mines and ports. Apart from PVs, the Chinese Government will likely continue to promote the usage of EVs in different areas, especially electric buses, taxis, and sanitation and logistics vehicles through supportive policies such as promoting bulk purchases by different government offices. BYD has showcased several products in these segments at various events (eg, several auto shows, Victory Day Parade); hence, we believe the company is one of the major policy winners in this aspect. BYD: T8 sanitation electric vehicle cleaning Tiananmen Square before the 2015 China Victory Day Parade Source: AutoSina Source: Company 47

48 BYD (1211 HK): 4 January 2016 More challenges in the long run Challenges from competitors As the China Government plans to increase the fuel efficiency requirement for OEMs by 34% by 2020 as compared to 2015, many OEMs are likely to launch NEVs into the market over the next 5 years. In the coming 5-year plan, NEVs are the major focus for many OEMs. For example, Geely targets NEV sales to reach 90% of its total new-car sales with more than 1m new-car sales by Even though BYD has a technology advantage over other local OEMs, especially in terms of its capability to produce its own batteries, we expect competition in the NEV segment to heat up over the next 5 years. NEV strategic plans of some major China auto OEMs Company Plans Geely NEV sales targeted to reach 90% of total sales by 2020, 65% of which would be PHEVs and hybrid EVs while the remaining 35% would be pure EVs. GWM According to market news, GMW's first EV sedan, C30EV, is targeted to be launched in The company also aims to launch its first hybrid SUV model in GAC For the next 5 years, GAC will invest CNY2bn to develop NEVs and launch 5 new NEV models including sedans and SUVs.. Changan Changan has invested CNY1bn to develop NEVs since 2001 and currently plans to invest CNY18bn more in the next 10 years. The company aims to introduce 34 new NEV products to the market over the next decade and targets accumulated NEV sales to reach 100,000 units by 2020 and 2,000,000 units by 2025, and expects to see NEVs account for 10% of total sales. SAIC The company will invest CNY20bn to develop EV products and aims to launch 30 NEV products consisting of 13 pure EV models and 17 hybrid EV models. It targets sales volume for NEVs to reach 600,000 units in 2020, of which 200,000 units would come from selfowned brands. Source: cnstock.com Summary of fuel-efficiency targets for major markets km/l (mpg) US EU Japan China S. Korea (29.0) 15.8 (37.2) 16.7 (39.3) 11.0 (25.9) 12.3 (28.9) (33.0) 18.0 (42.3) 19.6 (46.1) 14.4 (33.9) 14.8 (34.8) (36.0) 19.7 (46.3) 21.0 (49.4) 15.7 (36.9) 16.7 (39.3) (47.0) 25.8 (60.7) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) (56.0) 30.8 (72.4) ~ 35.0 (82.3) 23.4 (55.0) 21.3 (50.1) 16.7 (39.3) 5-YoY (%) US EU Japan China S. Korea % 13.9% 17.4% 30.9% 20.3% % 9.4% 7.1% 9.0% 12.8% % 31.0% 11.4% 35.7% 0.0% % 19.4%~35.7% 0.0% 0.0% 0.0% Improvement (%) US EU Japan China S. Korea % 71.1%~94.4% 19.4% 47.9% 12.8% % 56.3%~77.7% 11.4% 35.7% 0.0% Source: ICCT Note: No official fuel efficiency guidance has been provided for Korea (from 2015), Japan (from 2020), or China (from 2020) 48

49 BYD (1211 HK): 4 January 2016 No high hopes in the handset segment Mild growth from handset business During its recent results briefing, BYD guided for only moderate sales-volume growth in its handset business for 2015, which should not come as a surprise due to weakening handset demand growth in China. However, management also highlighted that the photovoltaic business seems to be improving in terms of profitability. We remain cautious about this segment and assume a flat margin trend in We look for revenue generated by the handset business to increase by 6-8% YoY in BYD: mobile handset revenue and growth ( E) (CNY mn) (%) 35,000 50% 30,000 25,000 20,000 15,000 10,000 5, E 2016E 2017E Revenue (LHS) YoY Growth (RHS) Source: Company, Daiwa forecasts 40% 30% 20% 10% 0% -10% -20% 49

50 BYD (1211 HK): 4 January 2016 Valuation We continue to apply an SOTP valuation for BYD but lower our multiples for its handset and conventional auto businesses We stick with our SOTP valuation methodology for BYD considering its diversified businesses. We still apply a 2016E PBR of 1.0x to its battery business, but now assign a lower PER of 8.0x (previous 10.0x) for its mobile handset business due to the weak sentiment towards this business. For its conventional auto business, we now apply a 2016E PER of 6.0x (previous 8.0x) which remains at the low end of the 2016E PER of 7-11x (excl. BYD) that we set for the auto OEMs under our coverage. We believe this segment is benefitting from the purchase tax cut, as about 60% of BYD s sales are for engines of <1.6L, according to our estimates. However, we would also highlight that this segment is characterised by fierce competition, which could put further pressure on BYD s profitability. For its NEV business, we believe the segment will remain the most important earnings driver for the company, and we assume BYD will remain one of the leading NEV OEMs in China. We now forecast the company s NEV unit sales to rise by 21-80% YoY in Given such a high growth rate and lack of market comparables, we believe a valuation of a 30.0x PER is reasonable and appropriate for the segment. Reiterate Outperform (2) as we are still positive on the overall outlook for the company However, we now expect more keen market competition in the NEV segment than we had previously after reviewing several major OEMs NEV strategies, and believe this fierce competition will put more pressure on the margins for BYD s NEV business. Nevertheless, we are revising up our E revenue based on the company s strong unit sales growth recorded in the year to November However, we are cutting our E EPS by 1-16% after revising down our EBIT margin forecasts for the automobile business over the same period from 5-7% to 5-6%, and the handset business from 6.5% to 5-6% due to increasing competition in the NEV space and weakening demand for handsets. As such, we are lowering our SOTP-based 12-month target price to HKD47 from HKD56. We reiterate our Outperform (2) rating as we remain positive on the sector outlook over the long term. BYD: SOTP valuation Valuation Multiple (x) NAV 16E (CNY m) Rechargeable Battery P/B 1.0x 11,967 Mobile handset P/E 8.0x 11,460 Auto - Conventional P/E 6.0x 4,556 Auto - NEV P/E 30.0x 91,579 Sub-total 119,562 - Net debt/cash (6,813) - Minority interest (4,302) Equity value (CNYm) 108,447 Exchange rate, 1HKD = x CNY 0.85 Equity value (HKDm) 127,585 Equity value/share (HKD) Current price (HKD) 42.4 Potential share price upside/downside (%) 10.8% Source: Daiwa forecasts 50

51 BYD (1211 HK): 4 January 2016 Risks Subsidies will be important, at least for the next few years Delays on the completion of infrastructure would greatly lower buyers willingness to purchase Market competition may lead to price cuts Lower handsets margins would be a drag on overall earnings Diminishing subsidies may be problematic At current production and sales levels, and taking into account the subsidies on NEVs, the margins on NEVs are comparable to those on conventional vehicles. We believe a rampup in unit sales of NEVs would help BYD lower costs in the future. However, if the government decides to cut the subsidies earlier than expected or impose stricter standards, such as a higher electric drive range for NEVs, this would severely hurt BYD s profitability. But we see a low probability of this scenario playing out. Delays in infrastructure completion Even though we believe the government is determined to speed up the construction of EVrelated infrastructure, such as charging facilities, several factors could slow down the process, including a lack of interest from private capital and difficulties in land acquisition and conversion. We believe a delay in infrastructure construction would be one of the major risks hindering NEV sales, despite the government potentially lengthening the NEV subsidy scheme in response. Keen competition within the industry As we have pointed out, many major OEMs recently revealed long-term NEV strategies. We believe some are very aggressive; for instance, Geely targets to increase the proportion of sales from NEVs to 90% by 2020 (from <5% in 2015E). Therefore, due to this intensifying market competition, the overall profitability in this segment is likely to be adversely affected. Drop in handset shipments may hinder performance We assume a stable margin trend for BYD s handset business. However, if global demand for handsets is weaker than expected in , this segment could drag down the company s overall P&L account. 51

52 Dongfeng Motor Group China Consumer Discretionary 4 January 2016 Dongfeng Motor Group (489 HK) Target price: HKD12.20 Share price (28 Dec): HKD10.64 Up/downside: +14.7% Initiation: attractive valuation and decent pipeline Valuation looks attractive vs. peers Rich pipeline from Dongfeng Nissan and Dongfeng Honda Initiate coverage with Outperform (2) rating and TP of HKD12.20 Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com Investment case: We think Dongfeng Motor s (DFM) current valuation looks attractive and believe the stock is a good proxy for the strong turnaround in industry PV growth that we have seen during 4Q15. Among DFM s major brands, we expect Dongfeng Nissan and Dongfeng Honda to show the strongest sales volume growth in Catalysts: Dongfeng Nissan to be major sales driver in Apart from a pick-up in sales volume for its SUV Murano, we expect the recent launches of its other SUVs, such as the Qashqai (launched in October) and T70X (September), and its sedan the Lannia (October), to be well received, making a meaningful full-year unit sales impact in In 2016, we forecast average monthly sales of 8,000 units for the Qashqai, 6,000 units for the T70X, 4,500 units for the Murano and 8,000 for the Lannia, and we look for Dongfeng Nissan to achieve an overall 17% YoY rise in new-car sales, much higher than the 3% YoY increase in Dongfeng Honda to record decent sales growth. We expect Dongfeng Honda to record a 15% YoY rise in new-car sales in 2016, with SUVs (such as the XR-V and CR-V) the major driver we expect sales volume to rise by 22% YoY for the XR-V and 8% YoY for the CR-V. Also, new sedans such as the Greiz (launched in November) and the new Civic (launching in 2016) should contribute to new-car sales for the year. M&A would be a bonus share-price catalyst. We believe the PRC Government might extend its ongoing sector-wide consolidation strategy to the auto sector, especially to the big four auto makers (SAIC Motor, Changan Motor, FAW Motor [all 3 not rated] and DFM), to support local brand development. Similar to other recent SOE M&A activity, we see limited synergies for DFM (if it were to merge with another automaker) but it could provide an additional share-price catalyst. Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 Dongfeng M (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 8,616 Major shareholder Dongfeng Motor Corporation (66.9%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 124, , ,312 Operating profit (m) 2,859 3,007 3,061 Net profit (m) 12,021 13,201 13,591 Core EPS (fully-diluted) EPS change (%) (6.4) Daiwa vs Cons. EPS (%) (1.2) (0.4) (1.4) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) Valuation: We initiate coverage of DFM with an Outperform (2) rating and 12-month TP of HKD12.20, based on a target 2016E PER of 7.0x, inline with its past-3-year average. The stock is now trading at a 2016E PER of 5.8x, which is also lower than the average of the Hong Kong-listed China auto OEMs at 6-11x. We think the current valuation has priced in DFM s discount for being an auto conglomerate. We expect improving investor sentiment on the auto industry in 2016 to help DFM trade at par with its past-3-year average valuation. Risks: The key risk to our call would be weaker-than-expected new-car sales, especially for Dongfeng Nissan and Dongfeng Honda. See important disclosures, including any required research certifications, beginning on page 103

53 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Dongfeng Motor Group (489 HK): 4 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We expect DFM s 2015 reported net profit to drop by 6% YoY, mainly due to a CNY2.3bn before-tax valuation gain from acquiring a 14.1% equity interest in PSA Peugeot Citroën Group in In 2016, we forecast net profit to rise by 10% YoY, due to rising unit sales for Dongfeng Nissan on its strong SUV pipeline (including the Murano, Qashqui and Venucia T70X), as well as for its new sedan the Lannia. However, we forecast only a 3% YoY rise in net profit in 2017, due mainly to the removal of the purchasetax cut, which we expect to end at the end of next year, and a weaker pipeline. DFM: net profit and net profit growth (CNYm) (YOY% ) 16, % 14, % 12, % 10, % 8,0 00 5% 0% 6,0 00 (5%) 4,0 00 (10%) 2,0 00 (15%) 0 (20%) E 20 16E 20 17E Net profit (LHS ) Growth YoY (RHS) Source: company, Daiwa forecasts Valuation DFM: 12-month forward PER (x) (2012-YTD 2015) The stock is now trading at 2016E PER of 5.8x, which is below its past-3-year average of 7.0x. Although the stock has long been trading at a discount to the other Hong Kong-listed China auto OEMs due to DFM s diversified business, we still see the current valuation, which is at the lower end of the stock s past-3-year average, as attractive. On improving investor sentiment for the sector after the implementation of the purchase-tax cut, we believe our target PER of 7.0x is reasonable and achievable. (PER) PER +1 SD Average PER -1 SD Source: Bloomberg, Daiwa forecasts; note: YTD through 28 December 2015 Earnings revisions DFM: Bloomberg-consensus EPS forecast revisions The Bloomberg consensus EPS forecasts for DFM began to be revised up in late September 2015, which we believe was mainly due to the implementation of the purchase-tax cut. We estimate that the tax cut will boost the company s 2016E PV sales volume by 8% YoY, but this is likely to create a high base for Further, as we believe the entry- and mid-level market is crowed with new models, we expect the margins of DFM s major JVs to suffer from fierce market competition. Overall, our E EPS are in line with consensus. (CNY) Source: Bloomberg 2015E 2016E 53

54 Dongfeng Motor Group (489 HK): 4 January 2016 Financial summary Key assumptions Year to 31 Dec E 2016E 2017E DF Nissan sales volume (units) n.a. 809, , , , ,000 1,144,000 1,202,000 DF PSA sales volume (units) n.a. 404, , , , , , ,000 DF Honda sales volume (units) n.a. 255, , , , , , ,000 DF Nissan sales volume growth (YoY %) DF PSA sales volume growth (YoY %) DF Honda sales volume growth (YoY %) Profit and loss (CNYm) n.a. n.a. (4.4) n.a. n.a (0.7) 2.0 (3.1) n.a. n.a (4.0) (0.7) Year to 31 Dec E 2016E 2017E Commercial vehicles 33,418 35,473 2,784 24,527 42,627 36,030 32,427 30,806 Passenger vehicles 88,143 94,921 3,254 11,905 36,671 86,011 80,556 75,475 Other Revenue 834 1, ,656 2,252 2,662 3,031 Total Revenue 122, ,441 6,090 37,263 80, , , ,312 Other income (2,462) (3,425) (168) (1,448) (1,727) (2,113) (1,966) (1,858) COGS (96,033) (105,051) (5,736) (32,582) (70,244) (109,378) (101,768) (96,194) SG&A (9,997) (9,916) (1,518) (4,447) (7,415) (9,943) (8,905) (8,198) Other op.expenses Operating profit 13,903 13,049 (1,332) (1,214) 1,568 2,859 3,007 3,061 Net-interest inc./(exp.) Assoc/forex/extraord./others ,064 11,552 12,786 10,911 12,257 12,582 Pre-tax profit 14,583 14,361 9,152 10,712 14,683 14,242 15,640 16,102 Tax (3,006) (3,401) (45) (109) (1,365) (1,324) (1,454) (1,497) Min. int./pref. div./others (596) (479) (15) (75) (473) (897) (985) (1,014) Net profit (reported) 10,981 10,481 9,092 10,528 12,845 12,021 13,201 13,591 Net profit (adjusted) 10,981 10,481 9,092 10,528 12,845 12,021 13,201 13,591 EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT 13,903 13,049 (1,332) (1,214) 1,568 2,859 3,007 3,061 EBITDA 17,913 16,200 (1,120) (432) 3,078 4,693 5,285 5,854 Cash flow (CNYm) Year to 31 Dec E 2016E 2017E Profit before tax 14,583 14,361 9,152 10,712 14,683 14,242 15,640 16,102 Depreciation and amortisation 4,010 3, ,510 1,834 2,278 2,793 Tax paid (2,379) (4,315) (52) (206) (1,144) (1,324) (1,454) (1,497) Change in working capital 2,665 (2,505) (1,297) (8,825) (1,643) (3,684) (4,376) (4,508) Other operational CF items (976) (1,476) (10,771) (12,157) (14,391) (10,586) (11,846) (12,231) Cash flow from operations 17,903 9,216 (2,756) (9,694) (985) Capex (5,054) (7,019) (555) (1,332) (3,501) (3,800) (4,000) (4,500) Net (acquisitions)/disposals 92 (140) (310) 8,524 (10,183) Other investing CF items (1,116) 6,624 5,634 10,790 12,988 8,067 8,642 8,703 Cash flow from investing (6,078) (535) 4,769 17,982 (696) 4,267 4,642 4,203 Change in debt (2,500) (701) (3,225) (145) 9,704 (3,000) (2,000) (2,000) Net share issues/(repurchases) Dividends paid (776) (1,551) (1,551) (1,504) (1,551) (1,723) (1,803) (1,980) Other financing CF items (29) (937) 0 (257) 70 (324) (411) (351) Cash flow from financing (3,305) (3,189) (4,776) (1,906) 8,223 (5,047) (4,214) (4,331) Forex effect/others Change in cash 8,520 5,492 (2,763) 6,382 6,542 (298) Free cash flow 12,849 2,197 (3,311) (11,026) (4,486) (3,318) (3,758) (3,841) Source: FactSet, Daiwa forecasts 54

55 Dongfeng Motor Group (489 HK): 4 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment 25,889 31,381 10,288 16,670 23,212 22,914 23,584 24,115 Inventory 13,935 12,511 1,198 4,245 9,735 13,672 13,217 12,657 Accounts receivable 17,897 19,600 3,199 14,738 15,871 17,401 20,816 19,676 Other current assets 24,616 20,524 12,215 21,969 20,339 25,204 27,463 29,665 Total current assets 82,337 84,016 26,900 57,622 69,157 79,192 85,079 86,113 Fixed assets 18,551 21,578 2,430 9,418 11,285 13,276 15,035 16,791 Goodwill & intangibles 4,021 4, ,943 5,349 5,324 5,287 5,237 Other non-current assets 5,713 7,253 32,293 44,015 59,682 62,525 66,140 70,020 Total assets 110, ,533 62, , , , , ,162 Short-term debt 13,638 15,971 2,697 17,597 29,256 28,579 29,661 26,713 Accounts payable 23,834 23,055 1,964 13,480 16,034 17,501 16,283 14,429 Other current liabilities 25,184 25,689 3,580 17,612 21,393 24,251 23,230 22,026 Total current liabilities 62,656 64,715 8,241 48,689 66,683 70,331 69,173 63,168 Long-term debt 6,289 2, Other non-current liabilities ,275 2,988 2,988 2,988 2,988 Total liabilities 69,286 67,949 8,363 51,964 70,021 73,669 72,511 66,506 Share capital 35,943 44,843 52,626 61,584 72,106 72,106 72,106 72,106 Reserves/R.E./others 1,551 1,551 1,292 1,551 1,723 12,021 23,419 35,029 Shareholders' equity 37,494 46,394 53,918 63,135 73,829 84,127 95, ,135 Minority interests 3,842 3, ,623 2,520 3,506 4,520 Total equity & liabilities 110, ,533 62, , , , , ,162 EV 73,470 65,812 37,113 42,661 35,340 33,015 30,797 24,453 Net debt/(cash) (5,962) (12,590) (7,591) 927 6,394 6,015 6,427 2,948 BVPS (CNY) Key ratios (%) Year to 31 Dec E 2016E 2017E Sales (YoY) (95.4) (7.0) (5.5) EBITDA (YoY) 70.2 (9.6) n.a. n.a. n.a Operating profit (YoY) 77.9 (6.1) n.a. n.a. n.a Net profit (YoY) 75.7 (4.6) (13.3) (6.4) Core EPS (fully-diluted) (YoY) 75.7 (4.6) (13.3) (6.4) Gross-profit margin EBITDA margin n.a. n.a Operating-profit margin n.a. n.a Net profit margin ROAE ROAA ROCE n.a. n.a ROIC (3.2) (2.2) Net debt to equity net cash net cash net cash Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts Company profile Dongfeng Motor Group (DFM) is engaged in the manufacture and sale of autos, engines and auto parts, as well as offering other auto-related business, such as auto finance. Through its subsidiaries and JVs with various foreign brands, DFM has a wide range of product lines, including 42 major commercial vehicle models, 35 truck models and 7 for buses. It also had 51 passenger vehicles models, consisting of 31 for sedans, 7 MPVs and 13 SUVs, as at the end-1h15. DFM also has a leading position in China s CV market, especially for medium- and heavy-duty trucks. 55

56 Dongfeng Motor Group (489 HK): 4 January 2016 Attractive valuation and decent pipeline Focus will be on the Qashqai, VenuicaT70X and Murano when it comes to 2016 sales volume growth Latest model launch means richer pipeline in 2016 Dongfeng Nissan should be the key revenue driver Compared to the other OEMs in China, DFM had strong product launches in 2H15, which should mean better sales volume growth in 2016 compared to its peers. Of all the brands under DFM, we believe investors will focus the most on the success of the new car sales of Dongfeng Nissan s recently launched models, particularly the SUVs the Qashqai (launched in October) and the Venucia T70X (launched in September). We expect Dongfeng Nissan to account for about 50% of DFM s net profit in We expect sales volume for the Qashqai to reach 8,000 units/month in 2016, while for the Venucia T70X, combined with the original T70, we expect sales to reach 6,000 units/month. Another recently launched SUV model, the Murano, which was launched in August 2015, was selling at around 2,500 units/month in November YTD. We assume average monthly sales of the Murano to increase to 4500 units/month in Major sedan sales should be driven by the Sylphy, Teana and Lannia in 2016 Dongfeng Nissan: Qashqai SUV In terms of DFM s sedan models, we believe the new Lannia, which was launched in late October 2015, will record 8,000 units/month in 2016, and that the Venucia R50X, which was launched in early September, will see sales of around 2,000 units/month. We think the most popular Nissan sedans will the Sylphy and Teana, for which we estimate average monthly sales of around 27,500 units (flat YoY) and 9,350 units (up 2% YoY), respectively, in Overall, we forecasts Dongfeng Nissan s total PV sales to record 17% YoY growth. Dongfeng Nissan: Venucia R50X Hatchback Source: company Source: company Dongfeng Nissan: Venucia Lannia Sedan Dongfeng Nissan: Venucia T70X SUV Source: company Source: company 56

57 Dongfeng Motor Group (489 HK): 4 January 2016 Greiz to compete with GAC Honda s new City model Dongfeng Honda should record stable growth We expect Honda s new sedan models such as the Greiz and the Civic to boost Dongfeng Honda s sales volume growth in Given the incremental sales volume pattern that we have seen for the Honda New City (under GAC Honda), which was launched in August 2015, we expect the Greiz (launched on 7 November) to record around 3,000 units/month next year. We do not have high expectations, as both models (the GAC Honda City and the Dongfeng Honda Greiz) target similar customers and were launched close together. Besides, the new Civic is likely to help total Civic sales improve to 4,000 units/month in 2H16 (we expect it to be launched in mid-2016) from 2,600 units /month for 2015, on our estimates. We believe the major sales volume drivers for Dongfeng Honda in 2016 will remain its SUV models, such as the CR-V (especially after the April 2015 facelift) and the XR-V (launched in December 2014). In 2016, we expect sales volume of 14,000 units/month for the CR-V and 12,000 units/month for the XR-V. Dongfeng Honda: Greiz sedan Dongfeng Honda: existing Civic Source: company Source: company Comparison of Greiz, New City and New Civic Manufacturer Price of top model Launch date in China Average monthly sales in 2014 average monthly sales in 2Q15-3Q15 Length (mm) Width (mm) Height (mm) Wheelbase (mm) Greiz Dongfeng Honda CNY106.8k 7 Nov 15 n.a. n.a. 4,495 1,705 1,477 2,600 City GAC Honda CNY109.8k 28 Aug 15 4k 3k 4,450 1,695 1,477 2,600 Civic Dongfeng Honda *CNY167.2k 2H16 4k* 3k 4,630 1,798 1,415 2,700 Rear view camera Available Engine Front and Side airbags GPS navigation system Start-stop system VSA stability assist Hill-start assist Leather seating Air-filtering system Greiz Available Available Not Available Available Available Available Not Available Honda Earthdreams City Available Only equipped with Not Available Available Available Available Not Available Available 1.5L front airbags Source: companies Note 1: *: sales refer to sales of the current model Note 2: Detailed configuration of the New Civic has not been released yet Lack of new models for DPCA Performance of other brands should continue to vary DPCA expected to record YoY decline in sales growth in 2016 We think that the only new models to make any meaningful contribution to Dongfeng Peugeot Citroën Automobile s (DCPA) sales volume in 2016 will be the recently launched Citroën C5 facelift (launched in October 2015), and the Peugeot 3008 facelift in 1H16. We expect sales of the C5 to reach 2,500 units/month and sales of the Peugeot 3008 to reach 6,100 units/month in 2016, compared to 2015 pre-facelift sales of around 2,000 units/month for the C5 and 5,500 units/month for the Peugeot However, we expect overall sales volume to be flat YoY, due to a lack of new models. 57

58 Dongfeng Motor Group (489 HK): 4 January 2016 DPCA: recently launched Citroën C5 Source: company Dongfeng Renault s Kadjar could turn out to be an attractive model in China in the long run Dongfeng Renault s Kadjar could surprise on the upside Renault s Kadjar SUV seems to have been selling well since it was first launched in France in April The sales volume for this model was close to that of Nissan s Qashqai. However, we believe Renault is likely to have a home base advantage when it comes to sales and distribution in France, and we do not expect it to replicate this in China. We currently assume sales volume of 5,000 units/month in China by the end of 2016, assuming it will start to launch the Kadjar in the country in March 2016 (full-year 2016E average of 3,500 units/month). We expect the Kadjar to be less popular than the Qashqai, given that the Kadjar will be the first model to be launched by Dongfeng Renault (likely to be in March 2016). We believe this will rise to 8,000 units/month by the end of 2017, reaching average monthly sales of 6,500 units/month in 2017, as we are confident that the Renault brand will sell well in China, even though it will take more time to get full brand recognition among car buyers. Renault: Kadjar SUV Source: company 58

59 Dongfeng Motor Group (489 HK): 4 January 2016 Better sector sentiment should help DFM as well Other share-price catalysts for DFM Improving sales volume growth on tax cut On 29 September 2015, the PRC Government announced several policies to support the auto industry, including a cut in the purchase tax, from 10% to 5%, from 1 October 2015 until 31 December 2016 (applies to all cars with engines of 1.6L or less). Even though only around half of DFM s models fall into this category (less than 1.6L engines), we think the tax cut boosted investor sentiment on the auto sector in October. We expect relatively better YoY sales growth for the industry in 2016 as a result of the cut, and believe DFM s shares should also benefit from a rerating of the sector. China and selected China OEM sales by engine size YTD 2015 November: China PV Small engines 68% Large engines 32% EV 1% Geely Small engines 79% Large engines 18% EV 3% BAIC Small engines 62% Large engines 37% EV 1% Great Wall Small engines 94% Large engines 6% EV 0% GAC Small engines 45% Large engines 55% EV 0% Brilliance BMW Small engines 34% Large engines 66% EV 0% Dongfeng Small engines 57% Large engines 43% EV 0% Changan Small engines 75% Large engines 25% EV 0% Source: cars with small engines of 1.6L or below Any news on M&A activity could boost investor sentiment We believe the fraud investigation will have a limited impact on DFM s daily operation M&A would be another share-price catalyst With ongoing SOE reforms in China, the PRC government is aiming to reduce the number of SOEs in some industries to improve efficiency and reduce losses. The railwayequipment players (CSR Corporation and CNR Corporation) have seen one merger so far (finalised in June 2015), while the state-owned shipping groups, COSCO Group and China Shipping Group and Sinotrans&CSC Group and China Merchants Group are also going through a restructuring and merger. We believe the auto sector, especially the big four auto makers (SAIC Motor, Changan Motor, FAW Motor and DFM), will be affected by consolidation. We believe the focus of any restructuring would be on how to improve the profitability of these companies self-owned auto brands. Similar to the other SOE mergers that we have seen, even though we expect only limited synergies, we would consider it a positive and thus a positive share-price catalyst, boosting investor sentiment on the stock. Fraud investigation On 2 November 2015, DFM announced that, according to the CPC Central Commission for Discipline Inspection, its executive director and president Mr Zhu Fushou was being investigated for serious disciplinary violations. With immediate effect, Mr Zhu was suspended from his role at DFM, and there is no news yet as to whether he has been charged. Even though this investigation may have raised concerns in the market about DFM s corporate governance, we are not concerned that it will have any material impact on its business as it is an SOE, and we don't think the government will allow it to go bankrupt or face large penalties. We think this investigation could continue for the next 3 years and believe there could be news on the senior management of other SOEs being investigated for similar reasons. 59

60 Dongfeng Motor Group (489 HK): 4 January 2016 Therefore, in terms of DFM, we expect the market to become less reactive to any future news flow in the near term. We believe there could be a management reshuffle given Mr Zhu s suspension, but that this is unlikely to have any material change on DFM s business development and long-term strategy. Weak trade data leading to lack of investor confidence in CV segment We expect little from commercial vehicle segment in We expect China s trade data to remain weak in Daiwa s Chief Economist Kevin Lai expects China exports to decline by 3.4% YoY and imports to decline by 6.4% YoY in As such, we believe the overall profitability of the logistics companies in China, especially freight-forwarding and transportation companies, to remain weak next year. This in turn leads us to believe that consumer confidence in the commercial vehicle (CV) segment will remain weak during the same period. Also, without new emissions standard being implemented in China in the near term and, given that replacement orders were mostly made in 2014, we do not expect CV sales to pick up in Overall, we expect a 10% YoY decline in China CV sales in 2016 and a further 5% YoY decline in We expect DFM s CV sales to record the same YoY declines for E. 60

61 Dongfeng Motor Group (489 HK): 4 January 2016 We forecast DFM s net debt-to-equity ratio to remain low in Financial analysis Strong balance sheet, indicated by stable low gearing ratio DFMs net gearing ratio has been stable for the past few years, at lower than 10%. We expect the ratio to be 7% in both 2015 and 2016 and 3% in 2017, mainly due to substantial dividend from JV brands. However, we think this will be partly offset by DFM s increasing capex, as management guides for an increase in overall production capacity to 3.1m vehicles by the end of 2016 (vs. guidance of 2.7m as at end-2015]. DFM: net debt-to-equity ratio 10 % 9% 9% 8% 7% 7% 6% 7% 6% 5% 4% 3% 3% 2% 1% 1% Net cash Net cash Net cash 0% E 20 16E 20 17E Source: company, Daiwa forecasts Payout ratio stable in ; we assume a 15% ratio in Although management has given no guidance on the company s dividend policy for 2015 or beyond, its payout ratio in was 12-15%. We expect management to maintain the payout ratio in this range and assume a 15% payout ratio in , which would translate into a E yield of % at the current share price. DFM: dividend per share and payout ratio (CNY) % 15% 14% 15% 13% 15% 15% 15% 16% 15% 14 % % E 20 16E 20 17E DPS (CNY, LHS) Payout ratio (%, RHS) Source: company, Daiwa forecasts 13 % 12% 11% 10 % Mixed margin performance likely in as DFM manufactures different brands, but overall net margin should be stable As DFM manufactures autos for several JV brands, including Japanese and European brands, we believe the margins for these different brands will move in different directions based on individual product pipelines and product mixes. For Dongfeng Limited (mainly in terms of its work in the manufacture and sales of Dongfeng Nissan), we believe its net margin peaked at 9.6% in 2014, and think its net margin will decline gradually to 8.3% in 2017, due mainly to significant market competition in the mid-level auto market. We expect a similar scenario for Dongfeng Honda and DPCA. We look for net margins to come down gradually to 8.8% in 2017 from 10.3% in 2014 for Dongfeng Honda and to 4.2% in 2017 from 5.1% in 2014 for DPCA. For DF Renault, we currently assume a net margin of 2% in 2016 and 4% in We expect this relatively low margin mainly as the Dongfeng Renault factory will still be in the early stages of production in its first 2 years of operation. 61

62 Dongfeng Motor Group (489 HK): 4 January 2016 DFM: net profit margin for major JVs 12% 10% 8% 6% 4% 2% 0% E 2016E 2017E DFL DPCA DHAC DF Renault DFM Pro forma net margin Source: company, Daiwa forecasts Note: DFL = Dongfeng Limited which owns Dongfeng Nissan; DPCA = Dongfeng PSA; DHAC = Dongfeng Honda We expect earningsgrowth momentum to continue in 4Q15 3Q15 results on an upward trend In 3Q15, DFM s revenue increased by 95% YoY, mainly due to the 100% consolidation of subsidiary DF PSA Sales Company. Investment income came in at CNY2,562m, up 3% YoY. We believe the mild growth was due to a strong rebound in sales volume for Dongfeng Honda (+106% YoY), but was partly offset by weak sales performance at DPCA (-19% YoY). Overall, net profit increased by 22% YoY, which helped to narrow the net profit decline in 9M15 to 11% YoY, from a YoY decline of 19% YoY in 1H15. We expect net profit in 4Q15 to grow at a similar pace, due to the impact of the 5% purchase-tax cut, as 57% of DFM s sales volume is for cars with engines of 1.6L or less. We believe the October and November 2015 sales figures support our view of the 4Q15 growth trajectory. Dongfeng Honda recorded strong sales volume growth of 52% YoY in October and 99% YoY in November, while November sales for DPCA rose by 12% YoY and those for Dongfeng Nissan rose by 23% YoY. Overall, DFM s November sales growth was 27% YoY, which was substantially higher than the company s November YTD growth of 5.9% YoY and the auto industry s November YTD growth of 6.1% YoY. DFM: income statement summary (CNYm) PRC GAAP YoY % (Equity method) 3Q14 3Q15 1H14 1H15 9M14 9M15 3Q15 1H15 9M15 Revenue 14,317 27,913 34,365 69,066 48,682 96,979 95% 101% 99% Cost of sales (12,418) (23,833) (29,065) (59,445) (41,483) (83,277) 92% 105% 101% Investment income 2,477 2,562 6,317 5,892 8,794 8,454 3% -7% -4% Profit before tax 2,098 2,887 9,429 8,028 11,527 10,915 38% -15% -5% Net profit 1,994 2,430 8,500 6,885 10,494 9,315 22% -19% -11% EPS % -19% -11% Source: company, Daiwa 62

63 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Dongfeng Motor Group (489 HK): 4 January 2016 Valuation and recommendation Trading near low end of past-3-year PER range Initiate with Outperform (2) rating and target price of HK12.20 Still undemanding even after recent rally Since late August 2015, DFM shares have rebounded by more than 50%, we believe due partly to the implementation of the 5% purchase-tax cut. However, the stock is still trading at only a 2016E PER of 5.8x. Although DFM has long traded at a discount to its Hong Kong-listed China OEM peers due to the conglomerate nature of its business, the current valuation of 5.8x is undemanding as it is close to the low end of the stock s past-3-year trading range of 4-9x. Decent upside expected from current level On the strong pipeline that we see for 2016, we believe DFM s sales volume will outperform the overall market, serving as a catalyst for a rerating of the stock. Hence, we consider the current share price as a good entry point for investors. We initiate coverage of DFM with an Outperform (2) rating. We set a 12-month target price of HKD12.20 based on 7.0x our 2016E EPS, which is in line with its past-3-year average. We believe our target PER of 7.0x is reasonable as DFM is now trading near the low end of its past-3-year range, and because we see better-than-industry sales volume growth in the coming year. Given the recovering market sentiment in the sector due to the purchasetax cut, we do not think it will be difficult for the valuation to bounce back to its past-3-year average. Our target price implies upside of 15% to our target price from current share price levels. DFM: 12-month forward PER (x) (2012 YTD 2015) (PER) Source: company, Daiwa forecasts PER +1 SD Average PER -1 SD Currency exposure to EUR is a negative for the company, in our view, especially given the CNY depreciation Risks Currency risk CNY depreciation a concern We believe the recent CNY depreciation is likely to affect DFM s profitability, as the company imports certain auto parts and components from Japan and Europe given its JVs with the various Japanese and European brands. The company has highlighted that for every 5% weakening in the CNY against the EUR, the company would record a CNY233m decrease in its after-tax profit. However, we believe the company s exposure to currency risks caused by fluctuations in the Yen is less than it is for the Euro, as the localisation rate for its Japanese brand JVs is higher than for its European peers. 63

64 Dongfeng Motor Group (489 HK): 4 January 2016 DFM not immune to intensifying market competition Market risk Severe market competition could drag down margins We believe competition in the China auto market is intensifying at a faster pace than the market has expected. Especially for the SUV segment, we believe the OEMs are keen on fighting for market share, as indicated by their SUV pipelines and because they keep introducing more SUV models into the market. Therefore, we believe possible price cuts and the resulting margin erosion could hurt DFM s profitability. Furthermore, we think the fact that the luxury brands have started to introduce more entry- and mid-level models into the market could put even more pressure on DFM s sales, given its high exposure to this segment. Escalation in Sino-Japan tensions stands a risk Political risk Sino-Japan tensions could crimp margins We think DFM could be exposed to potential political risk due to ongoing tensions between China and Japan, given the company s exposure to Japanese brands. In 2012, when China and Japan were in dispute over the Diaoyu Islands, the China OEMs with Japanese JVs, such as GAC and DFM, saw their sales slow significantly. Therefore, we believe the political climate between China and Japan could have an impact on the sales performance of DFM s Japanese brands while potentially benefiting their competitors. Further, political instability in other countries could affect export demand for Chinese domestic brands, especially as most of the local OEMs export to emerging countries, which are politically less stable than developed countries. Unexpected macro slowdown could result in further deterioration of CV segment profitability CV segment may be a drag CV segment could weigh on overall performance CV sales are closely correlated with the macro environment, particularly trade flows. DFM s CV segment is likely to be adversely affected by the current China and global macroeconomic slowdown. Hence, we conservatively assume modest profitability for the segment. However, an unexpected hard landing for China s economy would likely lead to the CV segment being a further drag on the company s overall performance. 64

65 Dongfeng Motor Group (489 HK): 4 January 2016 Company background A leading China auto OEM, with a broad product range Diversified product range, with both PVs and CVs A leading manufacturer in the China PV market Listed in Hong Kong in 2005, Dongfeng Motor is engaged in the manufacture and sales of autos, engines and auto parts, and is involved in other auto-related businesses such as auto finance. In 2014, DFM was one among the largest manufacturers in the China PV market based on sales volume. For its PV OEM business, DFM had 51 PV models, comprising 31 sedan models, 7 MPV models and 13 SUV models, as at the end-1h15. Its major products for the China market include well-recognised global brands such as Nissan, Infiniti, Honda, Peugeot, Citroen and Renault. Similar to its peers, besides manufacturing foreign brands, DFM also invests in and develops its own brand, namely Dongfeng Fengshen, which is run under the Dongfeng Passenger Vehicle Company. DFM has a leading position in China s CV market, especially for medium- and heavy-duty trucks. Through its subsidiaries and JVs with various foreign brands, DFM has a wide range of product lines, including 42 major commercial vehicle models, comprising 35 truck models and 7 bus models. Major profit contributors Big 3 account for largest share of JV profit DFM s own Dongfeng Fengshen is still loss-making. Its major profit contributors are its JVs with several foreign brands. In 2014, DFL (mainly in terms of its work in the manufacture and sales of Dongfeng Nissan), DPCA and DHAV accounted for 93% of the total share of DFM s profit from joint ventures, while its total profit from JVs accounted for 83% of its net profit. We believe the distribution in will be similar. DFM: profit share from JVs in % 20% 16% 58% DFL DPCA DHAC Others Source: Company, Daiwa estimates Note: DFL = Dongfeng Limited which owns Dongfeng Nissan; DPCA = Dongfeng PSA; DHAC = Dongfeng Honda 65

66 Dongfeng Nissan Passenger Vehicle Dongfeng Infiniti Dongfeng Motor Company Dongfeng Honda Dongfeng Peugeot Citroen Dongfeng Renault Dongfeng Pessenger Vehicle Dongfeng Commercial Vehicle Dongfeng LiuZhou Motor Dongfeng Honda Auto Parts Dongfeng Honda Engine Dongfeng Peugeot Finance Dongfeng Nissan Auto Finance Dongfeng Motor Group (489 HK): 4 January 2016 DFM: management profile Management Mr. Xu Ping Mr. Li Shaozhu Mr. Zhu Yanfeng Mr. Cai Wei Source: company Profile Mr. Xu has been the chairman of the board of directors of the company since He is also the chairman of the board of directors of Dongfeng Peugeot Citroën, Dongfeng Honda and Dongfeng Renault. Mr. Li is an executive director of the company. Mr. Li has more than 20 years business and management experience in the auto industry. Mr Zhu is the chairman of the Board, and assumed the role and duty of the president of DFM with effect from 2 November 2015, prior to the election of a new president of the company. Mr. Cai is the vice-president and the secretary of the board of directors of the company. He is a director of Dongfeng Peugeot Citroën, and the chairman of the board of directors of Dongfeng Honda Engine and Dongfeng Honda. DFM: development milestones Year Event 2004 Dongfeng Motor Group Co., Ltd established Dongfeng Motor Group Co., LTD listed on the Hong Kong Stock Exchange, with stock code On 30 August 2006, Nissan Motor and DFM jointly signed an agreement in Wuhan to establish Dongfeng Nissan Auto Finance Co., Ltd, in 2007 in China Dongfeng Motor Group Company Ltd awarded the title of Most Influential Chinese Overseas Listed Company of Acquired an equity interest in Dongfeng Yu'an to accelerate R&D for new EVs DFM acquired the commercial vehicle and other businesses from Dongfeng Motor Corp and formed a new JV with Volvo to develop medium and heavy-duty commercial vehicles under the Dongfeng brand DFM announced the restructuring plan for Sanjiang Renault, which was approved by the NDRC and a new JV, Dongfeng Renault, was formed by DFM and Renault S.A DFM undertook to subscribe 69,866,666 PSA shares, representing around a 14% stake in PSA DFM announced the establishment of Dongfeng Infiniti, a JV between DFM and Nissan Motor that is responsible for managing the sales operations of the Infiniti brand in China. Source: Company DFM: organisational chart Dongfeng Motor Corporation Public shareholders 25% 66.86% 33.14% Dongfeng Yueda Kia Dongfeng Auto Group Co. (489.HK) 50% 50% 50% 50% 100% 55% 75% 44% 50% 25% 100% 100% 100% Source: Company 66

67 Dongfeng Motor Group (489 HK): 4 January 2016 Dongfeng Nissan: Sunny Sedan Dongfeng Nissan: Sylphy Sedan Source: Company Dongfeng Nissan: Teana Sedan Source: Company Dongfeng Nissan: Qashqai SUV Source: Company Dongfeng Nissan: X-Trail SUV Source: Company Dongfeng Nissan: Murano SUV Source: Company Source: Company 67

68 Dongfeng Motor Group (489 HK): 4 January 2016 Dongfeng Honda: Civic Sedan Dongfeng Honda: CR-V SUV Source: Company Dongfeng Honda: XR-V SUV Source: Company Dongfeng Infiniti: Q50L Sedan Source: Company Dongfeng Infiniti: QX50 SUV Source: Company Dongfeng PSA: Citroen C3-XR SUV Source: Company Source: Company 68

69 Dongfeng Motor Group (489 HK): 4 January 2016 Dongfeng PSA: Citroen Elysee Sedan Dongfeng PSA: Citroen C4L Sedan Source: Company Dongfeng PSA: Peugeot 301 Sedan Source: Company Dongfeng PSA: Peugeot 308 Sedan Source: Company Dongfeng PSA: Peugeot 408 Sedan Source: Company Dongfeng PSA: Peugeot 3008 SUV Source: Company Source: Company 69

70 Dongfeng Motor Group (489 HK): 4 January 2016 Dongfeng Passenger Vehicle: Fengshen AX7 SUV Dongfeng LiuZhou: Joyear SUV Source: Company Source: Company Dongfeng LiuZhou: Future MPV Source: Company DFM: commercial vehicles Source: Company 70

71 Guangzhou Automobile Group China Consumer Discretionary 4 January 2016 Guangzhou Automobile Group (2238 HK) Target price: HKD7.00 (from HKD6.40) Share price (28 Dec): HKD6.94 Up/downside: +0.8% Encountering strong headwinds Japanese brands facing stiff competition from luxury/local brands A latecomer to China s SUV market boom in 2016E Maintain Hold (3) with new TP of HKD7.0, based on 8.5x 2016E PER Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com What's new: GAC s share price is up more than 50% since the year s trough in September on improving sentiment on the China Autos Sector after the government s decision to cut the purchase tax on vehicles with engines of 1.6L or smaller. While we believe the recent share-price rally has factored in the positive impact of the supportive tax policy, GAC is likely to face keen competition from the other OEMs in What's the impact: We expect the Japan brands, which focus on mid-range sedans and to which GAC has large exposure through its JVs with Toyota and Honda, to lose market share to the luxury brands in the first-tier cities, and to cheaper local brands in the lower-tier cities. As the licence plate restrictions are due to be rolled out in more cities over the next few years, the earnings growth potential of GAC s Japanese JV brands could be further dampened. In our view, SUVs are eating into the market share for sedans in China s PV market, yet GAC only has a limited range of SUVs. That said, sales of GAC s self-owned GS4, and that of GAC Toyota s Highlander, were better than expected in 2015, which should offset the losses for other sedan models. GAC is scheduled to launch a few SUV models in 2016 (including an SUV from Acura, which is a sub-brand of Honda, and the EV version of the GS4), which should drive its earnings growth in Nevertheless, we expect the margins and profitability on SUVs to deteriorate given the intensifying competition, as more OEMs rush to launch new models. We raise our E revenues by 16-76% to factor in the potential positive impact from the tax cut and the strong performance of the new models launched to date. However, our upward revisions of 3-11% for E EPS reflect a potential margin decline. We now forecast GAC s net profit to rise by 22% YoY to CNY3.9bn for For , we look for the net profit growth to slow to 17%/3% YoY, respectively. What we recommend: We maintain our Hold (3) rating and raise our 12- month target price to HKD7.0 (from HKD6.40), based on an unchanged 2016E PER of 8.5x, at the low end of the target PER range ( x) we apply to the other auto OEMs we cover, due to our concerns about Japanese cars losing market share to premium European brands under the licence-plate restrictions, as well as the popularity of cheaper local brands in lower-tier cities. The key upside and downside risks to our call: impact of weaker/stronger-than-expected currency fluctuations. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change Net profit change Core EPS (FD) change Source: Daiwa forecasts Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 Gzhou Auto (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 6,435 Major shareholder GZ Auto Industry Grp (57.6%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 28,828 44,717 49,934 Operating profit (m) (691) (374) (251) Net profit (m) 3,891 4,533 4,670 Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) (5.9) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: We are slightly more positive on GAC than the market for 2016, as some orders originally scheduled for 2017 have now been brought forward to 2016 on the back of the positive impact of the tax cut. See important disclosures, including any required research certifications, beginning on page 103

72 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Guangzhou Automobile Group (2238 HK): 4 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We look for GAC s net profit to rise by 22% YoY to CNY3.9bn for Japanese JV brands have been cutting prices during the course of 2015, and we expect pricing pressure on mid-range JV brands, such as those that GAC makes, to continue. For , we forecast net-profit growth of 17% YoY and 3% YoY, respectively, partly helped by the company s launch of some new SUV models. GAC: net profit forecasts (CNYm) 5,000 4,000 3,000 2,000 1, E 2016E 2017E Net profit (LHS) YoY Growth (RHS) Source: Company, Daiwa forecasts 170% 120% 70% 20% (30%) (80%) Valuation GAC: 1-year forward PER (x) Our 12-month target price of HKD7.0 is based on an 8.5x PER applied to our 2016E EPS forecast, which is at the low end of the target PER range of x we apply to the auto OEMs under our universe. We see Japanese cars, to which GAC has large exposure, losing market share to premium European brands under stronger licensing restrictions, as well as the popularity of cheaper local brands in lower-tier cities, and intensifying competition in the sedan market. (PER) PER +1 SD Average PER -1 SD Source: Bloomberg, Daiwa forecasts Earnings revisions We have seen continuous downward earnings revisions from the street since June Our EPS forecasts for E are now 4-7% above the consensus, as we assume higher passenger vehicle (PV) sales-volume growth from the forward shift demand as a result of purchase tax cut, but 6% lower than consensus earnings forecast for 2017E. GAC: Bloomberg consensus EPS forecast revisions (CNY) Source: Bloomberg 2015E 2016E 72

73 Guangzhou Automobile Group (2238 HK): 4 January 2016 Financial summary Key assumptions Year to 31 Dec E 2016E 2017E Volume - GAC Honda (unit) 386, , , , , , , ,000 Volume - GAC Toyota (unit) 269, , , , , , , ,000 Volume - GAC Motor (unit) 39,000 31,000 59, , , , , ,000 Volume Growth - GAC Honda (%) n.a. (6.2) (12.7) Volume Growth - GAC Toyota (%) n.a. 1.9 (8.8) Volume Growth - GAC Motor (%) n.a. (20.5) Profit and loss (CNYm) Year to 31 Dec E 2016E 2017E Vehcicle-related operations 7,460 10,719 12,713 18,124 21,553 27,840 43,532 48,512 Other revenue 1, ,185 1,423 Other Revenue Total Revenue 8,742 10,984 12,964 18,824 22,376 28,828 44,717 49,934 Other income (27) COGS (7,999) (10,560) (12,274) (16,830) (19,829) (25,489) (39,510) (44,103) SG&A (842) (1,806) (2,147) (2,784) (3,715) (4,468) (6,260) (6,841) Other op.expenses Operating profit (126) (545) (1,449) (672) (827) (691) (374) (251) Net-interest inc./(exp.) (128) (41) (193) (169) (307) (458) (572) (633) Assoc/forex/extraord./others 5,773 4,643 2,641 3,470 4,187 4,895 5,310 5,380 Pre-tax profit 5,520 4,057 1,000 2,629 3,053 3,746 4,364 4,496 Tax (2) (101) (126) (155) (180) (186) Min. int./pref. div./others (1,225) Net profit (reported) 4,295 4,272 1,134 2,653 3,185 3,891 4,533 4,670 Net profit (adjusted) 4,294 4,272 1,134 2,653 3,185 3,891 4,533 4,670 EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT (127) (545) (1,449) (672) (827) (691) (374) (251) EBITDA 72 (55) (781) ,331 1,724 Cash flow (CNYm) Year to 31 Dec E 2016E 2017E Profit before tax 5,520 4,057 1,000 2,629 3,053 3,746 4,364 4,496 Depreciation and amortisation ,216 1,441 1,704 1,975 Tax paid (42) (81) (117) (172) (83) (155) (180) (186) Change in working capital (825) (422) 1, , Other operational CF items (5,859) (4,677) (2,621) (3,426) (4,450) (4,078) (4,322) (4,156) Cash flow from operations (1,008) (633) ,303 3,128 2,638 Capex (1,349) (2,244) (2,948) (1,904) (3,511) (3,696) (3,806) (3,922) Net (acquisitions)/disposals (835) (1,079) (1,307) (1,077) (89) Other investing CF items 4,143 3,056 6,585 3, ,345 3,916 4,248 Cash flow from investing 1,960 (267) 2, (3,252) (351) Change in debt , ,500 4,000 5,000 Net share issues/(repurchases) Dividends paid (840) (686) (1,757) (538) (1,172) (1,030) (1,258) (1,465) Other financing CF items (55) 56 (31) (817) (988) (1,224) Cash flow from financing (434) (201) (1,749) 3,512 (909) 654 1,755 2,311 Forex effect/others Change in cash 518 (1,102) 1,065 4,767 (3,813) 1,605 4,993 5,275 Free cash flow (2,356) (2,877) (2,463) (1,356) (3,163) (2,393) (678) (1,284) Source: FactSet, Daiwa forecasts 73

74 Guangzhou Automobile Group (2238 HK): 4 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment 9,382 8,239 9,316 14,083 10,268 11,874 16,866 22,141 Inventory 1,353 1,537 1,397 2,036 2,661 2,832 4,390 4,900 Accounts receivable 2,845 2,980 3,303 4,725 5,515 7,105 11,021 12,307 Other current assets 6,242 8,903 6,258 5,669 8,434 8,434 8,434 8,434 Total current assets 19,822 21,659 20,274 26,514 26,878 30,245 40,712 47,783 Fixed assets 3,028 4,309 5,927 7,366 8,536 9,916 11,250 12,535 Goodwill & intangibles 2,112 3,257 4,141 4,234 5,499 6,373 7,142 7,804 Other non-current assets 13,558 15,388 19,091 19,729 21,459 23,009 24,403 25,535 Total assets 38,520 44,612 49,434 57,843 62,372 69,544 83,507 93,656 Short-term debt 1,053 2,100 2,515 9,397 9,541 10,041 11,041 12,041 Accounts payable 3,254 4,069 6,376 8,637 10,645 12,744 19,755 22,051 Other current liabilities Total current liabilities 4,339 6,206 9,030 18,059 20,222 22,832 30,869 34,174 Long-term debt 7,950 7,737 7,776 4,775 4,769 6,769 9,769 13,769 Other non-current liabilities ,212 1,212 1,212 1,212 Total liabilities 12,676 14,426 17,370 23,727 26,203 30,814 41,850 49,155 Share capital 6,148 6,148 6,435 6,435 6,435 6,435 6,435 6,435 Reserves/R.E./others 19,463 23,062 24,707 26,876 28,938 31,799 35,075 38,279 Shareholders' equity 25,612 29,210 31,142 33,311 35,373 38,234 41,510 44,714 Minority interests (213) Total equity & liabilities 38,520 44,612 49,434 57,843 62,372 69,544 83,507 93,656 EV 23,869 25,574 22,397 19,851 23,527 22,572 19,836 18,070 Net debt/(cash) (379) 1, ,042 4,936 3,943 3,669 BVPS (CNY) Key ratios (%) Year to 31 Dec E 2016E 2017E Sales (YoY) n.a EBITDA (YoY) n.a. n.a. n.a. n.a Operating profit (YoY) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net profit (YoY) n.a. (0.5) (73.5) Core EPS (fully-diluted) (YoY) n.a. (24.4) (74.4) Gross-profit margin EBITDA margin 0.8 n.a. n.a Operating-profit margin n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net profit margin ROAE ROAA ROCE n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. ROIC (0.5) (1.9) (4.5) (1.9) (2.1) (1.6) (0.8) (0.5) Net debt to equity net cash Effective tax rate 0.0 n.a. n.a Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts Company profile GAC is engaged in the manufacturing of vehicles and parts, as well as automobile finance and insurance and related services. It sells passenger vehicles under the Trumpchi marque, passenger and commercial vehicles under Gonow, SUVs under Changfeng Motor, and buses under GAC Bus. GAC has also formed JVs with a number of foreign brands, including Honda, Toyota, Mitsubishi and Fiat to sell passenger vehicles. It sells commercial vehicles through its GAC Bus and GAC Hino businesses. 74

75 Guangzhou Automobile Group (2238 HK): 4 January 2016 Tough times ahead in 2016 We believe the Japanese brands will likely lose market share to both Chinese and European luxury brands as a result of licensing restrictions Losing market share to local and luxury brands Mid-range Japanese brands losing market share on licensing restrictions In an effort to combat air pollution and traffic congestion, top-tier cities in China, like Beijing, Shanghai, Guangzhou, Shenzhen and Tianjin, have introduced policies to restrict new car registrations and curb the ownership of private cars in China. We believe more cities will follow suit in Japanese brands, such as Toyota and Honda, to which GAC has significant exposure via its various JVs, and which focus on mid-range sedans, would be impacted the most over the next few years, in our view. Under the licensing restrictions, we see Japanese brands in first-tier cites losing market share to European luxury brands, and in lower-tier cities to local Chinese brands. The reasons are as below: 1) In higher-tier cities where licence restrictions have been imposed, first-time car buyers, due to their relative affluence, are likely to purchase luxury cars, while replacement car buyers in these cities would seek to upgrade to premium European cars, given the marginal extra cost required versus upgrading to a mid-range sedan. 2) In lower-tier cities where restrictions have not yet been imposed and where disposable incomes are on the rise, first-time buyers would likely opt for entry-level local brand cars for their value, not mid-level sedans. GAC: market share since January 2015 (Market share %) 8% 7% 6% 5% 4% 3% Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 GAC's Market Share in China PV market (LHS) Growth YoY (RHS) Source: CAM (YoY %) 40% 30% 20% 10% 0% -10% A latecomer to China s SUV boom; profitability of new SUVs to deteriorate in 2016 on keen competition GAC s model portfolio is skewed to the slowing sedan market in 2015 China s SUV market posted robust sales-volume growth of 54% YoY for January to November 2015, accounting for 29% of total PV sales. However, by our estimates, more than 70% of the units GAC sold in 2015 comprised vehicles from the slowing sedan segment, while SUVs and MPVs combined accounted for only 30% of its total sales volume due to the company s limited range of SUV models. GAC, as a result, failed to catch China s SUV boom and became trapped in the keenly contested sedan market in Based on its product launch pipeline, the company seem to be making a concerted effort to increase its SUV exposure, including launching a GAC-Mitsubishi Outlander-PHEV and self-owned GS4-EV in 2016, after the launch of the Cherokee in 2H15. However, we believe the profitability of its new SUV models in 2016 would not be as good as it was in

76 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Guangzhou Automobile Group (2238 HK): 4 January 2016 Despite our forecast for continuous strong SUV sales unit growth of 33% YoY for 2016E (especially if we compare the 28% SUV penetration in China versus over 40% in the US), margins on the SUV will likely see a deterioration over the next 2 years given the intensifying competition in the segment as several other OEMs rushed into this lucrative segment of the market. Given the current visibility, about one-third of the new models launched during 2H15-1H16 will be SUVs, contributing around 35% of the total new model auto sales volume for China during the period. GAC: product mix 100% 80% 60% 40% 20% 0% 100% 80% 60% 40% 20% 0% GAC: product pipeline (2H ) GAC product pipeline 2H Model Type Launch time GAC Honda New City* Sedan 2H15 Crider (Facelift) Sedan 2H15 (Dec) Crosstour (Facelift) Sedan 2H15 (Dec) Acura SUV SUV 2016 GAC Toyota Levin HEV* Hybrid Sedan 2H15 Lingzhi EV EV Sedan 2016 GAC Fiat-Chrysler Cherokee SUV 2H15 GAC Mitsubishi Outlander PHEV PHEV SUV 2016 GAMC GS4 EV EV SUV 2016 GA3S PHEV PHEV Sedan 2016 Sedan SUV MPV Source: CAM Source: Company, various media Note: *already launched We forecast the 2016E and 2017E net profit to rise by 17% and 3% YoY respectively, impacted by a decreasing margin Financial forecasts We believe GAC Honda and GAC Toyota will continue to be the 2 key earnings contributors for GAC. However, Japanese brands and slowing sales volume amid the high operating leverage environment for the auto OEMs suggest that the net margin for the Japanese JVs is likely to come under increasing pressure. We are revising up our revenue forecasts for GAC by 17-76% for E on a potential forward shift in demand from China s purchase tax cut, and the strong sales-volume performance of the self-owned GS4. However, we are raising our earnings forecasts to a lesser extent, 3-11%, for E due to the potential for a margin decline. We now forecast GAC s net profit to rise by 22% YoY to CNY3.9bn for For 2016, we look for GAC s net profit to rise by 17% YoY for 2016, but slow to 3% YoY for 2017, due to the aforementioned forward shift in demand to 2016 on the purchase tax cut. We forecast GAC Honda to post sales volume growth of 14% YoY to 650k units in 2016, slowing from 19% YoY growth for The Honda City should help offset part of the volume slowdown in 2015, in our opinion. However, margins across the board could be under pressure given GAC s aggressive price discounting and its weaker-than-peer product mix. The Highlander SUV, contrary to its past strong sales performance, sold more than 9,000 units in October 2015, stronger than our previously forecast normalised sales-volume level of 6,000-7,000 units per month for the rest of the year. Such a result could be due to pentup demand as car buyers have been waiting for the new-generation model which was launched in April Having said that, we expect demand for high-end SUVs to continue to be strong, with few competitors in China in this niche market. 76

77 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Guangzhou Automobile Group (2238 HK): 4 January 2016 Valuation and recommendation Maintain Hold (3) rating with new TP of HKD7.0 We maintain our Hold (3) rating on GAC and set a new 12-month target price of HKD7.0 (from HKD6.40 previously), based on an unchanged 8.5x PER on our 2016E EPS forecast (from the 2015E-16E average previously), which is at the low end of the target PER range of x that we apply to the auto OEMs under our coverage. Our target price implies 1% upside from current levels. We expect GAC to continue to register negative free cash flow of CNY2-3bn per year over our forecast horizon on continual R&D and production capacity expansion. Dividends received from its JVs are unlikely to see significant growth on the sluggish performance of its Japanese brands. We see the potential for Japanese cars, to which GAC has large exposure, losing market share to premium European brands and other local brand rivals under strengthening licensing restrictions and intensifying competition in the sedan market. As such, sales momentum for GAC s high-end models is likely to be weak, as first-time buyers in lowertier cities opt for low-end cars or local brands, and replacement car buyers in higher-tier cities prefer luxury models and SUVs. However, the stock s current valuation, trading at the low end range of our coverage of China auto OEMs, looks well justified to us. GAC: PER bands (x) (PER) GAC: PER based valuation 2016E EPS (CNY) 0.70 PER (x) 8.5x Exchange rate, HKD1:CNY 0.85 Equity value/share (HKD/share) 7.00 Current price (HKD) 6.94 Potential share price upside/downside (%) 1% Implied target 2017E PER 8.2x 7 5 Source: Bloomberg, Daiwa forecasts PER +1 SD Average PER -1 SD Source: Daiwa forecasts Risks The main risk to our call on GAC is currency risk. The fluctuation of the Yen implies higher or lower prices of imported components for GAC s Japanese JVs. If the Yen depreciates/ appreciates against the CNY, this would imply upside/downside for the earnings of GAC Honda and GAC Toyota, which are currently the main profit contributors to the company. Other company-specific risks include better- or worse-than-expected sales volume from newly launched SUV models, and narrowing losses for its self-owned brands benefiting from the purchase tax cut, which would imply upside potential for our earnings forecasts. 77

78 Brilliance C hina Automoti ve China Consumer Discretionary 4 January 2016 Brilliance China Automotive (1114 HK) Target price: HKD8.90 Share price (28 Dec): HKD9.84 Up/downside: -9.6% Initiation: improving pipeline but expectations too high BMW Brilliance pipeline should do better in 2016 But market expectations look too high Initiating with Underperform (4) rating and TP of HKD8.90 Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com Investment case: We initiate coverage of Brilliance China with an Underperform (4) rating. On the one hand, the pipeline for 2016 looks promising, with the launch of the 3-series facelift in September 2015 and the coming 2-series sedan and X1 SUV in 2016 (we look for EPS growth of 14-16% YoY, after declining by 38% YoY in 2015E). But on the other hand, we believe Bloomberg-consensus expectations of an earnings recovery in are too optimistic. Our E EPS are 16-25% lower than consensus, mainly as we are more cautious on the impact of the purchase tax cut on the company s bottom line. Despite this, we expect BMW Brilliance to meet its 2015 sales volume target of 4% YoY. Catalysts: While unit sales of the 3-series facelift may be a near-term sales volume driver, sales of the X1 SUV are likely to continue to deteriorate until the launch of the new version, which we assume will be mid As such, we assume the new X1 SUV will boost overall X1 sales, resulting in 6% YoY growth in 2016, and 24% YoY in For the 2- series model, we expect monthly sales of around 2,000-2,500 units in We do not expect the 2-series to be as much of an earnings contributor over the next 2 years compared with the 3- and 5-series models. Separately, the purchase-tax cut should boost sentiment on the sector, but this should be less relevant to BMW Brilliance s financials as most of its models/sales are not eligible for the tax cut (ie, engines are bigger than 1.6L). Thus, we think current consensus forecasts have factored in overly optimistic expectations for earnings growth in Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Brilliance (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 5,026 Major shareholder Huachen Automotive Group (42.5%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 5,085 5,543 5,503 Operating profit (m) (423) (395) (353) Net profit (m) 3,340 3,873 4,405 Core EPS (fully-diluted) EPS change (%) (38.2) Daiwa vs Cons. EPS (%) (15.6) (21.5) (24.6) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) n.a. n.a. n.a. ROE (%) Valuation: The stock is trading currently at a 2016E PER of 11x, which is in line with its past-3-year average. However, with Beijing Benz emerging as a strong competitor and what we see as Brilliance s less-attractive model launches in (vs. Benz), we apply a 2016E PER of 10x (a 10% discount to its past-3-year average, which we think is appropriate given the circumstances), to derive our 12-month TP of HKD8.90. We initiate coverage with an Underperform (4) rating and expect to see downward consensus forecast revisions, leading to negative stock sentiment. Risks: The major risk to our call would be higher-than-expected new-car sales for the company, especially sales of its new models such as the 2- series sedan and new X1 SUV (scheduled to hit the market in 2016). See important disclosures, including any required research certifications, beginning on page 103

79 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Brilliance China Automotive (1114 HK): 4 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We forecast Brilliance s net profit to decline by 38% YoY for 2015 as a result of its weak pipeline and new car sales in China. However, with a better pipeline in late 2015 and 2016 (including the 3-series facelift, 2-series sedan and X1 SUV), we look for net profit to recover to 16% YoY growth in 2016 and 14% YoY in Brilliance: net profit and net profit growth (CNYm) 6,000 5,000 4,000 3,000 2,000 1, E 2016E 2017E Net profit (LHS) Growth YoY (RHS) Source: Company, Daiwa forecasts (YoY%) 80% 60% 40% 20% 0% (20%) (40%) (60%) Valuation Brilliance: 12-month forward PER (x) ( ) The stock is trading currently at 2016E PER of 11x based on our earnings forecasts, which is in line with the past-3- year consensus average. We expect more downside to the current valuation given that the competition from Beijing Benz has ramped up in 2015 and also as we expect downward earnings revisions to occur over the next 6 months after Brilliance announces its 2015 results. The recent purchase tax reduction should boost sentiment toward the stock slightly, but is unlikely to lead to a strong rerating to a level well above its past-3-year average. (PER) Source: Company, Daiwa forecasts PER +1 SD Average PER -1 SD Earnings revisions Our E EPS are 16-25% lower than the Bloombergconsensus figures, as we expect BMW Brilliance to just about meet its 2015 sales growth target of 4% YoY, and also because we expect the impact of the purchase tax reduction to be less significant for Brilliance. The fiercer competition in the auto industry is also having an impact on the bottom line. Brilliance: Bloomberg consensus EPS forecast revisions (CNY) Source: Bloomberg 2015E 2016E 79

80 Brilliance China Automotive (1114 HK): 4 January 2016 Financial summary Key assumptions Year to 31 Dec E 2016E 2017E BMW Sales volume 70, , , , , , , ,000 BMW blended ASP 305, , , , , , , ,000 Local brands sales volume 95,000 82,000 83,000 84,000 78,000 64,000 59,000 57,000 Local brands blended ASP 94,000 78,000 72,000 73,000 71,000 70,000 69,000 68,000 Profit and loss (CNYm) Year to 31 Dec E 2016E 2017E Domestic revenue n.a. 6,151 5,319 5,430 4,639 4,475 4,878 4,843 Overseas revenue n.a Other Revenue n.a (0) 0 Total Revenue 8,949 6,443 5,916 6,103 5,515 5,085 5,543 5,503 Other income COGS (7,725) (5,587) (5,220) (5,417) (4,952) (4,729) (5,128) (5,063) SG&A (825) (749) (878) (1,008) (987) (957) (1,004) (986) Other op.expenses Operating profit (99) (234) (258) (423) (395) (353) Net-interest inc./(exp.) (92) (117) (100) (92) (103) (102) (135) (125) Assoc/forex/extraord./others 1,034 1,862 2,494 3,650 5,704 3,828 4,359 4,834 Pre-tax profit 1,465 1,949 2,295 3,325 5,343 3,303 3,829 4,356 Tax 54 (58) (58) (8) (43) (27) (31) (35) Min. int./pref. div./others (248) (79) Net profit (reported) 1,271 1,812 2,301 3,374 5,403 3,340 3,873 4,405 Net profit (adjusted) 1,271 1,812 2,301 3,374 5,403 3,340 3,873 4,405 EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT (99) (234) (258) (423) (395) (353) EBITDA (95) (119) (265) (210) (143) Cash flow (CNYm) Year to 31 Dec E 2016E 2017E Profit before tax 1,465 1,949 2,295 3,325 5,343 3,303 3,829 4,356 Depreciation and amortisation Tax paid (49) (12) (3) (9) (47) (27) (31) (35) Change in working capital 531 (1,001) (108) (83) 1,100 (102) 239 (45) Other operational CF items (907) (1,702) (2,325) (3,526) (5,766) (3,665) (4,196) (4,671) Cash flow from operations 1,180 (628) (2) (154) 770 (333) 26 (186) Capex (431) (306) (526) (616) (737) (958) (958) (958) Net (acquisitions)/disposals 46 (301) (435) Other investing CF items (1,076) ,057 1,387 1,360 1,754 2,177 Cash flow from investing (1,461) ,219 Change in debt (268) Net share issues/(repurchases) Dividends paid (394) (437) (553) (465) (529) Other financing CF items (1,212) 25 (143) (7) (3) (163) (163) (163) Cash flow from financing (900) 722 (110) (250) (709) (716) (627) (691) Forex effect/others Change in cash (1,181) (647) Free cash flow 749 (934) (528) (770) 32 (1,291) (932) (1,144) Source: FactSet, Daiwa forecasts 80

81 Brilliance China Automotive (1114 HK): 4 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment , ,068 Inventory Accounts receivable 3,018 1,881 1,812 2,220 1,964 1,811 1,974 1,960 Other current assets 2,861 2,828 2,931 2,632 2,406 2,406 2,406 2,406 Total current assets 7,098 6,032 6,417 6,524 6,345 5,509 5,931 6,248 Fixed assets 1,585 1,670 1,745 1,686 1,960 2,440 2,904 3,350 Goodwill & intangibles ,055 1,375 1,686 1,987 Other non-current assets 4,285 4,848 7,471 10,050 13,847 16,315 18,919 21,577 Total assets 13,220 12,811 16,058 18,990 23,207 25,639 29,440 33,161 Short-term debt 3,593 3,087 2,827 2,826 3,223 3,139 3,289 3,264 Accounts payable 2,788 2,466 3,120 2,991 2,963 2,830 3,068 3,029 Other current liabilities 1,581 1, Total current liabilities 7,962 6,572 6,857 6,793 7,134 6,843 7,310 7,239 Long-term debt Other non-current liabilities Total liabilities 7,964 6,573 6,859 6,849 7,253 6,962 7,429 7,358 Share capital 6,325 6,989 10,015 13,015 16,931 16,931 16,931 16,931 Reserves/R.E./others ,787 6,195 10,072 Shareholders' equity 6,325 6,989 10,015 13,015 16,931 19,719 23,126 27,003 Minority interests (1,069) (752) (816) (874) (977) (1,041) (1,116) (1,200) Total equity & liabilities 13,220 12,811 16,058 18,990 23,207 25,639 29,440 33,161 EV 40,385 38,974 35,730 33,027 29,698 27,730 25,006 21,898 Net debt/(cash) 3,165 2,501 1,991 1,923 2,044 2,608 2,563 2,197 BVPS (CNY) Key ratios (%) Year to 31 Dec E 2016E 2017E Sales (YoY) 45.5 (28.0) (8.2) 3.2 (9.6) (7.8) 9.0 (0.7) EBITDA (YoY) (15.8) (48.3) (88.1) n.a. n.a. n.a. n.a. n.a. Operating profit (YoY) 60.3 (60.8) n.a. n.a. n.a. n.a. n.a. n.a. Net profit (YoY) n.a (38.2) Core EPS (fully-diluted) (YoY) n.a (38.2) Gross-profit margin EBITDA margin n.a. n.a. n.a. n.a. n.a. Operating-profit margin n.a. n.a. n.a. n.a. n.a. n.a. Net profit margin ROAE ROAA ROCE n.a. n.a. n.a. n.a. n.a. n.a. ROIC (1.0) (1.8) (1.6) (2.1) (1.7) (1.3) Net debt to equity Effective tax rate n.a Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout Free cash flow yield 1.8 n.a. n.a. n.a. 0.1 n.a. n.a. n.a. Source: FactSet, Daiwa forecasts Company profile Brilliance China Automotive is an automotive manufacturer in China. Through BMW Brilliance Automotive, a joint venture formed with BMW, the group produces the BMW 3-series sedan, 5- series sedan and X1 SUV in China. Further, BMW Brilliance plans to introduce a BMW 2-series sedan and X3 SUV in the near future to diversify its product range. The group also manufactures and sells minibuses under its own brand, Jinbei, and in 2014 introduced a premier product line, namely Huasong. In addition to auto manufacturing, Brilliance is also engaged in the manufacture of automotive components as well as diesel engines and gasoline engines for use in minibuses, sedans, SUVs and light duty trucks. 81

82 Brilliance China Automotive (1114 HK): 4 January 2016 Fighting back We forecast BMW Brilliance s new car sales to rise by 4% YoY in 2015 A better year in 2016 Behind target for 2015 BMW sales in China (represented by BMW Brilliance) have been disappointing this year, with only a 2.6% increase in November 2015 YTD, and significantly lagging the sales of Mercedes Benz (represented by Beijing Benz), which were up 93%YoY in November YTD. We believe the disappointing BMW sales were a result of BMW Brilliance s weak product pipeline in 2H14, during which it only introduced a facelift for the X1 SUV, while Benz launched its new C-class sedan and GLA SUV models. As a result, at the 1H15 results briefing, Brilliance revised down its 2015 unit sales-growth target from 10% YoY set in early 2015 to 4% YoY. We now expect BMW Brilliance to just about achieve its revised 2015 sales growth target, mainly due to a pick-up in sales in November and December. That said, we believe the market is being overly optimistic on the effects on BMW Brilliance of the recent purchase tax cut, which was announced on 29 September 2015, as most of the models (around 97%) manufactured by BMW Brilliance have engines that are larger than 1.6L, which means they are not eligible for the tax reduction. With reference to its new car sales in October 2015, when the tax reduction was implemented, BMW Brilliance recorded only a 3.5% YoY increase in sales, lagging behind the market s 13% YoY increase. However, unit sales in November increased substantially, by 18% YoY, driven mainly by the 3-series and 5-series sedans, for which sales rose by 32% YoY and 20% YoY, respectively. Although we think BMW Brilliance is likely to achieve its targeted 4% YoY sales volume in 2015, we expect the net profit margin in 2015 to decline by 4.0pp YoY, due to a decline in ASPs as a result of fierce competition. November 2015 YTD sales for BMW Brilliance and Beijing Benz YTD Nov sales units YoY % Brilliance BMW 262, % Beijing Benz 220, % Source: CAM Price trend of the middle configuration of BMW 3-Series (320Li) and 5-Series (525Li) (Price, CNY) 450,000 (Price, CNY) 450, , , ,000 Price increase due tolaunch of 3-Series facelift 350, , , ,000 Source: CAM Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Price of Mid config of BMW 320Li Price of Mid config of BMW 525Li 250,000 82

83 Brilliance China Automotive (1114 HK): 4 January 2016 BMW Brilliance: 3-series sedan (new facelift model) Source: company 2-series unlikely to replace the position of the 3- and 5-series Improving product pipeline in 2016, but not enough To reverse the weak growth trend for new-car sales, BMW Brilliance has planned a much better pipeline in Apart from the launch of the facelift for its 3-series model in September 2015, BMW Brilliance plans to launch a new 2-series sedan (first time in China) and a new X1 SUV in The 2-series is a new size of compact sedan in China. While we are not that positive on small sedans overall, if the pricing is not aggressive, such a product could still be an incremental sales booster for BMW. On a global basis, the 2- series sedan (which was launched in other countries in 2014) comprised around one-third of the sales of the 3-series. We therefore assume the new sedan can achieve monthly sales of only around 2,000-2,500 units in 2016, albeit still incrementally positive for BMW Brilliance s new-car sales. BMW: retail sales volume by model H15 1-series 216, , , , , ,033 86,029 2-series ,038 64,285 3-series 397, , , , , , ,369 4-series , ,580 79,351 5-series 175, , , , , , ,228 6-series 8,648 5,848 9,396 23,193 27,687 23,988 11,393 7-series 52,680 65,814 68,774 59,184 56,001 48,519 19,324 X1 8,499 99, , , , ,471 58,226 X3 55,634 46, , , , ,915 66,444 X ,688 28,146 X5 88, , , , , ,381 85,983 X6 41,667 46,404 40,822 43,689 36,688 30,244 22,125 Z4 22,761 24,575 18,809 15,249 12,866 10,802 4,576 BMW i ,793 12,562 Total 1,068,770 1,224,280 1,380,384 1,540,085 1,655,138 1,811, ,041 Source: company More significant contribution from X1 SUV in 2017E With respect to the new X1 SUV, we believe it will help BMW Brilliance recapture market share in the SUV market. The average X1 SUV has sold around 3,300 units/month as at November 2015 YTD, and we see this trend continuing until the launch of the X1 SUV facelift. Therefore, even though the new X1 SUV model may be able to achieve a higher level of sales of 4,500 units/month by the end of 2016, the average monthly sales in 2016 would still be just 3,625 units/month, an increase of 6% YoY on our forecasts. However, we see the X1 SUV s unit sales rising in 2017 to post 24% YoY sales volume growth. Overall, with the company s low base in 2015, we see a good chance that BMW Brilliance s fortunes will turn around in 2016 and 2017, and that the company will achieve new car sales growth of 15% YoY in 2016 and 11% YoY in 2017, on new model launches. Based on 83

84 Brilliance China Automotive (1114 HK): 4 January 2016 the YTD November sales number, BMW is still one of the leading luxury brands in China, even though we expect Beijing Benz to match its sales closely in Product pipeline of luxury cars Company Model Segment Launch date 3-series (Facelift) Sedan Sep-2015 Brilliance BMW 2-series Sedan 2016 X1 SUV 2016 FAW VW Audi Q7 SUV Dec-2015 A6 (Facelift) Sedan 2016 C350eL Sedan (Hybrid EV) Nov-2015 Beijing Benz GLC SUV 2016 New E-class Sedan 2016 Shanghai GM Cadillac ATS-L (Facelift) Sedan Oct-2015 CT6-40T Sedan end of 2015 Chery Jaguar Land Rover Discovery Sport SUV Nov-2015 Source: various media BMW Brilliance: 2-series Active Tourer BMW Brilliance: X1 SUV (new model) Source: company Source: company November 2015 YTD luxury brands sales in China YTD Nov sales units YTD YoY % FAW VW Audi 463, % Brilliance BMW 262, % Beijing Benz 220, % Volvo Car 58, % SAIC GM Cadillac 47, % Dongfeng Infiniti 22, % Source: CAM Brilliance: new vehicle sales forecasts 2015E 2016E 2017E BMV JV sales volumes 290, , ,000 3-series 98, , ,000 5-series 151, , ,000 X1 41,000 44,000 54,000 2-series - 29,000 30,000 1-series ,000 Shenyang Automotive(Jinbei minibuses)sales volume 64,000 59,000 57,000 Haise minibuses 55,000 50,000 47,000 Granse minibuses 9,000 9,000 9,000 Huasong 7 MPV 3,000 6,000 7,000 Source: Daiwa forecasts 84

85 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Brilliance China Automotive (1114 HK): 4 January 2016 Beijing Benz is catching up fast Market share may flow to Benz With many top-tier cities having imposed licence restrictions, we expect car buyers to favour luxury brands (such as BMW, Benz and Audi) over mid-range brands (such as Korean and Japanese brands) due to the expensive new car licence-plate fee and as the number of new licences are limited. As a result of rising disposable incomes in China and more luxury brands launching more affordable entry-level models, we believe mid-range cars will be squeezed. Such a situation is evidenced by the consistently strong, mostly double-digit, unit sales growth in the luxury segment in China (see the chart below). This was true even amid the slowdown in overall new car sales growth in China in 2015, and even when overall sales declined for some months. Even though this is a positive factor for BMW Brilliance, the company is currently up against strong competition from Beijing Benz. Compared to the start of 2014, when BMW Brilliance s monthly sales volume was double that of Beijing Benz, in November YTD 2015, Beijing Benz sales volume was already 93% of BMW Brilliance s, and we expect Beijing Benz to overcome BMW Brilliance to become the second most popular luxury brand in China (the No.1 is likely still FAW Audi). China new car licence restrictions in different cities Cities Plate issuance through Implementation date Quota (annual) Shanghai Bidding ,000 Beijing Lottery 12/23/ ,000 Guiyang Lottery 7/11/ ,000 Guangzhou Bidding and lottery 6/30/ ,000 Tianjin Bidding and lottery 12/15/ ,000 Hangzhou Bidding and lottery 3/25/ ,000 Shenzhen Bidding and lottery 12/29/ ,000 Luxury brand sales in China (Sales unit) (YoY %) 120,000 60% 100,000 40% 80,000 60,000 20% 40,000 0% 20,000 0 (20%) Source: Local governments, various media reports Source: CAM Luxury brands monthly sales (LHS) China overall PV YoY (RHS) Luxury brands YoY (RHS) Luxury brands: combined market share in 2015 (Luxury brands) 8% 7% 6% 5% 4% 3% 2% 1% 0% (German brands) 25% 20% 15% 10% 5% 0% Luxury brand breakdown (Breakdown of luxury brands, sales %) 100% 80% 60% 40% 20% 0% Source: CAM Luxury brands' overall market share in China (LHS) German brands' overall market share in China (RHS) Source: CAM Beijing Benz Brilliance BMW FAW VW Audi Dongfeng Infiniti SAIC GM Cadillac Volvo Brilliance should benefit the least from the purchase tax reduction Positive sentiment from purchase tax reduction On 29 September 2015, the China State Council announced a series of supportive policies for the auto sector, including a purchase tax reduction from 10% to 5%. Such measures should help boost overall new car sales in China, which we now forecast to increase by 12% YoY in 2016 (previously 4% YoY) from 7% YoY in However, Brilliance not likely to see much of a benefit from the purchase tax reduction, as only a small proportion of its car models have engine sizes smaller than 1.6L. Nevertheless, we expect the policy to help partly boost sentiment for the overall China Auto Sector. 85

86 Brilliance China Automotive (1114 HK): 4 January 2016 Brilliance BMW: YTD 2015 sales by engine size 3-series engine size <=1.6L 6.3% engine size >1.6L 93.7% 5-series engine size <=1.6L 0.0% engine size >1.6L 100.0% X1 engine size <=1.6L 0.0% engine size >1.6L 100.0% Brilliance BMW total engine size <=1.6L 2.1% engine size >1.6L 97.9% Source: CAM Note: Only 2L and 3L engine size model available for 5-series and only 2L engine size model for X1 We do not expect any higher rebates given current weak auto sales Lower YoY impact on increasing dealer margins After experiencing weak auto demand in 2H14, which led to many dealers in China having to sell at a loss to clear the previous high inventory, dealers in China joined forces to bargain for better rebates and a more frequent review of sales targets and incentive payments by OEMs to dealers. So far, the alliance has been successful in terms of bargaining for better margins from OEMs, such as BMW, Jaguar Land Rover (JLR) and Audi, and a more frequent review of sales targets on a quarterly basis (previously annual basis). In BMW s case, it paid CNY5.1bn in cash rebates to dealers in However, we believe such an impact will diminish in 2016, as BMW and the other OEMs are likely to revise down their sales targets and control their production to better fit demand which we believe was the case in 2H15. We believe the OEMs are now more concerned about ASP and margin erosion rather than chasing volume growth. Therefore, we think it unlikely that BMW will offer additional rebates to dealers in 2016, as it did in 2015 and Negotiations between BMW and its Chinese dealers Date Events 2H14 China auto market deteriorated unexpectedly in 2H14 and BMW missed the chance to adjust its yearly sales targets which caused most of the BMW dealers to pile up around 2-3 months of inventory (usually should be around 1.5 months). In order to gain the rebates offered by BMW, dealers started to cut prices to meet what they saw as unachievable sales targets. Late - Nov, 2014 Some BMW dealers started to take the lead and contacted other dealers, and eventually they formed an alliance. Early - Dec, 2014 The dealer alliance had 2 meetings with BMW, during which both sides preliminarily agreed on a subsidy of less than CNY6bn. Late - Dec, 2014 The two parties finalised a subsidy of CNY5.1bn. 17 April, 2015 BMW China and BMW Brilliance issued a circular to their dealers to reduce sales targets for 2Q15. Further, they announced that dealers achieving 85% of their sales targets would also be entitled to rebates, while those achieving equal to or more than 90% of their sales targets would get bonus rebates. Early - July, 2015 BMW China released more details of the rebate policy for 1H15. For imported models, dealers that achieve 100% of their sales targets are granted CNY16,000/vehicle sold, while for localised models, dealers that achieve 100% of their sales targets are granted CNY18,000/vehicle sold. For dealers that do not achieve 100%, but were above 85% of their sales target, they still get a rebate but it is lower. Source: Caxin, Sina Likely no near-term impact on the bottom line from CNY depreciation Low net gearing compared with peers indicates strong financials CNY depreciation only having a slight effect According to management, the company has already hedged most of its currency exposure and would not incur any forex gains or losses over the next 3 years. On the income statement, it may record a lower contribution from BMW Brilliance as the cost of BMW Brilliance would be recorded in Euros, while it receives revenue in CNY. Daiwa s chief economist, Kevin Lai expects the CNY to depreciate further by 4.8% against the Euro by the end of However, due to hedging, we believe BMW Brilliance s contribution should not be affected significantly by such currency movements. Financial analysis Relatively strong financials, but net margin should fall in coming years Between 2010 and 2014, Brilliance s net gearing ratio declined gradually from 50% to 12%. We believe one of the major reasons for this was that BMW Brilliance started to pay dividends to Brilliance China in 2011: CNY200m in 2011, CNY500m in 2012, CNY1,000m in 2013 and CNY1,250m in We expect this payout policy to continue, as BMW Brilliance s business is approaching maturity and it is capable of financing its own opex 86

87 Brilliance China Automotive (1114 HK): 4 January 2016 and capex. We consider Brilliance s current overall financials as healthy, due to its lowerthan-average net gearing ratio compared with its China peers and overseas counterparts. Brilliance: net gearing ratio 60% 50% 50% 40% 36% 30% 20% 10% 6% 20% 15% 12% 13% 11% 8% 0% Source: company, Daiwa forecasts Note: net gearing ratio calculated as (net debt/equity) Global major auto OEMS: net debt-to-equity ratio comparison ( ) China H-share listed China A-share listed US net cash net cash net cash net cash net cash Europe net cash Japan Korea Global Source: Bloomberg E 2016E 2017E Net gearing Daiwa forecasts But net profit margin might have peaked in 2014 Since 2009, we have observed a general uptrend in Brilliance BMW s net profit margin, which reached an all-time high of 11.7% in However, we believe the 2015 net profit margin is likely be adversely affected by the increase in rebates demanded by BMW Brilliance s dealers and general pressure on new-car sales in China. We expect this effect to last until end We forecast Brilliance BMW s net-profit margin to fall to 7.7% in BMW Brilliance: net margin ( E) 14% 12% 11.7% 10% 8% 8.3% 9.2% 8.3% 9.4% 7.7% 7.7% 7.7% 6% 4% 4.8% E 2016E 2017E Net margin Daiwa forecasts Source: company, Daiwa forecasts We expect payouts of 17% in 2015 and 12% in Brilliance started to pay a dividend in 2013, and its payout ratio was 12% in 2013 and 8% in We believe a payout ratio ranging from 10-15% is a reasonable assumption, and now assume payout ratios of 17% in 2015 and 12% in both 2016 and

88 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Brilliance China Automotive (1114 HK): 4 January 2016 Valuation and recommendation Negatives from competition and lack of benefit from purchase tax reduction don t look priced in Downside expected The stock is currently trading at 2016E PER of 11x based on our earnings forecasts, in line with its past-3-year average. We see more downside from the current valuation as we believe BMW Brilliance is currently facing much more competition from Beijing Benz than it was before. Also, BMW Brilliance is less likely to benefit from the purchase-tax reduction, and therefore investors are likely to focus more on local brands in Our E EPS are 16-25% lower than those of the Bloomberg consensus and, therefore, we expect more downward revisions to earnings forecasts, which could create negative sentiment on the stock. We believe the market is too optimistic about BMW Brilliance s planned new-model launches. We initiate coverage with an Underperform (4) rating Looking for a better entry point We initiate coverage of Brilliance with an Underperform (4) rating and 12-month target price of HKD8.90, based on a target PER of 10x on our 2016E EPS, which represents a 10% discount to the stock s past-3-year consensus average. We see such a valuation as appropriate, given the competition from Beijing Benz and Brilliance s relatively unaggressive model launch plans for Brilliance: 12-month-forward PER ( ) (PER) Source: Company, Daiwa forecasts Risks to our call PER +1 SD Average PER -1 SD Better-than-expected revenue from self-owned brands Brilliance s self-owned brands have been mostly engaged in the manufacture and sale of minibuses, which have been loss-making for the past 3 years. As the data shows that the cross-vehicle segment (sales volume) has also been shrinking over the same period, we now forecast a mild loss for this segment in However, if there is strong demand for the company s minibuses and/or its MPV Huasong, this could lead to a reduction in the net loss for Brilliance, and thus upside to our earnings forecasts. Less competition within the sector We believe BMW Brilliance s major competitors, such as FAW Audi and Beijing Benz, may now be more eager to penetrate the entry-level segments, which is evidenced by the introduction of the 2-series by BMW Brilliance, the GLC by Beijing Benz, and the A3 facelift and A4 by FAW Audi, etc. Given that a certain proportion of the entry-level segments segment in China are already occupied by some of the domestic brands, the entry of these foreign brands is likely to stir up a new round of competition, which may eventually lead to price cuts and margin erosion for Brilliance. However, there is a chance that the launch of new models by competitors could slow down due to concerns on demand for new cars in China. This would help BMW Brilliance better uphold its gross margin, in our view. 88

89 Brilliance China Automotive (1114 HK): 4 January 2016 Supportive policies may pose upside risk Better-than-expected benefits from supportive policies On 29 September, the State Council announced a series of supportive policies for the auto sector, including the purchase-tax reduction from 10% to 5%. We expect this to only slightly boost overall new car-sales in China. However, if the policy is more effective than we expect, this could lead to upside risks to our forecasts, despite Brilliance BMW s sales being the least likely to benefit versus peers (in terms of sales volume and models), given its limited exposure to models with engines of 1.6L or less. 89

90 Brilliance China Automotive (1114 HK): 4 January 2016 Company background A major player in China s luxury car segment that is heavily reliant upon BMW A leading luxury car OEM in China Riding on BMW Listed in Hong Kong in 1999, Brilliance is an automotive manufacturer in China. Through its subsidiaries, associated companies and joint ventures in China, the group manufacture and sell minibuses and automotive components. In 2003, the group established a joint venture with BMW, BMW Brilliance Automotive Ltd. (BMW Brilliance), to produce BMW 3-series and 5-series sedans in China. BMW Brilliance commenced the production and sale of the BMW X1 SUV in early At the end of 2014, BMW Brilliance introduced the very first China-produced BMW new energy vehicle, the 5-series long-wheelbase plug-in hybrid model, BMW 530Le, in China. Further, BMW Brilliance plans to introduce BMW 2-series sedans and the X3 SUV in order to broaden its product range in the near future. Brilliance: management profile Through its subsidiaries, Brilliance is engaged in the production and sale of minibuses in China under the brand Jinbei, with 3 separate platforms (Haise, Grand Haise, and Granse). A new premium MPV model was launched at the end of 2014 under a new brand, Huasong. In addition to auto manufacturing, Brilliance is engaged in the manufacture of diesel engines and gasoline engines for use in minibuses, sedans, SUVs and light duty trucks and automotive components, including window mouldings, strips, axles and stamped parts. Management Profile Mr Wu Xiao An Mr Wu has been the chairman of the board of directors of the company since 18 June 2002, and an executive director since 11 January Mr Wu has over 20 years of experience in the automotive industry and is primarily responsible for the overall strategic planning and business development of the group. Mr Qi Yumin Mr Qi has been an executive director, the president and the chief executive officer of the company since 6 January From 1982 to 2004, Mr Qi held various positions in Dalian Heavy Industries Co., Ltd., including chairman and general manager. From October 2004 to December 2005, he was the vice mayor of Dalian municipal government. He was qualified as a senior engineer professor level) by the Personnel Department of Liaoning Province in December Mr Wang Shiping Mr Wang has been an executive director of the company since 16 September Mr Wang was previously the deputy head engineer of Radiator Branch Company of China First Automobile Group Corporation, the general manager of FAW-ZEXEL Air-Condition Branch Company, the deputy general manager and director of Strategic Planning of Fawer Automobile Part Co., Ltd. Mr Wang is a senior engineer (researcher) in corporate management. Mr Tan Chengxu Mr Tan has been an executive director of the company since 10 November Mr Tan has been appointed as a director and the vice president of Huachen since March 2010, and a director and the vice chairman of Shenyang Automotive since June Mr Tan is a senior engineer. Mr Qian Zuming Mr Qian has been the chief financial officer of the company since 1st July, Mr Qian has been appointed as an assistant to the president of Huachen since December 2009 and a director of Shenyang Automotive since January Mr Qian is a fellow of the Institute of Financial Accountants of the United Kingdom. Ms. Lisa Ng Ms Ng has been a senior vice president of the company since October 2006, with primary responsibilities in investor relations, capital market transactions, and financial reporting review. In addition, she is also the company secretary to the board of directors and audit and compliance committee of BMW Brilliance. Ms Ng is a qualified Chartered Accountant with the Canadian Institute of Chartered Accountants. Ms Huang Yu Ms Yu is currently the vice president and chief accountant of the company. She is a certified public accountant of the PRC and also a member of the Association of Chartered Certified Accountants. Ms Huang is also qualified to be a lawyer in China. Mr Wang Tao Mr Tao has served as general manager of Shenyang Automotive since February Source: Company 90

91 Brilliance China Automotive (1114 HK): 4 January 2016 Brilliance: development milestones Year Event 1991 The company was initially established to hold a 51% interest in Shenyang Automotive, a Sino-foreign equity joint venture enterprise under the law of the PRC on 22 July Shenyang Automotive produced two principal types of minibuses under the JinBei brand, a version of Toyota's fourth generation 15-seat Hiace Minibus based on vehicle kits imported from Toyota, and a domestically designed 11-seat minibus based on domestic components Formal launch of Shenyang Automotive's Mid-priced Minibus, which later became the flagship products of Shenyang Automotive Established Xing Yuan Dong, a wholly owned subsidiary of the company, to centralise and consolidate the purchasing and sourcing of spare parts and automotive components for Shenyang Automotive so as to reduce production costs and optimise profits Shares were listed on the Stock Exchange of Hong Kong Limited The company acquired a 50% equity interest in Shenyang Xinguang, a manufacturer of gasoline engines for use in passenger vehicles The company entered into a technical assistance agreement with BMW relating to technical support and training to be provided to Shenyang Automotive in connection with the commencement and production of the "Zhonghua" sedans Huachen Automotive Group Holdings Company Limited became the substantial shareholder of the Company by acquiring a 39.45% interest in the company from the Chinese Financial Education Development Foundation The company, through its indirectly owned subsidiary, entered into a joint venture contract with BMW to produce and sell BMW sedans in the PRC. The company's effective interest in the joint venture was approximately 40.5% Commenced production of the BMW 3-series and 5-series sedans based on domestic and imported components Completed disposal of Zhonghua sedan business by Shenyang Brilliance JinBei Automobile Co., Ltd. to Huachen Automotive Group Holdings Company Limited The group entered into agreements for further acquisition of a 1% equity interest in each of Shenyang XinJinBei Investment and Development Co., Ltd. and Shenyang JinBei Automotive Industry Holdings Company Limited. With completion of the acquisition, the effective interest of the Company in BMW Brilliance increased to 50% The group entered into an agreement for the acquisition of a 9.9% equity interest in Shenyang Brilliance JinBei Automobile Co., Ltd. Upon completion, Shenyang Automotive directly and indirectly owned 60.9% of the company BMW Brilliance Automotive Ltd. commenced the production and sale of BMW SUVs in the PRC Listing of and dealings in the shares of Xinchen China Power Holdings Limited on the Main Board of The Stock Exchange of Hong Kong. Following the listing of Power Xinchen, the indirect shareholding of the Company in Power Xinchen fell from % to % The shareholders of BMW Brilliance Automotive Ltd. extended, four years before the expiry of the original agreement, the terms of the BMW Brilliance equity joint venture agreement by another ten years to BMW Brilliance introduced the very first China-produced BMW new energy vehicle, the 5-series long-wheelbase plug-in hybrid model Brilliance-BEA Auto Finance Co., Ltd commenced business following approval by local regulators in the PRC in April This joint venture will offer a number of products and services, with an initial focus on financing dealers for the purchase of automobiles and providing car loans to individuals and companies. Source: Company Brilliance: organisational chart Huachen Automotive Group Brilliance China Automotive (1114.HK) Ningbo Yuming Machinery Industrial Shenyang Brilliance JinBei Automobile Shenyang XingYuanDong Automobile Component Mianyang Brilliance Ruian Automotive Components Ningbo Brilliance Ruixing Auto Components Shenyang Chenfa Automobile Components Shenyang Brilliance Dongxing Automotive Components Shenyang Jindong Development Shenyang Brilliance Power Train Machinery Shanghai Hidea Auto Design Xinchen China Power Holdings (1148.HK) 60.9% 100% 100% 100% 25% 100% 100% 80.45% 49% 70.68% 31.07% Shenyang Xinguang Brilliance Automobile Shenyang Aerospace Mitsubishi Motors Engine Shenyang jinbei Vehicle Dies Manufacturing Public shareholders 42.48% 57.52% Shenyang JinBei Automotive 39.1% 50% 14.43% 48% 50% BMW Brilliance Automotive Source: Company 91

92 Brilliance China Automotive (1114 HK): 4 January 2016 BMW Brilliance: 5-series sedan BMW Brilliance: 530Le hybrid sedan Source: Company Source: Company BMW Brilliance: X3 SUV Source: Company 92

93 Great Wall Motor China Consumer Discretionary 4 January 2016 Great Wall Motor (2333 HK) Target price: HKD8.40 (from HKD8.90) Share price (28 Dec): HKD9.14 Up/downside: -8.0% Market share declining, margin erosion Share of SUV market likely to decline in 2016 on thinner pipeline GWM could suffer margin compression like SUV peers Reiterate Underperform (4) rating; long-term derating expected Kelvin Lau (852) kelvin.lau@hk.daiwacm.com Brian Lam (852) brian.lam@hk.daiwacm.com What's new: We still see a gloomy earnings-growth outlook for Great Wall Motor (GWM) in Its market share of SUVs (accounting for more than 80% of its sales volume YTD in 2015) has declined since January 2015, and we expect the decline to continue in We also think GWM will face margin pressure going into next year, like its peers. What's the impact: We attribute GWM s declining share of the SUV segment to its unsuccessful pricing strategy and the poorly received launch of its H8 model, which was delayed by more than a year. As the foreign brands have been offering price discounts as a result of weak car sales in China since mid-2015, the difference in the price of the H8 and similar SUVs (ie, the Dongfeng Honda CRV and FAW Mazda CX7) has narrowed significantly, affecting GWM s sales. And this situation looks likely to continue in With the unsuccessful upgrading of its brand in general, we have low expectations for the launch of its H7 in 2016, for which we estimate average monthly sales of 2,500 units. As a result, we expect GWM to have to rely heavily on sales of its H6 and H2 models in We are also not particularly inspired by GWM s bid to differentiate itself via its Blue and Red badge strategy for each model (ie, a sporty version and standard version for each of its models). With more new SUV models coming onto the market in 2016, and the little confidence we have in GWM s badge strategy, we believe 2016 will be a weak year for GWM. What we recommend: We reiterate our Underperform (4) rating but lower our 12-month TP to HKD8.40, from HKD8.90, after rolling forward our valuation basis to a 2016E PER of 7.5x, set at a discount of about 15% (previously 10%) applied to the stock s past 3-year-average PER of 9x (previously: 8.1x on our average E EPS) to factor in our concerns about a continuous decline in market share. We view our target PER as reasonable, as we expect GWM shares to be derated in Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change Net profit change Core EPS (FD) change Source: Daiwa forecasts Share price performance (HKD) (%) Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Great Wall (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 9,127 Major shareholder Baoding Great Wall Asset (56.0%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 69,968 77,482 87,264 Operating profit (m) 9,860 9,999 10,399 Net profit (m) 8,497 8,624 8,956 Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) (6.5) (15.0) (14.8) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E EPS are 7-15% lower than consensus, as we think GWM s product pipeline is relatively unexciting compared to its peers. The downward margin trend is also likely to continue over our forecast period. See important disclosures, including any required research certifications, beginning on page 103