buy the future stars china auto &...

See important disclosures, including any required research certifications, beginning on page 97

■ What's new We expect a shift in structural-growth strategy for China automakers from product quantity to quality over 2013-15, and believe the Bloomberg consensus has yet to factor in the strong 2013-14 earnings growth we see for Great Wall Motor (Great Wall) and Geely Automobile (Geely). In addition, we initiate coverage on two auto dealers, which we believe have favourable fundamentals and earnings-growth outlooks. ■ What's the impact New products should raise ASP and sales volumes: We think Great Wall and Geely can deliver above-consensus sales volumes and ASPs for 2013, as they plan to launch 10 and 6 new models, respectively, compared with only 3 for Dongfeng Motor Group’s (DFM) joint ventures (DF-Nissan and DF-Honda). Rising in-house engine production should increase gross margins: Engines typically account for about 15% of an automaker’s cost structure. Our industry research shows that a switch from importing to producing engines in-house usually leads to a 20-30% cut in costs. As such, we forecast Great

Wall’s in-house engine-production ratio to rise from 70% in 2012 to 85% in 2014, while Geely’s six-speed automatic gearbox produced in-house should become an earnings-growth driver over 2013-14. More R&D should lead to long-term earnings growth: As the China automakers have been raising R&D spending for the past three years, the quality of their local car brands has been catching up with that of the OEMs. We expect Great Wall’s and Geely’s FCF/car sold to outpace strongly their R&D/car sold in 2013-14, leading to an earnings upcycle in 2013. ■ What we recommend We reaffirm our Positive sector rating. Among the automakers, we upgrade Geely to Buy (1), downgrade Brilliance China Automotive (Brilliance) to Outperform (2), and downgrade Guangzhou Automobile Group (GAC) to Sell (5). We see further share-price upside potential for Great Wall and Geely, as we believe that with the companies’ leadership positions both stocks deserve to trade at 1SD above their seven-year-average PERs. We believe our SOTP valuations for the auto dealers point to attractive risk-reward profiles, and we initiate on China ZhengTong Auto Services Holdings (ZTA) with a Buy (1) and Zhongsheng Group Holdings (ZSG) with an Outperform (2). Both names stand to benefit when their high-margin after-sales services businesses gain momentum and as we believe their

earnings from new-car sales bottomed out in 2012. We prefer ZTA over ZSG, as ZTA focuses on luxury-car sales, and we expect its EBIT/dealer to be 38% higher than ZSG’s in 2013. We recommend a pair-trade, with a switch from DFM into ZTA, as we expect DFM to undergo operating deleveraging with a low ROCE in 2013, but look for ZTA to post a significant ROCE recovery with better revenue mix and operating leverage. ■ How we differ Our preference for the auto dealers over mid-range OEMs contrasts with the consensus view, while our earnings forecasts for the local-brand automakers Geely and Great Wall are higher than those of the consensus.

15 February 2013

Buy the future stars

• We expect margin expansion to drive earnings growth for domestic and luxury automakers in 2013

• Top buys are Geely and Great Wall for automakers; initiate on auto dealers with Buy for ZTA and Outperform for ZSG

• Pair-trade idea: switch from mid-range OEM name DFM into auto dealer ZTA

China Auto & Auto Dealers Sector

Key stock calls

Source: Daiwa forecasts.

Consumer Discretionary / China

Positive (unchanged)

Neutral

Negative

Jeff Chung(852) 2773 8783

[email protected]

New Prev.Great Wall Motor (2333 HK)Rating Buy BuyTarget 36.27 23.50Upside 15.5%

Geely Automobile (175 HK)Rating Buy OutperformTarget 5.50 3.95Upside 18.5%

China ZhengTong Auto Services Holdings (1728 HK)Rating BuyTarget 8.09Upside 15.1%

Brilliance China Automotive (1114 HK)Rating Outperform BuyTarget 11.77 11.40Upside 5.3%

Zhongsheng Group Holdings (881 HK)Rating OutperformTarget 14.19Upside 10.2%

How do we justify our view?How do we justify our view?

China Auto & Auto Dealers Sector 15 February 2013

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How do we justify our view?

Growth outlook

Valuation

Earnings revisions

Growth outlook China auto industry: sales-volume growth outlook

We expect 2013 to a better year for the China automakers than 2012, and forecast total sales-volume growth for passenger vehicles (PV) of 9.2% YoY to 6.9m units and SUVs of 26% YoY to 2.5m units. We expect competition in the mid-range segment to intensify and thus our preference lies with quality local brands such as Great Wall and Geely and luxury names such as Brilliance. Also, we believe the outlook for SUV sales remains strong for the next few years, and forecast them to account for 14.9% of China’s total PV sales volume for 2013 and 17.1% for 2014, while we expect sedan sales to represent less than 6.5%. We project sustained strong growth in sales volume for luxury cars of 20-22% YoY for the next two years.

Source: CAAM, Daiwa forecasts

Valuation China automakers: one-year forward PER bands

China automakers (excluding Brilliance and GAC, (given their historical share-price volatility) are trading at an average 2013E PER of 9.5x, in line with their past-seven-year average, which we consider cheap, given our positive sector view, an upcycle recovery in prospect and additional catalysts that we believe investors have overlooked. We envisage a continuous sector rally into 2Q13, as we look for good economic data for China and improving car-buying sentiment. We value the automakers for which we have stronger earnings outlooks, Great Wall and Geely, above 2013E PERs of 12x. For the auto dealers, we value both ZTA and ZSG’s new-car sales at a 2013E PER of 10.7x, in line with the automakers’ past-seven-year average (with Brilliance).

Source: Bloomberg, Daiwa forecasts

Note: DFM = Dongfeng Motor Group

Earnings revisions China Auto & Auto Dealers Sector: consensus EPS growth forecasts

The Bloomberg consensus turned more bullish on the outlook for Great Wall and Geely in 3Q12, and 2013 earnings forecasts for both companies have risen steadily since then. We expect this upward trend to continue in the coming months, as we envisage more catalysts for both companies that should lead to upside 2013 earnings surprises. Also, we believe 2013 will be a good year for the auto dealers as we expect a further rerating, with improving sentiment on new-car sales and better demand/supply conditions with the help from automakers.

Source: Bloomberg, Daiwa

Positive (unchanged)

Neutral

Negative

5.4%6.9%

9.2%10.5% 10.0%

20.2%

25.5% 26.0% 26.5% 27.0%

11.0%12.9%

14.9%17.1%

19.7%

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Total PV sales SUV sales SUV as % of PV

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(Forward-PER, x, non-weighted avg from Great Wall, Geely, DFM, Brilliance)

Avg + 2 s.d. = 18.93x

Avg + 1 s.d. = 14.26x

Avg = 9.6x

Avg - 1 s.d. = 4.92x

Avg - 2 s.d. = 0.25xThe sector (without Brilliance and GAC) is trading at 9.5x forward PER

The sector (with Brilliance, without GAC) is trading at 10.7x forward PER

0.50.60.70.80.91.01.11.21.3

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China Autos Sector (13E) Great Wall & Geely (13E)

ZSG (13E) ZTA (13E)

Index = 1 (as at 1 Jan 2012)


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Source: Daiwa forecasts

Sector stocks: key indicators

Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Brilliance China Automotive 1114 HK 11.18 Outperform Buy 11.77 11.40 3.2% 0.495 0.477 3.7% 0.603 0.691 (12.8%)

China ZhengTong Auto Services Holdings 1728 HK 7.03 Buy 8.09 0.341 0.522

Dongfeng Motor Group 489 HK 12.38 Underperform Underperform 11.44 8.75 30.7% 1.014 0.971 4.5% 1.090 1.008 8.2%

Geely Automobile 175 HK 4.64 Buy Outperform 5.50 3.95 39.2% 0.239 0.243 (1.7%) 0.334 0.323 3.6%

Great Wall Motor 2333 HK 31.40 Buy Buy 36.27 23.50 54.3% 1.865 1.560 19.6% 2.359 2.106 12.0%

Guangzhou Automobile Group 2238 HK 6.73 Sell Underperform 5.05 7.60 (33.6%) 0.182 0.722 (74.9%) 0.373 0.852 (56.2%)

Zhongsheng Group Holdings 881 HK 12.88 Outperform 14.19 0.480 0.915

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2


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What is not priced in? .................................................................................................................. 5 Investment summary ................................................................................................................ 5 Historical and YTD returns ...................................................................................................... 6 Stock recommendations .......................................................................................................... 6

New products should now drive revenue growth ...................................................................... 10 Ageing products are a risk ...................................................................................................... 10

Quality of local brands is improving rapidly .............................................................................. 13 R&D spending is key determinant of new-vehicle quality ..................................................... 13

SUVs should continue to lead sales growth ............................................................................... 16 Catalyst 1: new model launches improve ASPs .......................................................................... 17

R&D spending determines new-product quality, affecting ASPs .......................................... 17 Great Wall ............................................................................................................................... 17 Geely ........................................................................................................................................ 18 DFM ........................................................................................................................................ 20 GAC ........................................................................................................................................ 20 Brilliance ................................................................................................................................. 21

Catalyst 2: new engineering is improving margins .................................................................. 22 Rising in-house engine production is lifting gross margins ................................................. 22

Catalyst 3: a gift from the automakers to the dealers ............................................................... 26 Dealer EBIT margins should improve in 2013 ...................................................................... 26

Pair-trade idea: switch from DFM into ZTA ............................................................................. 30 We prefer dealers to OEMs ..................................................................................................... 31 ZTA unlikely to over-expand in 2013 ..................................................................................... 31 Introducing Daiwa’s ‘greed’ ratio .......................................................................................... 32 Upselling should raise EBIT margins for ZTA and ZSG ....................................................... 33 Improving fundamentals ....................................................................................................... 33 Potential inflection point in 2013 .......................................................................................... 34

Risks ........................................................................................................................................... 36 Company Section

Geely Automobile .................................................................................................................... 37 Great Wall Motor .................................................................................................................... 41 Brilliance China Automotive ...................................................................................................45 Dongfeng Motor Group .......................................................................................................... 49 Guangzhou Automobile Group ............................................................................................... 53 China ZhengTong Auto Services Holdings ............................................................................. 57 Zhongsheng Group Holdings ................................................................................................. 78

Contents


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What is not priced in?

Investment summary

Positive sector outlook for 2013 We believe 2013 will be a good year for the China automakers, as we expect the industry’s PV sales growth to rebound as we look for better economic growth and improving sentiment towards new-car sales. The China automakers (DFM, Great Wall and Geely – we have excluded Brilliance and GAC given their historically volatile share-price movements) are trading currently at an average 2013E PER of 9.5x on our EPS forecasts, in line with their past-seven-year average. We believe this valuation has already priced in the destocking trend that we are seeing currently, as well as the market-consensus forecast of around 8% YoY PV sales-volume growth for 2013. China automakers: one-year-forward PER bands


Positives that do not look factored in Though Great Wall’s and Geely’s share prices both rose by more than 120% in absolute terms in 2012 and we do not expect the shares to see the same triple-digit returns in 2013, we believe the market has been focusing too much on sales-volume growth and has not yet priced in the improving earnings quality we see for these quality local brands. We believe this is the case as: 1) we see greater visibility for the automakers’ ASPs, which we expect to increase in 2013 given their plans to launch more new models this year, 2) we see further room for gross-profit margin improvements, as more engines and auto parts are now being made in-house, and 3) local-brand dealers, are improving their sales per dealership, which should enable them to

strengthen their operating leverage compared with OEM automakers, with lower selling and distribution costs per car. Our six-month target prices for Geely and Great Wall imply more than 15% upside from current levels. In addition, we expect more positive share-price catalysts to materialise in 2014. Maintain Underperform on DFM; downgrade Brilliance to Outperform and GAC to Sell We believe competition between the mid-range and luxury brands will intensify in 2013. As such, for the mid-range automakers we maintain our Underperform (4) rating on DFM, and downgrade our rating on GAC to Sell (5), from Underperform (4), as we expect: 1) an ageing product mix, 2) poor free cash flow returns from R&D expenditures in past years, and 3) new dealers to need another year to ramp up new client bases. We do not see any positive catalysts for these stocks as near-term margin upgrades look unlikely. We downgrade our rating on luxury automaker Brilliance to Outperform (2), from Buy (1). The company has issued 2013 sales guidance which was more cautious than we expected. In addition, we now factor into our model for Brilliance the possibility of more price cuts by Japan automakers in 1H13 (in an effort to recoup market share), which could hurt the market share of the Brilliance-BMW joint venture.

We expect luxury dealers to rerate further We believe the luxury auto dealers, after going through a heavy capex cycle in 2011-12, offer more defensive business models than the luxury and mid-range automakers for 2013. Moreover, we believe intensifying competition among the luxury automakers will encourage them to provide better incentives for their dealers to boost sales. We initiate coverage on ZTA with a Buy (1) rating; we expect the company to see strong incremental growth in its after-sales and upselling (auto finance and insurance) businesses this year. This should lead to substantial improvements in EBIT/dealer, and we believe this earnings potential has not yet been factored in fully. Pair-trade idea: short DFM, long ZTA We see a pair trade idea between automakers and dealers, and recommend switching from DFM into ZTA. We believe that, in the absence of strong new product launches in 2013-14, any probability of DFM being rerated in 2014 depends heavily on the pace at which its new dealership contracts ramp up their business in China’s lower-tier cities. Based on this argument, we recommend buying the dealers such as ZTA, which we expect to ramp up their client bases in 2013, and thus to offer strong scope for a rerating over the coming

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(Forward-PER, x, non-weighted avg from Great Wall, Geely, DFM, Brilliance)

Avg + 2 s.d. = 18.93x

Avg + 1 s.d. = 14.26x

Avg = 9.6x

Avg - 1 s.d. = 4.92x

Avg - 2 s.d. = 0.25xThe sector (without Brilliance and GAC) is trading at 9.5x forward PER

The sector (with Brilliance, without GAC) is trading at 10.7x forward PER


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months, rather than investing in DFM and waiting for its new contracted dealers to ramp up in lower-tier cities (likely in 2014), and which therefore should offer less room for a rerating in 2013. China Auto & Auto Dealers Sector: ROACE

Source: Company, Daiwa forecasts

Historical and YTD returns

Year-to-date to 8 February, the China automakers have continued to outperform the MSCI China Index, following their outperformance for a fifth consecutive year in 2012. Among the automakers, Great Wall is the only stock that achieved positive returns in absolute and relative measures over 2009-2012, according to the benchmarks shown in the following table.

China auto stocks: absolute returns (%) 2008 2009 2010 2011 2012 YTD 2013Great Wall -74.8 237.0 136.0 18.1 115.6 28.4Geely -30.3 583.9 -21.7 -50.0 115.9 26.4DFM -54.5 347.2 19.9 -0.6 -10.2 3.5Brilliance -76.7 440.7 170.8 41.3 13.8 17.2BYD -6.5 439.0 -40.3 -58.8 38.1 38.1GAC 10.7 -35.9 0.0 -2.0Automakers sector average (absolute) -48.6 409.5 45.9 -14.3 45.5 18.6Zheng Tong -29.3 30.4Zhong Sheng -9.4 9.9Baoxin -62.8 42.7Dah Chong Hong -51.6 12.8Auto dealers sector average -38.3 24.0MSCI World Auto (absolute) -48.3 52.0 5.3 -21.7 28.1 6.5MSCI China (absolute) -53.0 60.6 4.6 -20.3 18.7 2.8

Source: Bloomberg

Note: YTD data in the tables is to 8 February 2013

As we have recently seen a strong pick-up in retail sentiment in China, backed by positive 4Q12 economic data, China auto-dealers shares have fared well YTD to 15 February, outperforming the MSCI World Auto index by 17.5% and the MSCI China index by 21.1%.

China auto stocks: returns relative to MSCI indices (%) 2008 2009 2010 2011 2012 YTD 2013GWM -26.5 184.9 130.7 39.9 87.5 22.0Geely 17.9 531.8 -27.0 -28.3 87.8 20.0DFM -6.3 295.2 14.5 21.1 -38.3 -3.0Brilliance -28.5 388.7 165.5 63.1 -14.2 10.7BYD 41.8 387.0 -45.6 -37.0 10.0 31.6GAC 5.4 -14.2 -28.1 -8.5Automakers (relative to MSCI World Auto) -0.3 357.5 40.6 7.4 17.4 12.1Zheng Tong -57.4 24.0Zhong Sheng -37.5 3.4Baoxin -90.9 36.3Dah Chong Hong -79.7 6.3Auto dealers (relative to MSCI World Auto) -66.4 17.5GWM -21.7 176.4 131.5 38.4 96.9 25.6Geely 22.7 523.3 -26.3 -29.7 97.1 23.6DFM -1.5 286.6 15.3 19.7 -28.9 0.7Brilliance -23.7 380.1 166.2 61.6 -4.9 14.4BYD 46.5 378.4 -44.9 -38.5 19.3 35.2GAC 6.2 -15.6 -18.7 -4.9Automakers (relative to MSCI China) 4.5 348.9 41.3 6.0 26.8 15.8Zheng Tong -48.0 27.6Zhong Sheng -28.2 7.1Baoxin -81.5 39.9Dah Chong Hong -70.3 9.9Auto dealers (relative to MSCI China) -57.0 21.1

Source: Bloomberg

We believe the current destocking cycle among automakers and the impact of the high car-buying season before the Lunar New Year have generated more momentum for a rerating of the auto dealers than the automakers.

Stock recommendations

Great Wall – Buy: still a high-growth stock Our 2013-14 EPS forecasts for Great Wall are 19-25% higher than those of the Bloomberg consensus. We expect Great Wall’s fundamentals to improve this year, and as such we believe it deserves trade at higher valuation multiples, given that we forecast its asset-turnover ratio to improve to 1.08x and its FCF/car sold to rise to CNY5,716 for 2013, much higher than respective levels of 0.78x and CNY1,846 for 2007. With our upbeat 2013-14 sales and earnings forecasts for the company and the catalysts we see for it, namely increased in-house production of engines, we believe Great Wall stock deserves to trade at 1SD above its past-seven-year average, especially given the enhanced quality of its models amid current expectations of an economic recovery in China.

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GWM Geely DFM GAC

Brilliance ZTA ZSA

Great Wall

Brilliance

DFM

GAC

GeelyZhongsheng

Zhengtong


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Great Wall: one-year-forward PER bands


Geely – upgrade to Buy: we expect a strong 2012-14 EPS CAGR As we forecast an EPS CAGR of 33% for Geely for 2012-14, we believe the stock deserves to trade in line with Great Wall’s target 2013E PER of 12x (we expect a 2012-14 EPS CAGR of 22% for Great Wall), given the improvements we expect in Geely’s cash flow, balance sheet and earnings quality over our forecast period. We upgrade our rating on the stock to Buy (1). We raise our six-month target price to HKD5.5 from HKD3.95 to reflect our view that the company offers a sustainable long-term revenue-growth business model. Our EPS forecasts are higher than those of the Bloomberg consensus, by 19% for 2013 and 30% for 2014, reflecting our above-consensus operating-profit-margin forecasts. Geely: one-year-forward PER bands


DFM – Underperform: a fat cat with a flattish earnings profile DFM shares have traded at an average PER of 8.4x over the past seven years. We forecast the company’s EPS growth to slow to a 2% CAGR for 2012-14 and project its ROCE to decline to 16.2% for 2013. We believe the stock should not trade above its past-seven-year average PER and should be a laggard in the sales

recovery we expect for the sector in 1H13. Our new six-month target price of HKD11.44 is based on a 2013E PER of 8.4x, in line with the seven-year average but lower than the sector’s average of 9.5x (without Brilliance and GAC) for the same period. DFM: one-year-forward PER bands


GAC – downgrade to Sell: looks expensive Given GAC’s volatile share price and relatively short trading history (since 3Q10), we use DFM as a valuation benchmark, in view of the companies’ similar levels of exposure to Japanese brand car sales. We apply DFM’s past-seven-year average + 1SD PER of 11x to our 2013 EPS forecast for GAC (we previously used a 2012E PER of 12x) to reflect the recovery we expect in its earnings over 2013-14, backed by new contributions from its joint ventures with Fiat and Mitsubishi. We are lowering our six-month target price to HKD5.05 from HKD7.60. We believe GAC remains an overvalued stock with poor earnings visibility. Thus, we downgrade our rating to Sell (5) from Underperform (4). GAC: one-year-forward PER bands


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Brilliance – downgrade to Outperform: better margins, but slowing sales-volume growth Given recent guidance by Brilliance, we believe it has shifted its focus to expanding overall margins by leveraging its strong brand premium, improving its in-house engine-production ratio and diversifying its product mix. However, we expect lower YoY sales-volume growth in 2013. We now expect 2012 sales-volume growth to fall by 50% over 2011; however, market sentiment is improving and we expect a higher EBIT in 2013-14. As such, we believe the stock deserves to trade at 15.6x our new 2013E EPS, compared with an average of 19x for 2011-12. Thus, we downgrade to Outperform (2) and upgrade our target price to HKD11.77 from HKD11.40. Brilliance: one-year-forward PER bands


ZTA – initiate with Buy; we forecast EBITDA to double over 2012-14 We use an SOTP methodology to derive our six-month target price of HKD8.09 for ZTA, assigning 2013E PERs of 10.7x to the company’s new-car sales business and 14.5x to its after-sales service business, and implying 15% upside potential from current levels. Our target price equates to a one-year-forward PER of 12.4x, which represents a 45% discount to the stock’s average valuation since its listing in December 2010.

ZTA: one-year-forward PER bands


ZSG – initiate with Outperform: an investible giant We believe ZSG distinguishes itself from its peers with a more defensive business model. We forecast gross profit for its after-sales services business to account for 58% of total gross profit for 2013. We believe ZSG’s profit mix should provide a good cushion against any future industry-wide slowdown in new-car sales, while it should benefit in an economic upcycle. We use an SOTP methodology to derive our six-month target price of HKD14.19. As we expect ZSG’s free cash flow and EBIT margin to recover in 2013, we believe the company’s after-sales services business should be valued on par with international auto dealers (a 2013E PER of 14.5x). We apply a 2013E PER of 10.7x to value ZSG’s new-car sales business, in line with the China automakers’ average 2013E PER at current share prices (excluding Brilliance). ZSG: one-year-forward PER bands


(5)

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25.68x Avg+2SD

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Auto dealers: we prefer ZTA to ZSG Though we forecast similar ROCEs for both ZTA and ZSG for 2013, we prefer ZTA among the auto dealers, as we foresee a better return/car sold and return/dealer for ZTA given the emphasis of its product mix on luxury cars and its stronger balance sheet. Pair-trade idea: switch from DFM into ZTA We recommend that investors switch from DFM into ZTA for the following reasons: 1. ZTA went through a substantial capex cycle in 2011-

12, and we expect it to generate strong earnings

from its after-sales service business for luxury cars for 2013-14.

2. The gross profit and the net profit/car sold and

service for a luxury-car dealer like ZTA are much higher than those for DFM, based on our analysis.

3. The cross-selling for ZTA as a luxury dealership

should lead to improved operating leverage. We think our stronger incremental earnings-growth outlook for ZTA’s luxury-car-service segment for 2013 has not yet been fully priced in.

China Auto Sector: valuation summary

Company Previous rating and TP New rating and TP UpsideMarket cap.

(USDbn) 12E PER 13E PER 14E PER 12E PBR 13E PBR 14E PBR 12E ROE 13E ROE 14E ROE

Great Wall (2333 HK) Buy (1), HKD23.5 Buy (1), HKD36.27 15.5% 12.32 13.5 10.7 9.1 3.7 2.9 2.3 30.1% 30.3% 28.5%Geely (175 HK) Outperform (2,) HKD3.95 Buy (1), HKD5.5 18.6% 4.48 15.6 11.2 8.6 2.4 2.0 1.6 18.4% 20.4% 21.8%Brilliance (1114 HK) Buy (1), HKD11.4 Outperform (2), HKD11.77 5.3% 7.45 18.2 14.9 12.0 4.5 3.5 2.7 29.3% 26.7% 25.4%DFM (489 HK) Underperform (4), HKD8.75 Underperform (4), HKD11.44 -7.6% 13.8 9.8 9.1 9.4 1.6 1.4 1.2 17.4% 16.2% 13.8%GAC (2238 HK) Underperform (4), HKD7.6 Sell (5), HKD5.05 -25.0% 5.74 29.8 14.5 10.6 1.2 1.1 1.0 3.9% 7.7% 9.8%non-weighted average 1.6% 8.8 17.4 12.1 9.9 2.7 2.2 1.8 19.8% 20.3% 19.9%

Zheng Tong (1728 HK) n.a. Buy (1), HKD8.09 15.0% 1.99 16.6 10.8 7.3 1.8 1.5 1.3 11.4% 15.3% 19.0%Zhong Sheng (881 HK) n.a. Outperform (2), HKD14.19 10.2% 3.17 21.6 11.3 8.1 2.5 2.0 1.6 12.1% 19.7% 22.2%non-weighted average 12.6% 2.6 19.1 11.1 7.7 2.2 1.8 1.5 11.8% 17.5% 20.6%


Note: multiples are based on closing share prices of 15 February 2013


- 10 -

New products should now drive revenue growth

Ageing products are a risk

The China automakers are introducing more new models to gain market share and mitigate the impact of intensifying competition. The trend between car-sale volume for new models and old models reversed for the first time from 2011 to 2012 (as displayed in the first chart on the right), suggesting to us that 2013 is likely to be a tough year for those automakers without a strong line-up of new products. Greater selection of models on the market We estimate that 635 PV models were available in the China market in 2012, compared with 591 in 2011, representing an increase of 7.4% YoY. Over 2008-12, we estimate that the China automakers launched between 93 and 128 new products or models a year, and that they stopped producing between 32 and 74 ageing models annually. China automakers: number of PV models

2008 2009 2010 2011 2012New models 93 128 104 116 93Old models 314 375 429 475 542Total models 407 503 533 591 635Models for which production stopped 39 32 74 58 49Models for which production stopped, as % of total models 8.7% 6.0% 12.2% 8.9% 7.2%Source: CAAM, Daiwa

Automakers facing greater risk due to older products For the sector in 2012, we forecast that the average car sale per new model launched that year rose by 49% YoY (12,011 units) versus a decline of 6.9% YoY (26,528 units) for old models. Competition appears to be intensifying. In next two charts we can see the start of the trend, whereby sales of new models picked up and sales of older models declined in 2011 and 2012. We believe 2013 could be an even tougher year for the automakers, as we expect sales of older models to continue to trend down given an active new-model launch schedule in the industry.

China: absolute unit sales of old and new PV models

Source: CAAM, Daiwa estimates

China: YoY change in unit sales of old and new PV models


Historically, Great Wall and German brands have been more resilient than other major brands Looking at the main automakers with a presence in China we note that for the first 10 months of 2012, the German and quality local brands, such as Great Wall, registered better sales-volume growth for both new and old models than the other major brands. China automakers: sales-volume growth summary (10M12)


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Unit sales per new model launched during the year

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(Units)

-18.8%

67.1%

33.5%

-26.6%

49.3%

-3.1% 23.4% 18.8% -3.1%

-6.9%

(40%)

(20%)

0%

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2008 2009 2010 2011 2012

Unit sales per new model launched (YoY)

Unit sales per old model (YoY)

54%39% 35% 29%

14%13% 12% 12% 11% 11% 9%1%

-4% -5% -6% -14%

31%

6%

24%21%

9% 7% 7%

-2% -6%-17%

-8% -8% -9%

-51%

-15% -17%

(60%)

(40%)

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Brill

ianc

e BM

W

Beiji

ng-M

erce

des

Benz

Gre

at W

all

FAW

-VW

DF-H

onda

SAIC

-VW

SAIC

-GM

Gee

ly

Beiji

ng-H

yund

ai

DF-Y

ueda

-KIA

DF-P

SA

DF-N

issa

n

BYD

GAC

-Toy

ota

GAC

-Hon

da

Cher

y

Jan-Oct YoY (total sales) Jan-Oct YoY (excluding new model sales)


- 11 -

2013 new model launches: Great Wall and Geely remain above industry average Among the key auto OEM joint ventures present China, each Japanese brand plans to launch 1-3 new models in 2013, compared with 5-10 new models for the German, US and local brands. Based on our forecasts, the number of new-model launches in 2013 represents relatively high percentages of 92% for Great Wall and 46% for Geely of their total models on the market in 2012, compared with 17-44% for most other OEMs, as the next table shows. Though the Donfeng-Peugeot (DF-PSA) joint venture plans to launch five new models this year, and we estimate its current gross-profit margin at 16%, compared with 21% for DF-Nissan, we believe potentially higher sales volumes for DF-Peugeot would not have a strong impact in terms of triggering major increases in the market’s earnings forecasts for DFM overall. Automakers in China: new models in 2013 as % of old models

Major automakers No. of new model launches

expected in 2013 Total models in

2012 2013 new/2012 total

ratio GAC-Fiat 1 1 100% Great Wall Motor 10 12 83% DF-PSA 5 10 50% GAC-Honda 3 6 50% Geely 6 13 46% FAW & SAIC VW 11 25 44% SAIC-GM 7 20 35% GAC-Mitsubishi 2 6 33% Chery 5 18 28% GAC-Toyota 1 4 25% DF-Honda 1 5 20% DF-Nissan 2 12 17%

Source: CAAM, compiled by Daiwa

Volkswagen and General Motors expected to compete for dominance in China Volkswagen (VW) plans to introduce eight new or revamped models in China this year, including the Santana, Golf, Skoda Octavia and Audi Q3, while General Motors (GM) plans to roll out the Cadillac XTS and three Opel models in China this year. For VW, a revamped Santana sedan and expansion of its Skoda brand would help it to expand into China’s lower-tier cities where it does not yet have a presence. The Santana, whose prices start at CNY84,900 for the revamped version, was the 10th best-selling car in the country in 2012, according to the China Association of Automobile Manufacturers (CAAM). GM's Buick Excelle was the best-selling model last year, with Ford Motor’s Focus in second, Chevrolet’s Sail in third and Chevrolet’s Cruze in seventh. We remain sceptical of DFM’s new-model outlook for 2013 We remain cautious on DFM’s new-model line-up for 2013, as the weighted-average age of DFM’s models is older than those of other automakers in China. Moreover, DFM-Nissan plans to launch only 2 new models in 2013, compared with 13 models by the market leader, Shanghai Automotive Industry Corporation (SAIC). In contrast, Great Wall’s younger model portfolio and 10 new model launches planned this year should help it to maintain high earnings visibility, in our view. Geely’s 3 new SUV models planned to be launched in 2013 should reduce significantly the currently high age of its model line-up relative to peers.


- 12 -

Large China automakers: new models and upgrades in 2013 Brand New model/upgrade Class Proposed launch period FAW-VW Jetta A Mar-13 FAW-VW CC B May-13 FAW-VW Golf7 A Oct-13 FAW-VW Audi Q3 SUV 2013 FAW-VW Audi A3 A 2013 SAIC-VW Santana A Jun-13 SAIC-VW Lavida A 1H13 SAIC-VW A-Plus A 2013 SAIC-VW Tuguan SUV Apr-13 SAIC-VW Skoda Yeti B 2H13 SAIC-VW C-class sedan C 1H13 SAIC-GM Cruze A 2013 SAIC-GM Excelle A 2013 SAIC-GM Regal B 2013 SAIC-GM Lacrosse C 2013 SAIC-GM Cadillac XTS D 2013 SAIC-GM Bao Chun SUV SUV 2013 SAIC-GM Bao Chun 630 A 2013 Changan-Ford Fiesta A Jan-13 Changan-Ford Fusion C 1Q13 Changan-Ford Ecosport SUV 1H13 Changan-Ford Kuga B 2013 Changan-Ford Focus B 2H13 FAW-Mazda Mazda 6 B 1Q13 FAW-Mazda CX5 SUV 3Q13 FAW-Mazda CX7 SUV 2Q13 DF-Nissan Tiena C 1Q13 DF-Nissan Livina A 1Q13 DF-Honda Spirior B 1H13 DF-PSA C5 B Apr-13 DF-PSA Elysee A 2H13 DF-PSA 301 A 4Q13 DF-PSA 3008 SUV Jan-13 DF-PSA DS5 B End-13 GAC-Honda New-Accord B 2013 GAC-Honda Crosstour B 2013 GAC-Honda Concept C B 2013 GAC-Toyota Dear B 2013 GAC-Fiat Hatch-back sedan A 2013 GAC-Mitsubishi Pajero Sport SUV 2013 GAC-Mitsubishi Mirage A 2013 Great Wall H6 Sport version SUV 1Q13 Great Wall H5 upgrade SUV 2Q13 Great Wall H7/H8 (delayed to 2014) SUV 2014 Great Wall C50 Sport version B 1Q13 Great Wall C35 A 4Q13 Great Wall C55 B 3Q13 Great Wall H2 SUV 3Q13 Great Wall M2 SUV 4Q13 Great Wall C20R A 1Q13 Great Wall V80 MPV 3Q13 Great Wall Wingle 5 Pick-up 2013 Geely EV8 SUV 3Q13 Geely EX8 MPV 3Q13 Geely GX5 SUV 4Q13 Geely SX7 SUV 1H13 Geely SC5 1.3T A 2Q13 Geely SC7 A 1H13 Chery A3 A 1H13 Chery A4 A 3Q13 Chery E3 A 1H13 Chery T21 SUV 2H13 Chery QQ A 1Q13

Source: Companies, compiled by Daiwa

Note: we have combined the A00 and A0 segments with the A-segment


- 13 -

Quality of local brands is improving rapidly

R&D spending is key determinant of new-vehicle quality

The quality of local PV brands in China has improved significantly over recent years, according to a study carried out by global market research company J.D. Power, Asia Pacific 2012 China Initial Quality Study. This study examines the problems experienced by new-vehicle owners during the first two-to-six months of ownership. The overall score for vehicle quality during this first ownership period (the initial quality score) is determined by problems reported per 100 vehicles (PP100), with a lower rate of problems reported indicating a higher vehicle quality. The initial quality score of domestic PV brands increased significantly in 2012, following a higher number of owner-reported problems experienced in 2011. Overall, the initial quality of domestic brands improved from 232 PP100 in 2011 to 212 PP100 in 2012, narrowing the gap in the score with international PV brands sold in China to 95 PP100 last year. The initial quality of international brands sold in China also improved, from 131 PP100 in 2011 to 117 PP100 in 2012. 2012 China Initial Quality Study: problems per 100 vehicles (PP100)

Source: J.D. Power, compiled by Daiwa

Great Wall’s and Geely’s high-quality models have been selling well In our sector initiation report (Safety matters, of 2 November 2011), we suggested that a car’s safety scores obtained from a crash test could be used to measure its overall quality. Last year, we argued that we believed local PV brands could enhance their sales volume through upgrades to safety standards, to include not only an air-bag but also a stronger automotive sheet, and enhancements to component quality and the overall car design. We highlighted Great Wall and Geely in this respect. For the first 10 months of 2012, we estimate that sales-volume growth of their 5-star safety models reached 38% YoY for Great Wall and 48% for Geely, higher than their total respective sales-volume for the period of 32% YoY and 13% YoY. Great Wall: sales-volume growth from quality PV models

5-star models’ sales

volumeTotal sales

volume 5-star models % of total

sales volumeJan-Oct 2011 218,530 367,858 59.4%Jan-Oct 2012 300,835 484,436 62.1%YoY growth 37.7% 31.7%

Source: CAAM, Company, Daiwa estimates

Geely: sales-volume growth from quality PV models

5-star models’ sales

volumeTotal sales

volume 5-star models % of total

sales volumeJan-Oct 2011 120,248 329,110 36.5%Jan-Oct 2012 178,204 372,547 47.8%YoY growth 48.2% 13.2%


Enhanced product quality from increased R&D spending In the chart that follows, for each China automaker we cover, for the period since 2008 we have added up its average R&D spending for the previous year and the prevailing year (ie, over a two-year period) and divided this by our forecast at the time of its number of vehicle sales in the prevailing year. The resultant ratios indicate how much R&D each automaker invested in over a two-year period for every car it was likely to have sold in the prevailing year. Extrapolating this to 2013 and 2014, we expect this ratio to trend upwards for both Geely and Great Wall, as we believe quality local brands will continue to shift away from a ‘cheapest-product-high-volume-sales’ strategy given current over-capacity in the low-end PV segment in China.

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Domestic brandsForeign brandsGap between Domestic and foreign brands

PP100

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/ChinaAutoSector111102.pdf#page=1


- 14 -

China automakers: 2-year average R&D spending per car sold

Source: Companies, CAAM, Daiwa forecasts

A two-year lag from R&D to production According to Geely, there is about a two-year lag between R&D spending and the use of that R&D in production. We believe increased R&D spending per vehicle by most local brands over recent years should lead to further quality enhancements in their vehicles over the next two years. Based on our recent discussions with the companies, we expect R&D as a percentage of revenue to stay flat YoY at about 3.2% for DFM and 4.2% for GAC in 2013, with total R&D spending for the year guided at CNY4.1bn for DFM and CNY101m for GAC, compared with our forecasts of CNY1.6bn for both Great Wall and Geely. We expect the ratio of R&D spending per car sold for DFM’s and GAC’s joint ventures with Japanese automakers to remain flat over the next two years. Some OEMs still prefer quantity to quality Contrasting with the approach of Great Wall and Geely, the OEM makers, which generally have better brand premium than the local brands and thus tend to rely more on the older technologies from their joint venture partners, are likely to focus heavily on expanding sales volumes, in our view. At the Guangzhou Auto Show in 2012, we thought the interior decoration was of low quality for DFM’s local model made with its DF-Nissan, the Venucia (based on its ageing Tiida model). DFM’s local brand Venucia: interior decoration

Source: Daiwa at Guangzhou Auto Show

During 2012, we saw a rapid shift in DF-Nissan’s product mix towards cheaper models. Sales volume of the low-priced Venucia as a percentage of DF-Nissan’s total sales increased from 3.8% in April to 15.1% in November last year. Venucia’s sales volume as % of DF-Nissan’s total sales volume

Source: Company, Daiwa estimates

Dealership strategies can influence product mixes Finally, our research shows that the ‘cheap-product-high-volume’ strategy pursued by some OEMS so far has been accompanied by aggressive expansion in their number of dealerships. In 2012, we estimate that DFM, GAC and the Brilliance-BMW joint venture expanded their number of dealerships more aggressively than the local brands (Great Wall and Geely) did, as shown in the ensuing chart. DFM applies exclusive dealership strategy for Venucia

Source: Daiwa

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DFM GAC Great Wall Geely

(CNY / vehicle)Geely told us the lag between R&D and the use of that R&D in production is about 2-years

0%

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- 15 -

China automakers: YoY change in total number of dealerships (2012)

Source: Companies, Daiwa estimates

33.1% 31.0%

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DFM BMW GAC Great Wall Geely


- 16 -

SUVs should continue to lead sales growth We forecast 9.2% YoY PV sales-volume growth for 2013 Buoyed by strong demand from non tier-1 cities that we project at 10-30% YoY, we forecast sales-volume growth for PVs in China to remain in the high single digits at 9.2% YoY for 2013 and accelerate to 10.5% YoY for 2014. SUV share of PV sales volume is rising The SUV contribution to total PV sales volume in the China market has been trending up consistently, from 6.4% for 2009 to 12.9% for 2012. We forecast SUV sales to account for 14.9% of total PV sales for 2013 and 17.1% for 2014, assuming unit SUV sales-volume increases of 0.5m YoY for 2013 and 0.67m YoY for 2014. We see further good potential for SUV sales as: 1) many Chinese consumers prefer bigger cars, and SUV fuel efficiency is improving with new turbo engines, 2) SUVs are suited to generally poor road conditions in non-tier-1 cities, and 3) more female drivers are opting for SUVs. SUV sales growth should continue to be driven by new models The gap in sales-volume growth rates between new and old SUV models has been widening since 2012 (the growth rate for new models outpaced that for old models by 9.4pp for 2012), and we expect the growth-rate differential to widen further in 2013 to 12.9pp, as we envisage a subdued outlook for ageing SUV models.

R&D investment in new models is key In order to prevent their overall model line-ups from ageing, we believe automakers will dedicate more resources to R&D over the next two years in order to speed up the face-lift cycle and the number of new-model launches. The statistics for recent years show that new models have tended to generate much higher sales-volume growth than old models. China: growth in SUV sales per old model vs. per new model

Source: CAAM, CEIC, Daiwa forecasts

Great Wall and Geely should benefit the most from strong demand for SUVs Our outlook for continuous sales-volume growth of new SUVs is underpinned by the launches of between 22 and 27 new models planned this year. Also, we expect to see the increasing substitution of sedans with SUVs. We expect Great Wall to launch five new SUV models in 2013 and Geely to launch six; thus, both stand to benefit the most from the trend. We forecast Great Wall’s SUV sales as a percentage of total sales volume to increase from 45% for 2012 to 54% for 2013, and Geely’s to rise from 7% to 18% over the same period.

China: sales volume of PVs and SUVs (No. of vehicles) 2009 2010 2011 2012 2013E 2014E 2015E

PV sales volume 10,315,363 13,748,884 14,498,020 15,493,592 16,919,002 18,695,498 20,565,047PV sales volume, YoY growth 52.9% 33.3% 5.4% 6.9% 9.2% 10.5% 10.0%SUV sales volume as % of PV sales volume 6.4% 9.6% 11.0% 12.9% 14.9% 17.1% 19.7%Total SUV models 57 65 75 88 105 128 156Total new SUV models 9 15 14 18 22 27 35No. of models for which production was ceased 2 1 5 1 5 4 7Ceased- production models as % of total models 3.5% 1.5% 6.7% 1.1% 4.8% 3.1% 4.5%SUV sales volume per old model 11,222 20,565 24,647 26,627 27,995 28,722 29,784SUV sales volume per model 11,558 20,401 21,250 22,732 24,005 24,910 25,957SUV sales volume new model 13,352 19,853 6,448 7,585 8,950 10,651 12,727Total SUV sales volume 658,821 1,326,036 1,593,714 2,000,410 2,520,517 3,188,453 4,049,336SUV per old model, YoY growth 20.7% 83.3% 19.8% 8.0% 5.1% 2.6% 3.7%SUV per model, YoY growth 34.2% 76.5% 4.2% 7.0% 5.6% 3.8% 4.2%SUV per new model, YoY growth 218.1% 48.7% -67.5% 17.6% 18.0% 19.0% 19.5%Total SUV sales volume, YoY growth 47.1% 101.3% 20.2% 25.5% 26.0% 26.5% 27.0%

Source: CAAM, CEIC, Daiwa forecasts

8.0%

5.1%

2.6%

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Sales growth per old model (YoY) Sales growth per new model (YoY)


- 17 -

Catalyst 1: new model launches improve ASPs

R&D spending determines new-product quality, affecting ASPs

The ‘positive loop’ Our industry analysis shows a positive historical correlation between automakers’ levels of R&D spending and improvements in car quality, and that this leads ultimately to higher ASPs for new models. ASP increases can be significant among the local brands, as the trend of recent years shows. We expect quality domestic brands, which are coming from a relatively low car-quality base, to increase their ASPs over the next few years on the back of their higher R&D spending in prior years than by the joint-venture OEMs. Consequently, we expect quality domestic brands such as Great Wall and Geely to enter a ‘positive growth loop’ with better blended ASPs and margin outlooks from 2013. This, in turn, should give them more funds available in the next round of R&D for new model launches over 2014-15. China auto market: positive growth loop

Source: Daiwa

Visibility on ASP increases We compare the past-two-year R&D spending per unit on 2012 car sales and the blended ASP trends. Our analysis suggests Great Wall and Geely offer higher visibility on blended ASP increases in 2013 than DFM and GAC.

Great Wall

Great Wall should benefit most from new model launches. At our investor meetings with the company in Europe in 4Q12, management emphasised that: 1) it was not its policy to reduce the ASPs of its existing products, 2) each year, 2-3 of its key products are given face-lifts, resulting in a slightly higher ASP, and 3) over the next three years it would not sacrifice profit margins to boost sales volume. Great Wall: new models scheduled in 2013 New model/upgrades Class Proposed launching periodH6 Sport version SUV 1Q13H5 upgrade SUV 2Q13C50 Sport version B 1Q13C35 A 4Q13C55 B 3Q13H2 SUV 3Q13M2 SUV 4Q13C20R A 1Q13V80 MPV 3Q13Wingle 5 Pick-up 2013

Source: Company, Daiwa

For Great Wall, with a relatively young average product age of 24.8 months currently, 10 new models due to be launched in 2013, and our forecast for R&D spending/car sold to increase by 17% YoY for 2012 and 24% YoY for 2013, we forecast its blended ASP to improve by 5.7% YoY for 2013. The launch of the H7 SUV scheduled in 2014 should improve Great Wall’s brand premium, while the company’s blended ASP is currently 10% higher than that of the domestic brands due to the perceived better quality of its cars. Great Wall: per-unit statistics and blended ASP

Source: CAAM, Company, Daiwa forecasts

Opening up more FCF for

R&D

New product launches

improve ASP and sales volume

New products+better in-house auto parts

production ratio improve gross margin

Operating leveage: Better products improve dealers'

asset turnover and efficiency, enhancing auto

makers' operating leverage

Opening up more resourcesfor technology

cooperation

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2-year average R&D per car sold (CNY)FCF per car sold (CNY)Blended ASP per car sold (CNY)

R&D, FCF Blended ASP

Current year FCF/car > previous year R&D /car


- 18 -

Great Wall: rising R&D spending boosts new products sales and ASP. We believe ASP increases over the past two years and the strong new model launches (10 models) scheduled in 2013 are a result of strong R&D investment, which was raised by 33% YoY for 2010 and 42% YoY for 2011. We estimate that Great Wall’s blended ASP rose by 2.8% YoY for 2011 and 7.2% YoY for 2012. We forecast Great Wall’s ASPs to improve by 5.7% YoY for 2013 and 4.3% YoY for 2014, due to the new model launches planned and the product mix being skewed towards SUVs. We believe such rises are sustainable, as we project the company’s R&D spending to rise by 57% YoY for 2012 and 54% YoY for 2013. Great Wall: Daiwa vs. consensus revenue forecasts (CNY m) 2012E 2013E 2014EConsensus 40,847 47,391 54,186Daiwa 43,311 56,918 71,563


2013E sales volume. Our 2013 sales-volume forecast is 10% higher than that of the Bloomberg consensus. We estimate that the average production level for September-December 2012 was 62,029 units a month, translating into 740,000 units for the full year. Once the Tianjing phase II factory starts operating in June this year, we expect capacity of 100,000 units to be added after a period of 6-9 months. 2013E ASP. We forecast the company’s ASP to rise by 5.7% YoY for 2013, due to changes in the product mix. We forecast SUVs to account for 54% of its total sales volume this year, up from 45% for 2012. We note that the ASP of SUVs is about 56% higher than sedans and 11% higher than the company’s blended ASP. 2014E sales. We see further upside to the company’s ASPs in 2014 due to the scheduled launches of high-end H7/H8 SUV models on the back of strong R&D. Regarding sales volumes for 2014, we expect the ramp-up of production at phase II factory and the new Xusui factory to lead to additional output of 150,000 units for 2014. Combined with the existing 740,000 capacity and the potential expansion on the company’s phase III factory in Tianjin, we forecast Great Wall’s total sales to exceed 930,000 units for 2014, which implies total sales-volume growth of 20.6% YoY for 2014 and 25.4% YoY for 2015. Our revenue forecasts exceed those of the consensus by 20% for 2014 and 32% for 2015. We expect consensus to raise forecasts on improved company guidance for ASP and volume increases at a later stage.

Geely

Geely offers a more appealing SUV product line-up. After adding up R&D spending, the capitalised intangible assets resulting from R&D, and total research-staff costs, we estimate that for 2011 Geely’s total R&D expenditure amounted to 5% of its revenue (CNY528m for capitalised assets, CNY635m in technology development expenses, and CNY372m in R&D salaries), and forecast an R&D spending/revenue ratio of 5.1% for 2012. We estimate that Geely’s R&D spending/car sold amounted to CNY2,179 in 2011 and CNY2,425 in 2012 and will reach CNY2,494 in 2013, the highest level among H-share listed peers. Based on this, we regard Geely as the most aggressive domestic automaker in terms of its dedication to upgrading the quality of its products. With its first SUV GX7 already launched and three more SUV models due to be launched in 2013, we forecast the company’s blended ASP to increase by 6.1% YoY for 2013 and 5.7% YoY for 2014. Geely believes its blended ASP for 2H12 was slightly better than for 1H12 due to an improved product mix. Geely: new models scheduled in 2013 New model/upgrade Class Proposed launch periodEV8 SUV 3Q13EX8 MPV 3Q13GX5 SUV 4Q13SX7 SUV 1H13SC5 1.3T A 2Q13SC7 A 1H13


Geely: per-unit statistics and blended ASP


Inside Geely’s Shanghai office and Cixi factory canteen last year On our visit to Geely’s Shanghai office in 4Q12, we saw posters that stated the company’s determination to improve its product quality by cooperating with Volvo.

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R&D, FCF Blended ASP

Current year FCF/car > previous year R&D /car


- 19 -

Geely office poster 1: (reads ‘Eight assets we got from Volvo: 1) a brand; 2) an R&D platform; 3) SPA platform; 4) factories in Sweden and Belgium with unit capacities of 570,000’)

Source: Daiwa

Geely office poster 2: (‘5) engine and auto-part plants; 6) a digital R&D platform; 7) 2,325 dealerships globally; 8) safety technology and property rights’)

Source: Daiwa

The following two photos show that Geely has close relationships with its Korea auto-parts suppliers and Volvo’s technology team. Although we cannot say how those relationships are likely to affect Geely’s long-term earnings, we believe close relations with its business partners provide the company with greater options when it comes to upgrading the quality of its products, improving the brand image over the long term, and allowing it to become a truly global player.

Geely: staff canteen inside Cixi factory catering to staff from Mando (second row of characters are Korean)

Source: Daiwa

Banner outside Geely’s Cixi factory canteen entrance welcoming Volvo’s technology team

Source: Daiwa

Geely: highest R&D/car sold of its peers. We estimate R&D spending increased by 38% YoY for 2010 and 35% YoY for 2011, which helped improved the company’s blended ASP by 8.5% YoY for 2010 and 6.2% YoY for 2011, mainly due to the launch of Emgrand models that were higher in quality than previous versions. We believe Geely has a strong commitment to R&D spending as, measured by the percentage of revenue, R&D increased from 3.9% for 2010 to 5% for 2011 (including capitalised assets). Improved R&D leverage. Geely’s two-year average R&D spending/car sold rose by 34% YoY for 2011 and is expected to rise to 11% YoY for 2012. We forecast the level to reach CNY2,425 for 2012, the highest in the sector, with our forecasts for the other automakers ranging from CNY700-1,500. Given that its product


- 20 -

mix is being geared towards high-quality models, we expect Geely to gain more leverage from R&D, and forecast the ratio to increase by 2.8% YoY for 2013 and 4.6% YoY for 2014. Geely revenue forecast: Daiwa vs. consensus (CNY m) 2012E 2013E 2014EConsensus 24,155 29,202 34,420Daiwa 25,290 31,550 37,895


Our 2013 forecasts. Our revenue forecast is 8% higher than company guidance. Our 2013 sales-volume forecast is in line with the consensus, but we forecast the blended ASP to improve by 5.7% YoY due a change in the product mix with the total sales volume of higher-quality models (GC7, GX7, EC7, and EC8) rising by 38% YoY. Our 2014 forecasts. With the higher base effect, we forecast the high-quality models mentioned above to see sales-volume growth slow to 22% YoY for 2014. Despite this, our 2014 revenue forecast is 8% above that of the consensus, as we forecast sales volume to increase by 14% YoY and blended ASP to increase by 5.7% YoY. The market still seems too cautious about Geely. We believe increased R&D spending results in better models with higher ASPs, and expect this to be the trend for quality local brands over the next few years. The ASPs of Geely’s new products range from CNY62,900 to CNY130,000 per unit, much higher than the company’s low-end product blended ASP of about CNY42,000/unit. With a change in product mix and better R&D leverage, we expect Geely’s FCF/car sold to be above its R&D/car sold for 2013, which should make more funds available for the next round of new-model development over 2014-15, such as potential new models under the Geely-Volvo joint venture. We believe the market has been too cautious about Geely’s short-term prospects and has overlooked the synergies likely to result from its R&D leverage being invested in the joint ventures’ more advanced technology platforms.

DFM

In our opinion, DFM’s golden age has ended. The company has been very successful in building various products by integrating platforms, with the blended ASP exceeding R&D/car sold from 2009 to 2011. However, with government subsidies ending in 2011 and intensifying competition among the OEMs, we expect the company’s blended ASP to trend down over 2012-13 and dip further for 2014 due to a change in

product mix towards more volume products, which should reduce the blended ASP. We believe DFM’s golden age is past, given an ageing product mix, the loss of share in the SUV market, and its underperformance against its peers in terms of sales of cars with engine sizes of more than two litres (see our company report, The end of a ‘golden’ period, published on 23 October 2012). As DF-Nissan’s new product, the infinite, is only due to be launched in 2014, we remain sceptical about its ageing product mix and forecast DF-Nissan’s blended ASP to fall by 2.2% YoY for 2013, following a 9.3% drop for 2012. DFM: 2-year R&D spending/current-year car sale vs. blended ASP


DFM: Daiwa vs. consensus revenue forecasts (CNY m) 2012E 2013E 2014EConsensus 130,196 142,434 154,506Daiwa 122,887 129,052 141,469


GAC

Visibility remains low for GAC. We forecast GAC’s new joint ventures with Fiat and Mitsubishi to add 93,508 units of sales for 2013, accounting for 13% of total sales of 744,443 units, and leading to joint ventures’ overall sales to rise by 22% YoY due to a low base effect. We forecast the company’s blended ASP to improve by 2% YoY for 2013 due to the launch of seven new models in the year. However, we forecast the domestic brand business to remain loss-making for 2013 due to high SG&A costs. We expect the two new joint ventures (Fiat and Mitsubishi) to contribute limited improvement to GAC’s operations. Overall, we forecast the company to deliver negative free cash flow over 2012-14E, an R&D/car sold below CNY1,000, and a blended ASP hovering between CNY122,550-125,802 during the same period.

105,000

110,000

115,000

120,000

125,000

(2,000)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2008 2009 2010 2011 2012E 2013E 2014E

R&D per car sold (CNY) FCF per car (CNY)Blended ASP per car (CNY)

R&D, FCF Blended ASP (CNY)

FCF/car < R&D/car

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/Dongfeng_Motor_Group_121023.pdf#page=1


- 21 -

GAC: 2-year average R&D spending/current-year car sale vs. FCF/car sale


GAC – pre-tax profit forecasts: Daiwa vs. consensus (CNY m) 2012E 2013E 2014EConsensus 2,004 3,035 3,788Daiwa 1,197 2,399 3,269


Brilliance

For the Brilliance-BMW joint venture, we forecast shipments of 200,000 units for 2013 (up 24% YoY), with 3-series sales volume up by 72% YoY, 5-series up by 14% YoY and X1 down by 1.5% YoY. With its product mix focused on the cheaper 3-series and SUVs, we forecast the blended ASP to dip by 3.5% YoY for 2013 and 2.5% YoY for 2014. Brilliance-BMW sales volume Units 2008 2009 2010 2011 2012E 2013E 2014E3 series 13,000 17,000 30,047 42,290 34,946 60,000 86,2105 series 20,000 27,000 40,441 65,097 105,598 120,000 146,7901 series (X1) 20,305 20,000 23,000


Brilliance: pre-tax profit forecasts – Daiwa vs. consensus (CNY m) 2012E 2013E 2014EConsensus 2,482 3,246 3,957Daiwa 2,672 3,479 4,439


We forecast an EBIT margin of 10% for 2013 and 10.4% for 2014 for the Brilliance-BMW joint venture, lower than BMW Group’s level of 11.8% for 2011 and 11.6% for 1H12. The new Tiexi factory engine workshop has started operations, and based on management’s guidance for the 2013 in-house engine production ratio, earnings could surprise on the upside 2013. Our sensitivity analysis suggests that every 0.1pp improvement in the joint venture’s EBIT margin would lead to a 1% improvement in 2013 EPS.

As R&D spending for Brilliance-BMW is mainly derived from its joint venture partners’ technology BMW Group, we are only able to evaluate Brilliance-BMW’s pre-tax profit/car sold (by dividing the joint venture’s profit by Brilliance-BMW sales volume) and the joint venture’s blended ASP. The downward trend we expect in the blended ASP in 2013 is due mainly to the product mix being skewed towards the cheaper 3-series. That said, we believe the joint venture’s pre-tax profit/car sold ratio will trend up in 2013 and be flat in 2014. As we forecast sales-volume growth to slow to 24-28% YoY for 2013-14 and expect product-mix changes, Brilliance’s adjusted-FCF per car should still be in line with that of previous years. Brilliance: adjusted-FCF and blended ASP


0

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2,000

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7,000

8,000

(150,000)

(100,000)

(50,000)

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150,000

200,000

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2010 2011 2012E 2013E 2014E

FCF per car Blended ASP per car R&D per car sold

Blended ASP, FCF (CNY) R&D (CNY)

Negative FCF

Low R&D level

335,000

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365,000

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17,200

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17,600

17,800

18,000

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18,600

2011 2012E 2013E 2014E

Adjusted-FCF per car sold Blended ASP per Brilliance-BMW

JV's pre-tax profit per car sold (CNY) Blended ASP (CNY)


- 22 -

Catalyst 2: new engineering is improving margins

Rising in-house engine production is lifting gross margins

Given the subdued economic backdrop since 2011, we believe the automakers have been focusing more on production of entire cars rather than just engines in order to hedge their total investment risk over time. This has led to asymmetric capacity expansion stages between whole-car factory and engine workshops. The result has been that the automakers’ in-house engine production ratios fell in 2012. China automakers: sales volume versus in-house engine-production level


Engines alone account for a significant proportion of the automakers’ total production costs (12-15%). We recently talked to Great Wall and Brilliance, and according to both companies, their in-house produced engines are 15-20% cheaper than imported engines. In theory, this implies that the automakers could cut their COGS, which should lead to significantly higher gross margins.

Incremental earnings growth in 2013 and 2014 depends more on endogenous factors than sales volume As such, with more automakers increasing their in-house engine-production ratios, we believe that any incremental earnings growth in 2013-14 will depend more on endogenous factors – such as higher in-house engine production ratios – than an improvement in sales volume. If we compare our 2013-14 earnings forecasts for the automakers with those of the Bloomberg consensus, it would appear that the consensus has not incorporated the fact that Great Wall’s and Geely’s new engine and gearbox workshops have started to ramp up productions. As Geely’s in-house engine-production ratio is already high, we believe any further margin expansion will depend more on the company’s use of its six-speed automatic gearbox produced in-house that is unique in the industry. Some of the examples between in-house engine-production ratio and gross margin improvements are shown in the following charts. SAIC: in-house engine-production ratio vs. gross margin

Source: CAAM, Daiwa

BYD: in-house engine-production ratio versus gross margin

Source: CAAM, Daiwa

57%

58%

59%

60%

61%

62%

63%

64%

65%

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

2007 2008 2009 2010 2011 2012E

Total PV sales Industry in-house engine production ratio

Total PV sales (units) In-house engine production ratio

Decreasing in-house engine production ratio

Increasing in-house engine production ratio

10%

11%

12%

13%

14%

15%

16%

17%

18%

20%

25%

30%

35%

40%

45%

2008 2009 2010 2011

SAIC in-house production ratio SAIC GPM

(In-house engine production ratio) (GPM)

3.8%

4.8%

5.8%

6.8%

7.8%

8.8%

9.8%

30%

35%

40%

45%

50%

55%

60%

2010 2011 Jan-Oct 2012

BYD in-house production ratio BYD Auto EBIT margin


- 23 -

Great Wall: adding 300,000 units of engine capacity in 2013 could be a catalyst Great Wall: in-house auto-parts production and start dates In-house production Start dateAnnual production of 100,000 diesel engines (GW4D20) Dec-12Annual production of 300,000 EG engines Dec-13Annual production of 200,000 sets of six-speed manual gearboxes Dec-12Annual production of 400,000 aluminium alloy castings Aug-13Annual production of 400,000 axles and brakes Jun-14Annual production of 400,000 interior and exterior decorations Sep-14Annual production of 400,000 automotive lightings Nov-12


Great Wall: in-house engine-production ratio vs. gross margin


Great Wall expanded its vehicle-production capacity faster than its engine capacity in 2012, which we believe resulted in a drop in its in-house ratio, to 70% in 2012, from above 75% recorded in 2011. That said, its 9M12 gross margin improved to 26.5% on the back of utilisation at the new Tianjin factory (producing H6 SUVs) ramping up to 87%. This is consistent with its 1Q12 gross margin of 25.5% (44% utilisation rate) and 1H12 gross margin of 26.3% (59% utilisation rate). We expect to see more earnings-growth catalysts when Great Wall’s new engine workshops start operating in 2013 and 2014. The company added production capacity of 100,000 diesel engines at the end of December 2012 and targets to increase its petrol-engine production capacity by 300,000 by the end of 2013. As such, we forecast the increase in capacity to improve Great Wall’s in-house engine-production ratio from 70% in 2012 to 85% in 2014. Great Wall – gross-margin forecasts: Daiwa vs. consensus

2012E 2013E 2014EConsensus 24.5% 24.6% 24.83%Daiwa 26.9% 27.7% 28.1%


Great Wall’s margin expansion. We forecast the number of SUVs equipped with diesel engines to improve from 27% in 2012 to 29% in 2013, which should improve Great Wall’s overall gross margin to 27.7% for 2013 and 28.1% for 2014 from 26.9% for 2012. We forecast a 2012-14 gross-profit CAGR of 31%. Geely: gearbox a potential catalyst The gross-margin expansion that we expect for Geely in 2013 and 2014 should depend on its in-house gearbox production ramp-up, given that its in-house engine-production rate is already high currently. We recently spoke to the company and understand that delays in the production of the automatic gearbox are mainly because one of Geely’s auto-parts suppliers took extra time to improve quality controls for two of key components (requiring a high level of precision, close to 0.02mm). As such, we are changing our gearbox ramp-up pace forecast to 7.8% MoM from 10% MoM. Geely: in-house engine production-ratio vs. gross margin


Geely’s margin expansion. We estimate that the monthly production of Geely’s six-speed automatic gearbox (made at its Xiangtan factory) alone improved to about 3,300 units by the end of 2012, and forecast a further improvement to 4,057 units by the end of 1Q13 and 5,588 by the end of 2Q13. This, together with the production at its new Jining factory (its second automatic gearbox plant), which is also ramping up, leads us to forecast total in-house production of six-speed automatic gearboxes of 12,844 units/month by December 2013, as we forecast that more than 25% of Geely’s monthly PV car sales will have automatic gearboxes (includes some of its EC7 and GC7 sedans). We forecast Geely’s gross margin to rebound to 18.6% for 2013 and 19.4% for 2014 from 17.4% for 2012. Geely: gross-margin forecasts – Daiwa vs. consensus



25%

25%

26%

26%

27%

27%

28%

28%

29%

60%

65%

70%

75%

80%

85%

90%

2010 2011 Jan-Oct 2012 2013E 2014E

GWM in-house production ratio GWM GPM

Better margin is due to change in product mix with SUV accounting for 59% gross profit in 2012 from 40% in 2011.

17.0%

17.5%

18.0%

18.5%

19.0%

19.5%

92%

93%

94%

95%

96%

97%

98%

99%

100%

2010 2011 Jan-Oct 2012 2013E 2014E

Geely in-house production ratio Geely GPM (RHS)


- 24 -

Geely: six-speed DSI automatic gearbox monthly shipments


DFM: in-house ratio already high; core problem is ageing product mix DFM. Over the past five years, there has been a correlation between the in-house engine-production ratio and the gross margin for the company. However, as the company’s in-house engine-production level reached 97% for 2011, we foresee limited upside to DFM’s gross margin in 2013 from a further in-house engine ratio enhancement. Thus, we believe DFM’s production model affords it limited scope for margin expansion compared with those of Great Wall and Geely, but more downside (given our concerns discussed earlier in this report). We forecast DFM’s gross margin to be 18.7% for 2013 and 19% for 2014. DFM: in-house engine-production ratio vs. gross margin

Source: CAAM, Daiwa estimates;

Note: in-house engine production ratio (LHS), GPM (RHS)

DFM gross-margin forecasts – Daiwa vs. consensus


Source:

GAC. For GAC, engines in the Highlander 3.5 litre and Yaris are all imported, with the engines in other car models mainly outsourced from FAW-Toyota. There was an inverse correlation between the in-house engine-production ratio and the EBIT margin in 2012,

due to the ageing product mix and increased competition in the B-class segment. GAC: in-house engine-production ratio vs. gross margin


Brilliance-BMW. The design capacity of the new engine workshop at Tiexi factory should match the whole-vehicle capacity of the new Tiexi factory, which we believe would mean a combined annual capacity of 100,000 units for both engines and cars by the end of 2013. The new 3-series turbo engines are produced in the Tiexi factory. We believe the upside potential for its in-house produced engine ratio should lift the Brilliance-BWM joint venture’s EBIT margin to above 10% for 2013. Summary: outlook for in-house engine-production ratios More pressure on DFM than other OEMs. Though DFM has achieved a very high in-house engine-production ratio over the past few years, we believe the company will face greater pressure to maintain an elevated utilisation rate on both engine workshops and whole-car factories in the next two years. China automakers: in-house engine-production ratios 2009 2010 2011 Jan-Oct 2012

DF-Nissan 86.4% 97.7% 96.2% 100.0%DF-Honda 100.0% 100.0% 100.0% 100.0%DF-PSA 96.3% 100.0% 99.1% 98.0%DFMG (JVs) 91.9% 99.0% 97.7% 99.6%BJ-Hyundai 92.9% 83.5% 75.3% 64.2%FAW-VW 98.4% 100.0% 100.0% 100.0%SAIC-VW 49.4% 47.5% 48.5% 44.7%SAIC-GM-Wuling 55.5% 64.6% 65.9% 75.7%SAIC-GM 19.1% 15.7% 15.8% 15.1%SAIC Group 43.0% 43.4% 43.6% 45.1%Great Wall 76.5% 76.0% 77.4% 70.1%Geely 100.4% 98.7% 97.0% 93.4%Chery 99.8% 100.0% 95.7% 92.1%BYD 14.2% 33.0% 57.1% 46.9%


0

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-12

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2

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-12

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Feb

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13E

Jun

13E

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3E

Aug

13E

Sep

13E

Oct

13E

Nov

13E

Dec

13E

Units

Problem from auto-part suppliers

16.0%

17.0%

18.0%

19.0%

20.0%

21.0%

22.0%

23.0%

24.0%

25.0%

90%

92%

94%

96%

98%

100%

102%

2008 2009 2010 2011 Jan-Oct 2012

DFM engine in-house production ratio DFM GPM

13%

14%

15%

16%

17%

18%

19%

70%

75%

80%

85%

90%

95%

2010 2011 2012E

GAC-Toyota in-house production ratio (LHS) GAC-Toyota GPM (RHS)

In-house ratio Gross margin


- 25 -

Higher OEM ratios should reduce auto-parts costs and narrow brand gap between local and joint venture automakers Based on information from Automotive News China in 4Q12 and January 2013, we summarise here foreign auto-parts suppliers’ expansion plans in China: BorgWarner expands Ningbo plant to produce engine parts:

• US supplier BorgWarner Inc. opened another factory at its production complex in Ningbo, China, in 2012 to produce engine-timing systems and variable cam-timing systems.

• The 16,500 square-metre facility will house test stands and assembly lines that will produce parts for 20 customers.

• The company also opened a 10,000 square-metre engineering centre in Ningbo in 2012, which will include a prototype shop plus two test stands for turbochargers and engines.

Johnson Controls to build 10 new seat plants:

• Johnson Controls Inc. plans to build 10 new seat plants in China over the next five years to offset a sluggish auto market in Europe and its more modest pace of expansion in North America.

• Johnson Controls currently has 56 plants in China – some wholly owned and some joint ventures – that generate total sales of USD5bn (CNY31bn).

Continental expands airbag controller output:

• Continental AG has signed an agreement to supply a Chinese automaker with its SPEED S airbag control unit starting in 2014.The SPEED S control unit integrates the stability control system's skid sensors with its airbag activation system.

• Continental has stated that it produces the controller in its new factory in the northeast China city of Changchu. Continental has invested USD48m (CNY300m) in the facility, which started production in January this year.

Alcoa opens aluminium wheel plant in Suzhou:

• Alcoa Inc. opened its first aluminium wheel plant in China in December 2012 to supply the local automotive market. Located in Suzhou in Jiangsu Province, the facility will produce forged aluminium wheels for trucks, trailers and buses.

• Alcoa did not release further information about the Suzhou plant. According to the Suzhou Government, the initial investment in the plant is estimated at

USD29m (CNY180m). Alcoa started selling imported aluminium wheels in China in 2004, and its aluminium wheel business now has sales offices in five Chinese cities.

Honeywell to supply turbochargers for Great Wall SUVs

• Honeywell International Inc. has started supplying turbochargers for two diesel-powered SUVs built by Great Wall since late December 2012. The turbochargers will be installed in the Haval H5 and H6 compact SUVs.

• Honeywell expects 20% of diesel-powered light vehicles in China to be fitted with its turbochargers in five years, up from 5% in 2012.

Bosch plans a second diesel-fuel injector plant in China:

• Robert Bosch GmbH (Bosch) plans to build its second diesel-fuel injector plant in China. The USD257m (CNY1.6bn) facility in Qingdao in east China's Shandong Province should start production in 2018.

• The facility will manufacture mainly diesel-fuel injectors for light- and heavy-duty trucks as well as cars.

• Bosch's first common rail-injector plant is in Wuxi in east China's Jiangsu Province. Like the first plant, the Qingdao plant will be owned jointly by Bosch and Wuxi Weifu, a Chinese diesel-injector manufacturer.

• In July, China will adopt the National IV emission standards, which are similar to the Euro IV emission standards. Bosch expects tougher emission controls to boost market demand in China for its diesel technology.


- 26 -

Catalyst 3: a gift from the automakers to the dealers

Dealer EBIT margins should improve in 2013

Our market research suggests that the automakers are likely to help their dealers more in 1H13 than 2012 to prevent discounts on new car sales at retail level from widening. In order to do so, we expect the automakers to: 1) reduce production or import levels, and 2) reduce the manufacturers’ suggested retail prices (MSRP) on their new products and wholesale prices at the same time, and transfer ASP cuts from the retail space to the factory, thereby helping dealers to improve gross-profit margins. Import volume has been slowing China: change in PV import sales volume (MoM)

Source: CEIC, Daiwa forecasts

Compared with 2011, China PV imports have been slowing consistently on a MoM basis since 2Q12, as automakers have realised that their sales targets set at the start of 2012 were too ambitious. ASP of imports trending down

We believe slowdowns in import volume and blended ASPs suggest partial discounts at the retail level could have been transferred to the production level.

China: import PV wholesale volume and blended ASP (YoY)


Favourable trend: dealer discounts have been decreasing We estimate that the gap between the retail prices of new cars and the MSRP has narrowed between 3Q12 and 4Q12. The magnitude of the discounts in tier-one and coastal cities has also been narrowing. Discounts on luxury Germany PV brands

Source: NDRC, Daiwa

Discounts at the dealer level (retail price vs. MSRP)

Source: NDRC, Daiwa

(40%)

(20%)

0%

20%

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Jan-

11Fe

b-11

Mar

-11

Apr-1

1M

ay-1

1Ju

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1Au

g-11

Sep-

11O

ct-1

1No

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Feb-

12M

ar-1

2Ap

r-12

May

-12

Jun-

12Ju

l-12

Aug-

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Oct

-12

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Restocking Destocking

(15%)

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Ma y

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-12

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12

LHS: Total imported units (YoY) RHS: Blended ASP changes (YoY)

-14.6%

-12.0%

-4.3% -4.2% -2.7%

-10.0%

-6.6%-4.1% -4.3%

-2.2%

(16%)

(14%)

(12%)

(10%)

(8%)

(6%)

(4%)

(2%)

0%

24-A

ug-1

2

27-S

ep-1

2

9-O

ct-1

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18-O

ct-1

2

25-O

ct-1

2

1-No

v-12

12-N

ov-1

2

22-N

ov-1

2

29-N

ov-1

2

5-De

c-12

25-D

ec-1

2Imports average OEM average

Bottom out

(8%)

(6%)

(4%)

(2%)

0%

2012

.7.1

7

2012

.08.

06

2012

-08-

20

2012

.9.6

2012

.9.1

3

2012

.9.2

0

2012

.9.2

7

2012

.10.

9

2012

.10.

18

2012

.10.

25

2012

.11.

01

2012

.11.

12

2012

.11.

22

2012

.11.

29

2012

.12.

05

2012

.12.

12

Tier-1 cities + Shenzhen average Coastal area average

Lower-tier and inland area average


- 27 -

Conclusion: dealer earnings visibility better than that of automakers in 1H13 As import wholesale volume and blended ASP declined, the magnitude of the discounts decreased at the dealer level in 4Q12. Our research in the market shows that reduced MSRPs lead to better sales at the retail level, which in turn improve gross-profit margins for dealers on new-car sales. In addition, we estimate that dealer working capital accounted for 50-100% of dealer EBIT for 2012; thus, better sales and asset turnover this year compared with 2012 would reduce inventory risk for dealers and improve their earnings visibility. Our auto tour in September 2012 suggested automakers had started to help dealers We learned from ZTA that new subsidies had been implemented by automakers: 1) CNY8,500 per imported BMW car sold in 1H12, and 2) CNY5,000 per local OEM BMW sold in 2Q12, to be booked in 2H12. ZTA also said that some companies had recently cut their 2012 sales targets in China: Volvo (Not listed) by 20%, BMW (Not rated) by 7%, and Audi (Not listed) by 13%. Negative catalyst: automakers may lower both wholesale prices and MSRPs in 1H13 Auto dealer inventories improved sharply YoY for 4Q12. In 1H13, we expect dealer stocks to be rerated before automaker stocks for the following reasons. Reason 1. In a recent conversation with Dah Chong Hong (Not rated), a luxury auto dealer, management said that in 1H13 it expected OEMs to cut wholesale prices and MSRPs together, to transfer discounts from the retail level to the automakers themselves, so as to improve dealer earnings visibility and minimise the effects of dealers undercutting each others’ ASPs. Reason 2. During our auto tour in November 2012, we learned from a Geely dealer that Japanese OEMs might cut their MSRPs sharply in 2013 to regain market share. Reason 3. During our recent conversation with DFM, we asked about the likelihood of MSRP cuts in 1H13. Management said it did not rule out the possibility. Great Wall and Geely should not be affected by negative catalyst By measuring and forecasting car sales growth/ dealership, we are able to estimate the dealer asset-turnover levels, which show the popularity of the car models they are selling, setting the benchmark for the inventory risk they could face. From 2011-12, we estimate that Geely, Great Wall, and Brilliance saw increases in their car sales/dealer ratios and declines

their selling and distribution expenses/car sales ratios, which we use as benchmarks to measure the operating leverage of the automakers resulting from sell-through efficiency at the dealer level. Geely: growth in car sales/dealer and dealership number (YoY)

2010 2011 2012E 2013E 2014ESelling and distribution cost per car per year growth 21.9% 12.5% -9.1% 4.2% 3.9%Dealership number per year growth 64.0% -6.0% -0.3% 2.7% 4.2%Car sales per dealership growth -21.2% 2.8% 0.2% 6.0% 5.1%Selling and distribution cost per car 2,866 3,224 2,929 3,053 3,172Dealership number 1,038 976 973 999 1,042Sales per dealership (domestic) 381 391 392 416 437

Source: Company, CAAM, Daiwa forecasts

Great Wall: growth in car sales/dealer and dealership number (YoY) 2010 2011 2012E 2013E 2014ESelling and distribution cost per car per year growth -12.3% -12.4% -10.4% 1.1% 5.9%Dealership number per year growth 7.7% 7.1% 20.0% 8.3% 8.7%Car sales per dealership per year growth 14.2% 14.3% 15.0% 11.4%Selling and distribution cost per car 2,944 2,578 2,309 2,335 2,473Dealership number 700 750 900 975 1060Sales per dealership 448 511 584 672 749


DFM: growth in car sales/dealer and dealership number (YoY) 2010 2011 2012E 2013E 2014ESelling and distribution cost per vehicle growth 10% -12% -5% 7% 0%Total dealership number growth 7% 41% 16% 6% 9%PV: sales per dealerships growth 44% 17% -21% -2% -3%Selling and distribution cost per vehicle 3,298 2,888 2,736 2,919 2,929Total vehicle sales per dealership 379 300 255 257 264PV: vehicle sales per dealership 454 530 421 411 400


We expect a better sell-through to dealers over 2012-14, which should give automakers the upper hand in negotiations on commission and incentive terms with their dealers. Combined with the sound number of new model launches planned by Great Wall and Geely in 2013, we forecast Great Wall’s and Geely’s car sales/dealer in 2013 to improve faster than the increase in their number of dealerships. GAC: growth in vehicle sales/dealer and dealership number (YoY)

2011 2012E 2013E 2014ESelling and distribution expenses per vehicle growth 77.4% 61.5% 7.9% 7.6%Total PV + CV dealership growth 46.4% 12.9% 14.3% 14.4%Vehicle sales per dealership growth -30.3% -15.0% 8.5% 0.1%Selling and distribution expenses per vehicle 803 1,296 1,399 1,505Total PV + CV dealership 1,400 1,581 1,808 2,067Vehicle sales per dealership 524 446 484 484



- 28 -

Brilliance-BWM: growth in car sales/dealer and dealership number (YoY) 2010 2011 2012E 2013E 2014E

BMW dealers: YoY change in number 40% 38% 31% 11% 19%BMW sales (units): YoY change 60% 52% 50% 24% 28%Sales volume per dealer growth 14% 10% 14% 12% 8%BMW dealers 210 290 380 420 500BMW annual sales (units) 70,488 107,387 160,849 200,000 256,000Sales per dealer 336 370 423 476 512


We remain sceptical that sales will recover for Japanese brands in 2013 As mentioned earlier in this report, we expect automakers to bear the cost of cutting their ASPs to improve market sentiment and the working capital of their dealers. Meanwhile, we believe the Japanese PV brands have been consistently losing market share over the past four years in the world’s biggest car market. Japanese brands: PV market shares among all JVs in China

Source: CAAM, Daiwa

Upside catalyst: weakening Yen According to DFM management, in terms of value, around 10% value of DF-Nissan’s and DF-Honda’s parts are imported from Japan. Our sensitivity analysis shows that a further 20% depreciation of the Yen against the US Dollar from its December 2012 level in 2013 would raise our 2013 net-profit forecast for DFM by 10-15% YoY. DFM plans to open new dealerships in low-tier cities in 2013 and 2014… Compared with most domestic brands, DFM’s three joint venture brands have more dealerships located in coastal areas, which have more mature market sizes and higher car-penetration rates. In 2013 and 2014, we expect the company to expand these dealerships in low-tier cities and inland areas.

Dealers: current locations in China


… but new dealers need time to mature The auto dealer turnover rates of DFM and GAC, measured by vehicle sales/dealer, declined consistently over 2010-11. We expect DFM’s EBIT margin to remain under pressure this year. To limit downside risk, we expect the company to adopt the following tactics: 1. Open more exclusive dealerships in inland areas to

raise sales volume, and/or 2. Cut MSRPs and wholesale ASPs simultaneously to

improve sell-through to the dealers.

We expect this to dilute DFM’s vehicle sales/dealers ratio and increase the selling expenses/car sales ratio for 2013, which would be likely to deleverage its dealer operations and affect the quality of dealer earnings because new dealers usually take 2-3 years to reach maturity. Our conference call with DFM in 3Q12 suggested that 20% of DF-Nissan’s dealers along the coastal areas were losing money in 2Q12, before the dispute between Japan and China over the Diaoyu Islands. At our conference call with DFM in January this year, management declined to comment on the profitability of the company’s dealers, but said it expected the total number of dealerships to increase by more than 5% YoY for 2013. We believe the pace of dealership expansion in inland and low-tier cities among the Japanese OEMs will be faster than the domestic brands in 2013 and 2014, leading to operating deleverage with declining car sales/dealer. Overall, relative to mid-range OEM brands we prefer quality domestic brands as: 1) most of their fully mature dealerships are located in low-tier cities where there is strong demand for auto sales, and 2) they have more prudent dealership expansion plans than the

35.2% 30.0% 23.2% 20.7%

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- 29 -

domestic brands, in our view. We believe that DFM, in order to maintain its high utilisation rate, will focus more on the total sell-in level rather than the average sell-through volume (ie, vehicle sales/dealer).

Luxury German brands: declining China OEM ratio is the biggest concern We believe BMW, as a global company, needs to balance its overseas and China utilisation rates. Given the still-subdued economic outlook in Europe, BMW China’s OEM ratio of sales as a proportion of the total sales has been declining, implying that the proportion of imported car sales was stronger in 4Q12 compared with 3Q12. We believe this may lead to a deliberate slowdown in the ramp-up of production at Brilliance-BMW’s new factory in 2013. German luxury car sales in China: OEM sales/total sales

Source: CEIC, Daiwa

Brilliance’s new factory ramp up has been slow We had expected the X1-SUV to be Brilliance’s key model in terms of sales volume in 2012. However, after reaching monthly sales of 3,400 units for May 2012, sales volume has fallen consistently on a month-on-month basis. Brilliance-BMW: sales volume of its X1 SUV

Source: CEIC, Daiwa forecasts

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- 30 -

Pair-trade idea: switch from DFM into ZTA Summary of investment idea We believe excessive expansion of dealership networks in 2011 led to YoY earnings declines for 2012, but companies that undertook scaled expansion in 2011 (such as ZTA) should start to be rewarded in 2013 with better incremental earnings and rises in the ROI from the after-sales services business. We believe the risks for DFM are as follows: 1. DFM has been losing market share in the SUV

segment since June 2012, and we expect its market share to fall further with only a few new models planned to be launched this year.

2. We foresee ASP dilution from a change in the

product mix to cheaper products. 3. We foresee operating deleverage as a result of

opening more exclusive dealerships in low-tier cities, leading to a less efficient sell-through with lower car sales/dealer.

Though we cannot rule out synergies from the strategy noted under point 3 above coming through in 2014, we believe success in this area depends much on the company’s dealers rather than its products, R&D, or production. Specifically, we recommend that investors switch from DFM into ZTA for the following reasons. 1. ZTA completed a heavy capex cycle at the end of

2011, and we believe it is about to see strong earnings from after-sales services for luxury cars.

2. Luxury dealerships’ gross profit and net profit per car sale and services are much better than for DFM.

3. Upselling of auto finance and insurance within a

luxury dealership generally improves operating leverage. We believe ZTA’s stronger incremental growth from the luxury car after-sales segment is not reflected fully in its current share price.

No. 1 reason we rate DFM Underperform: change in product mix To maintain a high utilisation rate and market share, DFM launched the Venucia and Ciimo in 2011. We compare these two models with models from its competitors that have a similar ASP and are of a similar type. Our analysis suggests monthly sales and the pace of production ramp-up for DFM’s two models were far below SAIC’s Baojun, Great Wall’s C30, and Geely’s EC7. We believe that to boost total sell-in volume of those models DFM will have to open more dealerships, which would dilute the average car sales/dealer. Domestic brands vs. JVs’ local brands

Source: CAAM, Daiwa

No. 2 reason: new dealerships need time to mature Past industry cycles suggest a significant negative correlation between growth in the number of dealerships and growth in car sales/dealer. It usually takes 2-3 years for a new dealership to mature. Recurring after-sales services revenue starts to flow after companies have built up a sizeable customer base through new-car sales. DFM: PV China dealership expansion and dealership performance


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Total PV dealership number growth PV: vehicle sales per dealerships growth


- 31 -

Given high competition among luxury PV brands in tier-one cities, we believe DFM will have no choice but to enter low-tier cities with cheap models. As such, we forecast a 15-16% YoY increase in dealership numbers for the company over 2012-14, resulting in the PV sales/dealer ratio declining by 20.6% for 2012, 2.2% for 2013 and 2.7% for 2014. We believe a 2012-14 recovery in terms of vehicle sales per dealers over 2012-14 would be very different from that seen over 2008-11, due to the following: 1. We forecast weighted-average product ages to be

much lower over 2008-11: 23 months for DF-Nissan (33.8 months currently), and 17.6 months for DF-PSA (42.4 months currently).

2. The auto subsidies available over 2009-11 are

unlikely to be repeated. 3. We expect competition to increase in coming years,

with luxury brands launching cheap entry-level models and local brands improving the quality of their offerings.

DFM: growth in car sales/dealer and dealership number

2009 2010 2011 2012E 2013E 2014EPV: vehicle sales/dealership 316 454 530 421 411 400CV: vehicle sales/dealership 41 32 16 16 16 16Total vehicle sales/dealership 299 379 300 255 257 264Selling and distribution cost per vehicle 3,003 3,298 2,888 2,736 2,919 2,929PV: vehicle sales/dealership (YoY) 32.2% 43.9% 16.7% -20.6% -2.2% -2.7%Selling and distribution cost per vehicle (YoY) -6.0% 9.8% -12.4% -5.2% 6.7% 0.3%


Conclusion: invest in mature dealers rather than those that are still developing Our negative view on DFM is premised mainly on the above assumptions (fast dealership expansion with slow sales increases). Given this, we believe investors should switch to auto dealers such as ZTA, which made large capex investments in 2011 and should have high visibility on after-sales service profit this year. We expect low visibility for DFM, as we forecast its sell-through efficiency to remain weak in both 2013 and 2014 with a moderation in its car sales/dealer.

We prefer dealers to OEMs

ZTA’s and ZSG’s incremental growth seems more attractive than DFM’s over 2013 and 2014, based on our forecasts. We believe the main earnings-growth driver for ZTA is its services, and forecast its gross profit/dealer to rise by 11-16% YoY for the next two years. For ZSG, we believe the principal earnings-growth driver will come from growth in sales volume, with growth in its car sales/dealer likely to outpace

growth in its number of dealerships over the next two years, leading to a gross profit/dealer of above 20% YoY over 2013-14, based on our forecasts. From an operational point of view, we forecast declines in DFM’s PV sales/dealer of 21% YoY for 2012, 2.2% YoY for 2013, and 2.7% YoY for 2014. Given the company’s inferior product mix compared with the German, US and Korean OEMs, and the limited upside we see from cost-cutting at the production level, we recommend a pair trade between DFM and the auto dealers, which have better operational efficiency. ZTA: expansion and gross-profit trend 2010 2011 2012 2013E 2014E

Selling and distribution cost per car sold 10.4% 16.3% 12.4% -2.1% 5.0%Selling and distribution + admin costs per car sold 32.5% 19.6% 19.1% -2.4% 4.3%Dealership number 41.2% 145.8% 11.9% 15.2% 13.2%Cars sales per dealership -11.0% 7.5% -12.4% 0.8% 5.2%Gross profit per new car sales 51.4% 50.9% -6.7% 3.8% 4.3%Gross profit per service 41.5% 16.4% 45.3% 17.1% 15.8%


ZSG: expansion and gross-profit trend

2010 2011 2012E 2013E 2014ESelling and distribution cost per car per year 22.8% 19.2% 28.6% 5.7% 5.2%Selling and distribution + admin costs per car per year 22.1% 19.7% 28.2% 4.7% 5.4%Dealership number 108.5% 42.9% 14.3% 14.4% 14.2%Cars sales per dealership/year -21.8% 12.3% 1.0% -0.3% 1.5%Gross profit per new car sales 25.5% 27.9% -29.1% 14.3% 5.2%Gross profit per service 13.6% 4.0% 29.8% 27.4% 13.2%


ZTA unlikely to over-expand in 2013

Overexpansion can be a bad thing Based on historical correlations, when gross profit from new car sales growth exceeds that of after-sales services, there is a tendency for auto dealers to undertake aggressive expansion. With the central government’s auto subsidies aimed at boosting the economy having kicked in after the sub-prime crisis in the 2008, we believe the auto retail market has become heavily distorted. The better sell-through level as a result of the subsidies has generated very high expectations of short-term returns in the market simply by building more shops and selling more cars. Consequently, dealers such as ZTA and ZSG have opened many new dealerships, expanding by 40-140% from their original size. However, going into 2013, we believe that as a result of revenue-mix changes and the sector’s expected recovery via organic growth rather than from government policy distortion, the over-expansionary bias should be milder.


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ZTA: over-expansion in 2011 on bullish outlook for new-car sales


ZSG: over-expansion in 2011 on bullish outlook for new-car sales


Introducing Daiwa’s ‘greed’ ratio

Calculating ‘average annual gross profit from after-sale servicing per customer’ To measure the gross profit from auto services each year for each customer, we first estimate the potential customer base. In this report, based on feedback from our discussions with ZTA and ZSG, we introduce our estimated probabilities of car buyers returning to the same dealer for services 1-4 years after purchasing a new car. These are set forth in the table below. Probability of car buyer returning to same dealer for services Within 1 year 90% Within 2 years 85%Within 3 years 80% Within 4 years 65%

Source: Daiwa estimates

Based on these assumptions, we derive the total customer base. By dividing the total gross profit from services by the total customer base (the number of cars sold in the past four years multiplied by the return

probabilities), we calculate the average annual gross profit from after-sale servicing per customer (AGPS). A greed ratio of >2.5 may indicate an over-expansionary bias Due to the fragmented nature of the market, with each of the top-3 dealers capturing less than 8% of the market size in terms of revenue, we believe dealers look for every opportunity to expand when they are cash-rich and their new-car sales volume reaches a growth rate of 30%+ YoY. We estimate that a greed ratio higher than 2.5x indicates that companies are likely to embark on heavy expansion, as occurred at ZSG in 2009-11 and at ZTA in 2010-11. Daiwa’s greed ratio


We believe that ZTA’s overexpansion in 2011 was associated with its strong balance sheet, high interest coverage with net cash, and strong new car sales growth, which led to its greed ratio overshooting 2.5. Subsequently, we think 2012 was a consolidation year for ZTA. We forecast new-car sales volume to rise only by 16% YoY for 2013 and 19% YoY for 2014, and we think these low growth rates should help to keep the greed ratio below 2.5 with only a gradual improvement in net gearing and interest coverage. ZTA: over-expansion in 2011 associated with strong balance sheet and higher over-expansionary tendency


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Greed ratio; Net gearing

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- 33 -

In conclusion, we believe the risk of ZTA over-expanding again in 2013 is relatively low compared with its past activity. In our view, the market has been over-sceptical and has put a high discount on ZTA’s valuation, on the grounds that a new round of aggressive expansion may occur in 2013.

Upselling should raise EBIT margins for ZTA and ZSG

For ZTA, although visibility in commission income from cross-selling (ie, car financing, insurance, second-hand car sales) remains low based on limited company disclosures, the ratio of cross-selling income to ZTA’s overall revenue (commission income is not accounted for under revenue, but under operating income) has increased from 0.61% in 1H11 to 0.66% in 2011 and 0.87% in 1H12, of which auto financing and insurance accounted for 80-90%, with the rest being second-hand car sales. ZTA: operating leverage


ZTA recognises that overall its auto-financing penetration rate has improved significantly, to 25% in 2012 from 15% in 2011. According to the company, auto makers have been aggressively promoting auto-financing and are apparently offering dealers a 2-3% rebate on the amount of auto financing per transaction. We take a conservative stance and forecast commission income from this business– auto-finance, insurance, second-hand car sales – to contribute 0.85% (CNY213m) of total revenue for 2012, 1.12% (CNY323m) for 2013 and 1.3% (CNY457m) for 2014. This income would be equivalent to 14% of total operating profit for 2013 and 15% for 2014, and would lead to an overall 2012-14 EBIT CAGR of 40% compared with CAGRs of 29% for gross profit and 21% for revenue during the same period.

ZSG: operating leverage


For ZSG, we forecast the total number of dealerships to increase from 160 at the end of 2012 to 183 at the end of 2013 and 209 at the end of 2014. We assume wages per staff member rise by 12% YoY over the next two years and that each dealership has 120 staff. Given the high demand for after-sales services that we expect over the coming years, with a rise in the car penetration rate on the back of the increased number of cars sold, we believe auto dealers will compete not only on price and service but also for engineers and experienced salespeople. We expect staff costs as a percentage of gross profit per dealer to remain at about 20% for the next two years. As mentioned, we believe operating leverage can be gained from auto finance and insurance, which we forecast to account for 1.2% of 2013 revenue and 1.3% of that for 2014. As a result, we forecast ZSG’s operating margin to rise to 6.1% for 2013 and 6.8% for 2014. As one of the biggest dealers in China, we believe ZSG will see rapid EBIT margin expansion, due to: 1) a steady margin recovery for its new-car sales, 2) a change in the profit mix, with after-sales services accounting for a greater proportion, and 3) positive operating leverage from strong commission income as a result of auto-finance and insurance. We forecast ZSG’s EBIT margin to rise from 4.5% for 2012 to 6% for 2013.

Improving fundamentals

ZTA has indicated it will refocus on organic growth from 2013 rather than M&A, via expanding its own dealerships. As such, we forecast FCF to gradually improve from the 2012 level to deliver an FCF yield of more than 7% for 2013. We also look for the asset-turnover ratio to rise to above 1.7x for 2013 and 1.9x for 2014, from 1.6x for 2012.

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ZTA: recovering FCF and asset turnover


We expect ZTA’s balance sheet to keep improving, and look for its net gearing to rise from 38% in 2012 to 25% in 2013, with its interest coverage moving up from 3.2x to 4.2x. Stripping out the value of its intangible assets, we forecast debt/equity to decline to 1.8x for 2013 and 0.8x for 2014, from 4.9x for 2012. ZTA: balance-sheet ratios


For ZSG, apart from the strong top-line recovery that we see for 2013, we expect SG&A expenses as a percentage of revenue to remain stable in 2013. We forecast the EBIT/dealer to improve by 40.7% YoY for 2013 and 14.9% YoY for 2014, which we expect to lead to a more stable asset turnover at above 1.8x and an improved FCF to above CNY1bn in 2013.

ZSG: FCF and asset-turnover ratio


Given the earnings and cash-flow improvements we expect for ZSG, we forecast the net-gearing ratio to improve to 118% for 2013 and 100% for 2014 with interest coverage rising slightly to 2.8x for 2013 and 3.2x for 2014. ZSG: balance-sheet ratios (%)


Potential inflection point in 2013

Long-term ROI. To determine long-term ROI, we divide the current-year EBIT by the past-five-year total capex plus the current-year maintenance capex. We use this ratio to estimate the investment-return level for every dollar invested over time.

Short-term ROI. To determine short-term ROI (incremental ROI), we divide the change in EBIT over the previous year by the past-two-year average capex. This ratio captures the short-term marginal return per dollar invested for the core business. Our analysis shows that the returns per marginal dollar spent are rising, as organic growth from the ramping-up of the dealerships accelerates.

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- 35 -

Using this measure, we see incremental ROI increasing much faster for ZSG than for ZTA in 2013. This is mainly because we forecast ZSG’s EBIT/dealer to rise by 41% YoY for 2013 (24% YoY for ZTA), mostly due to commission income from auto-finance and car insurance at the operating level, equivalent to 1.2% of 2013E revenue (26% of 2013E pre-tax profit), compared with 1.1% of 2013 revenue (19% of 2013E pre-tax profit) for ZTA. We believe the above difference is mainly due to: 1) ZSG having more mature dealerships, and 2) ZTA undertaking considerable M&A activity in 2011 with the ramp-up in operations started one year later than that of ZSG. We look for a solid rebound in ZTA’s ROI for 2013, as a result of the strong after-sales profit from its previous M&A. We also expect new-dealer after-sales services to ramp up in terms of revenue during 2013, with more incremental growth in 2014, with incremental ROI rising to 75% for 2014. ZTA: incremental ROI suggests an inflection point in 2014


ZSG’s growth looks evenly spread in 2013-14 ZSG: incremental ROI suggests an inflection point in 2013


That said, we still prefer ZTA to ZSG. Although we expect both dealers’ ROACEs to remain similar, we believe ZTA should see better EBIT/dealer and FCF/car sold in 2013-14, suggesting that its profitability should be better than ZSG’s. Furthermore, we expect a stronger balance sheet for ZTA in 2013, with a net-gearing ratio of 25% and interest coverage of 4.2x, compared to 118% and 2.8x for ZSG. Also, by stripping out all of the intangible assets, we forecast ZTA’s debt/equity to improve to 84% for 2014, compared with 100% for ZSG.

556.8%

-4.1% 17.9%75.1%

-100%

0%

100%

200%

300%

400%

500%

600%

0%

5%

10%

15%

20%

25%

30%

35%

2011 2012E 2013E 2014E

ROI ROCE Incremental ROI

ROI, ROCE Incremental ROI

184.8%

92.2%

-10.6%

53.3% 61.5%

(50%)

0%

50%

100%

150%

200%

2010 2011 2012E 2013E 2014E

ROI Incremental ROI ROCE


- 36 -

Risks Equity-placement risk Although our analysis suggests the chance for over-expansion of the dealer network is low 2013, we do not

rule out the chance the auto dealers will undertake M&A and fund it with new equity placements, which would dilute shareholder equity. Aggressive sales targets for automakers Dealer working capital would be under pressure if automakers continued to set aggressive sales targets, which could lead to an oversupply of cars for sale and a price war. Both automaker and dealer EBITDA margins would be affected if this were to materialise. Macroeconomic tightening Our economics team expects M2 growth to slow in 2H13 as inflation starts to rise. As auto sales have a high correlation to M2 growth, we believe an economic tightening by the government would lead to a slowdown in auto sales. Slowing auto exports China’s auto exports could fall sharply if global GDP growth were to slow. We believe domestic brands such as Geely and Great Wall, which have high export levels, would be affected. To offset the effects of an export slowdown, companies might cut prices in the domestic market so as to maintain their utilisation-rate and sales targets. This would affect automaker earnings.


■ What's new Geely’s monthly SUV sales for December 2012 reached 5,000 units, and we think its new product mix could result in positive earnings surprises throughout 2013. ■ What's the impact We expect Geely’s new SUV models to drive earnings growth and help to boost total sales volume growth by 17.6% YoY for 2013 from 14.7% YoY in 2012. We think the installation of automatic gearboxes in some SUVs will allow Geely to set higher ASPs for new models. Thus, we now expect 2013 blended ASP to rise by 6.1% YoY (5% YoY previously) and see a gross margin of 18.6% (18.4% previously). Furthermore, we forecast Geely’s car-sale/dealer ratio to rise by 6% YoY for 2013 and 5.1% YoY for 2014, and the number of its dealers to increase by 2.7% YoY for 2013 and 4.2% YoY for 2014. Thus we expect sales-and-distribution-cost/car-sold growth of less than 4.2% YoY for

2013-14. We think improved operating efficiency will raise 2013 FCF by 252% YoY, resulting in a net cash position of CNY1.6bn. We also expect Geely’s R&D/car sold to fall below its FCF/car sold in 2013, implying greater visibility into the funding of new model launches. We cut our sales volume by 1% for 2013E and 8.4% for 2014E, but raise our operating margin by 0.5pp for 2013E and 1.2pp for 2014E, on a better product mix and sell-through. Thus, we change our EPS by 3.6% for 2013E and -1.6% for 2014E. ■ What we recommend We forecast an EPS CAGR of 35% for 2012-14. We believe Geely deserves to be trading higher than Great Wall’s target 2013E PER of 12.3x (2012-14E EPS CAGR of 22%), though we recognize that Great Wall has a longer track record and market leadership position in the SUV segment. However, we see Geely as having more potential catalysts (ie, SUV and gearbox ramp-up, export-sales growth). We upgrade our rating to Buy (1) from Outperform (2) and raise our target price to HKD5.5 (from HKD3.95), based on a 2013E PER of 13x. Risks include a further macroeconomic tightening. For further details please refer to the sector part.

■ How we differ Our 2013-14E EPS are 19-30% higher than consensus due to our higher operating-margin forecasts.

Consumer Discretionary / China175 HK

15 February 2013

Geely Automobile

Stronger R&D, better operating leverage; upgrade to Buy

• Higher-margin SUVs and automatic-gearbox production ramp-up should improve the quality of 2013 earnings

• Operating leverage should improve further as car sale/dealer ratio should rise in 2013, improving the EBIT margin

• Our 2013-14E earnings are significantly higher than consensus on higher operating margins; raise target and upgrade to Buy


Source: FactSet, Daiwa forecasts


Geely Automobile175 HK

Target (HKD): 3.95 5.50Upside: 18.6%15 Feb price (HKD): 4.64

Buy (from Outperform)

OutperformHoldUnderperformSell

1

2

3

4

5

Forecast revisions (%)Year to 31 Dec 12E 13E 14ERevenue change (3.7) (3.5) (13.1)Net profit change (1.1) 4.1 (1.1)Core EPS (FD) change (1.7) 3.6 (1.6)

80

96

113

129

145

2.0

2.7

3.3

4.0

4.7

Feb-12 May-12 Aug-12 Nov-12 Feb-13

Share price performance

Geely Auto (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 2.41-4.64Market cap (USDbn) 4.483m avg daily turnover (USDm) 34.43Shares outstanding (m) 7,487Major shareholder Geely Holding (51.3%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 25,290 31,550 37,895Operating profit (m) 2,781 3,778 4,841Net profit (m) 2,050 2,867 3,712Core EPS (fully-diluted) 0.239 0.334 0.433EPS change (%) 32.8 39.9 29.4Daiwa vs Cons. EPS (%) 2.6 18.6 30.4PER (x) 15.6 11.2 8.6Dividend yield (%) 0.7 0.9 1.0DPS 0.025 0.032 0.037PBR (x) 2.4 2.0 1.6EV/EBITDA (x) 8.0 5.8 4.3ROE (%) 18.4 20.4 21.8

Jeff Chung(852) 2773 8783

[email protected]



- 38 -

Growth outlook Geely: key assumptions and forecasts

We believe Geely’s new SUV models will be an earnings-growth driver that will result in additional sales of 99,400 cars for 2013. We expect this to help to increase Geely’s total sales volume by 17.6% YoY for 2013 and 13.5% YoY for 2014, from 14.7% YoY in 2012E. With Geely’s improved product mix, we forecast its blended ASP to improve by 6.1% YoY for 2013 and 5.7% YoY for 2014, and for the gross margin to increase to 18.6% for 2013 and 19.4% for 2014 (vs. 18.4% and 18.9% previously). We forecast 2012-14 CAGRs of 22% for revenue, 29% for gross profit and 32% for operating profit, due to margin expansion, better operating leverage and more resources being spent on R&D.


Valuation Geely: PER bands

With an EPS CAGR of 35% that we forecast for 2012-14, we believe Geely deserves to trade above our target 2013 PER for Great Wall of 12x (2012-14E EPS CAGR of 22%), given the improvements that we see in Geely’s cash flow, balance sheet and earnings quality over our forecast period. We are upgrading our rating on the stock to Buy (1) and raising our target price to HKD5.5 (from HKD3.95) to reflect our view of the company’s sustainable long-term revenue-growth business model. The new multiple is slightly above 0.5SD over the past-seven-year PER average. Besides macroeconomic tightening, a slowdown in the ramp-up of Geely’s new SUV model due to quality control issues would be another risk to our call.


Earnings revisions Geely: Bloomberg-consensus EPS forecasts

The Bloomberg consensus has been revising up its 2013 adjusted-EPS forecast regularly since 4Q12, and we expect this to continue as we forecast Geely’s SUV production to improve to 8,000 units/month by April 2013, from 5,000 units/month in December 2012. Our EPS forecasts are higher than the consensus by 19% for 2013 and 30% for 2014 due to our higher operating-margin forecasts. Geely’s strategy appears to now focus on quality rather than quantity – ie, selling fewer cars, but the gross margin/car is higher than previously. As such, we are cutting our 2014 sales-volume forecast by 8.4%, but increasing our operating-margin forecast by 1.2pp to 12.8%, which leads to a mild cut to our 2014E EPS, of 1.6%.



Growth outlook

Valuation

Earnings revisions

0%

2%

4%

6%

8%

10%

12%

14%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2009 2010 2011 2012E 2013E 2014E

Revenue Pre-tax profit margin

(CNYm)

0

1

2

3

4

5

6

7

8

9

10

Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

(HKD)

19.59x

14.92x

10.25x

5.58x

0.90x

0.200.210.220.230.240.250.260.270.280.29

1/1/

2012

1/22

/201

2

2/12

/201

2

3/4/

2012

3/25

/201

2

4/15

/201

2

5/6/

2012

5/27

/201

2

6/17

/201

2

7/8/

2012

7/29

/201

2

8/19

/201

2

9/9/

2012

9/30

/201

2

10/2

1/20

12

11/1

1/20

12

12/2

/201

2

12/2

3/20

12

1/13

/201

3

2012E 2013E

(CNY) EPS

Buy (from Outperform)


1

2

3

4

5


- 39 -

Key assumptions

Profit and loss (CNYm)

Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ETotal sales volume (units) 181,517 204,205 325,413 415,286 421,611 483,483 568,451 645,032Blended ASP (CNY) n.a. 21,003 43,234 46,916 49,812 50,473 53,552 56,600Export sales volume (units) n.a. n.a. n.a. 20,555 39,600 101,908 152,862 189,549Car sales per dealer YoY growth (%) n.a. n.a. n.a. (21) 3 0 6 5Total R&D as % of revenue (%) n.a. 10 4 4 5 5 5 5

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECar sales 131 4,289 14,069 19,483 20,965 24,403 30,442 36,509Others 0 0 0 616 0 887 1,109 1,386Other Revenue 0 0 0 0 0 0 0 0Total Revenue 131 4,289 14,069 20,099 20,965 25,290 31,550 37,895Other income 8 308 358 787 997 1,095 1,343 1,684COGS (116) (3,638) (11,528) (16,379) (17,145) (20,889) (25,689) (30,555)SG&A (48) (503) (1,289) (2,113) (2,322) (2,580) (3,281) (4,017)Other op.expenses 0 0 0 (273) (137) (135) (145) (165)Operating profit (25) 456 1,610 2,120 2,358 2,781 3,778 4,841Net-interest inc./(exp.) (14) (11) (33) (192) (167) (154) (109) (102)Assoc/forex/extraord./others 346 473 (26) (7) (7) (5) (6) (6)Pre-tax profit 307 918 1,551 1,921 2,183 2,622 3,662 4,734Tax 1 (52) (231) (351) (467) (551) (769) (994)Min. int./pref. div./others (3) 13 (136) (181) (172) (22) (26) (28)Net profit (reported) 305 879 1,184 1,389 1,543 2,050 2,867 3,712Net profit (adjusted) 305 879 1,184 1,389 1,543 2,050 2,867 3,712EPS (reported)(CNY) 0.062 0.150 0.171 0.189 0.207 0.260 0.347 0.449EPS (adjusted)(CNY) 0.062 0.150 0.171 0.189 0.207 0.260 0.347 0.449EPS (adjusted fully-diluted)(CNY) 0.061 0.143 0.165 0.163 0.180 0.239 0.334 0.433DPS (CNY) 0.011 0.010 0.012 0.020 0.023 0.025 0.032 0.037EBIT (25) 456 1,610 2,120 2,358 2,781 3,778 4,841EBITDA (23) 597 1,975 2,625 3,000 3,521 4,638 5,821

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 307 918 1,551 1,921 2,183 2,622 3,662 4,734Depreciation and amortisation 2 141 365 504 642 740 860 980Tax paid (1) 10 (205) (214) (281) (551) (769) (994)Change in working capital 4 (59) (849) (701) (1,647) (955) (502) (1,086)Other operational CF items (667) (686) 101 500 318 164 121 115Cash flow from operations (355) 324 963 2,010 1,215 2,020 3,372 3,748Capex (21) (460) (717) (1,529) (1,420) (1,500) (1,550) (1,650)Net (acquisitions)/disposals 0 1,187 (346) (77) (128) (600) 0 0Other investing CF items 259 (1,002) (243) 261 (1,406) 50 60 70Cash flow from investing 238 (275) (1,306) (1,346) (2,954) (2,050) (1,490) (1,580)Change in debt (2) (54) 1,975 (639) 716 130 120 120Net share issues/(repurchases) 611 0 839 106 14 594 0 0Dividends paid (55) (60) (91) (148) (170) (209) (266) (306)Other financing CF items (32) (35) 1,243 (52) (166) (204) (169) (172)Cash flow from financing 522 (149) 3,966 (732) 393 312 (315) (358)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 405 (100) 3,623 (68) (1,346) 282 1,567 1,810Free cash flow (376) (136) 246 481 (205) 520 1,822 2,098

Financial summary


- 40 -

Balance sheet (CNYm)

Key ratios (%)


Company profile

Geely Automobile Holding Limited (Geely) manufactures and sells automobiles and related components. Geely's headquarters are in Hangzhou, the capital of Zhejiang Province, and it operates six car-assembly and power-train manufacturing plants in China.

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 762 1,743 5,392 4,636 3,384 3,661 5,222 7,027Inventory 14 487 641 987 1,358 1,374 1,619 1,925Accounts receivable 65 2,336 6,145 9,913 12,215 15,243 18,584 22,321Other current assets 3 508 0 2 0 0 0 0Total current assets 844 5,073 12,178 15,538 16,956 20,278 25,426 31,274Fixed assets 31 3,289 4,328 5,467 6,796 8,156 8,846 9,516Goodwill & intangibles 0 657 1,076 1,455 2,232 2,232 2,232 2,232Other non-current assets 2,045 1,131 1,220 1,514 1,613 1,608 1,602 1,595Total assets 2,920 10,151 18,802 23,974 27,597 32,274 38,105 44,616Short-term debt 19 686 1,510 1,097 2,532 2,562 2,582 2,602Accounts payable 37 4,161 7,329 10,508 12,114 14,204 17,288 20,245Other current liabilities 20 138 69 174 339 339 339 339Total current liabilities 76 4,985 8,908 11,778 14,985 17,104 20,208 23,185Long-term debt 0 87 1,318 1,562 843 943 1,043 1,143Other non-current liabilities 297 296 1,480 1,556 1,619 900 900 900Total liabilities 373 5,368 11,706 14,897 17,447 18,947 22,151 25,228Share capital 108 123 137 139 139 139 139 139Reserves/R.E./others 2,236 4,075 6,239 7,883 9,443 12,598 15,199 18,605Shareholders' equity 2,344 4,198 6,376 8,022 9,582 12,737 15,339 18,744Minority interests 203 585 721 1,056 568 590 616 644Total equity & liabilities 2,920 10,150 18,803 23,974 27,597 32,274 38,105 44,616EV 25,341 27,493 26,070 27,000 28,396 28,275 26,866 25,217Net debt/(cash) (743) (971) (2,565) (1,977) (9) (157) (1,598) (3,282)BVPS (CNY) 0.475 0.718 0.872 1.090 1.286 1.542 1.857 2.270

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) n.a. 3,174.0 228.0 42.9 4.3 20.6 24.8 20.1EBITDA (YoY) n.a. n.a. 230.7 32.9 14.3 17.4 31.7 25.5Operating profit (YoY) n.a. n.a. 252.9 31.7 11.2 17.9 35.9 28.2Net profit (YoY) n.a. 188.2 34.7 17.3 11.1 32.8 39.9 29.4Core EPS (fully-diluted) (YoY) n.a. 135.2 15.4 (1.1) 10.3 32.8 39.9 29.4Gross-profit margin 11.5 15.2 18.1 18.5 18.2 17.4 18.6 19.4EBITDA margin n.a. 13.9 14.0 13.1 14.3 13.9 14.7 15.4Operating-profit margin n.a. 10.6 11.4 10.5 11.2 11.0 12.0 12.8ROAE 26.0 26.9 22.4 19.3 17.5 18.4 20.4 21.8ROAA 20.9 13.4 8.2 6.5 6.0 6.8 8.1 9.0ROCE n.a. 11.2 20.8 19.6 18.7 18.3 20.8 22.7ROIC (2.7) 15.3 32.8 29.8 21.5 18.8 21.7 25.1Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cashEffective tax rate n.a. 5.7 14.9 18.3 21.4 21.0 21.0 21.0Accounts receivable (days) 91.2 102.2 110.0 145.8 192.6 198.1 195.7 197.0Current ratio (x) 11.1 1.0 1.4 1.3 1.1 1.2 1.3 1.3Net interest cover (x) n.a. 40.5 48.6 11.0 14.1 18.1 34.5 47.5Net dividend payout 18.0 6.8 7.3 10.6 11.0 9.7 9.3 8.2

Financial summary continued …


■ What's new We expect Great Wall’s margins, ASP and volumes to see sequential growth for the next three years, due to positive changes to its product mix backed by strong R&D. ■ What's the impact Improving earnings. As Great Wall plans to launch 11 new models in 2013, we expect the 2013 blended ASP to improve by 5.7% YoY (7.1% previously as we assumed a different product mix). With the shift in focus to SUVs since 2011, we are now more confident in the company’s product mix and forecast its 2013 FCF/car sold to be six times higher than its 2012E R&D/car sold. 2013 sales volume should be above consensus. We are raising our 2013 PV sales-volume forecast to 772,977 units from 710,342 units (10% higher than guidance and our previous forecast) because: 1) Great Wall’s past-four-month average production (September-December

2012) was 62,029 units/month, equivalent to 740,000 units/year, and 2) once the Tianjin phase II factory starts operating in June 2013, we forecast capacity to rise by 0.1m units a year. Once production starts at phase III of the Tianjin plant and at the new Xushui factory, we forecast the group’s total vehicle sales in 2014 to exceed 930,000 units. We forecast the in-house engine-production ratio to improve from 70% in 2012 to 85% in 2014. This partially explains why we are increasing our blended gross-margin forecasts to 27.7% for 2013 and 28.1% for 2014, from 26.9% in 2012E, and raising our operating-margin forecasts by 0.7pp for 2012, 0.5pp for 2013 and 0.5pp for 2014. These changes lead us to raise our 2012-14 earnings forecasts by 3-20%. ■ What we recommend We are raising our six-month target price to HKD36.27 (from HKD23.50), based on a 2013E PER of 12.3x, representing 1SD above the stock’s past-seven-year average (9x PER previously). We reaffirm our Buy (1) rating. Risks to our call include a further macro tightening. ■ How we differ Our revenue forecasts are higher than consensus by 20% for 2013 and

32% for 2014, as we believe Great Wall’s 2013 sales guidance is too conservative in light of the new model launches.


15 February 2013

Great Wall Motor

Still a high-growth stock

• Our revenue forecasts are higher than those of the consensus by 20% for 2013 and 32% for 2014

• Gross margin could rise in 2013-14, given the significant improvement we expect in the in-house engine-production ratio

• We believe the 2013 FCF/car sold will be 6x higher than the 2012E R&D/car sold; reaffirm Buy




Great Wall Motor2333 HK


Buy (unchanged)


1

2

3

4

5

Forecast revisions (%)Year to 31 Dec 12E 13E 14ERevenue change 10.7 7.8 (0.9)Net profit change 19.6 12.0 3.0Core EPS (FD) change 19.6 12.0 3.0

80

109

138

166

195

12

17

22

27

32



Great Wall (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 14.00-31.55Market cap (USDbn) 12.323m avg daily turnover (USDm) 25.01Shares outstanding (m) 3,042Major shareholder Baoding Innovation (56.0%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 43,311 56,918 71,563Operating profit (m) 6,676 8,904 11,187Net profit (m) 5,675 7,177 8,421Core EPS (fully-diluted) 1.865 2.359 2.768EPS change (%) 53.2 26.5 17.3Daiwa vs Cons. EPS (%) 8.0 19.0 25.4PER (x) 13.5 10.7 9.1Dividend yield (%) 0.0 0.0 0.0DPS 0.000 0.000 0.000PBR (x) 3.7 2.9 2.3EV/EBITDA (x) 8.9 6.4 4.9ROE (%) 30.1 30.3 28.5

Jeff Chung(852) 2773 8783

[email protected]



- 42 -

Growth outlook Great Wall: revenue and EBIT margin

Given that we see sufficient capacity expansion for Great Wall in 2013, and that we forecast the ASP to rise by 5.7% YoY for the period, we expect revenue to rise by 31% YoY for 2013 and 26% YoY for 2014. We also forecast the blended gross margin to improve to 27.7% for 2013 and 28.1% for 2014, due to improved in-house engine production. Great Wall should gain operating leverage in 2013, as we expect its car sale/dealer ratio to improve by 15% YoY in 2013, and we look for its EBIT margin to rise to 15.6% over the same period. Overall, we forecast an EPS CAGR of 22% for 2012-14, and look for the 2013 ROCE to rise to 37%. For more details please see sector part.


Valuation Great Wall: one-year forward PER bands (x)

We believe Great Wall’s fundamentals will improve sequentially from 2012 into 2014, and that the stock deserves to trade at a higher PER than currently. We forecast the company’s 2013 asset-turnover ratio to improve to 1.08x and its FCF/vehicle to improve to CNY5,716, much higher than the respective 0.78x and CNY1,846 for 2007 (the last time the stock traded above a 12x one-year forward PER). We are raising our six-month target price to HKD36.27 (from HKD23.50), based on a 2013E PER of 12.3x, which represents the stock’s past-seven-year average + 1SD (20% higher than the Bloomberg consensus and up from our previous target PER of 9x).


Earnings revisions Great Wall: Bloomberg-consensus EPS forecasts

The Bloomberg consensus has been regularly revising up its 2012 and 2013 EPS forecasts since September 2012, due to the high-season effect kicking in. Our 2013-14 EPS forecasts are now 19-25% higher than those of the Bloomberg consensus, as we are raising our sales-volume forecasts by 9% for 2013 and 5% for 2014 and our operating-margin forecasts by 0.5pp for each year.



Growth outlook

Valuation

Earnings revisions

0%2%4%6%8%10%12%14%16%18%

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

2006

2007

2008

2009

2010

2011

2012

E

2013

E

2014

E

Revenue (LHS) EBIT margin (RHS)

CNY (million)

(10)

0

10

20

30

40

50

60

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

7.42x Avg

2.74x Avg -1SD

12.10x Avg+1SD

-1.95x Avg -2SD

16.79x Avg+2SD

(HKD)

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

Jan-

12

Feb-

12

Mar

-12

Apr-1

2

May

-12

Jun-

12

Jul-1

2

Aug-

12

Sep-

12

Oct

-12

Nov-

12

Dec-

12

Jan-

13

2012E 2013E

(CNY) EPS

Buy (unchanged)


1

2

3

4

5


- 43 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales volume (vehicles) 107,820 120,446 209,860 363,482 462,679 621,438 772,977 932,205

Export sales as % of total sales volume

n.a. 43 16 14 17 15 15 15

Gross margin (%): PV total 24 18 17 25 25 27 28 28Gross margin (%) : Sedans n.a. n.a. 4 22 24 23 23 23Gross margin (%) : SUVs 23 23 25 26 26 30 30 30Gross margin (%) : Pick-up trucks 26 19 23 26 26 26 26 26Blended ASP (CNY/unit) 70,296 68,168 59,070 63,238 65,032 69,695 73,635 76,768SUV sales volume 51,855 44,006 51,278 136,982 147,341 279,956 419,934 566,911Sedan sales volume 0 9,754 76,811 122,843 187,504 199,256 201,249 203,261Pick-up truck sales volume 54,955 63,235 75,341 98,643 121,673 136,694 146,263 156,501

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESUVs 4,263 3,628 4,225 9,432 11,380 22,488 34,406 47,377Sedans and pick-up trucks 2,905 3,815 7,123 11,159 16,330 18,050 19,073 19,866Other Revenue 728 981 1,466 2,396 2,379 2,774 3,440 4,321Total Revenue 7,897 8,425 12,815 22,986 30,089 43,311 56,918 71,563Other income (29) (49) (31) 1 26 80 79 78COGS (5,768) (6,684) (10,256) (17,298) (22,594) (31,642) (41,166) (51,422)SG&A (790) (1,021) (1,332) (1,944) (2,477) (3,341) (4,537) (6,027)Other op.expenses (319) (217) (426) (881) (1,052) (1,732) (2,391) (3,006)Operating profit 991 454 770 2,864 3,992 6,676 8,904 11,187Net-interest inc./(exp.) 38 29 35 26 7 25 23 22Assoc/forex/extraord./others 24 103 108 152 131 145 181 202Pre-tax profit 1,052 585 913 3,041 4,130 6,846 9,108 11,410Tax (37) (33) 140 (214) (620) (1,095) (1,822) (2,853)Min. int./pref. div./others (70) (38) (49) (126) (84) (75) (109) (137)Net profit (reported) 945 514 1,003 2,701 3,426 5,675 7,177 8,421Net profit (adjusted) 945 514 1,003 2,701 3,426 5,675 7,177 8,421EPS (reported)(CNY) 0.364 0.188 0.372 0.986 1.185 1.865 2.359 2.768EPS (adjusted)(CNY) 0.364 0.188 0.372 0.986 1.185 1.865 2.359 2.768EPS (adjusted fully-diluted)(CNY) 0.364 0.188 0.372 0.986 1.217 1.865 2.359 2.768DPS (CNY) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000EBIT 991 454 770 2,864 3,992 6,676 8,904 11,187EBITDA 1,159 685 1,149 3,388 4,667 7,770 10,398 13,081

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 1,052 585 913 3,041 4,130 6,846 9,108 11,410Depreciation and amortisation 168 231 379 525 674 1,094 1,494 1,894Tax paid 0 0 0 0 0 0 0 0Change in working capital 173 51 77 (143) 358 (1,089) (1,096) (1,660)Other operational CF items (29) 20 (3) (301) (733) (1,195) (1,928) (2,959)Cash flow from operations 1,365 888 1,366 3,123 4,429 5,656 7,578 8,685Capex (1,449) (1,106) (960) (3,218) (3,759) (3,800) (3,200) (3,100)Net (acquisitions)/disposals 6 260 1,866 1,760 1,795 (3) (3) (3)Other investing CF items (322) (927) (1,460) (849) (1,700) 40 41 42Cash flow from investing (1,765) (1,773) (554) (2,307) (3,664) (3,763) (3,162) (3,061)Change in debt 0 0 39 (76) 225 0 0 0Net share issues/(repurchases) 1,542 0 0 0 3,894 0 0 0Dividends paid (159) (249) (195) (287) (663) (1,449) (1,819) (2,125)Other financing CF items 1 0 0 (849) 0 0 0 0Cash flow from financing 1,384 (249) (156) (1,212) 3,456 (1,449) (1,819) (2,125)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 984 (1,134) 656 (397) 4,221 444 2,597 3,499Free cash flow (84) (218) 406 (95) 671 1,856 4,378 5,585

Financial summary


- 44 -


Key ratios (%)


Company profile

Great Wall Motor Company manufactures and sells pick-up trucks and SUVs in China under its Great Wall brand name. The three key product lines are: Hover SUV, Sedan Voleex, and Wingle Pickup.

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 3,522 2,199 2,742 3,657 7,204 7,648 10,245 13,744Inventory 958 876 1,590 2,104 2,777 4,272 5,458 6,862Accounts receivable 810 1,210 3,386 8,053 9,382 14,078 18,776 24,237Other current assets 506 797 553 1,013 1,479 1,479 1,479 1,479Total current assets 5,796 5,083 8,271 14,827 20,842 27,477 35,959 46,323Fixed assets 4,055 5,461 6,263 8,425 11,868 14,577 16,286 17,495Goodwill & intangibles 2 2 2 2 2 2 2 2Other non-current assets 232 270 528 444 422 422 422 422Total assets 10,085 10,816 15,063 23,698 33,135 42,478 52,669 64,242Short-term debt 0 0 76 26 26 26 26 26Accounts payable 3,111 3,678 6,412 11,862 14,687 19,789 24,577 29,782Other current liabilities 7 13 11 0 0 0 0 0Total current liabilities 3,118 3,691 6,499 11,888 14,713 19,815 24,603 29,809Long-term debt 0 0 0 0 0 0 0 0Other non-current liabilities 109 108 726 1,410 1,400 1,340 1,275 1,210Total liabilities 3,227 3,799 7,225 13,298 16,113 21,155 25,878 31,019Share capital 1,095 1,095 1,095 1,095 1,095 1,095 1,095 1,096Reserves/R.E./others 5,347 5,639 6,497 8,920 15,642 19,918 25,326 31,671Shareholders' equity 6,442 6,734 7,593 10,015 16,737 21,014 26,422 32,767Minority interests 416 283 245 385 284 310 369 456Total equity & liabilities 10,085 10,816 15,063 23,698 33,135 42,478 52,669 64,242EV 73,504 74,663 74,119 73,382 69,812 69,393 66,855 63,443Net debt/(cash) (3,522) (2,199) (2,666) (3,631) (7,178) (7,622) (10,219) (13,718)BVPS (CNY) 2.496 2.459 2.773 3.658 5.502 6.907 8.685 10.771

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) n.a. 6.7 52.1 79.4 30.9 43.9 31.4 25.7EBITDA (YoY) n.a. (40.9) 67.9 194.8 37.7 66.5 33.8 25.8Operating profit (YoY) n.a. (54.2) 69.8 271.7 39.4 67.2 33.4 25.6Net profit (YoY) n.a. (45.6) 95.2 169.2 26.8 65.7 26.5 17.3Core EPS (fully-diluted) (YoY) n.a. (48.4) 97.9 165.2 23.4 53.2 26.5 17.3Gross-profit margin 27.0 20.7 20.0 24.7 24.9 26.9 27.7 28.1EBITDA margin 14.7 8.1 9.0 14.7 15.5 17.9 18.3 18.3Operating-profit margin 12.5 5.4 6.0 12.5 13.3 15.4 15.6 15.6ROAE n.a. 7.8 14.0 30.7 25.6 30.1 30.3 28.5ROAA n.a. 4.9 7.8 13.9 12.1 15.0 15.1 14.4ROCE n.a. 6.5 10.3 31.2 29.1 34.8 37.0 37.2ROIC 28.7 10.5 15.4 44.6 40.8 47.6 47.1 46.5Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cashEffective tax rate 3.5 5.6 n.a. 7.0 15.0 16.0 20.0 25.0Accounts receivable (days) n.a. 43.8 65.4 90.8 105.8 98.9 105.3 109.7Current ratio (x) 1.9 1.4 1.3 1.2 1.4 1.4 1.5 1.6Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Net dividend payout 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0



■ What's new Given recent guidance by Brilliance, we believe it has shifted its focus to expanding overall margins by leveraging its strong brand premium, improving its in-house engine-production ratio and diversifying its product mix. However, we lower our rating to Outperform (2) as we expect lower YoY sales-volume growth in 2013. ■ What's the impact EBIT should rise... With sales diversified into the 3-series, 5-series, and X1 SUV, we forecast adjusted EBIT to rise by 25% YoY for 2013 and 29% YoY for 2014. We expect rapid expansion to lead to capex of CNY344-396m per year over 2012-14, raising total assets by 33% YoY for 2012 and 23% YoY for 2013 and improving adjusted ROCE to 31% for 2013. …along with EBIT margins. We expect the company to improve its in-house engine production ratio,

leading to improved profitability for the Brilliance-BMW JV, which we estimate represents about 97% of 2013 pre-tax earnings. We forecast JV EBIT margins of 10% for 2013 and 10.4% for 2014 (9.2% for 2012E). We estimate that every 0.1pp rise in the JV’s EBIT margin leads to a 1% increase in 2013E EPS. But we cut our EPS on lower sales guidance. Given sluggish mini-van sales in 2012, we lower our segment forecasts by 21% for 2013 and 25% for 2014. Due to these cuts and company guidance, we lower our overall EPS forecasts by 12% for 2013 and 16% for 2014. While we believe mini-van sales have bottomed out, we expect their contribution to pre-tax profit to be less than 3% for 2013 (12% for 2011). We now forecast an overall EPS CAGR of 23% for 2012-14 (38% previously) on the reduced sales guidance. ■ What we recommend We now expect 2012 sales-volume growth to fall by 50% over 2011; however, market sentiment is improving and we expect higher EBIT in 2013-14. As such, we believe the stock deserves to trade at 15.6x our new 13E EPS, compared with an average of 19x for 2011-12. Thus, we downgrade to Outperform (2) but raise our target price to HKD11.77.

■ How we differ Our 2013-14 EPS forecasts are 0.5-2.4% below consensus due to our lower sales-volume forecasts.


15 February 2013

Brilliance China Automotive

Better margins, but downgrade on slowing sales-volume growth

• Management sets conservative sales target for 2013 • We expect higher Brilliance-BMW shipments and in-house

improvements in 2013 to lead to higher overall EBIT • However, we downgrade to Outperform on EPS cuts due to

expectations of slowing sales-volume growth




Brilliance China Automotive1114 HK


BuyOutperform (from Buy)

HoldUnderperformSell

1

2

3

4

5

Forecast revisions (%)Year to 31 Dec 12E 13E 14ERevenue change (25.2) (27.6) (31.9)Net profit change 5.1 (10.5) (13.5)Core EPS (FD) change 3.7 (12.8) (15.7)

65

75

85

95

105

6

7

9

10

12



Brilliance (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 6.29-11.18Market cap (USDbn) 7.453m avg daily turnover (USDm) 17.10Shares outstanding (m) 5,169Major shareholder Huachen Automotive Group (42.5%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 4,651 4,741 4,906Operating profit (m) 2 18 35Net profit (m) 2,529 3,120 3,891Core EPS (fully-diluted) 0.495 0.603 0.752EPS change (%) 37.7 21.9 24.7Daiwa vs Cons. EPS (%) 3.9 (3.4) (0.5)PER (x) 18.2 14.9 12.0Dividend yield (%) 0.0 0.0 0.0DPS 0.000 0.000 0.000PBR (x) 4.5 3.5 2.7EV/EBITDA (x) 167.4 138.3 121.3ROE (%) 29.3 26.4 25.4

Jeff Chung(852) 2773 8783

[email protected]



- 46 -

Growth outlook Brilliance: adjusted EBIT vs. ROCE

For the Brilliance-BMW JV, we forecast shipment growth of 24% YoY for 2013 and 28% YoY for 2014, resulting in adjusted EBIT rising by respective rates of 26% YoY and 28% YoY. With the change in the product mix skewed towards the entry-level 3-series and X1 SUV, we forecast the blended ASP to drop by 3.5% YoY for 2013 and 2.5% for 2014. Assuming strong capex of CNY344-396m a year between 2012-2014, we expect Brilliance’s ROCE to remain above 30% over 2013 and 2014.


Valuation Brilliance: PER bands

While we forecast the EPS CAGR to fall to 23% for 2012-14 from 40% for 2010-12E, we believe Brilliance has passed the high-volume growth stage and is entering a period of EBIT-margin expansion due to improvements in its in-house engine-production ratio. With improved market sentiment towards luxury car sales, we no longer believe the stock should trade at its past-seven-year average PER of 19x (1SD above the average). We now apply a PER of 15.6x to our 2014E EPS for a six-month target price of HKD11.77 (0.5SD above the average). Our smaller SD variance reflects the 50% reduction in sales volume that we expect for 2013. Risks to our call include a further macro tightening.


Earnings revisions Brilliance: consensus EPS-forecast revisions

The consensus EPS forecasts have been stable at around CNY0.47 for 2012 and CNY0.62 for 2013 over the past four months. We expect consensus earnings to be cut as a result of company guidance. However, we believe that the market has mostly priced in the negative sales-volume news and should offset this with a better EBIT-margin outlook and improved sentiment towards luxury-car sales in China.



Growth outlook

Valuation

Earnings revisions

29.5%

30.0%

30.5%

31.0%

31.5%

32.0%

32.5%

0

1,000

2,000

3,000

4,000

5,000

6,000

2010 2011 2012E 2013E 2014E

Adjusted EBIT (LHS) ROCE (RHS)

(CNY)

(5)

0

5

10

15

20

Jan-

06

Jun-

06

Nov-

06

Apr-0

7

Sep-

07

Feb-

08

Jul-0

8

Dec-

08

May

-09

Oct

-09

Mar

-10

Aug-

10

Jan-

11

Jun-

11

Nov-

11

Apr-1

2

Sep-

12

25.68x Avg+2SD

18.99x Avg+1SD

12.30x Avg

5.61x Avg-1SD

-1.08x Avg-2SD

(HKD)

0.45

0.50

0.55

0.60

0.65

0.70

Jan-

12

Feb-

12

Mar

-12

Apr-1

2

May

-12

Jun-

12

Jul-1

2

Aug-

12

Sep-

12

Oct

-12

Nov-

12

Dec-

12

Jan-

13

2012E 2013E

(CNY) EPS

BuyOutperform (from Buy)


1

2

3

4

5


- 47 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales volume (3 series) 11,700 13,000 17,000 30,047 42,290 34,946 60,000 86,210Sales volume (5 series) 22,000 20,000 27,000 40,441 65,097 105,598 120,000 146,790Sales volume (X1 SUV) 0 0 0 0 0 20,305 20,000 23,000Total sales volume (YoY % change) 31 (2) 33 60 52 50 24 28ASP-Rmb (3 series) 220,000 220,000 220,000 217,000 233,000 290,000 287,100 284,229ASP-Rmb (5 series) 368,000 368,000 368,000 370,000 425,000 425,000 416,500 408,170ASP-Rmb (X1 SUV) 0 0 0 0 0 270,000 267,300 265,964ASP-Rmb (Blended) 316,617 309,697 310,818 304,781 349,389 376,103 362,760 353,656

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EMini-van 5,394 5,473 6,149 8,949 6,443 4,651 4,741 4,906n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Other Revenue n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Total Revenue 14,149 5,473 6,149 8,949 6,443 4,651 4,741 4,906Other income 369 102 154 92 48 25 32 35COGS (13,015) (4,786) (5,294) (7,725) (5,587) (4,046) (4,125) (4,268)SG&A (1,123) (462) (641) (793) (749) (628) (631) (638)Other op.expenses (181) (49) (43) 0 0 0 0 0Operating profit 199 277 326 523 155 2 18 35Net-interest inc./(exp.) 2 (62) (63) (92) (117) (185) (243) (334)Assoc/forex/extraord./others 11 524 (268) 1,034 1,912 2,855 3,668 4,738Pre-tax profit 212 739 (5) 1,465 1,949 2,672 3,443 4,439Tax (45) (55) (41) 54 (58) (134) (310) (533)Min. int./pref. div./others 0 0 0 (248) (79) (10) (13) (15)Net profit (reported) 167 684 (46) 1,271 1,812 2,529 3,120 3,891Net profit (adjusted) 167 684 (46) 1,271 1,812 2,529 3,120 3,891EPS (reported)(CNY) 0.046 0.186 (0.010) 0.255 0.360 0.495 0.604 0.753EPS (adjusted)(CNY) 0.046 0.186 (0.010) 0.255 0.360 0.495 0.604 0.753EPS (adjusted fully-diluted)(CNY) 0.045 0.186 (0.009) 0.252 0.359 0.495 0.603 0.752DPS (CNY) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000EBIT 199 277 326 523 155 2 18 35EBITDA 932 722 787 803 292 262 318 365

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 212 739 (5) 1,465 1,949 2,672 3,443 4,439Depreciation and amortisation 733 445 461 280 138 260 300 330Tax paid (45) (55) (41) 54 (58) (134) (310) (533)Change in working capital 2,218 (394) 3,754 2,045 1,305 1,126 570 679Other operational CF items (374) (531) 1,358 (896) (1,698) (2,595) (3,343) (4,318)Cash flow from operations 2,745 204 5,527 2,948 1,636 1,329 660 597Capex (294) (484) (631) (378) (306) (396) (360) (344)Net (acquisitions)/disposals (422) (386) (828) (174) (836) (90) (100) (120)Other investing CF items (234) (637) 153 (909) 1,206 0 0 0Cash flow from investing (951) (1,507) (1,306) (1,461) 64 (486) (460) (464)Change in debt (130) 130 343 (558) 1,132 453 67 211Net share issues/(repurchases) 2 0 495 3 9 730 0 0Dividends paid 0 0 0 0 0 0 0 0Other financing CF items (845) 2,027 (177) (345) (419) (260) (325) (420)Cash flow from financing (973) 2,157 661 (900) 722 923 (258) (209)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 821 854 4,883 587 2,421 1,766 (57) (76)Free cash flow 2,450 (279) 4,897 2,570 1,329 933 300 253

Financial summary


- 48 -


Key ratios (%)


Company profile

Brilliance China Automotive (Brilliance) produces minibuses in China. The company also has a joint venture with BMW to produce BMWs (3-series, 5-series and X1 SUVs) in China

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 3,863 4,392 2,878 2,625 1,869 3,635 3,577 3,501Inventory 2,469 1,869 1,350 791 737 510 520 538Accounts receivable 2,657 2,309 1,884 3,018 1,881 1,482 1,502 1,605Other current assets 616 661 459 665 1,545 1,545 1,545 1,545Total current assets 9,605 9,231 6,571 7,098 6,032 7,172 7,144 7,189Fixed assets 3,567 4,146 1,342 1,585 1,670 1,886 2,046 2,160Goodwill & intangibles 1,350 1,371 164 185 198 208 208 228Other non-current assets 2,348 2,567 3,388 4,352 4,912 7,767 11,435 16,173Total assets 16,870 17,315 11,465 13,220 12,811 17,032 20,833 25,750Short-term debt 370 500 723 165 1,297 1,750 1,817 2,028Accounts payable 7,981 8,902 5,284 7,257 4,913 5,413 6,013 6,813Other current liabilities 292 1,647 1,305 540 362 362 362 362Total current liabilities 8,643 11,049 7,312 7,962 6,572 7,525 8,192 9,203Long-term debt 0 0 0 0 0 0 0 0Other non-current liabilities 1,968 399 425 2 2 2 2 2Total liabilities 10,611 11,448 7,736 7,964 6,573 7,526 8,194 9,205Share capital 394 394 394 394 394 394 394 395Reserves/R.E./others 5,656 5,660 4,628 5,931 6,595 9,854 12,974 16,864Shareholders' equity 6,050 6,054 5,022 6,325 6,989 10,248 13,368 17,259Minority interests 210 (186) (1,293) (1,069) (752) (742) (729) (714)Total equity & liabilities 16,870 17,315 11,465 13,220 12,811 17,032 20,833 25,750EV 43,161 42,366 42,996 42,916 45,120 43,817 43,955 44,257Net debt/(cash) (3,493) (3,892) (2,155) (2,460) (572) (1,885) (1,761) (1,473)BVPS (CNY) 1.644 1.647 1.007 1.255 1.387 1.983 2.586 3.339

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) 34.9 (61.3) 12.4 45.5 (28.0) (27.8) 1.9 3.5EBITDA (YoY) n.a. (22.5) 9.0 2.0 (63.6) (10.5) 21.4 14.9Operating profit (YoY) n.a. 39.2 17.7 60.5 (70.4) (98.9) 918.2 96.9Net profit (YoY) n.a. 309.5 n.a. n.a. 42.6 39.5 23.4 24.7Core EPS (fully-diluted) (YoY) n.a. 309.7 n.a. n.a. 42.4 37.7 21.9 24.7Gross-profit margin 8.0 12.5 13.9 13.7 13.3 13.0 13.0 13.0EBITDA margin 6.6 13.2 12.8 9.0 4.5 5.6 6.7 7.4Operating-profit margin 1.4 5.1 5.3 5.8 2.4 0.0 0.4 0.7ROAE 2.8 11.3 n.a. 22.4 27.2 29.3 26.4 25.4ROAA 1.1 4.0 n.a. 10.3 13.9 16.9 16.5 16.7ROCE 3.0 4.3 6.0 10.6 2.4 0.0 0.1 0.2ROIC 5.6 10.8 18.4 23.9 3.6 0.0 0.2 0.2Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cashEffective tax rate 21.2 7.5 n.a. n.a. 3.0 5.0 9.0 12.0Accounts receivable (days) 65.0 165.6 124.4 100.0 138.8 132.0 114.9 115.6Current ratio (x) 1.1 0.8 0.9 0.9 0.9 1.0 0.9 0.8Net interest cover (x) n.a. 4.5 5.2 5.7 1.3 0.0 0.1 0.1Net dividend payout 0.0 0.0 n.a. 0.0 0.0 0.0 0.0 0.0



■ What's new Given DFM’s weaker-than-expected sales growth in December 2012, we are less positive on the outlook for sales over 2013-14. ■ What's the impact Bleak 2013 outlook. We remain negative on DFM’s 2013 sales outlook due to: 1) an ageing product mix with the current weighted-average product age of 34 months for its DF-Nissan line-up and 43 months for its DF-PSA line-up, 2) a declining share of SUV sales, and 3) only a slight market-share recovery as only two new products are due to be launched by DF-Nissan, compared with 11 for VW and 7 for GM. As a result, we estimate DFM’s car sales/dealership ratio to fall by 2% YoY to 411 units for 2013. Overall, we now forecast the company’s 2013 PV blended ASP to drop by 1.7% YoY (compared with a fall of 1.1% YoY previously).

Flat sales growth expected. We believe management has been overly optimistic in its guidance for a sales recovery and has overlooked its declining market share. With an ageing and cheaper product mix than in 2012, a high base effect from 1Q12, as well as plans to launch fewer new models than its competitors this year, we now forecast a 2012-14 EPS CAGR of only 2% (6.7% previously). DFM’s balance sheet remains strong and we forecast 2013 free cash flow to turn positive at CNY4.8bn, with net cash position of CNY29bn. ■ What we recommend We maintain our Underperform (4) rating. We raise our six-month target price to HKD11.44 from HKD8.75 due to improved market sentiment, valuing the stock at its past-seven-year average PER of 8.4x (7x previously) to reflect DFM’s strong balance sheet. However, we expect earnings visibility to remain lower than that of other OEMs and local brands, and we believe the stock deserves to trade at a lower PER than Great Wall, Geely, and Brilliance. Risks to our call would include an acceleration in new-model launches. ■ How we differ Due to the higher SG&A costs we expect, our EPS forecasts are lower

than consensus by 5.6% for 2013 and 15.9% for 2014.


15 February 2013

Dongfeng Motor Group

A fat cat with flat growth

• We forecast single-digit volume growth for 2013 with a lower blended ASP YoY due to the company’s ageing product mix

• Declining SUV market share suggests little upside to the gross margin over the next 12 months

• We think the consensus has been overly optimistic about DFM’s sales recovery and has overlooked its declining market share




Dongfeng Motor Group489 HK

Target (HKD): 8.75 11.44Downside: 7.6%15 Feb price (HKD): 12.38

BuyOutperformHoldUnderperform (unchanged)

Sell

1

2

3

4

5

Forecast revisions (%)Year to 31 Dec 12E 13E 14ERevenue change (3.3) (9.2) (12.2)Net profit change 4.5 8.2 (4.5)Core EPS (FD) change 4.5 8.2 (4.5)

55

68

80

93

105

8

10

12

14

16



Dongfeng M (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 8.64-15.64Market cap (USDbn) 13.763m avg daily turnover (USDm) 37.85Shares outstanding (m) 8,616Major shareholder Dongfeng Motor Corp (66.9%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 122,887 129,052 141,469Operating profit (m) 10,436 11,540 11,135Net profit (m) 8,740 9,390 9,089Core EPS (fully-diluted) 1.014 1.090 1.055EPS change (%) (16.6) 7.4 (3.2)Daiwa vs Cons. EPS (%) (2.9) (5.6) (15.9)PER (x) 9.8 9.1 9.4Dividend yield (%) 1.5 1.6 1.6DPS 0.152 0.163 0.158PBR (x) 1.6 1.4 1.2EV/EBITDA (x) 3.9 3.7 3.5ROE (%) 17.4 16.2 13.8

Jeff Chung(852) 2773 8783

[email protected]



- 50 -

Growth outlook DFM: net profit, net-profit margin, and ROCE

We believe the golden period of earnings growth has ended for DFM. With a limited pipeline of new products for 2013, a declining blended ASP, and declining car sales/dealership, we forecast the company’s net profit to drop by 17% YoY for 2012, with the EBIT margin falling from 10.1% for 2011 to 8.5% for 2012. We look for a net-profit increase of 7% YoY for 2013, to factor in a one-off gain from an asset sale, and a decline of 3% YoY for 2014. We are not optimistic on 2014 earnings growth, and forecast a low 2012-14 EPS CAGR of 2%, resulting in low ROEs of 16% for 2013 and 14% for 2014 and a flat asset-turnover ratio over those years.


Valuation DFM: PER bands

The stock has traded at an average PER of 8.4x over the past seven years. We now forecast the company’s EPS CAGR to slow to 2% for 2012-14 (6.7% previously). In our opinion, the stock does not deserve to trade above its past-seven-year average and will be a laggard in the sales recovery we expect for the sector in 1H13. Our new six-month target price of HKD11.44 is based on a 2013E PER of 8.4x, in line with the stock’s seven-year average but lower than the sector average of 9.5x (without Brilliance) for the same period.


Earnings revisions DFM: consensus 2012-13 EPS forecast revisions

Our 2013-14 EPS forecasts for DFM now are 6-16% below those of the Bloomberg consensus, as we believe the company’s ageing product line-up and increased competition in the B-class segment will lead to muted earnings recovery in 2013.



Growth outlook

Valuation

Earnings revisions

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

(40%)

(20%)

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 2010 2011 2012E 2013E 2014E

Net profit growth (LHS) Net profit margin (RHS)

ROCE (RHS)

0

5

10

15

20

25

Jan-

06

Jun-

06

Nov-

06

Apr-0

7

Sep-

07

Feb-

08

Jul-0

8

Dec-

08

Ma y

-…

Oct

-09

Mar

-10

Aug-

10

Jan-

11

Jun-

11

Nov-

11

A pr-1

2

Sep-

12

(HKD)

13.68x

11.04x

8.40x

5.76x

3.12x

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1-Ja

n-12

22-J

an-1

2

12-F

eb-1

2

4-M

ar-1

2

25-M

ar-1

2

15-A

pr-1

2

6-M

a y-1

2

27-M

ay-1

2

17-J

un-1

2

8-Ju

l-12

29-J

ul-1

2

19-A

ug-1

2

9-Se

p-12

30-S

ep-1

2

21-O

ct-1

2

11-N

ov-1

2

2-De

c-12

23-D

ec-1

2

13-J

an-1

3

2012E 2013E

CNY (EPS)

BuyOutperformHoldUnderperform (unchanged)

Sell

1

2

3

4

5


- 51 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EPV total units 638,026 726,520 1,058,811 1,418,091 1,646,410 1,740,772 1,871,976 2,094,623DF-Nissan total units 271,900 350,600 519,000 660,999 808,589 772,995 800,000 896,000DF-Honda total units 127,000 164,000 210,600 260,600 262,621 282,182 330,000 369,600DF-PSA total units 207,000 178,000 270,000 373,366 404,139 440,028 485,000 533,500CV total units 311,500 331,402 371,931 527,865 526,313 414,754 427,197 465,644

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EPV 41,655 48,660 68,864 88,143 94,921 92,532 97,770 106,583CV 16,901 20,980 21,982 33,418 35,473 29,135 29,882 33,306Other Revenue 762 929 912 834 1,047 1,220 1,400 1,580Total Revenue 59,318 70,569 91,758 122,395 131,441 122,887 129,052 141,469Other income 745 927 1,166 1,643 1,799 2,010 3,140 2,050COGS (49,503) (58,688) (74,274) (96,033) (105,051) (100,329) (104,908) (114,559)SG&A (5,187) (6,034) (7,435) (9,997) (9,916) (9,462) (10,711) (12,166)Other op.expenses (1,432) (1,970) (3,110) (4,171) (4,943) (4,670) (5,033) (5,659)Operating profit 3,941 4,804 8,105 13,837 13,330 10,436 11,540 11,135Net-interest inc./(exp.) (175) (92) 109 450 652 574 205 135Assoc/forex/extraord./others 69 95 195 296 379 490 610 690Pre-tax profit 3,835 4,807 8,409 14,583 14,361 11,500 12,355 11,960Tax (202) (647) (1,671) (3,006) (3,401) (2,415) (2,594) (2,512)Min. int./pref. div./others (267) (205) (488) (596) (479) (345) (371) (359)Net profit (reported) 3,366 3,955 6,250 10,981 10,481 8,740 9,390 9,089Net profit (adjusted) 3,366 3,955 6,250 10,981 10,481 8,740 9,390 9,089EPS (reported)(CNY) 0.391 0.459 0.725 1.274 1.216 1.014 1.090 1.055EPS (adjusted)(CNY) 0.391 0.459 0.725 1.275 1.216 1.014 1.090 1.055EPS (adjusted fully-diluted)(CNY) 0.391 0.459 0.725 1.275 1.216 1.014 1.090 1.055DPS (CNY) 0.045 0.045 0.090 0.180 0.180 0.152 0.163 0.158EBIT 3,941 4,804 8,105 13,837 13,330 10,436 11,540 11,135EBITDA 5,967 7,081 10,794 17,822 16,444 13,936 15,360 15,185

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 3,835 4,807 8,409 14,583 14,361 11,500 12,355 11,960Depreciation and amortisation 2,026 2,277 2,689 3,985 3,114 3,500 3,820 4,050Tax paid (326) (693) (1,373) (2,379) (3,401) (2,415) (2,594) (2,512)Change in working capital 398 1,491 11,241 11,695 (1,447) (6,309) 83 (510)Other operational CF items (831) (612) (302) (1,960) (3,411) (1,240) (1,210) (1,190)Cash flow from operations 5,102 7,270 20,664 25,924 9,216 5,036 12,454 11,798Capex (2,751) (4,183) (3,011) (3,927) (6,072) (7,370) (7,657) (7,806)Net (acquisitions)/disposals 240 152 369 2,997 0 0 (3,600) 0Other investing CF items (719) (4,022) (10,352) (2,136) 1,749 700 (3,350) 650Cash flow from investing (3,230) (8,053) (12,994) (3,066) (4,323) (6,670) (14,607) (7,156)Change in debt 105 570 2,857 1,981 (580) 1,172 (550) (850)Net share issues/(repurchases) 0 0 0 0 0 0 0 0Dividends paid (345) (388) (388) (776) (1,551) (1,311) (1,408) (1,363)Other financing CF items (138) 707 21 (28) (1,058) 25 25 25Cash flow from financing (378) 889 2,490 1,177 (3,189) (114) (1,933) (2,188)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 1,494 106 10,160 24,035 1,704 (1,748) (4,087) 2,453Free cash flow 2,351 3,087 17,653 21,997 3,144 (2,334) 4,797 3,992

Financial summary


- 52 -


Key ratios (%)


Company profile

Through joint ventures, Dongfeng Motor Group manufactures diesel engines, light trucks, automobiles, castings, and related spare parts. It has joint ventures with Nissan, Honda, and Peugeot. The company is one of the top-three auto makers in China in terms of sales volume.

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 10,554 14,134 32,801 42,950 44,747 42,999 38,912 41,366Inventory 7,573 9,356 8,741 13,935 12,511 18,517 18,739 19,379Accounts receivable 10,212 8,617 12,352 17,897 19,600 18,517 20,153 22,868Other current assets 3,006 4,193 6,351 7,555 7,158 7,158 7,158 7,158Total current assets 31,345 36,300 60,245 82,337 84,016 87,192 84,963 90,770Fixed assets 16,438 18,390 18,703 18,551 21,578 25,848 33,705 37,911Goodwill & intangibles 1,961 2,241 2,480 2,773 3,001 2,951 6,781 6,481Other non-current assets 2,453 3,518 4,261 6,961 8,938 9,428 10,038 10,728Total assets 52,197 60,449 85,689 110,622 117,533 125,419 135,487 145,890Short-term debt 5,751 6,919 7,217 3,271 5,993 5,743 5,293 4,643Accounts payable 14,462 16,583 25,805 34,201 33,033 31,648 33,589 36,433Other current liabilities 8,787 9,955 17,414 25,184 25,689 25,714 25,739 25,764Total current liabilities 29,000 33,457 50,436 62,656 64,715 63,105 64,621 66,840Long-term debt 2,514 1,781 4,424 6,289 2,820 4,242 4,142 3,942Other non-current liabilities 284 319 274 341 414 714 1,014 1,314Total liabilities 31,798 35,557 55,134 69,286 67,949 68,061 69,777 72,096Share capital 8,616 8,616 8,616 8,616 8,616 8,616 8,616 8,616Reserves/R.E./others 9,097 13,439 18,668 28,878 37,778 45,207 53,188 60,914Shareholders' equity 17,713 22,055 27,284 37,494 46,394 53,823 61,804 69,530Minority interests 2,686 2,837 3,271 3,842 3,190 3,535 3,906 4,264Total equity & liabilities 52,197 60,449 85,689 110,622 117,533 125,419 135,487 145,890EV 85,450 82,346 66,945 55,034 51,460 54,235 57,532 53,898Net debt/(cash) (2,289) (5,434) (21,160) (33,390) (35,934) (33,014) (29,477) (32,781)BVPS (CNY) 2.056 2.560 3.167 4.352 5.385 6.247 7.173 8.070

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) 22.9 19.0 30.0 33.4 7.4 (6.5) 5.0 9.6EBITDA (YoY) 31.1 18.7 52.4 65.1 (7.7) (15.3) 10.2 (1.1)Operating profit (YoY) 37.5 21.9 68.7 70.7 (3.7) (21.7) 10.6 (3.5)Net profit (YoY) 61.7 17.5 58.0 75.7 (4.6) (16.6) 7.4 (3.2)Core EPS (fully-diluted) (YoY) 61.7 17.5 58.0 75.7 (4.6) (16.6) 7.4 (3.2)Gross-profit margin 16.5 16.8 19.1 21.5 20.1 18.4 18.7 19.0EBITDA margin 10.1 10.0 11.8 14.6 12.5 11.3 11.9 10.7Operating-profit margin 6.6 6.8 8.8 11.3 10.1 8.5 8.9 7.9ROAE 21.0 19.9 25.3 33.9 25.0 17.4 16.2 13.8ROAA 7.0 7.0 8.6 11.2 9.2 7.2 7.2 6.5ROCE 14.7 15.4 21.4 29.7 24.4 16.6 16.2 14.1ROIC 21.5 22.1 45.0 126.7 94.2 43.4 30.1 22.8Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cashEffective tax rate 5.3 13.5 19.9 20.6 23.7 21.0 21.0 21.0Accounts receivable (days) 54.0 48.7 41.7 45.1 52.1 56.6 54.7 55.5Current ratio (x) 1.1 1.1 1.2 1.3 1.3 1.4 1.3 1.4Net interest cover (x) 22.5 52.2 n.a. n.a. n.a. n.a. n.a. n.a.Net dividend payout 11.5 9.8 12.4 14.1 14.8 15.0 15.0 15.0



■ What's new We believe the Bloomberg consensus has yet to reflect fully the long-term implications of the market-share losses for Japanese brand cars in 4Q12. ■ What's the impact Remains loss-making. Following GAC’s recent profit warning, we now forecast its 2013 gross profit to rise by 61% YoY to CNY756m (CNY915m previously). However, we expect this be offset by high SG&A costs, leading to operating losses of CNY1.9bn for 2013 and CNY2.3bn for 2014. JV recovery. We forecast GAC-Honda sales volume to rise by 12% YoY and that of GAC-Toyota to rise by 5% YoY for 2013. Together with the Fiat and Mitsubishi divisions, which account for 13% of total JV sales volume, we now forecast the JVs’ combined 2013 pre-tax profit to increase by 63% YoY to CNY4.4bn (CNY7.4bn previously).

Weak balance sheet. With the recent approval of a CNY6bn bond issuance, we now forecast a net-gearing ratio of 23% for 2013 (0.08% previously). We also are concerned about the risk of equity-raising, as we forecast FCF to remain negative over 2013-14, with finance costs rising by 14% YoY in 2013 and 42% YoY in 2014. Poor ROACE. As we now forecast the JVs’ pre-tax margins to recover to 6.8% for 2013 and 7.9% for 2014, we expect adjusted asset turnover to remain low at 0.4x, with EBIT/car sale staying below CNY3,000 and 2013-14 ROACE flat at 5-6%. Overall, we are cutting our forecasts for PV sales volume by 34% for 2013 and 25% for 2014 and our pre-tax profit by 60% for 2013 and 51% for 2014. ■ What we recommend We now believe GAC should trade at 11x our 2013E EPS, or 1SD above the stock’s past-seven-year average. Trading currently at 14.5x our 2013E EPS, the stock looks expensive. We downgrade our rating to Sell (5), and lower our six-month target price to HKD5.05 from HKD7.60. Risks to our view include better-than-expected sales volume from the new Fiat and Mitsubishi JVs.

■ How we differ We believe the market has not fully priced in the long-term effects of the recent profit warning for 2012.


15 February 2013

Guangzhou Automobile Group

Bleak outlook; downgrade to Sell

• We expect high earnings growth in 2013-14 from a low base • However, FCF should stay negative for next two years with net

gearing increasing over 2013-13 on higher financing costs • Stock is trading at 14.5x our 2013E EPS and looks significantly

overvalued; lower target price to HKD5.5 and downgrade to Sell




Guangzhou Automobile Group2238 HK

Target (HKD): 7.60 5.05Downside: 25.0%15 Feb price (HKD): 6.73

BuyOutperformHoldUnderperformSell (from Underperform)

1

2

3

4

5

Forecast revisions (%)Year to 31 Dec 12E 13E 14ERevenue change (0.3) 18.0 27.8Net profit change (74.9) (56.2) (45.4)Core EPS (FD) change (74.9) (56.2) (45.4)

50

66

83

99

115

4.5

5.8

7.0

8.3

9.5



Gzhou Auto (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 4.79-9.15Market cap (USDbn) 5.743m avg daily turnover (USDm) 7.66Shares outstanding (m) 6,618Major shareholder GAIG (58.8%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 13,048 17,990 22,499Operating profit (m) (1,426) (1,908) (2,277)Net profit (m) 1,168 2,401 3,292Core EPS (fully-diluted) 0.182 0.373 0.512EPS change (%) (73.9) 105.5 37.1Daiwa vs Cons. EPS (%) (50.7) (30.0) (19.4)PER (x) 29.8 14.5 10.6Dividend yield (%) 1.0 2.0 2.8DPS 0.053 0.109 0.149PBR (x) 1.2 1.1 1.0EV/EBITDA (x) 21.1 12.8 10.3ROE (%) 3.9 7.7 9.8

Jeff Chung(852) 2773 8783

[email protected]



- 54 -

Growth outlook GAC: pre-tax profit and gross margin

Due to a low base of comparison in 2012 and the new JVs set up with Fiat and Mitsubishi, we forecast total PV sales for GAC to increase by 22% YoY for 2013, with the Japan brands as a percentage of total sales volume falling from 85% for 2012 to 77% for 2013. Meanwhile, we forecast the company’s gross margin to improve to 4.2% for 2013 and look for pre-tax profit growth YoY of 100% for 2013 and 36% for 2014. We forecast a dividend-payout ratio of about 30% for both 2012 and 2013 and expect the 2012 dividend to drop by 75% YoY.


Valuation GAC: PER bands

Given GAC’s volatile share price and relatively short trading history (since 3Q10), we use DFM as a benchmark to value GAC given the companies’ similar levels of exposure to Japanese brand car sales. We apply an 11x PER, representing 1SD above DFM’s past-seven-year average, to our 2013 EPS forecast for GAC (previously a 2012E PER of 12x). Our higher multiple reflects the recovery we expect in earnings over 2013 and 2014, backed by the new contributions from from the Fiat and Mitsubishi JVs. Having said that, we believe the stock is significantly overvalued at current levels. Source: Bloomberg, Daiwa

Earnings revisions GAC: consensus 2012-13 EPS-forecast revisions

The 2012-13 Bloomberg-consensus EPS forecasts have been cut consistently over the past 13 months, likely due to increased competition in the B-class sedan segment.



Growth outlook

Valuation

Earnings revisions

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

1,000

2,000

3,000

4,000

5,000

6,000

2007 2008 2009 2010 2011 2012E 2013E 2014E

Pre-tax profit (LHS) Gross margin (RHS)

Pre-tax profit (CNY) Gross margin

0

5

10

15

20

25

Sep-

10

Nov-

10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov-

11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov-

12

Jan-

13

(HKD)

30x

25x20x

15x

10x

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

Jan-

12

Feb-

12

Mar

-12

Apr-1

2

May

-12

Jun-

12

Jul-1

2

Aug-

12

Sep-

12

Oct

-12

Nov-

12

Dec-

12

Jan-

13

2012E 2013E

CNY (EPS)

BuyOutperformHoldUnderperformSell (from Underperform)

1

2

3

4

5


- 55 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales volume - PV (JVs + local 465,593 478,234 575,210 719,517 734,146 704,799 874,587 1,001,450Sales volume - CV 4,778 2,245 3,112 4,704 6,248 7,355 8,537 9,622ASP PV (CNY/unit) 92,882 91,524 87,366 78,602 82,135 76,386 77,913 80,484Gross margins PV(%) 17 17 17 8 4 4 4 5

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EPV (non-JV) revenue 41,285 6,092 6,137 7,460 9,863 11,702 16,372 20,557CV revenue 482 257 312 545 462 533 606 669Other Revenue 639 37,422 43,804 737 660 813 1,012 1,274Total Revenue 42,407 43,770 50,254 8,742 10,984 13,048 17,990 22,499Other income (29) (6) (429) 58 840 583 683 783COGS (35,277) (36,446) (41,918) (7,999) (10,560) (12,578) (17,234) (21,419)SG&A (3,097) (4,414) (4,687) (842) (1,806) (2,479) (3,346) (4,140)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 4,004 2,904 3,220 (41) (541) (1,426) (1,908) (2,277)Net-interest inc./(exp.) 111 157 45 (128) (41) (110) (148) (302)Assoc/forex/extraord./others 838 399 716 5,690 4,639 2,734 4,454 5,848Pre-tax profit 4,953 3,460 3,980 5,522 4,057 1,198 2,399 3,269Tax (138) (602) (724) (2) 110 36 72 98Min. int./pref. div./others (1,378) (1,291) (1,224) (1,225) 105 (65) (70) (75)Net profit (reported) 3,437 1,567 2,032 4,295 4,272 1,168 2,401 3,292Net profit (adjusted) 3,437 1,567 2,032 4,295 4,272 1,168 2,401 3,292EPS (reported)(CNY) 0.982 0.448 0.541 0.699 0.695 0.182 0.373 0.512EPS (adjusted)(CNY) 0.982 0.448 0.541 0.699 0.695 0.182 0.373 0.512EPS (adjusted fully-diluted)(CNY) 0.982 0.448 0.541 0.699 0.695 0.182 0.373 0.512DPS (CNY) 0.000 0.000 0.000 0.110 0.209 0.053 0.109 0.149EBIT 4,842 3,419 3,935 5,649 4,098 1,308 2,547 3,571EBITDA 5,547 4,024 4,905 5,849 4,348 1,558 2,797 3,821

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 4,953 3,460 3,980 5,522 4,057 1,198 2,399 3,269Depreciation and amortisation 705 721 970 199 250 250 250 250Tax paid (273) 31 156 (829) 0 0 0 0Change in working capital (203) (199) 4,218 (539) 467 (36) 344 173Other operational CF items (813) (410) (506) (5,590) (5,892) (2,624) (4,306) (5,546)Cash flow from operations 4,369 3,604 8,818 (1,238) (1,118) (1,213) (1,314) (1,854)Capex (1,164) (2,679) (3,206) (2,719) (2,244) (2,479) (1,789) (1,738)Net (acquisitions)/disposals (23) (40) (755) 65 (265) 0 0 0Other investing CF items 1,865 (2,070) (4,048) 4,614 998 650 750 850Cash flow from investing 678 (4,789) (8,009) 1,960 (1,511) (1,829) (1,039) (888)Change in debt 134 341 6,071 617 1,501 1,100 3,700 2,000Net share issues/(repurchases) 0 0 0 0 0 0 0 0Dividends paid 0 0 0 0 0 0 0 0Other financing CF items (456) (481) (405) (644) (1,328) (285) (508) (796)Cash flow from financing (322) (140) 5,666 (27) 173 815 3,192 1,204Forex effect/others 0 0 0 0 0 0 0 0Change in cash 4,724 (1,325) 6,475 696 (2,455) (2,227) 839 (1,538)Free cash flow 3,205 925 5,612 (3,956) (3,362) (3,692) (3,103) (3,592)

Financial summary


- 56 -


Key ratios (%)


Company profile

Guangzhou Automobile Group manufactures, sells, and services automobiles. The company also makes automobile parts and components, and is involved in auto financing and related services for both the overseas and domestic markets.

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 13,315 14,021 24,470 15,624 17,140 14,913 15,752 14,214Inventory 1,294 1,658 2,242 1,353 1,537 1,966 2,366 2,897Accounts receivable 2,297 2,220 1,666 2,845 2,980 3,396 4,633 5,733Other current assets 0 0 0 0 637 672 744 842Total current assets 16,906 17,899 28,378 19,822 22,293 20,947 23,495 23,687Fixed assets 6,281 8,139 9,374 3,751 5,324 7,553 9,092 10,580Goodwill & intangibles 217 518 965 1,446 2,273 2,273 2,273 2,273Other non-current assets 3,346 3,516 4,912 13,501 14,721 17,455 21,910 27,757Total assets 26,750 30,072 43,628 38,520 44,612 48,229 56,770 64,297Short-term debt 1,325 1,292 7,649 7,950 7,737 8,837 12,537 14,537Accounts payable 0 0 56 121 91 900 2,881 4,684Other current liabilities 54 294 492 265 392 1,042 1,792 2,642Total current liabilities 1,379 1,586 8,197 8,336 8,220 10,779 17,210 21,864Long-term debt 967 1,454 1,070 1,053 2,100 2,100 2,100 2,100Other non-current liabilities 7,801 8,202 12,900 3,287 4,106 4,106 4,106 4,106Total liabilities 10,147 11,242 22,167 12,676 14,426 16,985 23,416 28,070Share capital 3,935 3,935 3,935 6,148 6,149 6,150 6,151 6,152Reserves/R.E./others 5,903 7,474 9,125 19,463 23,061 24,053 26,092 28,889Shareholders' equity 9,838 11,409 13,060 25,612 29,210 30,203 32,243 35,041Minority interests 6,765 7,421 8,402 233 976 1,041 1,111 1,186Total equity & liabilities 26,750 30,072 43,628 38,520 44,612 48,229 56,771 64,297EV 31,540 31,944 28,450 29,410 29,471 32,864 35,794 39,407Net debt/(cash) (11,023) (11,275) (15,750) (6,621) (7,303) (3,975) (1,115) 2,423BVPS (CNY) 2.811 3.260 3.479 4.166 4.414 4.564 4.872 5.295

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) n.a. 3.2 14.8 (82.6) 25.6 18.8 37.9 25.1EBITDA (YoY) n.a. (27.5) 21.9 19.2 (25.7) (64.2) 79.5 36.6Operating profit (YoY) n.a. (29.4) 15.1 43.5 (27.5) (68.1) 94.7 40.2Net profit (YoY) n.a. (54.4) 29.7 111.4 (0.5) (72.6) 105.5 37.1Core EPS (fully-diluted) (YoY) n.a. (54.4) 20.9 29.1 (0.5) (73.9) 105.5 37.1Gross-profit margin 16.8 16.7 16.6 8.5 3.9 3.6 4.2 4.8EBITDA margin 13.1 9.2 9.8 66.9 39.6 11.9 15.5 17.0Operating-profit margin 11.4 7.8 7.8 64.6 37.3 10.0 14.2 15.9ROAE 69.9 14.8 16.6 22.2 15.6 3.9 7.7 9.8ROAA 25.7 5.5 5.5 10.5 10.3 2.5 4.6 5.4ROCE 51.3 16.9 15.2 17.4 10.9 3.2 5.6 7.1ROIC 139.5 36.5 39.7 (0.3) (2.6) (5.7) (6.4) (6.4)Net debt to equity net cash net cash net cash net cash net cash net cash net cash 6.9Effective tax rate 2.8 17.4 18.2 0.0 n.a. n.a. n.a. n.a.Accounts receivable (days) 9.9 18.8 14.1 94.2 96.8 89.2 81.5 84.1Current ratio (x) 12.3 11.3 3.5 2.4 2.7 1.9 1.4 1.1Net interest cover (x) n.a. n.a. n.a. 44.3 100.8 11.9 17.2 11.8Net dividend payout 0.0 0.0 0.0 15.7 30.1 29.2 29.2 29.2



■ Investment case Following aggressive business expansion in 2011 and consolidation in 2012, China ZhengTong Auto Services Holdings (ZTA) looks set to deliver strong margin expansion in 2013. We expect its earnings to improve sequentially into 2014, with good earnings visibility for its high-margin luxury car after-sales service segment, and project its EBITDA to double over 2012-14. We initiate coverage with a Buy (1) rating. High-margin after-sales services business poised for growth: Over 2013-14, we forecast ZTA to generate sales-volume growth of 16-19% YoY and after-sales service revenue growth of 38-39% YoY. We project ZTA’s profitable after-sales services business to account for 47% of total gross profit for 2013 and 49% for 2014, and to help lift the gross-profit margin by 0.7pp YoY each year to 10.8% for 2014.

Auto finance and insurance as new drivers: We forecast group CAGRs of 21% for revenue and 29% for gross profit over 2012-14. Boosted by its auto-finance and insurance businesses, we expect the group’s EBIT margin to expand to 6.7% for 2013 and 7.4% for 2014 (from 5.5% for 2012E) and its free cash flow to turn positive once more in 2013, with a 7.3% FCF yield for 2013. Excessive expansion unlikely: We believe ZTA is unlikely to undertake major M&A expansion this year. Excluding its intangible assets, we forecast its net debt/ equity ratio to improve to 1.8x for 2013 and 0.8x for 2014. ■ Catalysts We expect most of ZTA’s luxury OEM auto makers to lower retail and wholesale ASPs simultaneously as well as to set lower sales growth targets this year, so as to improve dealers’ margins. ■ Valuation Our SOTP-derived six-month target price is HKD8.09, assigning 2013E PERs of 10.7x to new-car sales and 14.5x to after-sales services, and implies 15% upside potential.

■ Risks If OEM makers’ sales targets prove over-optimistic, ZTA’s cash flow could be at risk once more, potentially leading to ASP cuts and margin compression.

Consumer Discretionary / Hong Kong1728 HK

15 February 2013

China ZhengTong Auto Services Holdings

Initiation: moving into over-drive in 2013

• We expect strong after-sales earnings growth for ZTA from luxury cars and commission income via upselling

• Well-diversified brands should allow its core EBIT/dealership ratio to exceed peers’ by 19-22% over the next two years

• Our above-consensus 2013-14E EPS reflect our stronger operating leverage assumptions; initiate coverage with a Buy

Consumer Discretionary / Hong Kong

China ZhengTong Auto Services Holdings1728 HK

Target (HKD): 8.09Upside: 15.0%15 Feb price (HKD): 7.03

Buy (initiation)


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ZhengTong (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 3.65-9.74Market cap (USDbn) 1.993m avg daily turnover (USDm) 5.47Shares outstanding (m) 2,200Major shareholder Value partners (9.8%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 28,251 33,267 41,012Operating profit (m) 1,504 2,163 2,963Net profit (m) 752 1,151 1,699Core EPS (fully-diluted) 0.341 0.522 0.770EPS change (%) 35.2 53.1 47.6Daiwa vs Cons. EPS (%) (0.1) 6.9 20.3PER (x) 16.6 10.8 7.3Dividend yield (%) 0.0 0.0 0.0DPS 0.000 0.000 0.000PBR (x) 1.8 1.5 1.3EV/EBITDA (x) 8.5 5.9 4.3ROE (%) 11.4 15.3 19.0

Jeff Chung(852) 2773 8783

[email protected]



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Growth outlook ZTA: operating profit and EBIT margin

We forecast ZTA to maintain sales-volume growth of 16-19% YoY over 2013-14. We expect revenue growth to be driven by its high-margin after-sales services business for luxury cars, and forecast this business to generate CAGRs of 21% for revenue and 29% for gross profit in 2012-14. We also expect positive operating leverage from ZTA’s auto-finance and insurance business, which we expect to raise its EBIT per dealer by 24% for 2013 and 21% for 2014 and support EBIT-margin expansion to 6.7% for 2013 and 7.4% for 2014.


Valuation ZTA: 1-year-forward PER bands

Our six-month target price for ZTA of HKD8.09 is derived from our SOTP valuation and implies 15% upside from current levels. Our target price equates to a one-year-forward 2013E PER of 12.4x, corresponding to a 45% discount to the stock’s average PER since its listing in December 2010, underpinning our view that ZTA offers strong scope for a rerating over the coming months.


Earnings revisions ZTA: consensus EPS forecasts

The 2013 Bloomberg-consensus EPS forecast for ZTA has trended down consistently since 2Q12, due to a rise in inventory days and heavy retail discounts, but has started to rise in recent weeks on the back of the high season effect and better GDP growth outlook. As we expect automakers to set less-aggressive sales targets for 2013 than they did for 2012, and given declining new-car supply in China, we forecast gradual profit-margin expansion for ZTA for 1H13 and onwards.

Source: Bloomberg


Growth outlook

Valuation

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Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ELuxury car sales volume (Units) 2,210.0 2,745.0 4,637.0 9,494.0 21,380.0 46,215.0 54,534.0 66,531.0Mid-range car sales volume (Units) 13,257.0 11,768.0 16,961.0 17,650.0 18,734.0 24,085.0 27,096.0 30,618.0

Gross profit from new car sales (CNY, million)

90.9 103.6 198.1 377.0 840.7 1,374.7 1,656.7 2,057.1

Gross profit from after sales (CNY, million)

72.7 99.7 149.3 265.6 457.1 1,164.2 1,582.4 2,180.8

Cars sales per dealership (Units) 1,031.1 907.1 1,270.5 1,131.0 679.9 1,065.2 1,074.1 1,129.6Revenue per dealership (CNY, 173.2 159.1 231.8 274.4 212.0 372.1 372.4 398.6EBIT per dealership (CNY, million) 4.9 5.2 13.5 19.9 14.8 23.5 29.3 35.3

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ENew car sales (CNY million) 2,651 2,662 4,270 7,009 12,953 25,114 29,006 35,182After-sales (CNY million) 206 268 380 602 1,047 2,582 3,557 4,928Other Revenue 53 116 330 423 444 555 705 902Total Revenue 2,909 3,046 4,981 8,034 14,444 28,251 33,267 41,012Other income 19 19 26 38 96 213 325 457COGS (2,734) (2,825) (4,567) (7,308) (13,058) (25,605) (29,891) (36,600)SG&A (121) (155) (221) (368) (650) (1,356) (1,537) (1,907)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 74 84 220 396 831 1,504 2,163 2,963Net-interest inc./(exp.) (21) (36) (26) (47) (104) (460) (499) (532)Assoc/forex/extraord./others 0 0 5 41 21 25 30 35Pre-tax profit 52 48 198 390 749 1,069 1,694 2,465Tax (21) (13) (48) (91) (187) (267) (424) (616)Min. int./pref. div./others 0 (2) (4) (23) (38) (50) (120) (150)Net profit (reported) 32 34 146 276 524 752 1,151 1,699Net profit (adjusted) 32 34 146 276 524 752 1,151 1,699EPS (reported)(CNY) 0.021 0.023 0.097 0.180 0.252 0.342 0.523 0.772EPS (adjusted)(CNY) 0.021 0.023 0.097 0.180 0.252 0.342 0.523 0.772EPS (adjusted fully-diluted)(CNY) 0.021 0.023 0.097 0.180 0.252 0.341 0.522 0.770DPS (CNY) 0.000 0.006 0.000 0.000 0.008 0.000 0.000 0.000EBIT 74 84 220 396 831 1,504 2,163 2,963EBITDA 101 116 257 445 908 1,789 2,458 3,268

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 52 48 198 390 749 1,069 1,694 2,465Depreciation and amortisation 27 32 37 48 76 285 295 305Tax paid (11) (9) (6) (85) (99) (267) (424) (616)Change in working capital (81) (82) 689 (470) (947) (830) 221 (503)Other operational CF items 69 (15) (645) (6) 160 435 469 497Cash flow from operations 57 (24) 273 (124) (60) 691 2,255 2,148Capex (71) (36) (96) (198) (414) (986) (1,168) (1,086)Net (acquisitions)/disposals 13 15 (8) (17) (5,965) 0 0 0Other investing CF items (16) (23) (50) 34 (57) 0 0 0Cash flow from investing (74) (44) (155) (182) (6,436) (986) (1,168) (1,086)Change in debt 178 (60) 11 456 2,643 1,313 (750) (855)Net share issues/(repurchases) 0 0 0 3,016 1,684 0 0 0Dividends paid 0 (9) 0 0 (16) 0 0 0Other financing CF items (145) 141 (7) 88 (157) (460) (499) (532)Cash flow from financing 33 71 3 3,559 4,154 853 (1,249) (1,387)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 16 3 122 3,254 (2,342) 558 (162) (325)Free cash flow (14) (60) 177 (322) (474) (295) 1,087 1,063

Financial summary


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Key ratios (%)


Company profile

China ZhengTong Auto Services Holdings (ZTA) was established in 1999 as a leading premium sales, service, spare parts and surveys (4S) dealership group in China. The company focuses on premium and luxury brands such as BMW, Jaguar, Land Rover, Audi, Volkswagen, Volvo, and Porsche. It receives commission income from its auto- finance and insurance services.

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 238 290 1,072 4,393 2,277 2,836 2,674 2,349Inventory 237 310 295 749 3,244 4,567 4,466 5,393Accounts receivable 248 399 599 868 2,946 3,096 3,646 4,607Other current assets 0 0 0 0 0 0 0 0Total current assets 723 998 1,966 6,010 8,467 10,498 10,785 12,349Fixed assets 313 309 351 404 984 1,900 2,989 3,984Goodwill & intangibles 0 0 0 75 6,199 5,989 5,779 5,569Other non-current assets 135 135 191 243 339 360 385 415Total assets 1,172 1,442 2,509 6,732 15,989 18,747 19,937 22,317Short-term debt 398 338 349 721 4,220 5,533 4,783 3,928Accounts payable 688 976 1,634 1,847 4,156 4,799 5,469 6,854Other current liabilities 17 23 61 73 306 306 306 306Total current liabilities 1,103 1,337 2,043 2,641 8,683 10,638 10,558 11,088Long-term debt 0 0 0 0 0 0 0 0Other non-current liabilities 4 5 6 18 985 985 985 985Total liabilities 1,107 1,342 2,049 2,659 9,668 11,623 11,543 12,073Share capital 129 127 224 171 188 188 188 188Reserves/R.E./others n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Shareholders' equity 65 91 444 4,015 6,210 6,962 8,113 9,812Minority interests 0 9 16 58 112 162 282 432Total equity & liabilities 1,172 1,442 2,509 6,732 15,989 18,747 19,937 22,317EV 12,590 12,488 11,684 8,696 14,343 15,123 14,625 14,210Net debt/(cash) 160 48 (723) (3,672) 1,943 2,698 2,110 1,579BVPS (CNY) 0.044 0.060 0.296 2.624 2.987 3.165 3.688 4.460

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) n.a. 4.7 63.6 61.3 79.8 95.6 17.8 23.3EBITDA (YoY) n.a. 15.2 121.4 73.2 104.1 97.0 37.4 32.9Operating profit (YoY) n.a. 14.0 161.9 80.3 109.7 80.9 43.9 36.9Net profit (YoY) n.a. 6.7 331.5 89.2 89.9 43.4 53.1 47.6Core EPS (fully-diluted) (YoY) n.a. 6.7 331.5 85.5 39.7 35.2 53.1 47.6Gross-profit margin 6.0 7.2 8.3 9.0 9.6 9.4 10.1 10.8EBITDA margin 3.5 3.8 5.2 5.5 6.3 6.3 7.4 8.0Operating-profit margin 2.5 2.8 4.4 4.9 5.8 5.3 6.5 7.2ROAE 96.9 43.3 54.6 12.4 10.3 11.4 15.3 19.0ROAA 5.4 2.6 7.4 6.0 4.6 4.3 5.9 8.0ROCE 31.8 18.6 35.3 14.2 10.8 13.0 16.7 21.7ROIC 39.6 33.0 (287.1) 442.1 14.4 12.5 16.0 19.9Net debt to equity 244.4 53.0 net cash net cash 31.3 38.7 26.0 16.1Effective tax rate 39.5 26.7 24.4 23.2 25.0 25.0 25.0 25.0Accounts receivable (days) 15.6 38.8 36.6 33.3 48.2 39.0 37.0 36.7Current ratio (x) 0.7 0.7 1.0 2.3 1.0 1.0 1.0 1.1Net interest cover (x) 3.5 2.4 8.4 8.4 8.0 3.3 4.3 5.6Net dividend payout 0.0 27.0 0.0 0.0 3.0 0.0 0.0 0.0



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EBITDA expected to double in 2012-14 We initiate coverage of luxury and mid-range car dealer ZTA with a Buy (1) rating. We believe ZTA’s high-margin after-sales services business is poised to grow strongly this year, and expect this business to fuel top-line growth and profit-margin expansion for the company over the next two years. In addition, we expect ZTA to gain greater operating leverage from upselling (ie, persuading customers to buy auto finance and insurance products together with their car purchase), which we expect to account for a significant portion of EBIT going forward. We forecast faster growth in EBIT than gross profit for the company over 2012-14 (CAGRs of 40% for EBIT and 29% for gross profit). We see 2013 as a harvesting year for ZTA and expect a strong increase in its ROE with a low probability of further excessive business expansion through M&A. We believe the stock offers a favourable risk/reward profile with strong scope for a rerating over the next six months.

Revenue assumptions and outlook

Sales-volume forecasts Reflecting its business expansion through M&A activity in past years, ZTA delivered strong growth in sales volume of 48% YoY for 2011, and we forecast even higher growth of 75% YoY for 2012. We forecast sales-volume growth for its luxury and mid-range cars to moderate to 18-22% YoY for 2013 and 12.5-13% YoY for 2014, given the current low penetration of luxury cars in China and high replacement potential in first-tier cities. ASPs and revenue forecasts We estimate that ZTA’s blended ASP for its luxury cars was 4 times higher than that for its mid-range cars in 2012. On our estimates, the blended ASP for the company increased by 10.6% YoY for 2012, due mainly to a shift in its product mix, with luxury cars’ share of its total sales volume rising from 53% for 2011 to 66% for 2012E.

That said, we believe auto makers will lower both wholesale and retail prices in 2013 to reduce the price discounts offered by retailers compared to wholesale prices. As a result, we forecast the blended ASP for ZTA’s luxury cars to decline by 1.5% YoY and that for mid-range cars to decline by 2.3% YoY for 2013, leading to a 0.5% YoY dip in the company’s blended new-car ASP this year. For 2014, we forecast a 0.5% YoY recovery in the company’s luxury-car blended ASP but a further 2% YoY decline in the blended ASP for its mid-range cars, due to intensifying competition in this segment. Still, as ZTA is shifting its product mix towards a greater magnitude of sales of luxury cars, we forecast its blended new-car ASP to increase by 1.9% YoY for 2014, leading to new-car revenue growth for the company of 15.5% YoY for 2013 and 21.3% YoY for 2014. ZTA: trend in sales volume, ASP and revenue

2010 2011 2012E 2013E 2014EDealerships No. of dealerships 24 59 66 76 86Luxury 14 43 50 60 70Mid-range 10 16 16 16 16Sales volume (no. of cars) Total 27,144 40,114 70,300 81,629 97,149% change YoY 25.7 47.8 75.3 16.1 19.0Luxury cars 9,494 21,380 46,215 54,534 66,531% change YoY 104.7 125.2 116.2 18.0 22.0Mid-range cars 17,650 18,734 24,085 27,096 30,618% change YoY 4.1 6.1 28.6 12.5 13.0Luxury cars as % of total volume 35.0 53.3 65.7 66.8 68.5ASPs Blended new-car sales ASP (CNY) 258,215 322,898 357,245 355,333 362,146% change YoY 30.6 25.0 10.6 -0.5 1.9Luxury 505,793 494,979 480,130 472,928 475,293% change YoY 4.7 -2.1 -3.0 -1.5 0.5Mid-range 125,042 126,511 121,451 118,658 116,284% change YoY 4.5 1.2 -4.0 -2.3 -2.0Revenue (CNYm) New-car sales 7,009 12,953 25,114 29,006 35,182% change YoY 64.1 84.8 93.9 15.5 21.3Total after-sales business 602 1,047 2,582 3,557 4,928% change YoY 58.1 74.1 146.5 37.8 38.6Lubricant oil sales, logistics services 423 444 555 705 902% change YoY 28.2 4.8 25.0 27.0 28.0Total revenue 8,034 14,444 28,251 33,267 41,012% change YoY 61.3 79.8 95.6 17.8 23.3After-sales as % of total revenue 7.5 7.3 9.1 10.7 12.0


Revenue mix We expect strong revenue growth over the next two years for ZTA’s after-sales activities, which encompass the sale of spare parts, maintenance services, logistics services, and lubricant-oil sales. We forecast the following YoY revenue growth rates: spare parts – 42% for 2013 and 49% for 2014; maintenance services – 40% for 2013 and 41% for 2014; logistics services – 28% for 2013 and 27% for 2014; and lubricant oil – 55% for 2013 and 65% for 2014. As such, we expect the


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company’s total after-sales business to generate revenue growth of about 38% YoY for each of 2013 and 2014, and account for 10.7% of total revenue for 2013 and 12% for 2014. ZTA: revenue breakdown by business activity (%) 2010 2011 2012E 2013E 2014ESales of motor vehicles 87.2 89.7 88.9 87.2 85.8Sales of motor spare parts 1.6 1.7 2.6 3.2 3.8Provision of maintenance services 5.9 5.6 6.5 7.5 8.3Provision of logistics services 2.1 1.0 0.7 0.7 0.7Sales of lubricant oil 3.2 2.0 1.3 1.4 1.5


Dealership efficiency ZTA increased its number of dealerships substantially over 2010-11, which, along with the economic slowdown in 9M12, led to a decline in its number of cars sold per dealership in 2012, as the next table shows. However, due to the company’s product-mix shift towards more luxury-car sales, we estimate that revenue per dealership rose sharply by 75.5% YoY for 2012. After the 2012 consolidation, we expect both the cars sold/dealership and the revenue/dealership ratios to improve in 2014, assuming further increases in the company’s number of dealerships, of 15% YoY for 2013 and 13% YoY for 2014. ZTA: dealership efficiency metrics for car sales

2010 2011 2012E 2013E 2014ECars sales volume per dealership (no. of vehicles) 1,131 680 1,065 1,074 1,130Revenue per dealership (CNY m) 274 212 372 372 399Gross profit per dealership (CNY m) 27 22 38 43 49Efficiency (% change YoY) Number of dealerships 41.2 145.8 11.9 15.2 13.2Cars sales volume per dealership -11.0 7.5 -12.4 0.8 5.2Revenue per dealership 18.4 -22.7 75.5 0.1 7.0


Auto finance and insurance new drivers We believe ZTA’s auto-finance and insurance business offers a new growth driver for revenue and operating profit. According to ZTA, commission income amounted to CNY81m for 2011, comprising auto financing and auto insurance (together about 75% of total commission income), with a small proportion coming from second-hand car sales. Commission income rose to CNY83m for 1H12 (321% YoY growth). According to the company, its auto-finance penetration rate increased significantly in 2012, to about 25%, from 10-15% in 2011. Though there is no systematic way to quantify this operating income at this stage, we estimate that ZTA’s auto-finance and insurance business accounted for about 0.41% of its new-car revenue for 2010 and 0.63% (54% YoY growth) for 2011, and with the commission rate equivalent to 3.9% of its gross profit for 2010 and 5.8% (49% YoY growth) for 2011. We expect commission income from this

business to contribute 0.85% (CNY213m) of total revenue for 2012, 1.12% (CNY323m) for 2013 and 1.3% (CNY457m) for 2014. We consider these assumptions as reasonable, as the commission income from this business reached CNY83m in 1H12, equating to 39% of our full-year 2012 commission-income forecast of CNY213m (32% for the same period in 2011).

Profit-margin outlook

New-car sales We forecast the gross-profit margins that ZTA generates from its new-car revenue for luxury and mid-range cars to pick up slightly to respective levels of 6% and 3.4% for 2013. The ratio of ZTA’s new car sales volume between luxury and mid-range cars was stable at around 2:1 in 2012, but we expect it to move in favour of luxury cars over the next two years with the company’s product emphasis having shifted toward this segment. ZTA: gross-profit margins on new-car sales


Our industry research suggests that auto makers are taking a more cautious line on accumulating high inventories at retailers in China. We expect this ultimately to result in high working-capital levels at dealers, reducing their cash flow, slowing down the next round of expansion in dealership numbers, and in turn dampening auto makers’ longer-term sales growth. As such, we believe automakers will adopt more conservative sales targets for 1H13 than seen in past years, and offer their dealers more stable gross-profit margins on new-car revenue, and thus we expect a stabilisation of gross-profit margins on new-car revenue for dealers like ZTA. As discussed in the previous section, we expect auto makers to lower both wholesale and retail ASPs in 1H13 in order to help dealers, so as to transfer the discount

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Luxury Mid-range


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from the retail level to the auto makers themselves. This assumption underpins our gross-profit margin forecasts on ZTA’s new-car revenue of 6% for its luxury cars and 3.4% for mid-range cars for 2013, which leads to segmental gross profit growing 20.5% in 2013. Further, our industry research shows that in the car industry, the after-sales business tends to be more stable than the new-car sales business, and has high earnings visibility. In developed countries, after-sales gross profit accounts for about 80% of total gross profit for auto dealers. We forecast ZTA’s gross profit from its after-sales business to rise to 47% for 2013 and 49% for 2014, with a 44% gross-profit margin for both years. ZTA: gross profit and gross-profit margins Gross profit 2010 2011 2012E 2013E 2014ENew-car sales gross profit (CNY m) 377 841 1,375 1,657 2,057% change YoY 90.3 123.0 63.5 20.5 24.2After-sales gross profit 266 457 1,164 1,582 2,181% change YoY 77.9 72.1 154.7 35.9 37.8Lubricant oil sales, logistics services 84 88 107 136 174% change YoY 25.8 4.1 22.1 27.0 28.0Total gross profit 727 1,386 2,646 3,375 4,412% change YoY 75.4 90.6 91.0 27.6 30.7After-sales gross profit as % of total gross profit 36.5 33.0 44.0 46.9 49.4Gross-profit margin (%) Luxury 6.7 6.8 5.8 6.0 6.1Mid-range 2.5 5.1 3.0 3.4 3.6After-sales 44.2 43.6 45.1 44.5 44.2Lubricant oil sales, logistics services 19.9 19.8 19.3 19.3 19.3Blended gross margin 9.0 9.6 9.4 10.1 10.8


After-sales business should help drive strong earnings growth We forecast ZTA’s after-sales business to deliver lower revenue and net profit CAGRs over 2012-14 compared with those recorded over 2009-11. Having said that, we forecast the gap between the gross and net profit CAGRs to have widened from 7pp for 2009-11 to 21pp for 2012-14, implying that ZTA should gain more operating leverage. ZTA: revenue and earnings CAGRs (%) 2009-11 2012-14ENew-car revenue 74 18After-sales revenue 45 45Total revenue 70 22New-car gross profit 106 22After-sales gross profit 59 45Total gross profit 83 34Net profit 90 55


Delving into the high-margin after-sales business

Business model strengthens as repeat customer business evolves Our look at auto dealers’ business models reveals that generating new-car sales volume is crucial for a new dealer that does not yet have an established customer base. As the customer base expands, the highly profitable after-sales business starts to kick in (we estimate that ZTA’s cumulative new-car sales volume from 2007 to the end of 2012 reached 189,136 vehicles, which creates a large potential customer pool that could need after-sales services). With the low base effect in 2009 and 2010, ZTA generated strong sales-volume growth of new cars over 2009-11. With a higher volume base now, we do not expect the very strong growth in new-car sales volume in 2009-11 to be repeated in 2013. However, ZTA’s enlarged customer base should enable it to generate more after-sales business, and thus make its business model more defensive compared with the auto makers in an industry down-cycle. The bigger customer base should also enable the business to benefit from improving market sentiment in a new-car sales upcycle. ZTA: cumulative new-car sales volume


Business model skewed towards after-sales On average, ZTA’s average dealership age is about 4 years, which is slightly younger than 4.5 years for peer Zhong Sheng Group (ZSG), but higher than 2.4 years for peer Baoxin. For auto dealers, the average age of the dealerships usually acts as a benchmark to measure the maturity of the after-sales business. As we expect ZTA’s after-sales service business to account for a rising proportion of its gross-profit over 2013-14, this should reduce ZTA’s reliance on new-car sales, thereby making its business model more defensive.

15,467 29,98051,578

78,722

118,836

189,136

270,765

367,914

0

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100,000

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200,000

250,000

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400,000

2007 2008 2009 2010 2011 2012E 2013E 2014E

(No. of cars)


- 64 -

ZTA – gross profit: after-sales services vs. new-car sales


Frequency of demand for after-sales servicing on luxury cars more stable than that for mid-range cars In the after-sales services business, the number of luxury vehicles serviced per month by ZTA tends to be more stable than that for the mid-range segment (see the following normalised 2012 service frequency statistics). ZTA: number of cars serviced each month in 2012


While we forecast the after-sales segment to only contribute 10.7% of ZTA’s total revenue for 2013, with a high segmental gross margin of 44.5% (versus the blended margin on new car sales remaining at just 3.4-6.0%), we believe an accumulation of the customer base will incrementally contribute to stronger rerating momentum for ZTA in 2013.

Upselling: adding ‘alpha’

Car financing, insurance, second-hand car sales should improve operating leverage Although visibility in commission income from cross-selling (ie, car financing, insurance, second-hand car sales) remains low based on limited disclosures by

ZTA, the ratio of cross-selling income to the company’s overall revenue (commission income is not accounted for under revenue, but under operating income) has increased from 0.61% in 1H11 to 0.66% in 2011 and 0.87% in 1H12, of which auto financing and insurance accounted for 80-90%, with the rest being second-hand car sales. ZTA recognises that overall its auto-financing penetration rate has improved significantly, to 25% in 2012 from 15% in 2011. According to the company, auto makers have been aggressively promoting auto-financing and are apparently offering dealers a 2-3% rebate on the amount of auto financing per transaction. We take a conservative stance and forecast these commissions – auto-finance, insurance, second-hand car sales – to generate income equivalent to 14% of operating profit for 2013 and 15% for 2014. ZTA’s vision to enhance its auto financing, insurance and second-hand car businesses Second-hand autos: 1. Was one of the first to set up a used-car centre; it

established three second-hand car centres in Beijing, Wuhan and Hohhot as independently operated business units.

2. Establish an online auction platform for second-

hand autos. 3. Strengthen its ties with manufacturers and establish

a brand for the group’s second-hand automobile business.

4. Promote a business model that integrates auto

replacement and sales of new autos. Automobile financing: 1. Cooperate with car makers to launch an auto

financing business. 2. Cooperate with banks to develop auto financing

services. Other extended service businesses: 1. Further develop other extended services, such as the

auto insurance and warranty businesses. 2. Prepare to set up separate companies to run the

extended service businesses independently.

0

500

1,000

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2007 2008 2009 2010 2011 2012E 2013E 2014E

Gross profit (New car sales) Gross profit (After sales)

(CNYm)

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Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Luxury Mid-range

Luxury car service (units) Mid-range car service (units)


- 65 -

Catalyst: auto makers may bear more of the dealers’ discounts at the retail level

Dealers’ margins should improve further in 2013 Our research suggests that auto makers are likely to help their dealers more in 1H13 so as to prevent new car sales discounts at the retail level from widening. In order to do so, we expect auto makers to: 1) lower their production or imports, and 2) lower their new products’ retail prices (MSRP) and wholesale prices together, and transfer ASP cuts from the retail space to the factory without diluting dealers’ margins. Our logic and how we form this view are set forth below. Point no.1: PV imports have been slowing since 3Q12 while wholesale ASPs have also followed a similar trend. Point no.1: China PV imports and blended wholesale ASP


Point nos. 2 and 3: The magnitude of discount on luxury German brands has been narrowing since the end of 3Q12 and stabilised at the -4% level in November/beginning of December 2012. This also coincided with a similar trend that had been seen for new car sales in tier-1 cities and coastal areas since the beginning of 4Q12.

Point no.2: German luxury car retail sales discount magnitude in China


Point no.3: retail discount on new PV sales in tier-1 cities and coastal areas


In conclusion, we believe automakers will set conservative 1H13 sales targets to maintain a demand/supply balance at the retail level in 2013. Second, point nos. 2 and 3 we present above show a lagged correlation between a trending down ASP at the wholesale level and the narrowing discount at the retail level. As such, we believe that with a recovery in market sentiment and a further cut in wholesale prices, dealers’ new car discounts will improve further in 1H13 give their better earnings visibility than the automakers. 2013 a year of margin recovery rather than ASP growth for auto dealers Following the above logic, we therefore forecast ZTA’s ASPs for its luxury segment to drop by 1.5% YoY and that for the mid-range segment to drop by 2.3% YoY for 2013, with the gross margins on new-car sales improving to 6.0% for luxury and 3.4% for mid-range.

-15%

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-11

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-11

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-12

Ma y

-12

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2

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12

LHS: Total imported units (YoY) RHS: Blended ASP changes (YoY)

-14.6%

-12.0%

-4.3% -4.2% -2.7%

-10.0%

-6.6%-4.1% -4.3%

-2.2%

(16%)

(14%)

(12%)

(10%)

(8%)

(6%)

(4%)

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0%

24-A

ug-1

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ep-1

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ct-1

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ct-1

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ov-1

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c-12

25-D

ec-1

2

Imports average OEM average

Bottom out

(8%)

(6%)

(4%)

(2%)

0%

2012

.7.1

7

2012

.08.

06

8/20

/201

2

2012

.9.6

2012

.9.1

3

2012

.9.2

0

2012

.9.2

7

2012

.10.

9

2012

.10.

18

2012

.10.

25

2012

.11.

01

2012

.11.

12

2012

.11.

22

2012

.11.

29

2012

.12.

05

2012

.12.

12

Tier-1 cities + Shenzhen average Coastal area average

Lower-tier and inland area average


- 66 -

Earnings forecasts

As China’s auto dealership sector remains a fragmented business with a low concentration ratio, we expect to see quite a bit of M&A activity over the next 5 years in addition to organic growth from the company expanding the number of its own dealerships. We believe that how long this medium-long term volatility will last is hard to forecast; therefore an SOTP valuation seems to us to be the most appropriate method to fairly capture both the risks and the growth potential among those auto dealers. ZTA: segmental contribution to total EPS


We forecast 2012-14 EPS CAGRs of 57% for after-sales services, 41% for new-car sales and 57% for upselling commissions, with EPS from the non-new-car-sales segment as a percentage of total EPS expected to rise from 55% in 2012 to 58% in 2013 and 60% in 2014. ZTA: trend of EPS mix


0.090 0.1410.227

0.3490.1390.153

0.219

0.305

0.0230.047

0.076

0.116

0.0

0.2

0.4

0.6

0.8

1.0

2011 2012E 2013E 2014E

After sales services New car sales Auto financing, insurance, second-hand car sales

EPS (CNY)35.7% 41.4% 43.5% 45.3%

55.0% 44.8% 41.9% 39.6%

9.3% 13.7% 14.6% 15.1%

0%

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2011 2012E 2013E 2014E

After sales services New car sales Auto financing, insurance, second-hand car sales


- 67 -

ZTA: Daiwa key assumptions and forecasts (revenue and gross margin) Dealerships 2010 2011 2012E 2013E 2014ENo. of dealerships 24 59 66 76 86No. selling luxury cars 14 43 50 60 70No. selling mid-range cars 10 16 16 16 16Sales volume 2010 2011 2012E 2013E 2014ETotal sales volume (number of cars) 27,144 40,114 70,300 81,629 97,149% growth 25.7 47.8 75.3 16.1 19.0Luxury 9,494 21,380 46,215 54,534 66,531% growth 104.7 125.2 116.2 18.0 22.0Mid-range 17,650 18,734 24,085 27,096 30,618% growth 4.1 6.1 28.6 12.5 13.0Luxury car as % of total volume 35.0 53.3 65.7 66.8 68.5ASPs 2010 2011 2012E 2013E 2014ENew car sales ASP (CNY) 258,215 322,898 357,245 355,333 362,146% growth 30.6 25.0 10.6 -0.5 1.9Luxury 505,793 494,979 480,130 472,928 475,293% growth 4.7 -2.1 -3.0 -1.5 0.5Mid-range 125,042 126,511 121,451 118,658 116,284% growth 4.5 1.2 -4.0 -2.3 -2.0Revenue 2010 2011 2012E 2013E 2014ENew car sales revenue (CNYm) 7,009 12,953 25,114 29,006 35,182% growth 64.1 84.8 93.9 15.5 21.3After-sales revenue 602 1,047 2,582 3,557 4,928% growth 58.1 74.1 146.5 37.8 38.6Sales of lubricant oil and logistic segment 423 444 555 705 902% growth 28.2 4.8 25.0 27.0 28.0Total revenue 8,034 14,444 28,251 33,267 41,012% growth 61.3 79.8 95.6 17.8 23.3After sales as % of total revenue 7.5 7.3 9.1 10.7 12.0Gross profit 2010 2011 2012E 2013E 2014ENew-car sales gross profit (CNYm) 377 841 1,375 1,657 2,057% growth 90.3 123.0 63.5 20.5 24.2After-sales gross profit 266 457 1,164 1,582 2,181% growth 77.9 72.1 154.7 35.9 37.8Sales of lubricant oil and logistics segment 84 88 107 136 174% growth 25.8 4.1 22.1 27.0 28.0Total gross profit 727 1,386 2,646 3,375 4,412% growth 75.4 90.6 91.0 27.6 30.7After-sales gross profit as % of total gross profit 36.5 33.0 44.0 46.9 49.4Gross margin (%) 2010 2011 2012E 2013E 2014ELuxury 6.7 6.8 5.8 6.0 6.1Mid-range 2.5 5.1 3.0 3.4 3.6After-sales 44.2 43.6 45.1 44.5 44.2Sales of lubricant oil and logistic segment 19.9 19.8 19.3 19.3 19.3Blended gross margin 9.0 9.6 9.4 10.1 10.8



- 68 -

ZTA: Daiwa key assumptions and forecasts (efficiency, operating leverage, earnings quality and over-expansion meter) Per dealership measure 2010 2011 2012E 2013E 2014ECars sales per dealership (Units) 1,131 680 1,065 1,074 1,130Revenue per dealership (CNYm) 274 212 372 372 399Gross profit per dealership (CNYm) 27 22 38 43 49EBIT per dealership (CNYm) 20 15 24 29 35Efficiency (YoY % growth) 2010 2011 2012E 2013E 2014EDealership number 41.2 145.8 11.9 15.2 13.2Cars sales per dealership -11.0 7.5 -12.4 0.8 5.2Revenue per dealership 18.4 -22.7 75.5 0.1 7.0Gross profit per dealership 31.0 -17.8 74.9 10.8 15.6EBIT per dealership 47.9 -25.7 59.0 24.3 20.5Gross profit per new car sales 51.4 50.9 -6.7 3.8 4.3Gross profit per service of the year 41.5 16.4 45.3 17.1 15.8Gross profit per service (Spread over past 5-year customer base) 21.9 29.1 64.3 -1.1 5.4Operating leverage (%) 2010 2011 2012E 2013E 2014ESG&A as % of revenue 4.6 4.5 4.8 4.6 4.7staff cost as % of GP per dealer 19.1 20.2 17.0 19.8 20.5Salary per staff YoY growth 46.3 -12.0 73.1 12.0 10.0Upselling commission as % of revenue 0.36 0.56 0.76 0.98 1.12Balance sheet and earning quality 2010 2011 2012E 2013E 2014EDebt/equity (%) 18 67 78 57 38Debt/equity (excluding all intangible assets) (%) 18 3421 487 183 84Net gearing (%) -90 31 38 25 15Interest coverage 8.5x 6.8x 3.2x 4.2x 5.4xFCF (CNYm) -319 -6,480 -295 1,087 1,063Adjust asset turnover ratio (%) 120 91 152 168 186ROACE (%) 15.8 13.1 13.9 19.4 23.9ROI (%) 82.2 24.1 19.7 24.7 30.7Incremental ROI (%) 234 557 -4 18 75Over-expansion ability 2010 2011 2012E 2013E 2014EDealer's 'greed ratio' 3.37 3.94 2.24 2.35 2.32Adjusted FCF/car sold (CNY) -14,869 -163,719 -5,725 11,647 9,144Working capital as % of revenue 43.1 71.6 44.1 40.8 41.1



- 69 -

When overexpansion is bad

ZTA unlikely to over-expand in 2013

Based on historical correlations, when gross profit from new car sales growth exceeds that of after-sales services, there is a tendency for auto dealers to undertake aggressive expansion. With the central government’s auto subsidies aimed at boosting the economy having kicked in after the sub-prime crisis in the 2008, we believe the auto retail market has become heavily distorted. The better sell-through level as a result of the subsidies has generated very high expectations of short-term returns in the market simply by building more dealerships and selling more cars. Consequently, dealers such as ZTA and ZSG have opened many new dealerships, expanding by 40-140% from their original size. However, going into 2013, we believe that as a result of revenue-mix changes and the sector’s expected recovery via organic growth rather than from government policy distortion, the over-expansionary bias should be milder. ZTA: over-expansion in 2011 due to bullish expectations on new car sales


ZSG: over-expansion in 2011 due to bullish expectation on new-car sales

Source: Company, Daiwa forecast

Introducing Daiwa’s ‘greed’ ratio

Calculating ‘average annual gross profit from after-sale servicing per customer’ To measure the gross profit from auto services each year for each customer, we first estimate the potential customer base. In this report, based on feedback from our discussions with ZTA and ZSG, we introduce our estimated probabilities of car buyers returning to the same dealer for services 1-4 years after purchasing a new car. These are set forth in the table below. Probability of car buyer returning to same dealer for services Within 1 year 90% Within 2 years 85%Within 3 years 80% Within 4 years 65%


Stage 1: Following the above logic, we derive the total customer base (new car sales) over the past four years. Stage 2: We apply four sets of probabilities of car buyers returning to the same dealer for services between one and four years (we generated the above probabilities after consulting with several luxury auto dealers in China). Stage 3: We multiply the results from stages 1 and 2 to get the potential client pool from the past 4 years that would return to same dealer for services in the current year. Stage 4: By dividing the current year’s total gross profit from services by the total customer base (stage 3 result), we calculate the average gross profit from after-sales servicing per customer (AGPS).

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Dealership expansion pace


- 70 -

A greed ratio of >2.5 may indicate an over-expansionary bias Dealer’s ‘greed’ ratio


Due to the fragmented nature of the market, with each of the top-3 dealers capturing less than 8% of the market size in terms of revenue (statistics shown on page 17), we believe dealers look for every opportunity to expand when they are cash-rich and their new-car sales volume reaches a growth rate of 30%+ YoY. We estimate that a greed ratio higher than 2.5x indicates that companies are likely to embark on heavy expansion, as occurred at ZSG in 2009-11 and at ZTA in 2010-11. ZTA: over-expansion in 2011 associated with strong balance sheet and higher over-expansionary tendency


We believe that ZTA’s overexpansion in 2011 was associated with its strong balance sheet, high interest coverage with net cash, and strong new car sales growth, which led to its greed ratio overshooting 2.5. Subsequently, we think 2012 was a consolidation year for ZTA. We forecast new-car sales volume to rise only by 16% YoY for 2013 and 19% YoY for 2014, and we think these low growth rates should help to keep the greed ratio below 2.5 with only a gradual improvement in net gearing and interest coverage.

In conclusion, we believe the risk of ZTA over-expanding again in 2013 is relatively low compared with its past activity. In our view, the market has been over-sceptical and has put a high discount on ZTA’s valuation, on the grounds that a new round of aggressive expansion may resurface in 2013.

2013 could be a rerating year

Rising ROACE and ROI with stable greed ratio Improving return and over-expansionary bias towards opening of new dealerships


We forecast ZTA’s luxury car sales volume to rise by 18% YoY for 2013, which implies gross-profit increases of 21% YoY for new-car sales and 36% YoY for after-sales services. With this, together with the synergy on operating leverage, we forecast ROACE to improve from 13.9% in 2012 to 19.4% in 2013 and ROI (EBIT divided by past-5-year capex plus current-year maintenance capex) to improve from 19.7% for 2012 to 24.7% for 2013, without triggering a rise in the greed ratio. Improving earnings and balance sheet Recovering FCF and asset turnover


3.37

3.94

2.24 2.35 2.32

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- 71 -

ZTA has indicated it will refocus on organic growth from 2013 rather than M&A, via expanding its own dealerships. As such, we forecast FCF to gradually improve from the 2012 level to deliver an FCF yield of more than 7% for 2013. We also look for the asset-turnover ratio to rise to above 1.7x for 2013 and 1.9x for 2014, from 1.6x for 2012. ZTA: improving balance sheet


We expect ZTA’s balance sheet to keep improving, and look for its net-gearing ratio to improve from 38% in 2012 to 25% in 2013, with its interest coverage moving up from 3.2x to 4.2x. Stripping out the value of its intangible assets, we forecast the debt/equity ratio to decline to 1.8x for 2013 and 0.8x for 2014, from 4.9x for 2012. 2013 could be a rerating year for ZTA with better incremental ROI ZTA: incremental ROI


Long term: To determine the long-term ROI, we divide ZTA’s current-year EBIT by the past-five-year total capex plus the current-year maintenance capex. We use this ratio to estimate the investment-return level for every dollar invested over time.

Short term: To determine the short-term ROI (incremental ROI), we divide the change in EBIT over the previous year by the past-two-year average capex. This ratio captures the short-term marginal return per dollar invested for the core business. Our analysis shows that the returns per marginal dollar spent are rising, as organic growth from the ramping-up of the dealerships accelerates. We look for a solid rebound in ZTA’s ROI for 2013, as a result of the strong after-sales profit from its previous M&A. We also expect new-dealer after-sales services to ramp up in terms of revenue during 2013, with more incremental growth in 2014, with incremental ROI rising to 75% for 2014.

Sum-of-the-parts valuation

We apply a 14.5x PER to the after-sales segmental businessBased on Bloomberg-consensus forecasts, US auto dealers are trading currently at a non-weighted average 2013E PER of 14.5x. As such, we apply a PER of 14.5x, which is in line with the global benchmark, to determine China auto-dealer EPS from the after-sales and service segmental businesses. Major US auto dealers: 2013E consensus valuations

13E (PER) 13E (PBR) 13E (ROE)AUTONATION INC 16.4 2.685 19.433CARMAX INC 21.1 2.885 14.733ASBURY AUTOMOTIVE GROUP 12.3 2.331 19.666LITHIA MOTORS INC-CL A 13.4 2.264 18.465GROUP 1 AUTOMOTIVE INC 12.6 1.591 13.033SONIC AUTOMOTIVE INC-CLASS A 12.3 1.873 18.097PENSKE AUTOMOTIVE GROUP INC 13.4 1.96 16.048Non-weighted average 14.5 2.2 17.1


We apply a 10.7x PER to the new-car-sales business and commission business We believe the risks facing auto dealers and auto makers are similar, with dealers’ sell-through affecting makers’ sell-in. In our view, new-car sales will remain a higher risk business than after-sales service going forward, with lower earnings visibility and volatile FCF due to the high demand amongst auto dealers for working capital. With destocking still taking place for luxury cars and seasonal demand starting to wane, we conservatively apply a 10.7x PER to ZTA’s new-car sales business (1SD below the stock’s past-three-year average).

0

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(100%)

(80%)

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(40%)

(20%)

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2010 2011 2012E 2013E 2014E

Net gearing (LHS) (%) Interest coverage ratio (RHS) (times)

556.8%

-4.1% 17.9%75.1%

(100%)

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ROI ROCE Incremental ROI

ROI, ROCE Incremental ROI


- 72 -

ZTA: forward-PER bands

Source: Company, Daiwa forecasts [ZTA PER]

ZTA: SOTP valuation 2013E EPS 2013E PER (x) Value per share (CNY)EPS (after-sales services) = CNY0.227 14.5 3.29EPS (new-car sales) = CNY0.219 10.7 2.34EPS (upselling) = CNY0.076 10.7 0.82SOTP result CNY6.44 / HKD8.09


Our SOTP valuation suggests ZTA shares are worth HKD8.09 each, implying 15% upside potential over the next six months. We initiate coverage with a Buy (1) rating.

Risks

Equity-placement risk Although our analysis suggests that the chance of dealers over-expanding their dealer networks is low for 2013, we do not rule out the possibility that the auto dealers will undertake M&A and fuel it with new equity placements, which could result in a dilution of existing shareholders’ equity. Aggressive sales targets for automakers Dealers’ working capital would be under pressure if the automakers continued to set aggressive sales targets, which could lead to an over-supply of cars for sale and a price war. Both automakers’ and dealers’ EBIT margins would be affected if the above case were to materialise. Macroeconomic tightening Our economics team expects M2 growth to slow in 2H13 as inflation starts to rise. As auto sales have a high correlation with M2 growth, we believe economic tightening by the government would lead to a slowdown in auto sales.

Slowing auto exports China’s auto exports could fall sharply if global GDP growth were to slow. We believe domestic brands such as Geely and Great Wall, which have high levels of exports, would be affected. To offset the effects of an export slowdown, companies might cut prices in the domestic market so as to maintain their utilisation-rate and sales targets. This would affect the automakers’ earnings.

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Avg +2SD = 32.99x

Avg = 17.86x

Avg +1SD = 25.43x

Avg -1SD = 10.29x

Share price (HKD)


- 73 -

Company background

History

ZTA’s first Nissan dealership store (Shanghai Shenxie Automobile Trading) was opened in Shanghai in 1999. The founder, Mr. Wang Muqing, had worked previously for over 25 years at a state-owned industrial company. In 1996, Mr. Wang started selling commercial vehicles. However, in 2004 he wound down this business and turned instead to the auto dealership business. In 2004-05, ZTA built six dealerships in Hubei Province and also entered the market in Inner

Mongolia and other central provinces such as Hunan. The company began to focus more on luxury brands such as the BMW/Mini towards the end of 2005. Between 2007 and 2009, ZTA set up 6 new dealerships with 5 for BMW brands. The company then expanded its number of dealerships to 17, including 8 luxury brands. ZTA was listed in Hong Kong in December 2010 and by the end of that year it owned 24 dealerships (14 luxury brands). Later on, the company acquired two more Audi shops in Jiangxi and Shandong Provinces. In 2H11, ZTA’s acquisition of the SCAC Group attracted significant attention from investors because in 2010 SCAC was the 9th largest Chinese auto dealership group in terms of revenue (ZTA was only ranked 20th at that time). ZTA became the 7th largest dealership group in China after the SCAC acquisition.

ZTA: current company structure

Source: Company


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Board composition Key board members include four executive directors, one non-executive director and three independent directors. ZTA: profiles of key management Wang, Kunpeng (40) Executive Director and CEO; graduated from Jilin University of

Technology with a diploma in auto engineering; Also worked as a sales manager for FAW-VW from 2002 to 2006.

Li, Zhubo (42) Executive Director and CFO; has a diploma in auditing and 19 years of experience in financial management in the automobile industry.

Shao, Yongjun (37) Executive Director and Vice President; has a bachelor's degree in Accounting and MBA from Shanghai Jiao Tong University; was previously an auditor with KPMG.

Chen, Tao (41) Executive Director; has a bachelor's degree in Machinery Design and Manufacture; was a management consultant up until 2009.

MOK, Kwok Choi Peter (42) Chief Operating Officer; obtained a bachelor's degree in Art from the University of Hong Kong in 1991 and an MBA from University of Strathclyde in 2005; has 10 years’ experience in dealership store operations.

Wang, Limin (46) Vice President; responsible for dealership operations under SCAS; achieved a bacherlor's degree in Automobile Engineering and doctoral degree in Economics from Nankai University in 2011.

Source: Company

Product and revenue mix

ZTA is an all-round luxury car dealer 2011: China auto dealer market share among the top-100 players

Rank Chinese name English name

A: Market share

(Revenue)

B: Market share

(Volume) A / B

1 广汇 Guanghui 7.5% 9.5% 0.8

2 庞大 Pangda 6.5% 9.9% 0.7

3 国机 Sinomach 6.0% 2.7% 2.2

4 利星行 Lei Shing Hong 5.6% 1.9% 3.0

5 中升 Zhong Sheng 4.9% 3.7% 1.3

6 浙江元通 Zhenjiang Materials 3.3% 4.3% 0.8

7 正通 ZhengTong 2.9% 1.4% 2.0

8 广物汽贸 Guangdong Goods 2.8% 5.2% 0.5

9 上海永达 Yongda 2.7% 1.4% 1.9

10 天津浩物机电 Tianjin Haowu 2.3% 1.5% 1.6

11 海南惠通嘉华 Huitong 1.8% 0.8% 2.3

12 湖北恒信德龙 Hengxin Delong 1.7% 1.6% 1.1

13 上海汽车工业 Shanghai Auto Industry 1.5% 1.2% 1.2

14 北京祥龙博瑞 Xianglong Borui Auto 1.5% 1.0% 1.5

15 广西长久 Changjiu 1.5% 1.8% 0.8

16 东创建国 Eastern Kingo Auto 1.4% 2.8% 0.5

17 宝信汽车 Baoxin 1.4% 0.7% 2.1

18 山东远通 Shandong Yuantong 1.3% 2.3% 0.6

19 万帮金之星 Wanbang 1.3% 0.9% 1.4

20 润东 Rundong 1.2% 1.1% 1.2

Top-20 Top 20-dealer market share as % of top 100 59% 56% 1.1

Top 21-100

The other 80 dealers average market share as % top 100 0.51% 0.56% 0.9

Source: Sinomach, Daiwa estimates

Among the top-100 dealerships in China, in terms of 2011 revenue market share, ZTA was ranked No. 7 with 2.9% of revenue and 1.4% of sales volume. Concentrates more on luxury brands … Dealerships: premium vs. middle-range mix

Source: Company

In 2012, we estimate over 66% of ZTA’s dealers sold luxury brand cars. In 2H11, with the acquisition of SCAC, ZTA acquired 23 dealerships, with 9 being Jaguar Land Rover (JLR) dealerships. The total consideration of the acquisition was CNY5.5bn. … but more diversified within different luxury brands ZTA versus peers: number of luxury brands managed

Source: Company

ZTA has the highest number of luxury brands among the H-share listed China auto dealers, which means its product mix is more diversified than those of its domestic peers.

0%

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Zheng Tong Zhong Sheng Yongda Baoxin


- 75 -

ZTA: brand mix (1H12)

Source: Company

We estimate that 74% of ZTA’s dealerships sell luxury cars. We believe ZTA is also well-diversified within the luxury segment, with BMW accounting for 24.6% of its total number of dealerships, Audi 9.8% and JLR 27.9%. Top-3 brands – sales details ZTA’s top-3 brands: sales volume as % of total volume


We estimate that the above top-3 brands accounted for roughly 58% of ZTA’s 2012 sales volume.

Diversification among locations Dealerships: geographical mix summary


Around 54% of ZTA’s dealers are located in first-tier and large coastal cities. With the next wave of demand for luxury cars likely to come from inland and lower-tier cities, we see ZTA as being well-positioned to capture this next potential wave of demand, given that it has a wide geographical mix.

Audi9.8%

BMW + Mini24.6%

Benz1.6%

JLR & Volvo27.9%

Imported VW3.3%

Porsche3.3%

Infiniti1.6%

Acura1.6%

Mass market brands26.2%

49%

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Audi BMW

JLR & Volvo Top-3 brands sales as % of total sales

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Beijing+Shanghai+Tianjin+Zhejiang+Guangdong

Other areas (Central and inland area)

(Number of dealerships)


- 76 -

ZTA: dealership locations

Source: Company

High sales visibility from BMW and Audi ZTA: JLR dealerships and sales volumes as a % of China total


We believe the sales-through visibility with Audi and BMW has been consistently better than that for Mercedes-Benz.

ZTA: BMW dealerships and sales volume as a % of China total


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AUDI BMW Benz

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5.7%

BMW dealership numbers BMW sales volume


- 77 -

ZTA: JLR dealerships and sales volumes as a % of China total


Audi, BMW and JLR contribute most of ZTA’s sales volume.

12.9%

13.1%

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JLR dealership numbers JLR sales volume


■ Investment case 2013 should be a better year. With consumer sentiment in the car market improving, we expect growth in Zhongsheng Group Holdings’ (ZSG) average car sales per dealership to stabilise YoY for 2012-14, with dealerships rising by 14.3% for 2012, 14.4% for 2013 and 14.2% for 2014. Also, we believe ZSG’s ROCE and ROI will rebound significantly, enhancing earnings quality greatly, and that its FCF will turn positive and net gearing will fall. We expect a better margin outlook for ZSG’s new-car sales in 2013, lifting the gross margin from 8.8% for 2012 to 10.1% for 2013 and the net margin from 1.7% to 2.7% over the same period. We initiate coverage with an Outperform (2) rating and a six-month target price of HKD14.19. EBIT expansion. We foresee improved operating leverage and forecast ZSG’s EBIT margin to rise from 4.5% for 2012 to 6% for 2013 on higher commission income from auto insurance and auto finance.

Defensive business model. ZSG’s addition of after-sales services should improve its business outlook. For 2013, we forecast revenue from after-sales services to account for 12.7% of total revenue, up from 10.2% for 2012E, and make up 58% of ZSG’s total 2013 gross profit. We expect improved profitability to lead the 2013 EBIT/dealer ratio to rise to CNY21m, up 41% YoY. We expect stable mid-term earnings for ZSG with less reliance on new-car sales. ■ Catalysts We expect the OEM automakers to reduce retail and wholesale ASPs simultaneously this year, in an effort to ease price competition, by transferring potential discounts at the retail level to the automakers, which should improve the dealers’ EBIT margins and working capital. ■ Valuation

We use an SOTP methodology to derive our target price of HKD14.19. As we expect ZSG’s FCF and EBIT margins to recover in 2013, we believe the company’s after-sales services business should be valued on par with international auto dealers (2013E PER of 14.5x). We apply a 2013E PER of 10.7x to value ZSG’s new-car sales business, in line with the current PER of China automakers.

■ Risks ZSG’s high reliance on sales of Japan brands in the mid-range segment and weak Mercedes-Benz cars in the luxury segment could delay recoveries in earnings and cash flow.

Consumer Discretionary / Hong Kong881 HK

15 February 2013

Zhongsheng Group Holdings

Initiation: risk-reward profile looks attractive

• We expect significant net gearing and ROCE improvements in 2013 for China’s largest listed auto dealer

• We believe FCF has bottomed out and will turn positive this year, and expect EBIT margin expansion

• Initiating coverage with an Outperform rating and target price of HKD14.19


Consumer Discretionary / Hong Kong

Zhongsheng Group Holdings881 HK

Target (HKD): 14.19Upside: 10.2%15 Feb price (HKD): 12.88

BuyOutperform (initiation)


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105

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Zhongsheng (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 7.99-16.40Market cap (USDbn) 3.173m avg daily turnover (USDm) 2.86Shares outstanding (m) 1,908Major shareholder Mountain Bright Ltd (11.8%)

Financial summary (CNY)Year to 31 Dec 12E 13E 14ERevenue (m) 53,201 64,129 76,182Operating profit (m) 2,403 3,871 5,084Net profit (m) 916 1,746 2,432Core EPS (fully-diluted) 0.480 0.915 1.274EPS change (%) (35.4) 90.7 39.3Daiwa vs Cons. EPS (%) (10.7) 2.1 10.8PER (x) 21.6 11.3 8.1Dividend yield (%) 0.0 0.0 0.0DPS 0.000 0.000 0.000PBR (x) 2.5 2.0 1.6EV/EBITDA (x) 11.9 7.7 6.0ROE (%) 12.1 19.7 22.2

Jeff Chung(852) 2773 8783

[email protected]



- 79 -

Growth outlook ZSG: operating profit and EBIT margin

We forecast revenue growth for ZSG’s car sales to slow from 27% YoY for 2012 to 21% YoY for 2013. We forecast after-sales services revenue to increase by 50% YoY for 2013 and 34% YoY for 2014. Overall, we forecast ZSG’s EBIT/dealership to increase by 41% YoY for 2013 and 15% YoY for 2014, faster than the rate of increase in the number of dealerships, which we forecast at 14% YoY for the next few years.


Valuation ZSG: one-year forward PER bands

We use an SOTP methodology to value the stock. For ZSG’s after-sales business, we apply a PER of 14.5x to our 2013 EPS forecast, in line with the average 2013E PER of 14.5x for its global peers based on consensus forecasts at current share-price levels. For new-car sales and upselling (auto-finance and insurance), we apply 2013E PERs of 10.7x, in line with China automakers’ past-seven-year-average. ZSG stock is trading currently at a 2013E PER of 11.3x, 65% below its past-three-year average, comparing favourably with the average 2013E PER of its global peers.


Earnings revisions ZSG: consensus 2012-13 EPS forecast revisions

The 2013 Bloomberg-consensus EPS forecast has been cut consistently since August 2012 on low sector inventory levels and narrowing price discounts at the retail level. However, car-sales growth recovered in the 4Q12 high season, and we believe investor sentiment towards ZSG is turning more positive, as: 1) China’s economic data and GDP growth outlook have improved, and 2) the company’s earnings over the medium term should be more stable now that it is less dependent on new-car sales.



Growth outlook

Valuation

Earnings revisions

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Operating profit (LHS) EBIT margin (RHS)

(CNYm)

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Avg = 17.64x

Avg -1sd = 12.78x

Avg -2sd = 7.93x

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(CNY) EPS

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- 80 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ELuxury car sales volume 6,687.0 6,661.0 8,044.0 16,589.0 35,217.0 55,283.0 70,444.0 84,602.0Mid-range car sales volume 25,290.0 34,688.0 53,419.0 83,598.0 125,500.0 130,230.0 141,100.0 160,622.0Gross profit from new car sales 551.3 436.0 616.9 1,261.6 2,588.7 2,117.4 2,760.7 3,366.1Gross profit from after sales 169.7 343.4 556.5 1,030.3 1,719.7 2,577.2 3,744.6 4,913.0Cars sales per dealership 1,184.3 1,378.3 1,307.7 1,022.3 1,148.0 1,159.5 1,156.0 1,173.3Revenue per dealership 337.2 351.6 292.0 245.3 299.3 332.5 350.4 364.5EBIT per dealership 16.8 14.1 15.9 16.2 19.3 15.1 21.2 24.3

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ENew car sales (CNY million) 8,622 9,702 12,482 21,937 38,240 47,776 56,007 65,312After-sales (CNY million) 481 853 1,240 2,106 3,664 5,426 8,123 10,869Other Revenue 0 (7) 0 0 0 0 0 0Total Revenue 9,103 10,549 13,722 24,043 41,903 53,201 64,129 76,182Other income 27 33 69 295 331 582 797 995COGS (8,382) (9,771) (12,543) (21,750) (37,595) (48,507) (57,624) (67,903)SG&A (302) (393) (508) (1,012) (1,942) (2,873) (3,431) (4,190)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 446 418 740 1,576 2,698 2,403 3,871 5,084Net-interest inc./(exp.) (51) (104) (81) (200) (513) (1,067) (1,317) (1,523)Assoc/forex/extraord./others 7 5 7 8 10 5 4 2Pre-tax profit 402 318 667 1,384 2,194 1,341 2,558 3,563Tax (99) (83) (174) (302) (551) (335) (640) (891)Min. int./pref. div./others (19) (16) (22) (51) (226) (91) (173) (241)Net profit (reported) 284 219 471 1,031 1,417 916 1,746 2,432Net profit (adjusted) 284 219 471 1,031 1,417 916 1,746 2,432EPS (reported)(CNY) 0.156 0.120 0.258 0.564 0.743 0.480 0.915 1.274EPS (adjusted)(CNY) 0.156 0.120 0.258 0.564 0.743 0.480 0.915 1.274EPS (adjusted fully-diluted)(CNY) 0.156 0.120 0.258 0.564 0.743 0.480 0.915 1.274DPS (CNY) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000EBIT 446 418 740 1,576 2,698 2,403 3,871 5,084EBITDA 495 478 828 1,729 3,058 2,858 4,455 5,926

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014EProfit before tax 402 318 667 1,384 2,194 1,341 2,558 3,563Depreciation and amortisation 49 61 88 153 361 455 584 842Tax paid (65) (95) (120) (171) (362) (335) (640) (891)Change in working capital (217) (54) (292) (1,458) (1,628) (7,906) (605) (2,079)Other operational CF items (11) 107 (144) (764) (205) 1,285 1,329 1,887Cash flow from operations 159 337 199 (856) 359 (5,161) 3,227 3,323Capex (132) (213) (327) (1,216) (2,261) (1,757) (2,179) (2,522)Net (acquisitions)/disposals (77) (124) (285) (569) (1,030) 0 0 0Other investing CF items (37) (217) 166 (543) (165) 0 0 0Cash flow from investing (245) (554) (446) (2,328) (3,456) (1,757) (2,179) (2,522)Change in debt 94 97 449 2,479 4,273 3,000 3,000 3,000Net share issues/(repurchases) 0 0 0 2,910 0 0 0 0Dividends paid 0 0 0 0 (200) 0 0 0Other financing CF items n.a. n.a. n.a. (211) 524 (1,067) (1,317) (1,523)Cash flow from financing 45 833 317 5,178 4,596 1,933 1,683 1,477Forex effect/others 0 0 0 0 0 0 0 0Change in cash (42) 615 70 1,994 1,500 (4,985) 2,731 2,278Free cash flow 27 124 (128) (2,071) (1,901) (6,918) 1,048 801

Financial summary


- 81 -


Key ratios (%)


Company profile

Zhongsheng Group Holdings Limited owns a comprehensive 4S dealership network nationwide, covering affluent cities and regions of China. The Group focuses on luxury and mid-to-high end automobile brands, namely luxury brands of Mercedes-Benz, Lexus and Audi, and mid-to-high end brands of Toyota, Nissan and Honda.

As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ECash & short-term investment 635 1,205 1,458 4,161 6,339 1,355 4,086 6,364Inventory 706 1,133 1,024 3,453 6,380 9,568 9,788 10,976Accounts receivable 55 61 87 285 467 729 878 1,044Other current assets 706 725 1,114 2,701 4,686 7,050 7,960 9,446Total current assets 2,102 3,125 3,683 10,599 17,872 18,703 22,713 27,830Fixed assets 460 549 838 1,789 3,887 4,895 6,104 7,340Goodwill & intangibles 345 434 878 2,874 5,024 5,318 5,704 6,148Other non-current assets 42 63 105 938 1,077 1,082 1,086 1,088Total assets 2,949 4,171 5,504 16,200 27,860 29,997 35,607 42,405Short-term debt 1,033 1,158 1,797 4,924 10,028 13,028 16,028 19,028Accounts payable 646 836 1,093 2,985 5,680 3,588 4,263 5,023Other current liabilities 443 458 362 1,154 1,906 2,128 2,144 2,510Total current liabilities 2,122 2,451 3,252 9,062 17,613 18,744 22,435 26,561Long-term debt 0 0 0 0 1,263 1,263 1,263 1,263Other non-current liabilities 21 34 105 423 706 706 706 706Total liabilities 2,142 2,485 3,357 9,485 19,583 20,713 24,404 28,530Share capital 0 0 0 0 0 0 0 0Reserves/R.E./others 757 1,633 2,111 5,936 7,092 8,008 9,754 12,186Shareholders' equity 757 1,633 2,111 5,936 7,092 8,008 9,754 12,186Minority interests 49 53 37 779 1,186 1,276 1,449 1,689Total equity & liabilities 2,949 4,171 5,504 16,200 27,860 29,997 35,607 42,405EV 20,204 19,762 20,132 21,299 25,893 33,968 34,410 35,373Net debt/(cash) 398 (47) 339 764 4,951 12,936 13,205 13,927BVPS (CNY) 0.414 0.893 1.155 3.247 3.716 4.196 5.111 6.385

Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014ESales (YoY) n.a. 15.9 30.1 75.2 74.3 27.0 20.5 18.8EBITDA (YoY) n.a. (3.3) 73.1 108.7 76.9 (6.5) 55.9 33.0Operating profit (YoY) n.a. (6.4) 77.2 112.9 71.2 (10.9) 61.1 31.3Net profit (YoY) n.a. (23.1) 115.3 119.0 37.4 (35.4) 90.7 39.3Core EPS (fully-diluted) (YoY) n.a. (23.1) 115.3 119.0 31.7 (35.4) 90.7 39.3Gross-profit margin 7.9 7.4 8.6 9.5 10.3 8.8 10.1 10.9EBITDA margin 5.4 4.5 6.0 7.2 7.3 5.4 6.9 7.8Operating-profit margin 4.9 4.0 5.4 6.6 6.4 4.5 6.0 6.7ROAE 75.1 18.3 25.2 25.6 21.8 12.1 19.7 22.2ROAA 19.3 6.1 9.7 9.5 6.4 3.2 5.3 6.2ROCE 48.5 24.9 33.6 29.5 25.2 12.5 20.9 24.6ROIC 55.9 21.7 26.5 24.7 19.5 10.2 12.5 14.6Net debt to equity 52.6 net cash 16.0 12.9 69.8 161.5 135.4 114.3Effective tax rate 24.6 26.2 26.1 21.8 25.1 25.0 25.0 25.0Accounts receivable (days) 1.1 2.0 2.0 2.8 3.3 4.1 4.6 4.6Current ratio (x) 1.0 1.3 1.1 1.2 1.0 1.0 1.0 1.0Net interest cover (x) 8.8 4.0 9.2 7.9 5.3 2.3 2.9 3.3Net dividend payout 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0



- 82 -

Initiation: risk-reward profile looks attractive

More mature but defensive

We believe 2013 will be a better year than 2012 for auto dealers. Among these we think that ZSG, one of the biggest dealers in China, will see rapid EBIT margin expansion, as we expect: 1) a steady margin recovery for its new-car sales, 2) a change in the profit mix, with after-sales services accounting for a greater proportion, and 3) positive operating leverage from strong commission income as a result of auto finance and insurance. We believe the company distinguishes itself from its peers with a more defensive business model, and we expect the gross profit for its after-sales services to account for 58% of total gross profit for 2013. We believe ZSG’s profit mix provides a good cushion against any future industry-wide slowdown in new-car sales, while it should also benefit in an economic upcycle. ZSG: dealerships, ASP, sales volume and revenue

2010 2011 2012E 2013E 2014EDealerships No. of dealerships 98 140 160 183 209Luxury 27 44 53 72 93Mid-range 71 96 107 111 116Sales volume Total 100,187 160,717 185,513 211,544 245,224% growth YoY 63.0% 60.4% 15.4% 14.0% 15.9%Luxury 16,589 35,217 55,283 70,444 84,602% growth YoY 106.2% 112.3% 57.0% 27.4% 20.1%Mid-range 83,598 125,500 130,230 141,100 160,622% growth YoY 56.5% 50.1% 3.8% 8.3% 13.8%Luxury car as a % of product mix 16.6% 21.9% 29.8% 33.3% 34.5%ASPs New car sales blended ASP (CNY) 218,960 237,931 257,532 264,751 266,337% growth YoY 7.8% 8.7% 8.2% 2.8% 0.6%Luxury 494,924 543,928 516,731 506,397 503,865% growth YoY 4.7% 9.9% -5.0% -2.0% -0.5%Mid-range 164,198 152,064 147,502 144,109 141,227% growth YoY 1.1% -7.4% -3.0% -2.3% -2.0%Revenue New car sales revenue (CNYm) 21,937 38,240 47,776 56,007 65,312% growth YoY 75.7% 74.3% 24.9% 17.2% 16.6%After-sales revenue 2,106 3,664 5,426 8,123 10,869% growth YoY 67.7% 74.0% 48.1% 49.7% 33.8%Total revenue 24,043 41,903 53,201 64,129 76,182% growth YoY 75.0% 74.3% 27.0% 20.5% 18.8%After-sales revenue as a % of total revenue 8.8% 8.7% 10.2% 12.7% 14.3%


Volume forecasts. In terms of 2011 revenue market share, ZSG ranked as the fifth-largest auto dealer in China. As 65% of the company’s dealers sell Japanese brands, we forecast 2013 sales volume for mid-range new cars to rise by only by 8.3% YoY. We expect the 2013 sales growth of luxury cars Mercedes-Benz and Lexus to be better than that for 2012, and forecast 27% YoY sales-volume growth for ZSG’s luxury segment for 2013. Overall, we forecast the total sales-volume growth rate to slow slightly to 14% YoY for 2013, from 15.4% YoY for 2012E, as we believe it will take some time for sales of Japanese brand autos to recover to a normal level. ASP and revenue forecasts. ZSG’s luxury car blended ASP was 3.5x higher than that of mid-range cars for 2012. Although we factor in ASP declines of 2% YoY for luxury cars and 2.3% YoY for mid-range cars in 2013, with the product mix throughout the year moving in favour of sales of luxury brands, we forecast blended ASP growth of 2.8% YoY for 2013 and 0.6% YoY for 2014. After-sales business revenue forecasts. We forecast revenue for ZSG’s after-sales business to rise by 50% YoY for 2013 and 34% YoY for 2014, factoring in average after-sales-revenue per dealership increases of 16% YoY for 2013 and 15% YoY for 2014. Dealership efficiency ZSG: per-dealership efficiency

2010 2011 2012E 2013E 2014ECars sales per dealership 1,022 1,148 1,159 1,156 1,173Revenue per dealership (CNYm) 245 299 333 350 365Gross profit per dealership (CNYm) 23 31 29 36 40EBIT per dealership (CNYm) 16 19 15 21 24Efficiency measure (YoY growth) Dealership number 108.5% 42.9% 14.3% 14.4% 14.2%Cars sales per dealership -21.8% 12.3% 1.0% -0.3% 1.5%Revenue per dealership -16.0% 22.0% 11.1% 5.4% 4.0%Gross profit per dealership -6.8% 31.5% -4.7% 21.2% 11.4%EBIT per dealership 1.6% 19.7% -22.2% 40.7% 14.9%


We expect 2013 to be a year of recovery for ZSG, with a higher percentage of sales from mid-range brands than for its competitor China ZhengTong Auto Services Holdings (ZTA). We forecast ZSG’s revenue-per-dealership growth to be higher than its car-sales-per- dealership growth in 2013 with dealership expansion at about 14% YoY (we assume that it will open 19 luxury dealers and four mid-range dealers this year). Upselling forecasts In order to lock in clients and increase customer retention rates, dealers are tending to increase the


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upselling (auto-finance and insurance) penetration rate. According to our research, the upselling penetration rate for some of ZSG’s luxury dealers increased from 15% for 2011 to about 30% for 2012. Most luxury auto dealers expect this ratio to rise over the coming years. For 2011, ZSG’s commission income of CNY234m mainly consisted income from upselling. The amount increased from CNY82.6m for 1H11 to CNY186m for 1H12, a rise of 125% YoY. Although we are unable to quantify accurately this operating income at this stage, we believe auto financing and insurance turnover should have a strong correlation with new-car sales. We estimate commission income was equivalent to 0.52% of new-car sales revenue for 2010 and 0.61% for 2011. As the commission income for these two businesses grew by 106% YoY for 2011, we forecast the ratio to improve to 1% for 2012 to CNY478m, 1.2% for 2013 to CNY672m, and 1.3% for 2014 to CNY849m.

Margin forecasts

After-sales could be an incremental growth driver

ZSG: gross profit (CNY m) 2010 2011 2012E 2013E 2014ENew-car sales gross profit (CNYm) 1,262 2,589 2,117 2,761 3,366% growth 104.5% 105.2% -18.2% 30.4% 21.9%After-sales gross profit 1,030 1,720 2,577 3,745 4,913% growth 85.1% 66.9% 49.9% 45.3% 31.2%Total gross profit 2,292 4,308 4,695 6,505 8,279% growth 95.3% 88.0% 9.0% 38.6% 27.3%After-sales gross profit as a % of total profit 45.0% 39.9% 54.9% 57.6% 59.3%Gross margin Luxury 8.1% 9.3% 6.0% 6.2% 6.3%Mid-range 4.3% 4.2% 2.1% 2.7% 3.0%After-sales 48.9% 46.9% 47.5% 46.1% 45.2%Blended gross margin 9.5% 10.3% 8.8% 10.1% 10.9%


Our research suggests that most China automakers are currently more cautious when it comes to high levels of inventory being accumulated at the retail level, as this should eventually result in high working capital for the dealers, the drying-up of cash flow and a slowdown in the next round of dealership expansion, which might dampen long-term sales growth. As a result, we expect automakers to set less-aggressive 1H13 sales targets than for previous years and reduce dealer supplies and sales targets for 1H13 to improve gross margins on new-car sales at the dealerships. We forecast ZSG’s luxury segment gross margin to improve mildly to 6.2% for 2013 and 6.3% for 2014. We expect the improvement to be mild and gradual, because ZSG’s

luxury segment focuses mainly on Mercedes-Benz and Lexus, the sales of which we understand still underperform those for BMW and Audi. With the recovery we are seeing in the mass market, we forecast only a mild 2013 gross-margin improvement of 0.6pp for the mid-range new car sales segment as there is currently an over-supply in this segment. As a result, we do not expect the profitability of this segment to return to 2010-11 levels any time soon. We expect ZSG’s after-sales-service margin to decline gradually, by about 1pp a year for the next three years, as the owners of mid-range cars tend to be more flexible in terms of choosing after-sales service providers than luxury-car owners. ZSG has relatively high exposure to this segment as more than 65% of its dealers specialise in mid-range brands.

Earnings growth should be strong… ZSG: revenue and earnings growth

2009-11 CAGR 2012-14E CAGRNew car sales revenue (CNYm) 75% 17%After-sales revenue 71% 42%Total revenue 75% 20%New-car sales gross profit (CNYm) 105% 26%After-sales gross profit 76% 38%Total gross profit 92% 33%Net profit 73% 63%


Overall, we forecast the after-sales revenue CAGR for 2012-14 to be lower than that for 2009-11, as ZSG has passed the initial fast ramp-up stage for new dealerships. However, we expect ZSG to see more operating leverage through upselling, which we expect to account for about 26% of ZSG’s pre-tax profit for 2013. As such, we forecast a strong net-profit CAGR of 63% for 2012-14. … due to improved operating leverage Operating leverage: stable staff costs


0.0%

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0.6%

0.8%

1.0%

1.2%

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2008 2009 2010 2011 2012E 2013E 2014E

Staff costs as a % of GP per dealerOther income excluding interest income as % of revenue

Staff cost Other income


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We forecast the total number of dealerships to increase from 160 at the end of 2012 to 183 at the end of 2013 and 209 at the end of 2014. We assume wages per staff member rise by 12% YoY over the next two years and that each dealership has 120 staff. Given the high demand for after-sales services that we expect over the coming years, with a rise in the car penetration rate on the back of the increased number of cars sold, we believe auto dealers will compete not only on price and service but also for engineers and experienced salespeople. We expect staff costs as a percentage of gross profit per dealer to remain at about 20% for the next two years. As mentioned earlier, we believe operating leverage can be gained from auto finance and insurance, which we forecast to account for 1.2% of 2013 revenue and 1.3% of that for 2014. As a result, we forecast ZSG’s operating margin to rise to 6.0% for 2013 and 6.7% for 2014. Earnings forecasts For 2012-14, we forecast EPS CAGRs of 73% for after-sales services, 57% for new car sales, and 48% for the upselling businesses, with EPS from the after-sales services and upselling segments as a percentage of total EPS increasing from 63% for 2012 to 66% for 2014. ASG: contribution to EPS by segment


ZSG: EPS mix


0.278 0.2190.453

0.656

0.436

0.178

0.327

0.4380.029

0.082

0.135

0.180

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2011 2012E 2013E 2014E

EPS Service segment EPS New car sales segment EPS Upselling segment

EPS (CNY)

37.4%45.7% 49.5% 51.5%

58.7% 37.1% 35.7% 34.4%

3.9%17.2% 14.8% 14.1%

0%

20%

40%

60%

80%

100%

2011 2012E 2013E 2014E

EPS Service segment EPS New car sales segment EPS Upselling segment


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Key assumptions and forecasts (revenue and gross margin) Dealerships 2010 2011 2012E 2013E 2014ENo. of dealerships 98 140 160 183 209Luxury 27 44 53 72 93Mid-range 71 96 107 111 116Sales volume 2010 2011 2012E 2013E 2014ETotal 100,187 160,717 185,513 211,544 245,224% growth 63.0% 60.4% 15.4% 14.0% 15.9%Luxury 16,589 35,217 55,283 70,444 84,602% growth 106.2% 112.3% 57.0% 27.4% 20.1%Mid-range 83,598 125,500 130,230 141,100 160,622% growth 56.5% 50.1% 3.8% 8.3% 13.8%Luxury car as a % of product mix 16.6% 21.9% 29.8% 33.3% 34.5%ASPs 2010 2011 2012E 2013E 2014ENew car sales blended ASP (CNY) 218,960 237,931 257,532 264,751 266,337% growth 7.8% 8.7% 8.2% 2.8% 0.6%Luxury 494,924 543,928 516,731 506,397 503,865% growth 4.7% 9.9% -5.0% -2.0% -0.5%Mid-range 164,198 152,064 147,502 144,109 141,227% growth 1.1% -7.4% -3.0% -2.3% -2.0%Revenue 2010 2011 2012E 2013E 2014ENew car sales revenue (CNYm) 21,937 38,240 47,776 56,007 65,312% growth 75.7% 74.3% 24.9% 17.2% 16.6%After-sales revenue 2,106 3,664 5,426 8,123 10,869% growth 67.7% 74.0% 48.1% 49.7% 33.8%Total revenue 24,043 41,903 53,201 64,129 76,182% growth 75.0% 74.3% 27.0% 20.5% 18.8%After-sales revenue as a % of total revenue 8.8% 8.7% 10.2% 12.7% 14.3%Gross profit 2010 2011 2012E 2013E 2014ENew-car sales gross profit (CNYm) 1,262 2,589 2,117 2,761 3,366% growth 104.5% 105.2% -18.2% 30.4% 21.9%After-sales gross profit 1,030 1,720 2,577 3,745 4,913% growth 85.1% 66.9% 49.9% 45.3% 31.2%Total gross profit 2,292 4,308 4,695 6,505 8,279% growth 95.3% 88.0% 9.0% 38.6% 27.3%After-sales gross profit as a % of total profit 45.0% 39.9% 54.9% 57.6% 59.3%Gross margin 2010 2011 2012E 2013E 2014ELuxury 8.1% 9.3% 6.0% 6.2% 6.3%Mid-range 4.3% 4.2% 2.1% 2.7% 3.0%After-sales 48.9% 46.9% 47.5% 46.1% 45.2%Blended gross margin 9.5% 10.3% 8.9% 10.1% 10.9%

Source: Company, Daiwa forecasts and estimates


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Key assumptions and forecasts (efficiency, operating leverage, earnings quality and over-expansion meter) Per-dealership measure 2010 2011 2012E 2013E 2014ECars sales per dealership (Units) 1,022 1,148 1,159 1,156 1,173Revenue per dealership (CNYm) 245 299 333 350 365Gross profit per dealership (CNYm) 23 31 29 36 40EBIT per dealership (CNYm) 16 19 15 21 24Efficiency measure (YoY growth) 2010 2011 2012E 2013E 2014EDealership number 108.5% 42.9% 14.3% 14.4% 14.2%Cars sales per dealership -21.8% 12.3% 1.0% -0.3% 1.5%Revenue per dealership -16.0% 22.0% 11.1% 5.4% 4.0%Gross profit per dealership -6.8% 31.5% -4.7% 21.2% 11.4%EBIT per dealership 1.6% 19.7% -22.2% 40.7% 14.9%Gross profit per new car sales 25.5% 27.9% -29.1% 14.3% 5.2%Gross profit per service of the year 13.6% 4.0% 29.8% 27.4% 13.2%Gross profit per service (spread over the past-five-year new car sales) 22.3% 7.1% 8.2% 13.6% 8.8%Operating leverage 2010 2011 2012E 2013E 2014ESG&A as a % of revenue 4.2% 4.6% 5.4% 5.4% 5.5%Staff cost as a % of GP per dealer 20.7% 18.6% 20.5% 19.8% 19.9%Salary per staff YoY increase n.a. 2.3% 5.0% 12.0% 12.0%Upselling commission as a % of revenue 0.5% 0.6% 0.9% 1.0% 1.1%Balance sheet and quality 2010 2011 2012E 2013E 2014EDebt/equity 0.7x 1.4x 1.5x 1.5x 1.5xDebt/equity (excluding all intangible assets) 1.1x 2.6x 2.6x 2.3x 2.0xNet gearing 11% 60% 139% 118% 100%Interest coverage 7.0x 4.9x 2.2x 2.8x 3.2xFCF (CNYm) -2,077 -1,910 -6,918 1,048 801Adjusted asset turnover ratio 1.50x 1.52x 1.79x 1.83x 1.82xROACE 29.5% 25.2% 12.5% 20.9% 24.6%ROI 50.6% 40.8% 29.8% 39.5% 43.6%Incremental ROI 184.8% 92.2% -10.6% 53.3% 61.5%Expansion ability 2010 2011 2012E 2013E 2014EDealer 'greed ratio' 2.40x 2.86x 1.88x 1.89x 1.83xFCF/car unit sold (CNY) -20,730 -11,884 -37,289 4,953 3,267Working capital as % of revenue 14.0% 13.8% 25.8% 22.3% 21.5%

Source: Company, Daiwa forecasts and estimates


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Improving fundamentals

Strong top-line recovery expected in 2013 Apart from the strong top-line recovery that we see for 2013, we expect SG&A expenses as a percentage of revenue to remain stable in 2013. We forecast the EBIT/dealership to improve by 40.7% YoY for 2013 and 14.9% YoY for 2014, which we expect to lead to a more stable asset turnover at above 1.8x and an improved FCF to above CNY1bn in 2013. ZSG: FCF and asset turnover


Given the earnings and cash-flow improvements we expect, we forecast the net-gearing ratio to improve to 118% for 2013 and 100% for 2014 with interest coverage rising slightly to 2.8x for 2013 and 3.2x for 2014. ZSG: balance sheet


Possible earnings-inflection point

ZSG: ROCE, ROI, and incremental ROI


Long term. To determine the long-term return on investment (ROI), we divide ZSG’s current-year EBIT by the past-five-year total capex plus the current-year maintenance capex. We use this ratio to estimate the investment-return level for every dollar invested over time, giving a basic cost-benefit analysis.

Short term. To determine the short-term (incremental ROI), we divide the change in EBIT over the previous year by the past-two-year average capex. This ratio captures the short-term marginal return per dollar invested for the core business. Using this measure, we see incremental ROI increasing much faster for ZSG than for ZTA in 2013. This is mainly because we forecast ZSG’s EBIT/dealership to rise by 41% YoY for 2013 (24% YoY for ZTA), mostly due to commission income from upselling at the operating level, equivalent to 1.2% of 2013E revenue (26% of 2013E pre-tax profit), compared with 1.1% of 2013 revenue (19% of 2013E pre-tax profit) for ZTA. We believe the above difference is mainly due to: 1) ZSG having more mature dealerships, and 2) ZTA undertaking considerable M&A activity in 2011 with the ramp-up in operations started one year later than that of ZSG.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

(8,000)(7,000)(6,000)(5,000)(4,000)(3,000)(2,000)(1,000)

01,0002,000

2007 2008 2009 2010 2011 2012E 2013E 2014E


(CNY) (x)

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2009 2010 2011 2012E 2013E 2014E

Net gearing ratio (LHS) Interest coverage ratio (RHS)

Net gearing Interest coverage (x)

184.8%

92.2%

-10.6%

53.3% 61.5%

(50%)

0%

50%

100%

150%

200%

2010 2011 2012E 2013E 2014E

ROI Incremental ROI ROCE


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Valuation

SOTP more appropriate than DCF China’s auto-dealership industry is fragmented, with none of the top-100 players having a revenue market share of more than 8% for 2011. We expect M&A activity and organic expansion to continue over the coming years. We therefore believe an SOTP-based methodology is the best way to reflect both the risks and the business-growth potential for auto dealers. Based on Bloomberg-consensus forecasts, US auto dealers are trading currently at a non-weighted average 2013E PER of 14.5x. In that mature market almost 80% of dealer gross profit is from the after-sales services segment. We therefore use a PER of 14.5x as a benchmark to value China auto-dealer earnings in the after-sales business.

Major US auto dealers: 2013E consensus valuations

(PER) (PBR) (ROE)AUTONATION INC 16.4 2.685 19.433CARMAX INC 21.1 2.885 14.733ASBURY AUTOMOTIVE GROUP 12.3 2.331 19.666LITHIA MOTORS INC-CL A 13.4 2.264 18.465GROUP 1 AUTOMOTIVE INC 12.6 1.591 13.033SONIC AUTOMOTIVE INC-CLASS A 12.3 1.873 18.097PENSKE AUTOMOTIVE GROUP INC 13.4 1.96 16.048Non-weighted average 14.5 2.2 17.1


We see new-car sales being a higher-risk business for China dealers in the future, with lower relative earnings visibility due to high demand for working capital. We therefore apply a 2013E PER of 10.7x to the China auto dealer new car-sales and upselling businesses, the same multiple we use to value China automakers and slightly below ZSG’s past-three-year average forward PER of -1.5SD. ZSG: forward PER bands


ZSG: SOTP valuation 2013E PER (x) Value per share (CNY)

EPS (after-sales services) 14.5 6.56EPS (new-car sales) 10.7 3.50EPS (upselling) 10.7 1.29SOTP result HKD14.19 /CNY11.36


Our SOTP-based valuation suggests a value for ZSG of CNY11.36, which converts to HKD14.19, implying 10.2% upside potential from current levels. We therefore initiate coverage with an Outperform (2) rating.

Risks

Overreliance on Japanese brands ZSG has 13 Toyota dealers in China. For 2011, the company’s Toyota dealerships accounted for 5.9% of the total number of Toyota dealerships in China but 6.8% of total Toyota sales there. We estimate that, in terms of dealership numbers, about 65% of ZSG’s dealers now sell Japanese brands. In 2013, we believe auto dealers with more non-Japanese or diversified brand line-ups will have better asset-turnover ratios. We forecast ZSG’s asset-turnover ratio to be stable over 2013-14 at about 1.8x, slightly higher than that of ZTA in 2013 but even with ZTA in 2014. Dealerships: brand mix (2012)


0

5

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Avg = 17.64x

Avg -1sd = 12.78x

Avg -2sd = 7.93x

Mercedes-Benz13.9%

Lexus8.8% Audi

6.6%Porsche

2.2%

Lamborghini0.7%FAW VW

0.7%

Imported VW0.7%Imported Infiniti

0.7%Toyota32.8%

Nissan22.6%

Others10.2%


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Japanese brands: PV market shares among all JVs in China

Source: CAAM, Daiwa

Among non-Japanese brands, Mercedes-Benz has not been doing well ZSG has 12 Mercedes-Benz dealers, accounting for about 25% of its total luxury dealers and 14% of total dealers. Given the strength of the competition from BMW and Audi, as well as higher expected OEM ratios in 2013 from other luxury brands such as JLR, we believe ZSG’s relatively lower exposure to luxury brands and the weakness of Mercedes-Benz sales within the luxury segment will reduce its earnings-growth visibility more than for its peers, such as ZTA. We forecast ZSG’s EBIT/dealership to range from CNY21-24m for 2013-14, which is lower than our forecast of a range of CNY29-35m for ZTA. As a result, we forecast net-profit margins for ZSG of 2.7% for 2013 and 3.2% for 2014, lower than those for ZTA of 3.5% for 2013 and 4.1% for 2014. China: sales of selected luxury cars (YoY)


Equity placement risk Although our analysis suggests the chance for over-expansion of the dealer network is low 2013, we do not rule out the chance the auto dealers will undertake M&A and fund it with new-equity placements, which would dilute shareholder equity. Aggressive sales targets for automakers Dealer working capital would be under pressure if automakers continued to set aggressive sales targets, which could lead to an oversupply of cars for sale and a price war. Both automaker and dealer EBITDA margins would be affected if this were to materialise. Macroeconomic tightening Our economics team expects M2 growth to slow in 2H13 as inflation starts to rise. As auto sales have a high correlation to M2 growth, we believe an economic tightening by the government would lead to a slowdown in auto sales. Slowing auto exports China’s auto exports could fall sharply if global GDP growth were to slow. We believe domestic brands such as Geely and Great Wall, which have high export levels, would be affected. To offset the effects of an export slowdown, companies might cut prices in the domestic market so as to maintain their utilisation-rate and sales targets. This would affect automaker earnings.

38.10% 43.70% 44.30% 48.70%

10.30%10.50% 15.60%

17.90%10.80%

7.70%7.40%

5.10%5.70%

8.10%9.50% 7.60%

35.20% 30% 23.20% 20.70%

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100%

2009 2010 2011 9m2012

German brands Other European brands Korean US Japanese

(40%)

(20%)

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80%


Audi BMW Mercedes-Benz


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Company background

History

ZSG was founded in 1998 by Huang Yi (the current chairman) and Li Guoqiang (the current CEO). In 1998, the company established its first dealership in Dalian. In 1999, it opened its first Audi dealership. From 2000-07, ZSG expanded its network into Yunnan, Fujian, Shanghai, Jiangsu, Guangdong, and Sichuan. Three major acquisitions were made in 2007 before the company was listed on the Hong Kong Stock Exchange. Following the listing, ZSG’s dealership network continued to expand, with the total number increasing from 30 in 2008 to 47 in 2009, 15 of which were acquired. In 1H10, the company acquired 12 dealerships and established another 10. In 2010, the company acquired and also took a 50% equity interest in B&L Motor. In September 2010, Zhongsheng acquired Fuzhou Huarui Automobile Sales Service and Fuzhou Grand Rich Da Trade which ran 6 Dongfeng Nissan 4S dealerships in China. ZSG: acquisitions 25-May-12 70% equity stake in Carlsson 5-Mar-12 20% equity stake in Loong Wah Motor for CNY222m 30-Sep-11 50% equity in Loong Wah Motors for CNY643m 22-Dec-10 55% equity stake in New Wing for CNY260m 22-Nov-10 50% equity stake in B&L Motor Holding for CNY1.1bn 16-Sep-10 100% equity interest in Huarui & Grand Rich for CNY 197m

Source: Company

At the end of 2010, ZSG acquired a 55% equity interest in New Wing Enterprises, the owner of 15 dealerships. In September 2011, the company bought a 50% equity interest in Loong Wah Motors, the owner of 16 dealerships, for CNY643m. Overall, the number of dealerships rose from 98 in 2010 to 140 in 2011.

Board composition

Key board members include five executive directors, one non-executive director, and three independent non-executive directors.

ZSG: profiles of key management Huang, Yi (49) Executive director and chairman. Bachelor’s degree in Economics

(Xiamen University). Has 24 years of experience in China auto industry.

Li, Guoqiang (48) Executive director and CEO. Deputy chairman of China Automobile Dealers Association since 2009. More than 20 years of experience in China auto industry.

Du, Qingshan (49) Executive director. Bachelor’s degree in Economics from Shanghai University of Finance and Economics and an MBA from Dongbei University of Finance and Economics. Has 21 years of experience in accountancy and finance fields.

Yu, Guangming (54) Executive director. Degree in English from Shanghai International Studies University. More than 10 years of experience in China auto industry.

Si, Wei (49) Executive director; Degree in English and American literature from Beijing Normal College. Has 20 years of experience in auto industry.

Zhang, Zhicheng (39) Vice-president of new car sales. MBA from Dongbei University of Finance and Economics. Has 7 years of experience in auto industry

Liu, Geng (42) Vice-president of after-sales services and accessories. Bachelor's degree from Harbin Institute of Technology. Has 18 years of relevant experience.

Source: Company


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Company structure

Source: Company

Mr. Huang Mr. Li

Blue Natural GeneralAtlantic Other public

Zhongsheng Group Holdings Ltd. (881: HK)

Nobe Villa

Olympia Well Super Charm Billion Great

Zhongsheng International

Hokuryo ZhongshengHoldings

Dalian Yuzeng Dalian Xinshengrong Zhongsheng Dalian

4S Dealership Business

65.70% 3.83%

100%

30.47%

Offshore

100%100%

100%100%

Onshore


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Brands in the dealerships

Heavy exposure to Toyota and Nissan ZSG dealerships: brand mix (1H12)


ZSG: brands sold


ZSG: Toyota car sales and dealerships as % of total in China


As at 1H12, 32% of ZSG’s dealers sold only Toyotas and 64% sold only Japanese brands. The company’s Toyota dealership number accounted for 5.9% of total Toyota dealerships in China for 2011, but with a sales-volume market share of 6.8%.

ZSG: luxury and mid-range dealer numbers


The ratio of luxury to mid-range dealers for ZSG changed from 2.6 for 2010 to 2.1 for the first 10 months of 2012. We believe the increased exposure to luxury-car sales will improve ZSG’s profitability over the next few years.

Mercedes-Benz13.9%

Lexus8.8% Audi

6.6%Porsche

2.2%

Lamborghini0.7%FAW VW

0.7%

Imported VW0.7%Imported Infiniti

0.7%Toyota32.8%

Nissan22.6%

Others10.2%

6.8%

5.9%

5.4%

5.6%

5.8%

6.0%

6.2%

6.4%

6.6%

6.8%

7.0%

2011 sales volume in China 2011 outlet number in China

ZSG's market share

6 7 1027

44 5121 23

37

71

96106

0

20

40

60

80

100

120

140

160

180

2007 2008 2009 2010 2011 10M12Luxury Mid-range


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Dealership locations


Geographical breakdown of dealerships (10M12) Luxury Mid-range to high end Total

Northeast 9 32 41Northern 8 1 9Eastern 16 25 41Southern 13 17 30Southwest and northwest interior regions 5 31 36Total 51 106 157

Source: Company

ZSG has high exposure to non-tier-one cities. We believe the next motorisation population will emerge in low-tier and inland cities, where the company has a strong dealership network with a ratio of 1:2 between tier-1 and non-tier-1 cities.

ZSG: dealer mix between large and small cities


48 52

92 101

0%

20%

40%

60%

80%

100%

2011 1H12

Tier-1 cities and key coastal areas Other areas and inland areas


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New-car sales and after-sales results up to 9M12

ZSG: total car sales

Source: Company

ZSG: cars serviced (units)

Source: Company

For 9M12, ZSG sold 142,000 cars (+35% YoY) and repaired 1.45m cars (+37% YoY). From 2007 to 2011, the company sold 395,693 cars. Adding this to our forecast for 2012 sales of 185,513 units indicates that the total customer base would increase to 581,206. Strong expansion from 2009-11 ZSG: dealership numbers (organic expansion and acquisitions)


Large market share In terms of 2011 revenue and volume-sales market share, ZSG ranked among the top-five dealers in China. At the end of 1H12, the company had a total of 153 dealers (48 of them selling only luxury cars), the highest among all the H-share listed dealer companies. Its main focus was on mid-range and mass-market brands, with 105 dealers in this segment at the end of 1H12. China: 4S auto dealership breakdown by segment 2008 2009 2010 2011 1H12ZSG 30 47 98 140 153

Luxury 7 10 27 44 48Mass market 23 37 71 96 105

ZTA 16 17 24 59 61Luxury 7 8 14 43 45

Mass market 9 9 10 16 16Baoxin 13 17 20 33 42

Luxury 3 7 10 23 32Mass market 10 10 10 10 10

Yongda 29 38 52 64 66Luxury 12 18 29 39 40

Mass market 17 20 23 25 26

Source: Companies

Strong client base ZSG: car sales (units)

2007 2008 2009 2010 2011 1H12Luxury cars 6,687 6,661 8,044 16,589 35,217 26,354Mid-range cars 25,290 34,688 53,419 83,598 125,500 64,522

Source: Company

Compared with the other H-share listed auto dealers, a major strength of ZSG is its large customer base. We estimate that from 2007 to 2012, ZSG sold 581,206 cars. Can be a defensive stock given the large number of mature dealerships China auto dealership groups: average dealership age (years)

Source: Companies, Daiwa estimates

Newly established dealers rely heavily on profit from new-car sales as there is no large customer base to generate the high-margin after-sales services business. It generally takes dealerships 2-3 years to mature. At 4.5 years, ZSG has a higher average dealership age than its peers.

31,97741,349

61,463

100,187

160,717

105,000

142,000

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

2007 2008 2009 2010 2011 9M11 9M12

New car sales volume

320

530

760

1040

1500

1060

1450

0

200

400

600

800

1,000

1,200

1,400

1,600

2007 2008 2009 2010 2011 9M11 9M12

Number of cars serviced (tho, units)

27 3047

98

140

1 2

16

18

13

215

35

24

4

020406080

100120140160180

2008 2009 2010 2011 10m12

Existing dealerships New dealerships Acquired dealerships

4.5

4 4

2.4

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Zhongsheng Zhengtong Yongda Baoxin


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Daiwa’s Asia Pacific Research Directory

HONG KONG

Nagahisa MIYABE (852) 2848 4971 [email protected] Regional Research Head

Hiroaki KATO (852) 2532 4121 [email protected] Regional Research Co-head

John HETHERINGTON (852) 2773 8787 [email protected] Regional Deputy Head of Asia Pacific Research; Regional Head of Product Management

Pranab Kumar SARMAH (852) 2848 4441 [email protected] Regional Head of Research Promotion

Mingchun SUN (852) 2773 8751 [email protected] Head of China Research; Chief Economist (Regional)

Dave DAI (852) 2848 4068 [email protected] Deputy Head of Hong Kong and China Research; Pan-Asia/Regional Head of Clean Energy and Utilities; Utilities; Power Equipment; Renewables (Hong Kong, China)

Kevin LAI (852) 2848 4926 [email protected] Deputy Head of Regional Economics; Macro Economics (Regional)

Chi SUN (852) 2848 4427 [email protected] Macro Economics (China)

Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong Research; Head of Hong Kong and China Property; Regional Property Coordinator; Property Developers (Hong Kong)

Jeff CHUNG (852) 2773 8783 [email protected] Automobiles and Components (China)

Grace WU (852) 2532 4383 [email protected] Head of Greater China FIG; Banking (Hong Kong, China)

Jerry YANG (852) 2773 8842 [email protected] Banking (Taiwan)/Diversified Financials (Taiwan and China)

Leon QI (852) 2532 4381 [email protected] Banking (Hong Kong, China)

Joseph HO (852) 2848 4443 [email protected] Head of Industrials and Machineries (Hong Kong, China); Capital Goods –Electronics Equipments and Machinery (Hong Kong, China)

Bing ZHOU (852) 2773 8782 [email protected] Consumer/Retail (Hong Kong, China); Hotels, Restaurants and Leisure - Casinos and Gaming (Hong Kong, Macau)

Eric CHEN (852) 2773 8702 [email protected] Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional)

Felix LAM (852) 2532 4341 [email protected] Head of Materials (Hong Kong, China); Cement and Building Materials (China, Taiwan); Property (China)

John CHOI (852) 2773 8730 [email protected] Head of Multi-Industries (Hong Kong, China); Small/Mid Cap (Regional); Internet (China)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong, China); Hong Kong and China Research Coordinator; Transportation (Regional)

Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group; Custom Products Group

Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES

Rommel RODRIGO (63) 2 813 7344 ext 302

[email protected]

Head of Philippines Research; Strategy; Capital Goods; Materials

Danielo PICACHE (63) 2 813 7344 ext 293

[email protected]

Property; Banking; Transportation – Port

SOUTH KOREA

Chang H LEE (82) 2 787 9177 [email protected] Head of Korea Research; Strategy; Banking/Finance

Sung Yop CHUNG (82) 2 787 9157 [email protected] Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Anderson CHA (82) 2 787 9185 [email protected] Banking/Finance

Mike OH (82) 2 787 9179 [email protected] Capital Goods (Construction and Machinery)

Sang Hee PARK (82) 2 787 9165 [email protected] Consumer/Retail

Jae H LEE (82) 2 787 9173 [email protected] IT/Electronics (Tech Hardware and Memory Chips)

Thomas Y KWON (82) 2 787 9181 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game

TAIWAN

Mark CHANG (886) 2 8758 6245 [email protected] Head of Research; Regional Head of Small/Medium Cap; Small/Medium Cap (Regional)

Birdy LU (886) 2 8758 6248 [email protected] IT/Technology Hardware (Handsets and Components)

Christine WANG (886) 2 8758 6249 [email protected] IT/Technology Hardware (PC Hardware)

Chris LIN (886) 2 8758 6251 [email protected] IT/Technology Hardware (Panels)

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Head of Research; Strategy; Banking/Finance

Navin MATTA (91) 22 6622 8411 [email protected] Automobiles and Components

Saurabh MEHTA (91) 22 6622 1009 [email protected] Capital Goods; Utilities

Mihir SHAH (91) 22 6622 1020 [email protected] FMCG/Consumer

Deepak PODDAR (91) 22 6622 1016 [email protected]

Materials

Nirmal RAGHAVAN (91) 22 6622 1018 [email protected] Oil and Gas; Utilities

SINGAPORE

Adrian LOH (65) 6499 6548 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore)

Srikanth VADLAMANI (65) 6499 6570 [email protected] Banking (ASEAN)

David LUM (65) 6329 2102 [email protected] Property and REITs

Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India)


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Daiwa’s Offices

Office / Branch / Affiliate Address Tel Fax

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18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, Lumpini, Pathumwan, Bangkok 10330, Thailand

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This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Capital Markets Co. Ltd., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures. Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship

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- 98 -

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available. Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

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The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions. Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.) If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in

the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the

amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices,

real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants.

*The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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