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Executive summary
Outlook
We believe that the China auto sector has just commenced its high growth phase with
accelerated penetration, as experienced by Japan and Korea decades ago. Yet unlike those
countries, China’s auto market is likely to experience a longer growth period, in our view,
since China’s massive population and huge land area have led to varying development paces,
with some regional auto markets still under-explored. Another factor is the potential
enlargement of the auto market through urbanization. Moreover, further development of the
used car market could spur replacement demand while greater acceptance of the auto
financing concept would hasten auto penetration. Last but not least, the stronger
consumption appetite of the younger generation Chinese has made them an important group
of potential buyers that would fuel sales volume growth.
With the upbeat sales outlook and more controlled capacity expansion plans amongst auto
manufacturers, we are optimistic that auto production utilization should stay healthy. Also,
given diminishing room for cutting costs and more rational pricing for cars, we foresee that
the pace of auto price cuts should slow. We believe a potential gasoline price hike would
alter the future product mix towards economy vehicles but is unlikely to drag down overall
sales momentum.
In summary, we remain confident that with numerous catalysts to drive the auto market even
higher in terms of volume, the China auto sector should be able to sustain above-consensus
11.9% 2007-15 sales volume CAGR with margin pressure abating. Nevertheless, with
exceptional performance in 2007, the commercial vehicle segment is likely to record sub-par
growth in 2008, partly attributable to the implementation of a stricter emission rule.
Valuation
The China auto sector is currently only valued on par with its global peers (at 13x FY08E PE)
and at a discount to the India auto sector. The sector’s valuation gap to the H-share index has
also widened. We believe these are unjustified considering the China auto sector’s growth
prospects. We believe the sector could test its previous high in 2004, the period before
macro tightening, at 16x forward PE.
With a cautious outlook for the commercial vehicle segment, we favor passenger vehicle
plays, or to be more specific, those with strong foreign brands under their umbrellas.
Consequently, our top buys in the sector are Dongfeng (0489.HK) and Denway (0203.HK). On
a separate note, although the auto part sector should benefit from the increasing global
outsourcing trend and resilient domestic demand, we believe winners will be the few who
have leading market share and visible margin sustainability, such as Fuyao Glass (.600660.SS,
Not Rated), Minth (0425.HK, Not Rated), and Xinyi Glass (0868.HK, Not Rated).
Risks
In case of a visible economic slowdown, perhaps caused by another round of tightening, the
public’s optimism in their purchasing power could deteriorate. Moreover, such weaker
sentiment could also be triggered by a significant retreat of the equity market valuation, thus
leading to subdued auto consumption. Besides, if some players slashed their product prices
deeply and initiated another round of price wars, we would expect worsening profitability.
Table of Contents Page
Executive Summary ..................................................................................................................................................4
Remarkable Results for 2007 ....................................................................................................................................7
Earnings Forecasts Cut in Worst-Case Scenario ........................................................................................................8
Valuation and Stock Picks.......................................................................................................................................14
Companies ...............................................................................................................................................................17
Bank of China: Less Demanding Valuation ......................................................................................................18
Bank of Communications: Still Backed by HSBC ............................................................................................22
China CITIC Bank: Developing Cross-border and Retail Bank Business.........................................................26
China Construction Bank: Highest ROE Among H-share Banks......................................................................30
China Merchants Bank: Top Retail Bank in China............................................................................................34
Industrial & Commercial Bank of China: Moderate Rise in ROE.....................................................................38
All pricing is as of the market close on March 5, 2008, unless otherwise indicated.
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