Identifying 3 winning growth strategies; Geely up to CL-Buy, Changan (A)/GAC (H) to Buy

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1 September 28, 2013 China: Automobiles Equity Research Identifying 3 winning growth strategies; Geely up to CL-Buy, Changan (A)/GAC (H) to Buy 3 possible winning strategies for car makers We believe Chinese auto firms with purely local brands can (1) grow the profitability of those brands via quality/brand image/pricing upgrades. It is crucial to balance cost advantages while investing more into R&D and quality, in our view. As for those firms that derive most of their profit from joint ventures (JVs) but also have local brand operations, they can (2) maintain the profitability of their JVs and grow their local brands via leveraging the know-how of their JV partners; and/or (3) grow their JV profitability via the introduction of more new models, refreshing of existing models, further localization of components, and stricter cost control. Geely/Great Wall rank as local leaders; GAC/Changan better placed growing JVs To identify potential industry leaders, we score auto firms in our coverage based on several criteria. Our results suggest that Geely/Great Wall stand out in terms of local brand leadership. Among the firms with substantial JV exposure, SAIC screens as having high return on capital and a strong balance sheet, while Guangzhou Auto (GAC)/Changan/Brilliance appear better placed to grow their JV profit due to strong product cycles. 3 Buy upgrades; Geely onto CL, SAIC off We upgrade Geely to Buy, and add the stock to our Conviction List (CL), due to its top ranking in terms of local brand leadership, improving product mix/asp, and synergy with Volvo. We also upgrade Changan (A) and GAC (H) to Buy given the strong product cycles of their major JVs (Changan- Ford/GAC-Honda/GAC-Toyota/GAC-Fiat) and attractive valuation vs. peers. We take SAIC off CL on its relatively low earnings growth vs. peers, but stay Buy on attractive near-term valuation. Sinotruk down to Sell; Neutral on Dongfeng/Great Wall (H)/BYD We downgrade Sinotruk to Sell on its declining market share and weak return outlook (consistently at the fourth quartile). We are Neutral-rated on Dongfeng (upgrade), Great Wall (H) (upgrade), and BYD (downgrade). For our coverage universe, we revise our 2013E-15E EPS on company-specific factors, and introduce 2016E EPS. Reflecting our estimate revisions and the roll forward of valuation timeframe (now 2014E P/B vs. 2014E-16E average ROE), we adjust our target prices. RELATED RESEARCH Steering through policy waves; local leaders to benefit; Buy Great Wall (H); Baoxin off CL, April 17, 2013 GEELY COMES OUT TOPS FOR LOCAL BRAND LEADERSHIP Source: Company data, Gao Hua Securities Research. Yipeng Yang Goldman Sachs does and seeks to do business with companies +86(10) yipeng.yang@ghsl.cn Beijing Gao Hua Securities Company Limited Yuqian Ding +86(10) yuqian.ding@ghsl.cn Beijing Gao Hua Securities Company Limited covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non-us affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research Geely Greatwall BYD FAW car ChangAn 2.35 SAIC 2.13 JAC 2.06 GAC Dongfeng Brilliance

2 Table of contents Overview: Identifying local/jv leaders; Geely (onto CL), Changan (A), GAC (H) up to Buy 3 Identifying winning strategies for robust medium-term growth 5 Scorecard system highlights Geely/Great Wall as local winners, Changan/GAC JV winners 9 GS Scorecard Part 1: Geely, Great Wall, and BYD shine in terms of local brand leadership 10 GS Scorecard Part 2: JV exposure favors Changan, GAC 26 GS Scorecard Part 3: Return of capital Great Wall best placed 31 GS Scorecard Part 4: Balance sheet strength generally strong, excluding BYD 32 Rolling forward valuation; Buy Geely (on CL), Changan (A), and GAC (H) 33 Geely: Up to CL-Buy on product mix/asp expansion and synergy with Volvo 39 GAC (H): Up to Buy on JV profitability turnaround 42 Changan (A): Up to Buy on stronger-than-expected Ford volume/profitability 45 Sinotruk: Down to Sell on market share loss and sustained fourth quartile ROE 47 SAIC: Off Conviction List, but retain Buy on attractive near-term valuation 50 Dongfeng: Downgrade to Neutral on relatively low growth profile 52 Great Wall (H): Downgrade to Neutral on fair valuation 54 BYD: Upgrade to Neutral on improved visibility of EV growth/policy 56 Appendix: Global autos valuation comparisons 61 Disclosure Appendix 65 The prices in the body of this report are based on the market close of September 26, Goldman Sachs Global Investment Research 2

3 Overview: Identifying local/jv leaders; Geely (onto CL), Changan (A), GAC (H) up to Buy Identifying winning growth strategies for different types of car makers in China In China, we identify three possible winning growth strategies for two different types of car makers. For auto firms with purely local brands (herein referred to as pure local players ), we believe they can (1) grow the profitability of their local brands via quality/brand image/pricing upgrades. It is crucial to balance their cost advantages while investing more in R&D and quality, in our view. For auto firms that derive most of their profit from joint ventures (JVs) but also have local brand operations (herein referred to as JV players ), we believe they can (2) maintain the profitability of their JVs and grow their local brands via leveraging the know-how of their JV partners; and/or (3) grow their JV profitability via the introduction of more new models, refreshing of existing models, further localization of components, and stricter cost control. Introduction of a scorecard system to identify potential local/jv leaders We develop a scorecard system to identify the potential local and JV leaders: (1) Among the pure local players, Geely/Great Wall/BYD occupy the top three rankings. Nevertheless, BYD has weak return/balance sheet strength hence we believe Geely/Great Wall could be the potential long-term local leaders. Geely enjoys the top ranking under the local brands leadership criteria mainly due to its high score in quality, CO2 efficiency, low-cost positioning, economies of scale, and innovative patents. Great Wall has also scored well in terms of profitability, CO2 efficiency, low-cost positioning, and economies of scale. (2) For the JV players, none of their local brands scored well compared to the pure local players, but Changan and SAIC may be better placed for their local brands to achieve breakeven over the next three years. (3) Among JV players, SAIC/Dongfeng are currently well positioned in terms of their JV exposures, particularly SAIC, whose major JVs are both strong in return on capital and balance sheet strength. However, both companies score relatively low in growth potential due to their high market share base and profitability of their major JVs. GAC/Changan/Brilliance may be better placed to grow their JV profit as a result of strong JV product cycles. Rolling forward P/B-ROE valuation For most of the auto firms in our coverage, we continue to use P/B-ROE as our main valuation methodology because of its consistently high correlation with share price movements over time (current R-square at 0.74/0.91 for A/H shares). We roll forward our valuation from 2013E P/B vs. 2013E-15E average ROE to 2014E P/B vs. 2014E-16E average ROE as we believe investors are starting to look at 2014 P/B and ROE when making their investment decisions. For BYD, we continue to use the SOTP valuation due to its different business nature (covering auto assembly, handset assembly and service, electric vehicle battery, solar panel, and others). For Changan (B), we continue to use the A-B premium methodology (unchanged at 30%) since the B-share market is segregated from the other markets. For Weichai (A/H), we continue to use the SOTP valuation due to the public listing of its associate company Kion in June 2013, and apply an unchanged 5% conglomerate discount based on empirical cases. We newly apply a 12% valuation discount on SAIC and Dongfeng to reflect their relatively low growth profiles vs. peers in the next three years. Goldman Sachs Global Investment Research 3

4 Three Buy upgrades: Geely (onto CL), Changan (A), GAC (H) We upgrade Geely to Buy from Neutral, and add the stock to our Conviction List (CL), primarily due to its top ranking in terms of local brand leadership, improving product mix/asp, and synergy with Volvo. We also upgrade Changan (A) and GAC (H) to Buy from Neutral on strong product cycles of their major JVs (Changan-Ford/GAC-Honda/GAC-Toyota/GAC-Fiat) as well as attractive valuation vs. peers. We downgrade Sinotruk to Sell from Neutral on declining market share and weak return outlook (ROE consistently lying at the fourth quartile). We also downgrade Dongfeng and Great Wall (H) to Neutral from Buy. We see Dongfeng as having relatively low earnings growth, and believe Great Wall (H) s shares have fully priced in the company s strong profit growth, following the recent share price rally. We upgrade BYD to Neutral from Sell on strong electric vehicle (EV) growth outlook and favorable policy environment. We take SAIC off CL on relatively low earnings growth, but keep the stock as Buy on attractive nearterm valuation. Exhibit 1: We adjust our target prices; upgrade Geely to Buy and add it to our Conviction List, upgrade GAC (H)/Changan (A) to Buy, downgrade Dongfeng/Great Wall (H) to Neutral, downgrade Sinotruk to Sell, upgrade BYD to Neutral, and remove SAIC from our Conviction List but retain Buy Valuation summary China auto coverage Valuation Summary - China Auto 9/26/ Month 12 Month TP Potential Ticker Company Name Currency Rating Close TP-new TP-old Chg. up/downside Methodology Target 2014E PB Key risks 3836.HK Harmony HKD Buy % 36.6% PB-ROE: H Share 2.3 Weaker price/margin erosion of luxury and super luxury new car sales 0175.HK Geely HKD Buy* % 31.3% PB-ROE: H Share 1.8 Lower government subsidy; lower vol/price of new models SZ Changan (A) CNY Buy % 28.4% PB-ROE: A Share 2.6 Lower vol/price of SUV/low-end sedan/minivan SS JAC CNY Buy % 25.1% PB-ROE: A Share 1.9 SUV volume/pricing due to competition; Lower than expected commercial vehicle 1293.HK Baoxin HKD Buy % 24.2% PB-ROE: H Share 2.6 Price/margin erosion of new car sales; potential restriction from BMW on new car sales post NCGA acquisition SS SAIC CNY Buy % 22.5% PB-ROE: A Share 1.3 Higher price/margin erosion; weaker local brand sales 1728.HK Zhengtong HKD Buy % 21.8% PB-ROE: H Share 1.3 Lower price/volume of luxury car, esp. JLR and Volvo HK GAC HKD Buy % 20.8% PB-ROE: H Share 1.4 Lower vol. of new models; lower JVs' margin SZ Weichai (A) CNY Neutral % 12.7% SOTP NA Weaker/stronger than expected export growth; ASP/MS gain on strict Implementation of Euro IV emission standard SZ FAW Car CNY Neutral % 12.7% PB-ROE: A Share 1.7 Progress in the restructuring; higher/lower vol of new models and price SZ Changan (B) HKD Neutral % 10.5% A-B premium NA Higher/lower vol/price of SUV/low-end sedan/minivan 2333.HK Great Wall (H) HKD Neutral % 7.4% PB-ROE: H Share 2.8 Higher/lower price erosion; higher/lower volume in compact SUV/sedan; 1211.HK BYD HKD Neutral % 3.1% SOTP NA Higher/lower vol/price of new car models; higher/lower e-bus sales; higher/lower subsidy 1114.HK Brilliance HKD Neutral % 0.4% PB-ROE: H Share 2.5 Higher/lower vol./price; higher/lower electric vehicle expenditure SS Huayu CNY Not rated 9.36 NA NA NA NA NA NA NA 1899.HK Xingda HKD Neutral % -2.3% PB-ROE: H Share 0.9 Higher/lower radial cord/sawing wire price erosion 0489.HK Dongfeng HKD Neutral % -2.5% PB-ROE: H Share 1.2 Higher/lower price/volume; slower recovery of Nissan/Honda s sales 0881.HK Zhongsheng HKD Neutral % -13.0% PB-ROE: H Share 1.7 Strong/lower price/volume of luxury car; Japanes brands recovery 2338.HK Weichai (H) HKD Neutral % -15.8% SOTP NA Weaker/stronger than expected export growth; ASP/MS gain on strict Implementation of Euro IV emission standard SS Great Wall (A) CNY Neutral % -17.3% PB-ROE: A Share 3.2 Higher/lower price erosion; higher/lower volume in compact SUV/sedan; 0425.HK Minth HKD Neutral % -19.4% PB-ROE: H Share 1.3 Quicker/slower Japanese brands vol. recovery; higher/lower pricing 3808.HK Sinotruk HKD Sell % -21.6% PB-ROE: H Share 0.4 Higher vol of HDT domestic/export market * denotes the stock is on our regional Conviction List. Source: Datastream, Gao Hua Securities Research. Goldman Sachs Global Investment Research 4

5 Identifying winning strategies for robust medium-term growth JVs contribute majority of profits in China s passenger car industry The auto companies in our coverage produce about two-third of the total passenger cars sold in China, and as such we believe that the financial summary of our coverage acts as a good proxy to the China passenger car industry. In 2012, 70% of coverage volume and 97% of coverage profit were contributed by JVs. The local brands from JV players lost 15% of coverage profit despite 8% volume share, while local brands from the pure local players contributed 22% coverage volume/18% coverage profit. By 2015E, we believe JVs may still contribute bulk of the volume/profit of the industry, but with lower shares. We also estimate the volume/profit from local brands, especially from the pure local players, to increase faster than the industry. Exhibit 2: In 2012, JVs contributed 70% of coverage volume... Volume in 000 units Exhibit 3:...but 97% of coverage profit Profit in Rmb mn 9,000 8,000 22% 100% 45,000 40,000 97% -15% 18% 100% 7,000 6,000 70% 8% 35,000 30,000 5,000 25,000 4,000 20,000 3,000 15,000 2,000 10,000 1,000 5,000 0 JVs JV players' local brands Pure local players Total 0 JVs JV players' local brands Pure local players Total Source: IHS, Company data. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 5

6 Exhibit 4: By 2015E, we expect JVs to contribute 66% of coverage volume... Volume in 000 units Exhibit 5:...and 78% of coverage profit Profit in Rmb mn 16,000 14,000 12,000 10,000 8,000 6,000 4,000 66% 11% 23% 100% 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 78% -4% 26% 100% 2,000 10,000 0 JVs JV players' local brands Pure local players Total 0 JVs JV players' local brands Pure local players Total Source: IHS, Gao Hua Securities Research. Source: IHS, Gao Hua Securities Research. We expect local brands to grow slightly faster than JV brands and achieve 35% market share in 2020E In our previous report, Six industry trends determine long-term view: Buy Great Wall (H) and Dongfeng, Sell BYD, dated February , we explained our view that Chinese local brands could regain China market share by upgrading their product/image. We believe that local brands could grow slightly faster than JV brands and achieve 35% market share in 2020E. Goldman Sachs Global Investment Research 6

7 Exhibit 6: We see six trends on China car market size and structure evolvement China car market size and structure evolvement Trends Stocks implications Market size (k unit) CAGR 705 3,267 36% 11,626 29% 15,548 10% 24,864 7% 1.Growth sustained at 7% to 2020E Domestic market : Int l luxury brands 3.4% 3.4% 5.8% 8.7% 10.0% 2. Luxury fever Brilliance (BMW) is growing faster Int l mainstream brands 76.5% 68.6% 63.6% 61.8% 55.0% 3.Divergence within mainstream international brands in growth Within international brands: Changan (Ford), GAC (Honda/Toyota/Fiat) might better placed in growing JV profit Domestic brands 20.1% 28.0% 30.6% 29.5% 35.0% 4.Structural shift to local brands: some stand out as potential longterm winners Within Domestic brands: Geely/Great Wall stand out as potential longterm winners Overseas market/ export 0.7% 1.2% 4.0% 4.5% 6.0% 5.Growing export Geely/Great Wall Electric car: Incl.: HEV/PHEV/EV 0% % % % 2013E 5.0% 2020E 6. Electrification: HEV/PHEV/EV to reach 5% car market by 2020E BYD Source: Global Insight, Gao Hua Securities Research. Goldman Sachs Global Investment Research 7

8 We see three possible winning growth strategies for two different types of car makers in China For pure local players: 1. To grow the profitability of pure local brands For pure local players, we believe a possible winning strategy is to grow the profitability of their pure local brands via product/quality/brand image/pricing upgrade. Usually, pure local brands are relatively weak in quality, brand image and have to resort to attractive pricing in order to attract customers. We believe that a potential way to success for pure local players is to upgrade their product, quality, brand image as well as price to grow market share as well as profitability. During the process of upgrading, we believe it is crucial to balance cost advantages while investing more into R&D/product/quality, hence we develop a comprehensive scorecard system, analyzing eight different categories which may impact long-term competitiveness of local brands. Based on our scorecard, we identify Geely and Great Wall as potential long-term winners among companies with purely local brands. For JV players: 2. To maintain profitability of JVs and to grow local brands In our view, the first strategic approach is to maintain the profitability of JVs and to grow local brands via leveraging the know-how learned from the JV partners. In general, the product and quality from JV players local brands are relatively higher than the pure local players, but none of their local car brands are profitable so far due to the lack of low-cost positioning, low economies of scale, and low capacity utilization. Most local brands from JV players currently are weak in EV as well. Among JV players, we believe that Changan and SAIC may have better opportunities to achieve breakeven of their local brands in the coming three years due to their relatively balanced positions in quality/innovation/pricing as well as scale/low-cost positioning. If Changan can improve its price/mix and SAIC can improve its scale (especially to increase the average sales volume per platform), they could achieve higher ranking with their local brands. 3. To grow profitability of JVs We believe another possible winning strategy for JV players is to grow the JV profitability via introduction of more new models, refreshing of existing models, further localization of key components, and stricter cost control. However, as products and brands of JVs are controlled by foreign partners (Chinese partners/listcos are more or less like the financial investors of the JVs), we develop a separated/much-simplified scorecard focusing on profitability and growth of the JVs rather than the drivers of JVs competitiveness in the long run. We see SAIC/Dongfeng as well positioned currently, especially the former, which is also strong in return and balance sheet strength. However, both companies score relatively low in growth potential. We believe that GAC/Changan/Brilliance may be better placed to grow their JV profit due to strong product cycles. Goldman Sachs Global Investment Research 8

9 Scorecard system highlights Geely/Great Wall as local winners, Changan/GAC JV winners We classify auto companies with a JV structure such as SAIC//Dongfeng/Changan/GAC/Brilliance as JV players, and those without such as Great Wall/Geely/BYD/FAW Car/JAC as pure local players. In general, JV players also have local brand operations, but most of the volume/profit is contributed by their JV operations and their local passenger car brands are unprofitable. In contrast, the pure local players derive substantial profit contribution from their local brands. In order to make apple-to-apple comparisons, our scorecard consists of four different parts to identify the local and JV winners in our coverage: 1. A comprehensive local brands scorecard system with eight dimensions to identify potential long-term winner among local brands. The local scorecard is suitable to evaluate all listcos as they all have local brands. 2. A simplified scorecard for JVs with focus on current and future financial result, since we believe that the JV players are more or less like financial investors of their JVs: They do not own the brands, products, or core technology of the JVs and their foreign partners control most of the intellectual property rights of the brands/products/technology. The simplified JV scorecard is suitable to evaluate the current and future JV exposure of JV players, namely, SAIC//Dongfeng/Changan/GAC/Brilliance. 3. In order to reflect the overall return situation of the listco, we also add current and future return of capital for each listco. We view CROCI as an important parameter to ascertain how well companies translate their competitive advantage into financial return. 4. Long-term participants are likely to benefit from strong balance sheets, which provide a good basis for companies to invest in new technologies, maintain product development levels, and manage the cyclical and structural challenges facing the industry. Hence, we rank balance sheet strength of each listco. We have the following findings from our scorecard analysis (see Exhibits 7 and 8 for details): Among local brands, Geely/Great Wall/BYD are ranked as top 3. Nevertheless, BYD has weak return/balance sheet strength hence we choose Geely/Great Wall as the potential long-term local winners. Geely is ranked as No. 1 in the local brands leadership scorecard mainly due to its high score in quality, CO2 efficiency, low cost position, economies of scale, and innovative patent. Great Wall is very strong in profitability, CO2 efficiency, low cost position, and economies of scale. Among JV players, we see none of their local brands score well compared to pure local players, esp. in terms of high COGS, low utilization, and weak EV development. Changan and SAIC might have better opportunities to achieve breakeven of their local brands in 3 years as they achieve relative high score in local brand leadership among JV players. Among JV players, SAIC/Dongfeng are positioned well currently in their JV exposures, esp. SAIC s major JVs are strong in both return and Balance Sheet strength. However both companies score relatively low in growth potential due to high bases of market share and profitability of their major JVs. GAC/Changan/Brilliance may be better placed to grow their JV profit as a result of strong JV product cycles. Goldman Sachs Global Investment Research 9

10 Exhibit 7: GS auto scorecard summary: SAIC/Dongfeng lead in current JV exposure while Changan/GAC excel in JV growth; Geely/Great Wall/BYD rank high among local players GS auto scorecard summary JV players Pure local players Listco SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC Part 1: Local brand leadership Part 2: JV exposure Current position NA NA NA NA NA Growth potential NA NA NA NA NA Part 3: Return of capital CROCI CROCI E Part 4: B/S strength (gearing) Note: The dotted-line rectangles refer to key highlights; the number of points represents the scores of each local brand, the more the points, the better the score. Source: Company data, Gao Hua Securities Research. GS Scorecard Part 1: Geely, Great Wall, and BYD shine in terms of local brand leadership We have developed a scorecard system to evaluate the local brands long-term competitiveness in order to identify the potential long-term winner of the local brands. We quantify 8 criteria: price/mix, low cost position, economies of scales, innovation, EV and CO2 efficiency, Quality, exports, and local brand profitability. Although none of the local brands under our coverage is a stand-out leader in all dimensions and each of them has its own strengths and weaknesses, we believe Geely, Great Wall, and BYD are the comparative local brand leaders. We have also taken into account our scorecard analysis for our rating changes. Goldman Sachs Global Investment Research 10

11 Exhibit 8: GS Auto scorecard part 1: Local brand leadership is intended to evaluate local brands on the rankings in eight dimensions GS Auto Scorecard overview local brand leadership JV players Pure local players Part 1: Local brand leadership 1. Pricing/mix SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 1.1 Average unit price (2013E) 1.2 Price premium (2013E) 2. Low cost position SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 2.1 Salary of the production sites (2012) 2.2 Units per employee (2012) 2.3 Capacity utilization ( averag 3. Economies of scale SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 3.1 Size in Unit (2013E) 3.2 Size in Revenue (2013E) 3.3 No. and percentage of cars produced N/A 4. Innovation SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 4.1 R&D budget (2012) 4.2 R&D/Sales (2012) 4.3 Patent 5. EV and CO2 efficiency SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 5.1 Fuel efficienct cars Sales (2012) 5.2 Fuel consumption (2012) 5.3 EV sales(2013e) N/A N/A N/A N/A 5.4 Battery/BMS for EV (2013E) N/A N/A N/A 6. Quality SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 6.1 JD Power overall score (2012) N/A 6.2 Crash Test (2012) N/A 7. Export % sales (2012) SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 8. Local brand profitability SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW car JAC 8.1 Net earnings (2012) 8.2 Net earnings (2015E) 8.3 NPM (2012) 8.4 NPM (2015E) Score (1 to 5 is from low to high) Note: The number of points represents the scores of each local brand, the more the points, the better the score. Source: China Auto Market, Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 11

12 1. Pricing/mix In our view, pricing and product mix are the key building blocks with which auto companies create a competitive advantage. The realized average price per unit sold can vary significantly across different car companies. Product mix is one key factor that explains the differences in average prices, i.e. a small car manufacturer such as Geely or BYD will have a lower average unit price compared to that of FAW Car, which offers a greater proportion of larger vehicles. In Exhibit 9, we plot the average realized price per unit (passenger cars only) against a theoretical (based on a car company s product mix) average price, in an attempt to isolate an OEM s price premium. Exhibit 9: FAW Car has the highest ASP while BYD sold cars at low prices GS scorecard part 1 - local brand leadership: 1. Pricing/mix Part 1: Local brand leadership 1. Pricing/mix SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 1.1 Average unit price (2013E) 1.2 Price premium (2013E) Note: The number of points represents the score in the category. The more the points, the better the score. Source: Gao Hua Securities Research. Exhibit 10: Average unit price In Rmb, 2013E Exhibit 11: Price premium Real vs. theoretical ASP by company, Rmb, 2013E FAW car Real ASP SAIC Greatwall Dongfeng JAC Geely BYD ChangAn Brilliance GAC SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance brand only. Source: Gao Hua Securities Research. Note: Local Theoretical ASP Note: Our theoretical price is based on market price average. Due to their low pricing than JV products, the local brands are all located below the pricing line. Source: Gao Hua Securities Research. Goldman Sachs Global Investment Research 12

13 2. Low-cost position The automotive industry is a highly competitive industry which must cope with overcapacity, productivity improvement and rising labor costs. To determine the relative cost position of the companies across our coverage universe, we analyze three key factors: (1) Salary of the production sites; (2) revenues per employee; (3) capacity utilization. Exhibit 12: Geely/Great Wall/Changan/FAW Car lead the low-cost position, while GAC s low ranking is partly due to its small scale as a late comer GS Scorecard part 1 - local brand leadership: 2. Low-cost position 2. Low cost position SAIC ChangAn JAC FAW Car BYD Geely Greatwall GAC Dongfeng Brilliance 2.1 Salary of the production sites (2012) 2.2 Units per employee (2012) 2.3 Capacity utilization ( average) Note: The number of points represents the score in the category. The more the points, the better the score. Source: Company data, Gao Hua Securities Research. Exhibit 13: Salary of the production sites Annual average salary in the cities where the production sites locate, in Rmb 000, 2012 Exhibit 14: Units per employee Units per employee, SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance 0 SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Note: BYD has relatively lower units per employee partly due to higher degree of vertical integration. Source: CEIC. Source: Company data. Goldman Sachs Global Investment Research 13

14 Exhibit 15: Capacity utilization ( average) Capacity utilization in %, average 100% 95% 90% 80% 81% 72% 74% 70% 66% 60% 50% 53% 50% 48% 58% 40% 30% 30% 20% 10% 0% SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: Company data. Goldman Sachs Global Investment Research 14

15 3. Economies of scale Due to high costs associated with quality/product upgrade, we believe economies of scale are becoming more important. To establish a relative scale, we focus on: (1) size in unit; (2) size in revenues; (3) the total number of cars and percentage of cars produced from the top-three platforms. Exhibit 16: Great Wall/FAW Car screen as the leaders in terms of economies of scale GS Scorecard part 1 - local brand leadership: 3. Economies of scale 3. Economies of scale SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 3.1 Size in Unit (2013E) 3.2 Size in Revenue (2013E) 3.3 No. and percentage of cars produced in top 3 platforms (2013E) N/A Note: The number of points represents the score in the category. The more the points, the better the score. Source: Gao Hua Securities Research. Goldman Sachs Global Investment Research 15

16 Exhibit 17: Size in unit Passenger car volumes only. For JVs volumes counted by shareholding %, in 000 units, 2013E Exhibit 18: Size in revenue Passenger car revenue only. For JVs, revenue counted by shareholding %, in Rmb mn, 2013E SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: Gao Hua Securities Research. Source: Gao Hua Securities Research. Exhibit 19: % of cars produced in top 3 platforms Car volume from top3 platform as % of total volume, 2013E 90% 84% 83% 80% 72% 78% 75% 74% 72% 70% 64% 65% 60% 50% 40% 30% 20% 10% 0% SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance N/A Source: Gao Hua Securities Research. Goldman Sachs Global Investment Research 16

17 4. Innovation We believe the emergence of long-term industry structural winners is likely to be driven by innovation capability, which enables companies to constantly upgrade their products and expand market share/penetration. In order to assess the innovation activities, we compare: (1) R&D budget (absolute amount, total spending include both capitalized expenditure and expenditure charged to P&L; (2) R&D/sales; (3) number of patents (innovative only, excluding design patents). Exhibit 20: SAIC has the highest R&D budget, GAC s investment is the highest in terms of R&D as % of sales, while Changan/Geely lead in number of patents GS Scorecard part 1 - local brand leadership: 4. Innovation 4. Innovation SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 4.1 R&D budget (2012) 4.2 R&D/Sales (2012) 4.3 Patent Note: The number of points represents the score in the category. The more the points, the better the score. Source: State Intellectual Property Office of P.R.C, Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 17

18 Exhibit 21: R&D budget R&D expense, in Rmb mn, 2012 Exhibit 22: R&D as % of sales R&D as % of sales, , % 6,000 5, % 8.69% 8.00% 5, % 4,000 3,000 2,000 1,000 1, ,576 1, ,126 4, % 5.00% 4.00% 3.00% 2.00% 1.00% 5.02% 5.75% 3.27% 2.72% 5.80% 4.15% 2.22% 3.37% 3.81% 0 SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance 0.00% SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: Company data. Source: Company data. Goldman Sachs Global Investment Research 18

19 Exhibit 23: Innovation - Patent No. of patents by the end of June SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: State Intellectual Property Office of P.R.C, Gao Hua Securities Research. Goldman Sachs Global Investment Research 19

20 5. Electric Vehicle (EV) and CO2 efficiency This part of our scorecard is intended to quantify company s ability to cope with the tighter fuel consumption regulation and the R&D capabilities in EV/battery. We use 2012 fuel consumption data announced by MIIT. However, product-mix is one key factor that helps explain the differences in fuel consumption: i.e. a small car manufacturer such as Geely or BYD will have a lower average fuel consumption compared with FAW Car, which offers a greater proportion of larger vehicles. Below we plot the average fuel consumption per unit (passenger cars only) against a theoretical (based on a car company s product mix) fuel consumption, in an attempt to isolate an OEM s mix effect. We also evaluation the EV sales and whether the company has developed battery/battery management system (BMS) for EV. Exhibit 24: BYD is strong in both EV and CO2 efficiency while Geely excels in fuel efficient car sales GS Scorecard part 1 - local brand leadership: 5. EV and CO2 efficiency 5. EV and CO2 efficiency SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 5.1 Fuel efficient cars Sales (2012) 5.2 Fuel consumption (2012) 5.3 EV sales(2013e) N/A N/A N/A N/A 5.4 Battery/BMS for EV (2013E) N/A N/A N/A Note: The number of points represents the score in the category. The more the points, the better the score. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 20

21 Exhibit 25: Fuel efficient car sales As % of total volume, 2012 Exhibit 26: Fuel consumption Real fuel consumption vs. standard, in litre/100km, % 60% 66% Briliance 50% 40% 30% 20% 50% 35% 19% 52% 38% 27% Real Fuel Consumption JAC SAIC Greatwall Dongfeng BYD Changan GAC FAW Geely 10% % 0% 0% 0% SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Standard Fuel Consumption Source: Company data, Gao Hua Securities Research. Exhibit 27: EV sales EV sales volume in unit, 2013E Source: Company data, Gao Hua Securities Research. Exhibit 28: BYD is the only OEM owning both Battery/BMS Technology Battery/Battery management system technology, 2013E 8, ,000 6, , ,000 4, , , , N/A N/A N/A N/A SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance 0 N/A N/A N/A SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: Company data, Gao Hua Securities Research. Note: The score is defined by whether an OEM owns Battery/BMS technology. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 21

22 6. Quality In the process of brand/product upgrade, we believe quality improvement is the key to change the previous customer perception of low price/low quality on local brands. Here we compared JD Power overall score (including 5 dimensions: Vehicle Dependability Study, Initial Quality Study, APEAL Study, Sales Satisfaction Index and Customer Service Index) of the models from local brands as well as the crash test score from CATARC (China Automotive Technology and Research Center), the official institution carrying on C- NCAP (China New Car Assessment Program) safety test in China. We see Geely and SAIC take the lead in product quality. Exhibit 29: We see Geely and SAIC take the lead in product quality GS Scorecard: 6 EV and CO2 efficiency 6. Quality SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC 6.1 JD Power overall score (2012) N/A 6.2 Crash Test (2012) N/A Note: The number of points represents the score in the category. The more the points, the better the score. Source: JD Power, CATARC, Gao Hua Securities Research Exhibit 30: JD power overall score 2012 Exhibit 31: Crash test SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Note: The JD power overall score is the average of 5 dimensions: Vehicle Dependability Study, Initial Quality Study, APEAL Study, Sales Satisfaction Index and Customer Service Index. N/A 5 0 SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance N/A Source: JD Power. Source: CATARC. Goldman Sachs Global Investment Research 22

23 7. Export In our view, China car market growth might sustain at high single digit in the long run (CAGR at 7% from 2013E to 2020E). With the domestic growth slowing down, we believe overseas market is becoming a more and more important growth driver for Chinese OEMs. We believe the overseas market provides ample room for local brands to grow in the future while the opportunities remain limited for JVs. We see Geely/Great Wall/BYD best positioned in export. Exhibit 32: Geely/Great Wall/BYD have more export exposure GS Scorecard 7 strategic positioning/transformation 7. Export % sales (2012) SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC Note: The number of points represents the score in the category. The more the points, the better the score. Source: Company data, Gao Hua Securities Research. Exhibit 33: Geely is doing well in export, booking 22% export as % of sales in 2012 Export as % of total revenue, % 22% 20% 15% 15% 14% 10% 11% 10% 5% 0% 1% 0% 0% 0% 0% SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: Company data. Goldman Sachs Global Investment Research 23

24 8. Local brand profitability We also compare the absolute net earnings as well as net profit margin (NPM) percentage of local brands (including both current status and future estimations) to assess their profitability. We see Great Wall and Geely as the most profitable companies among the local peers based on their highest net earnings and NPM in both 2012 and 2015E. Exhibit 34: Great Wall screens as the best company in local brand profitability in China, followed by Geely GS Scorecard 7 local brand profitability 8. Local brand profitability SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW car JAC 8.1 Net earnings (2012) 8.2 Net earnings (2015E) 8.3 NPM (2012) 8.4 NPM (2015E) Note: The number of points represents the score in the category. The more the points, the better the score. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 24

25 Exhibit 35: Net earnings In Rmb mn, 2012 Exhibit 36: Net earnings In Rmb mn, 2015E 6,000 5,000 4,000 3,000 2,000 1, ,000-2,000-3,000-1,000-2,000 SAIC ChangAn 200 JAC -756 FAW car 793 BYD 2,040 Geely 5,038-1,503-1,200 Greatwall GAC Dongfeng -225 Brilliance 14,000 12,000 10,000 8,000 6,000 4,000 2, ,000-1, SAIC ChangAn 1,100 2,134 1,589 JAC FAW Car BYD 11,464 4,557-1, Geely Greatwall GAC Dongfeng Brilliance Source: Company data. Source: Gao Hua Securities Research. Exhibit 37: Net profit margin In %, 2012 Exhibit 38: Net profit margin In %, 2015E 15.0% 10.0% 5.0% 0.0% 1.7% 3.0% 8.3% 13.2% 20.0% 15.0% 10.0% 5.0% 3.6% 4.1% 4.5% 9.5% 15.1% -5.0% -10.0% -15.0% -20.0% -7.0% -9.6% SAIC ChangAn JAC -2.6% FAW car BYD Geely Greatwall -18.4% -6.1% -16.3% GAC Dongfeng Brilliance 0.0% -5.0% -10.0% -15.0% -4.0% -2.5% SAIC ChangAn JAC FAW car BYD Geely Greatwall -5.0% -10.0% -12.0% GAC Dongfeng Brilliance Source: Company data. Source: Gao Hua Securities Research. Goldman Sachs Global Investment Research 25

26 GS Scorecard Part 2: JV exposure favors Changan, GAC We apply a simplified scorecard for JVs with focus on current and future financial results, since we believe that the JV players are more or less like financial investors to their JVs: the Chinese auto firms do not own the brands, products, or core technology of the JVs while their foreign partners control most of the intellectual property rights on the brand/product/technology of JVs. The simplified JV scorecard is suitable to evaluate the JVs of SAIC/Dongfeng/Changan/GAC/Brilliance. Among these JV players, we see SAIC and Dongfeng as well positioned with their strong current volume, and profitability (NPM %), while we expect Changan/GAC/Brilliance to enjoy higher growth in the next three years. Exhibit 39: SAIC ranks highly in terms of current JV exposure, while Changan/GAC/Brilliance display greater growth potential GS Scorecard 7 Strategic positioning/transformation JV players Pure local players Part 2: JV exposure 1. Current position SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC NA NA NA NA NA 1.1 JV volume (2012) NA NA NA NA NA 1.2 JV profit (2012), 100% NA NA NA NA NA 1.3 JV NPM (2012) NA NA NA NA NA 2. growth potential SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC NA NA NA NA NA 2.1 JV E volume CAGR NA NA NA NA NA 2.2 JV E earnings CAGR NA NA NA NA NA 2.3 JV NPM change (2015E vs. 2012) NA NA NA NA NA Note: The number of points represents the score in the category. The more the points, the better the score. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 26

27 Exhibit 40: Greatest JV contribution for SAIC in terms of volume JV volume in unit, 100% counted, 2012 Exhibit 41: and profit Net profit in Rmb mn, 100% counted, ,000,000 2,500,000 2,672,666 40,000 35,000 38,000 2,000,000 1,500,000 1,542,798 30,000 25,000 20,000 19,940 1,000, , , , ,849 SAIC ChangAn GAC Dongfeng Brilliance 15,000 10,000 5, ,242 5,043 4,650 SAIC ChangAn GAC Dongfeng Brilliance Source: Company data. Source: Company data. Exhibit 42: JV NPM JV NPM in %, 2012 Exhibit 43: JV E volume CAGR JV volume E CAGR, in % 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 12.0% 5.0% 5.5% 10.8% 8.3% 30.0% 25.0% 20.0% 15.0% 10.0% 12.4% 20.7% 24.3% 14.1% 28.1% 2.0% 5.0% 0.0% SAIC ChangAn GAC Dongfeng Brilliance 0.0% SAIC ChangAn GAC Dongfeng Brilliance Source: Company data. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 27

28 Exhibit 44: JV E earnings CAGR JV net profit E CAGR, in % Exhibit 45: JV NPM change (2015E vs. 2012) JV NPM change, 2015E vs. 2012, in % 70.0% 60.0% 62.0% 5.0% 4.0% 3.8% 50.0% 3.0% 2.3% 40.0% 30.0% 34.2% 29.3% 2.0% 1.0% 0.8% 20.0% 10.0% 0.0% 11.3% 2.7% SAIC ChangAn GAC Dongfeng Brilliance 0.0% -1.0% -2.0% -3.0% SAIC ChangAn GAC Dongfeng Brilliance -0.2% -2.6% Source: Company data, Gao Hua Securities Research. Source: Company data, Gao Hua Securities Research. Goldman Sachs Global Investment Research 28

29 We believe Changan (A), GAC (H) may benefit from market share/npm expansion of Changan-Ford, GZ-Honda, GZ- Fiat In Exhibit 46, we compare international car makers global market share vs. China market share in 2012 and 2015E based on IHS/Global Insight data. We observe that laggards with strong product cycles are likely to gain market share, e.g., Ford/PSA. We also see OEMs which opened new production JVs in China are likely to obtain market share as well (e.g., Fiat and Mitsubishi). Hence, we believe Changan (A) and GAC (H) may benefit from the rising market share of Ford, Fiat and Mitsubishi. Although Dongfeng should benefit from PSA s rising market share in China, we see this as having a less beneficial impact on Dongfeng, as PSA only contributes a small portion of Dongfeng s net profit (c.10%). Exhibit 46: We estimate that Ford, PSA, Fiat, and Mitsubishi will gain market share in China Market share in %, in 2012 and 2015E Source: IHS, Gao Hua Securities Research. Goldman Sachs Global Investment Research 29

30 In Exhibit 47, we compare international car makers global NPM vs. their China JVs NPM in 2012 and 2015E based on company disclosure and our estimation. We see NPM expansion for OEMs such as Changan-Ford, GZ-Honda, and GZ-Fiat, due to their strong product cycle and increase of localization rate. We also believe current JV leaders like Shanghai-Volkswagen (SVW) and Shanghai- GM (SGM) may largely maintain their high NPM in the coming 3 years albeit with limited upside due to a high base. We believe Changan (A) and GAC (H) may benefit from margin expansion of Changan-Ford, GZ-Fiat and GZ-Honda. Exhibit 47: We estimate that Changan-Ford/GZ-Honda/GZ-Fiat will expand NPM Net profit margin in %, 2012 and 2015E Abbrev notes: CA-F: Changan-Ford; CA-M: Changan-Mazda; CA-S: Changan-Suzuki; GZ-T: GZ-Toyota; GZ-H: GZ-Honda; GZ-F: GZ-Fiat; B-BMW: Brilliance-BMW; SGM: SAIC-GM; SVW: SAIC-VW; DF-N: DF-Nissan; DF-H: DF-Honda; DF-P: DF-PSA; Source: IHS, Gao Hua Securities Research. Goldman Sachs Global Investment Research 30

31 GS Scorecard Part 3: Return of capital Great Wall best placed We view CROCI as an important parameter to ascertain how well companies translate their competitive advantages into financial returns. Great Wall holds the number one spot among peers. Exhibit 48: Great Wall ranks No. 1 in terms of return on capital JV players Pure local players Part 3: Return of capital (CROCI) SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC CROC CROCI (2012) CROCI (2015E) Note: The number of points represents the score in the category. The more the points, the better the score. Source: Company data, Gao Hua Securities Research. Exhibit 49: Great Wall currently enjoys the highest CROCI %, 2012 Exhibit 50: and we see this trend continuing in 2015E %, 2015E 50.0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% 44.6% 40.2% 23.9% 17.7% 20.1% 10.7% -0.6% 9.5% 36.3% 22.8% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 25.1% 23.5% 22.0% 16.5% 11.7% 26.4% 38.0% 17.0% 15.7% 27.2% SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance SAIC ChangAn JAC FAW car BYD Geely Greatwall GAC Dongfeng Brilliance Source: Company data. Source: Gao Hua Securities Research. Goldman Sachs Global Investment Research 31

32 GS Scorecard Part 4: Balance sheet strength generally strong, excluding BYD In the long term, China auto firms are likely to benefit from a strong balance sheet, which may enable them to invest in new technologies, maintain product development levels, and manage the cyclical and structural challenges facing the industry. Exhibit 51: JAC has the strongest balance sheet, while BYD appears to be weak JV players Pure local players Part 4: B/S strength (gearing) SAIC Dongfeng ChangAn GAC Brilliance Greatwall Geely BYD FAW Car JAC Gearing (2013E) Note: The number of points represents the score in the category. The more the points, the better the score. Source: Gao Hua Securities Research. Exhibit 52: BYD has the highest gearing Gearing ratio, 2013E 80% 60% 62% 40% 20% 0% -20% -40% -14% SAIC -2% ChangAn -35% JAC 5% FAW car BYD -9% Geely -21% Greatwall 0% GAC -17% Dongfeng -1% Brilliance Source: Gao Hua Securities Research. Goldman Sachs Global Investment Research 32

33 Rolling forward valuation; Buy Geely (on CL), Changan (A), and GAC (H) P/B-ROE remains our main methodology; rolling forward to 2014E P/B vs. 2014E-16E average ROE We continue to use P/B-ROE as our primary valuation methodology because of its consistently high correlation with share price movements over time (current R-square at 0.74/0.91 for A/H shares). We roll forward our valuation timeframe from 2013E P/B vs. 2013E-15E average ROE to 2014E P/B vs. 2014E-16E average ROE as we believe investors are starting to look at 2014 P/B and ROE when making their investment decisions. We highlight below the valuation premium/discount applied to our coverage: We keep our 10% premium on Great Wall (A/H) to reflect its first quartile ROE/CROCI over the medium term; We continue to apply a 10% premium on Baoxin given its first quartile ROE/CROCI; We continue to apply a 34% premium on FAW Car in light of the planned asset injection/faw Group listing; We lower our premium for Brilliance to 15% (was 20%) as we believe our change to 2014E-16E ROE has already captured part of its strong medium-term growth; We continue to apply a 10% discount (equivalent to previous 0.1X P/B discount) on Xingda due to its small market cap of less than US$1 bn; We newly apply a 12% discount (in line with the historical valuation discount since January 2011) to SAIC and Dongfeng to reflect their low growth profiles in the next three years; We do not apply any premium/discount for the rest of our coverage. We adopt different valuation methodologies for the following stocks: BYD: We continue to use the SOTP valuation due to its different business nature (covering auto assembly, handset assembly and service, electric vehicle battery, solar panel, and others); Changan (B): We continue to use the A-B premium methodology (unchanged at 30%) since the B-share market is segregated from other markets; Weichai (A/H): We continue to use the SOTP valuation due to the public listing of its associate company Kion in June We apply an unchanged 5% conglomerate discount based on empirical cases. Please refer to our previous report, Weichai Power (H): Up to Neutral after pullback; softer HDT outlook fully priced in, July 4, 2013 for details. Goldman Sachs Global Investment Research 33