Brilliance China (1114 HK)

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1 Equity Research Consumer Discretionary Brilliance China (1114 HK) Buy (maintained) Target price: HK$25.75 New 5 Series continues to drive new product cycle, highly anticipated X3 SUV to be launched in 2018 Chongjing Deng SFC CE No. BEY953 dengchongjing@gfgroup.com.hk GF Securities (Hong Kong) Brokerage Limited 2930/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong New 5 Series maintained steady rampup The model s monthly YoY decline in Oct was the smallest during 10M17 due to a low comparable sales base and the steady rampup of the model since its launch in late June this year. The model has remained beyond the 11,000unit level after its sales breakthrough in Oct with steady rampup. We believe higher monthly sales close to 13,000 units could be achieved in NovDec. High expectations for the X3 SUV The company will begin to sell the X3 SUV in Management sees higher sales volume for the higherpriced midsized SUV in 2019, when it can contribute towards its fullyear results. Management expects the model to be competitive against its Audi Q5 and Mercedes Benz GLC peers. We expect the X3 to give the JV an edge in terms of sales as it is the first midsized BMW SUV in China and the bigger sales contribution from SUVs will also help to improve BMW s market penetration among JV brands in China. 9M17 results maintained steady growth We estimate 9M17 earnings for BMW Brilliance to be ~Rmb4.0bn, up ~5 YoY, driven by rising sales volume for BMW Brilliance models. However, the decrease in quarterly earnings attributable to Brilliance China would be slight at ~6% to Rmb1.2bn, based on our estimates. We think the decline in earnings partly came from the destocking of older versions of the BMW 5 Series, which triggered price discounts and promotion efforts by the company as well as marketing expenses on the new 5 Series models. As the destocking is close to an end with the steady rampup of the new 5 Series, we expect the profitability of the BMW 5 Series to improve in 4Q17, thus boosting overall profitability for BMW Brilliance. Stock performance Jun16 Aug16 Nov16 Feb17 May17Aug17 Brilliance China Hang Seng Index Source: Bloomberg Key data Nov 13 close (HK$) Shares in issue (m) 5, Major shareholder Brilliance Auto(42.38%) Market cap (HK$ bn) M avg. vol. (m) W high/low (HK$) 21.25/6.88 Source: Bloomberg More NEV development ahead Besides the EV version of the X3 SUV set to be launched in 2020, there are plans for a plugin hybrid version of the new 5 Series to be sold in Alongside the current plugin hybrid version of the X1 SUV, this will give the JV three NEV models. Management is also considering an electric version of the 3 Series in 2019, or launching a different electric model to strengthen its NEV lineup. We expect a rise in demand for the NEV versions of its top selling models, such as the X1 and 5 Series, while the EV version of the X3 will push further tech advancements. Maintain Buy and TP of HK$25.75 We think the BMWBrilliance JV s sales growth will be 25.8% YoY in 2017, less than our previous estimate of 34.5% YoY growth, which was mostly impacted by the slower rampup in the 5 Series in 3Q17; but we maintain our sales estimates for given the steady growth seen in the JV s models. We forecast an earnings CAGR of 43% during on the back of a strong product cycle from BMW models. The stock is trading at 11.6x our 12month forward 2018 EPS estimate of Rmb1.59, below its historical average of 14x, and undervalued, in our view. We maintain our Buy rating and target price of HK$25.75, based on 14x 2018E P/E, in line with its historical average. Stock valuation Turnover Net profit EPS EPS YoY P/E Yiled (%) BPS P/B ROE(%) (Rmb m) (Rmb m) (Rmb) (%) (Rmb) ,863 3, (35.3) ,514 3, E 6,148 4, E 6,389 7, E 6,649 10, Note: Updated as of 13 Nov 2017

2 BMW Brilliance Oct sales down on a monthly basis BMW Brilliance sold 30,421 units in Oct, up 20.4% YoY but down 11.8% MoM. The monthly decline came after a consecutive threemonth rise in sales for the JV. 10M17 sales growth remained strong at 23.9% YoY (312,842 units). New 5 Series maintained steady rampup The JV sold 11,099 of the new 5 Series in Oct. The monthly YoY decline was the smallest during 10M17 due to a low comparable sales base and the steady rampup of the model since its launch in late June this year, and the model has remained beyond the 11,000unit level after its sales breakthrough in Oct with steady rampup. The sales reflect the model s good market response, with a 2.5month waiting list; we expect the new model to see higher sales close to 13,000 units in NovDec on the back of its strong market demand, according to our channel checks. 3Series and X1 SUV sales declined The 3 Series sedan saw a 0.5% YoY and 26.5% MoM decline in Oct, we believe due to the monthly rise in sales for the Audi A4L. But the model s 10M17 sales indicate steady growth of 27.5% YoY and still kept a strong level of growth compared with its German JV peers. The company has launched the upgraded version of the BMW 3 Series which should boost monthly sales in NovDec, in our view. Besides, we expect the company to have a more active marketing strategy to boost sales during the peak season amid its fierce competition with peer model Audi A4L. The X1 SUV saw sales slide 19.2% MoM after high sales in 3Q17. We are confident the model will see further growth in NovDec, which would strengthen fullyear growth. The model s sales grew 79.7% YoY during 10M17. We think the model s monthly decline was caused by the upgraded version of Mercedes Benz's GLA. We expect this situation to continue in NovDec, but as there may be an increase in car purchase spending towards the yearend as the economy continues its steady growth, and as overall demand for SUVs is strong, we expect a noticeable monthly rebound for the X1 SUV, meaning it will be a strong sales support for the JV this year, particularly as the model posted the strongest growth among the JV s models in 10M17, up 79.7% YoY to 74,020 units. High expectations for the X3 SUV The company will begin to sell the X3 SUV in The model should be available from May and see improved sales by Aug after its initial rampup period. Management sees higher sales volume for the higherpriced midsized SUV in 2019, when it can contribute towards its fullyear results. To meet NEV targets in China, there will be an EV version of the vehicle in 2020 this will be BMW s first EV model in China; there are also plans to export the model. Management expects the model to be competitive against its Audi Q5 and Mercedes Benz GLC peers. To facilitate X3 production, management expects total capacity to reach 550k units by 2018, with production to be split between its Tiexi and Dadong plants. We expect the X3 to give the JV an edge in terms of sales as it is the first midsized BMW SUV in China, which should meet demand from buyers wanting more spacious vehicles, particularly families now with two children. The bigger sales contribution from SUVs will also help to improve BMW s market penetration among JV brands in China. 9M17 results maintained steady growth BMW Group s 9M17 earnings from equity investment (mainly from BMW Brilliance) came in at 634m, up 76% YoY. We estimate 9M17 earnings for BMW Brilliance to be ~Rmb4.0bn (stripping out earnings/loss estimates for BMW Group s other JVs), up ~5 YoY, driven by rising sales volume for BMW Brilliance models, up 24.3% YoY in 9M17, and improved profitability. However, the decrease in quarterly earnings attributable to Brilliance China would be slight at ~6% to Rmb1.2bn, based on our estimates. As 3Q17 saw 14.7% YoY growth in sales volume, we think the decline in earnings partly came from the destocking of older versions of the BMW 5 Series, which triggered price discounts and promotion efforts by the company as well as marketing expenses on the new 5 Series models. As the destocking is close to 2

3 an end with the steady rampup of the new 5 Series, we expect the profitability of the BMW 5 Series to improve in 4Q17, thus boosting overall profitability for BMW Brilliance. Own brand remains lossmaking, Renault to improve operating efficiency We expect own brand sales to grow modestly by 5.2% in 2017, followed by 2.9%3% growth during The company thinks the disappointing sales of its Huasong model was mainly due to the timing of its launch, given the weak market in 2015, as well as the high prices for this highend domestic MPV, which deterred buyers. Management aims to improve model sales and still thinks the impairment loss for the Huasong will be less than Rmb700m. The company s cooperation with Renault is expected to help improve its minibus segment in terms of technology, purchasing and cost management. There are plans to use the Renault platform to develop its Jinbei models, meaning its product mix will include both Renault and ownbrand models. This should improve sales in its minibus segment. We think the cooperation with Renault will lead to improvements in technology and design of its ownbrand models, while greater cost management and expense control should also benefit the segment over the long run. This should improve segment profitability. More NEV development ahead Besides the EV version of the X3 SUV set to be launched in 2020, there are plans for a plugin hybrid version of the new 5 Series in Alongside the current plugin hybrid version of the X1 SUV, this will give the JV three NEV models. Management is also considering an electric version of the 3 Series in 2019, or launching a different electric model to strengthen its NEV lineup. The company will also take a further step in NEV development with its auto battery assembly, with raw batteries purchased from CATL, which already supplies batteries for the JV s Zino and X1 models. This battery plant should cost around Rmb200m. We believe the company is responding to increased NEV development and requirements in China. We expect a rise in demand for the NEV versions of its top selling models, such as the X1 and 5 Series, while the EV version of the X3 will push further tech advancements. Maintain Buy and TP of HK$25.75 The new 5 Series has seen steady rampup and we expect further growth in NovDec. Besides, the JV has been supported by the strong growth of the X1 SUV in 10M17 (up 79.7% YoY) and considerable growth for the 3 Series (up 24.3% YoY in the same period). The company will launch the X3/X2 SUVs in 2018/19, which we expect to be competitive and should give it a further edge in its product mix given strong demand for SUVs. We think the BMWBrilliance JV s sales growth will be 25.8% YoY in 2017, less than our previous estimate of 34.5% YoY growth, which was mostly impacted by the slower rampup in the 5 Series in 3Q17; but we maintain our sales estimates for given the steady growth seen in the JV s models. We forecast an earnings CAGR of 43% during on the back of a strong product cycle from BMW models. The stock is trading at 11.6x our 12month forward 2018 EPS estimate of Rmb1.59, below its historical average of 14x, and undervalued, in our view. We maintain our Buy rating and target price of HK$25.75, based on 14x 2018E P/E, in line with its historical average. Figure 38: Key estimates for BMWBrilliance ASP (Rmb) 353, , , , , , ,000 ASP growth (%) 1.4% 4.1% 5.4% 4.1% 3.9% 6.3% 4.4% Sales volume (units) 206, , , , , , ,000 Sales growth (%) 28.5% 34.7% 3.1% % 30.5% 19.6% 3

4 (Rmb bn) (Rmb bn) ('ooo units) (Rmb bn) Figure 39: BMWBrilliance sales volume and growth Figure 40: BMWBrilliance ASP, revenue and growth % 3 25% 2 15% 1 5% % 4 35% 3 25% 2 15% 1 5% 5% 1 BMW Brilliance sales volume BMW Brilliance sales growth BMW Brilliance revenue BMW Brilliace revenue growth BMW Brilliance ASP growth Figure 41: BMWBrilliance EBIT and growth Figure 42: Brilliance China net income and growth BMW Brilliance EBIT (LHS) BMW Brilliance EBIT growth (RHS) NI (LHS) NI growth (RHS) 4

5 Figure 43: Financial statements Income Statement Balance Sheet Yearend Dec 31 (Rmb m) E 2018E 2019E Yearend Dec 31 (Rmb m) E 2018E 2019E Revenue 4,863 5,125 6,148 6,389 6,649 Noncurrent assets Cost of sales (4,655) (4,954) (5,933) (6,133) (6,350) Intangible assets 1,423 1,339 1,606 1,928 2,313 Gross profit Property, plant and equipment 2,042 2,250 2,475 2,722 2,994 Other income Land lease prepayments Interest income Interests in associates 1,578 1,703 1,873 2,061 2,267 Selling expenses (547) (612) (707) (703) (718) Interests in jointly controlled entities 14,011 17,645 21,256 25,507 30,609 General and administrative expenses (394) (383) (1,111) (596) (491) Prepayments for longterm investments Finance costs (147) (133) (154) (160) (166) Availableforsale financial assets Share of results of: joint ventures 3,823 3,993 5,990 8,307 10,810 Other noncurrent assets Share of results of: associates Total noncurrent assets 19,897 24,034 28,512 33,700 39,875 Profit before income tax expense 3,325 3,425 4,692 7,632 10,344 Current assets Income tax expense (45) (36) (49) (80) (109) Cash and cash equivalents 1, ,082 1,244 1,431 Profit for the year 3,280 3,389 4,642 7,552 10,236 Shortterm bank deposits Profit attributable to: Pledged shortterm bank deposits 1,326 1,339 1,808 2,259 2,824 Equity holders of the Company 3,495 3,682 4,995 7,992 10,764 Inventories 1,211 1,104 1,325 1,590 1,908 Noncontrolling interests (214) (293) (352) (440) (528) Accounts receivable 1,445 1,584 1,901 2,281 2,737 Notes receivable ,016 1,219 1,463 Cash Flow Statement Other current assets 1,134 1,552 2,173 2,607 3,129 Yearend Dec 31 (Rmb m) E 2017E 2018E 2019E Total current assts 7,175 7,009 9,516 11,434 13,749 Profit before income tax expense 3,325 3,538 4,692 7,632 10,344 Current liabilities Depreication & amortization Accounts payable 3,038 3,324 3,989 4,787 5,744 JV/Associate adjustment (4,043) (4,352) (6,307) (8,687) (11,266) Notes payable 2,157 2,330 2,796 3,355 4,026 Change in working capital (317) (285) (256) (231) (208) Other current liabilities 1,074 1,323 1,587 1,905 2,286 Other operating (108) Shortterm bank borrowings 1,585 1,325 1,789 2,415 3,260 Enterprise income tax paid (58) (35) (49) (80) (109) Income tax payable Net Cash used in operations (1,021) (945) (1,723) (1,158) (1,019) Total current liabilities 7,872 8,323 10,184 12,487 15,344 CAPEX (609) (851) (851) (851) (851) Noncurrent liabilities Investment 1,200 1,200 3,000 3,000 3,000 Deferred government grants Other nonoperating (757) Longterm bank borrowings Net cash generated from investing activities ,650 2,650 2,650 Total noncurrent liabilities Issue of share capital Net assets 19,064 22,599 27,640 32,434 38,055 Dividend paid (453) (553) (554) (554) (554) Share capital Other nonoperating 1, Reserves 19,500 23,327 28,368 33,162 38,783 Net cash used in financing activities (499) (499) (499) Total equity attributable to equity holders 19,896 23,724 28,765 33,559 39,180 Increase in cash and cash equivalents (108) (130) ,131 Total equity attributable to noncontralling interests (832) (1,125) (1,125) (1,125) (1,125) Cash and cash equivalents, as at 1st Jan 1,179 1, ,368 2,360 Total equity 19,064 22,599 27,640 32,434 38,055 Cash and cash equivalents, as at 31st Dec 1, ,368 2,360 3,492 Key Assumptions Key Financial Ratios Yearend Dec E 2018E 2019E Yearend Dec E 2018E 2019E Units sales growth_minibus (%) (25.3) ROE (%) ASP growth_minibus(%) 18.1 (2.4) ROA (%) Units sales growth_bmw (%) Interest cover (X) (3.9) (5.2) (9.5) (5.6) (4.5) ASP growth_bmw (%) (5.4) (4.1) Dividend cover (X) GPM (%) Current ratio (X) Selling & distribution expense/revenue (%) Quick ratio (X) General & administrative expense/revenue (%) Adjusted G&A expense/revenue (%) OPM (%) (11.7) (13.4) (32.0) (23.4) (21.8) 5

6 Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between 5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 1 Neutral Expected sector relative performance ranges between 1 and 1 Cautious Sector expected to underperform benchmark by more than 1 Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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