China autos and auto parts

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1 China autos and auto parts EQUITY: AUTOS & AUTO PARTS New wheels and new drivers Replacement, financing, and favourable seasonality to fuel sales growth upgrade in 2H14F We raise our 2014F PV sales volume growth forecast to 13% from 12% Defying market concerns over a slowdown in the beginning of the year, including a real estate market slowdown and more new car sales restrictions, new passenger vehicle (PV) sales volume grew at 11% YTD, which beats consensus of 8-10% at end We attribute such resilience to the emergence of replacement demand, auto financing, and rising affordability in lower-tier cities. As a result, we raise our PV sales volume growth forecast for 2014F and 2015F to 12.9% and 11.4% (from 12.1% and 11.0%), respectively. Any risk of a significant slowdown in 2H14F should be well-contained, owing to these structurally positive factors, as well as further macro policy easing, as projected by the Nomura economics team, in our view. We expect the Street to start raising its forecasts around the interim results season in August. Key beneficiaries of these positive trends will be SUVs (partly replacementdemand driven), entry-level luxury models (thanks to rising affordability and availability of auto financing), and OEMs with strong new model pipelines (to capture the peak-season demand from September onwards), in our view. Replacement demand is starting to make a real positive impact Replacement demand is an increasingly critical driver for China s auto demand, contributing more than first-time buyers to PV sales growth by 2015F, we estimate. This might explain why slower property sales this year have not led to a visible and negative impact on PV sales, since replacement demand should be less affected by property sales, as opposed to first-time buyers who typically purchase their cars after buying their homes, in our view. Auto financing will help fuel growth in lower-tier cities In China, approximately 20% of car buyers utilise auto financing, compared with typically 70% in overseas matured markets. We believe more financing packages will help fuel auto penetration, especially in lower-tier cities. Stock picks: SAIC (OEM top pick) and Nexteer (auto parts top pick) In view of our positive sector view and the favourable seasonality in 2H, we expect the sector P/E (now 8.8x) to be re-rated towards 10-11x. We initiate coverage of SAIC (OEM top pick) and Nexteer (auto parts top pick) with Buy, both offering c40% upside potential. Among the rest, we favour GAC (Buy), Dongfeng (upgrade to Buy) and Brilliance (upgrade to Neutral) going into the interim results season in August for their likely strong 1H numbers, but around results, recommend switching into Great Wall (Buy) and Geely (upgrade to Buy) on our expected 2H recovery. We have no Reduce-rated stocks. Global Markets Research 9 July 2014 Anchor themes We remain constructive on the 2H14F outlook for new auto sales, underpinned by growing replacement demand and availability of auto financing. We prefer SUVs, entry-level luxury, and OEMs with strong new model pipelines. Nomura vs consensus Our 2014F new PV sales volume growth forecast of 13% y-y is above consensus of 10%. Research analysts China Autos & Auto Parts Benjamin Lo - NIHK benjamin.lo@nomura.com Joseph Wong - NIHK josephmh.wong@nomura.com Fig. 1: Stock for action Market Cap Price TP Up/downside 2014F EPS 2015F EPS 2014F 2015F 2014F 2014F 2014F Div yld Ticker Rating (USDm) (HKD) (HKD) (%) Growth Growth PER (x) PER (x) PBR (x) ROE (%) Brilliance 1114 HK NEUTRAL 10, % 29% 13% % 1.1% Dongfeng 489 HK BUY 15, % 17% 17% % 1.9% Geely 175 HK BUY 3, % -23% 30% % 1.2% Great Wall 2333 HK BUY 12, % 13% 29% % 3.2% GAC 2238 HK BUY 8, % 61% 28% % 2.2% SAIC Motor Ch BUY 27,650 CNY15.56 CNY % 11% 11% % 8.6% Johnson 179 HK NEUTRAL 3, % 4% 7% % 1.7% Minth 425 HK BUY 2, % 14% 16% % 3.3% Nexteer 1316 HK BUY 1, % 11% 27% % 1.8% Source: Bloomberg, Nomura estimates. Initiating coverage for SAIC Motor and Nexteer. Pricing as of 4 July Note: For Johnson Electric, "14F" here refers to the fiscal year ending in March See Appendix A-1 for analyst certification, important disclosures and the status of non-us analysts.

2 Nomura China autos and auto parts 9 July 2014 Contents 4 Summary of our new ratings, TPs and estimates; initiate coverage on SAIC and Nexteer 5 PV sales volume growth - 5M14 at 11%; we raise our FY14F forecast to above-consensus 13% 7 Replacement demand: A long-term underpinning growth factor 9 Auto financing fuelling further auto penetration in China 13 Valuations: Sector P/E likely to head higher from August onwards 14 Seasonality factor 18 Investment risks 22 Appendix 1 New models in 2H14 24 Appendix 2 Market share trends 24 Luxury segment Germany s big 3 still the dominant force 26 Mid-size segment 27 Compact and subcompact segments Competition remains intense 28 SUV segment 29 Appendix 3 - China auto parts industry 29 Overview 30 Competitive landscape 31 Future development 32 Appendix 4 Global auto market outlook 33 Brilliance China 37 Dongfeng Motor 41 Geely Automobile 45 Great Wall Motor 2

3 Nomura China autos and auto parts 9 July Guangzhou Auto 53 SAIC Motor 63 Johnson Electric Holdings 67 Minth Group 71 Nexteer Automotive 92 Appendix A-1 3

4 Nomura China autos and auto parts 9 July 2014 Summary of our new ratings, TPs and estimates; initiate coverage on SAIC and Nexteer We update and revise our estimates and target prices for all auto stocks under our coverage universe in this report in view of the release of the latest sales volume data as well as the themes discussed herein. Additional details can be found in the individual company reports in the companies section. The two figures below summarise our estimate revisions and valuation methodologies. We have more detailed discussions on valuations for the sector and for each of the companies under our coverage in the valuation section and the company sections of this report. Regarding our ratings, we upgrade Dongfeng and Geely to Buy, and Brilliance to Neutral. We maintain our Buy rating on GAC and Great Wall. We also initiate coverage on two companies, SAIC and Nexteer, with Buy ratings. There is no Reduce rating in our coverage universe. Fig. 2: Summary of revisions to our ratings, TPs and EPS forecasts 2014F EPS (loc) Source: Bloomberg, Nomura estimates Note: For Johnson Electric, "14F" here refers to the fiscal year ending in March 2015 Current Previous % change 2015F EPS (loc) TP (HKD) 2014F EPS (loc) 2015F EPS (loc) Ticker Rating (old rating) TP (HKD) OEM Brilliance 1114 HK NEUTRAL (REDUCE) % 11.0% 12.2% Dongfeng 489 HK BUY (NEUTRAL) % 23.6% 31.7% Geely 175 HK BUY (NEUTRAL) % -15.0% 0.9% Great Wall 2333 HK BUY (BUY) % -10.0% -4.9% GAC 2238 HK BUY (BUY) % -3.8% -3.5% SAIC Motor CH BUY (NR) CNY n.a. n.a. n.a. n.a. n.a. n.a. Auto parts Johnson Electric 179 HK NEUTRAL (NEUTRAL) % -0.2% -0.2% Minth Group 425 HK BUY (BUY) % -4.9% -1.0% Nexteer 1316 HK BUY (NR) n.a. n.a. n.a. n.a. n.a. n.a. TP (HKD) 2014F EPS 2015F EPS Fig. 3: Summary of valuation methodology Company Ticker Rating TP (HKD) Valuation methodalogy Nomura comments OEM Brilliance 1114 HK Neutral x mid 15F P/E (representing LT average) Dongfeng Motor (DFM) Source: Bloomberg, Nomura estimates 489 HK Buy x mid 15F P/E (representing long-term average) Geely 175 HK Buy x P/B 2015F BVPS (representing - 1 SD below historical mean) Great Wall Motor (GWM) Guangzhou Auto Corp (GAC) 2333 HK Buy x mid 15F P/E (representing -1 SD below LT 2238 HK Buy x mid 15F P/E (representing long-term average) SAIC CH Buy CNY21.2 8x mid 15F P/E (representing LT average) Auto parts Minth 425 HK Buy x mid 15F P/E (representing +1 SD above mean) Given our concern on Brilliance's growth and valuation headwinds have alleviated, we rebased our target multiple back to LT average. Despite a near-term pick-up in earnings growth, we still assign LT-average as our target P/E multiple, as we do not see a multi-year re-rating story yet. We raised our TP to reflect the roll-forward 2015F BVPS, allowing us to look past the restructuring disruption in 2014F and hence better reflect the potential recovery We assign a lower target P/E (from LT average of 11x to -1 SD below mean) given the H8 uncertainty. A robust new model pipeline should continue to underpin strong earnings growth for GAC, hence justifying our target P/E at LT average. We consider 8x P/E to be reasonable when compared with Dongfeng Motor which has a similar LT growth profile and a LT-average P/E multiple of 8.5x. We assign +1 SD above mean as our target P/E multiple owing to its high earnings quality and track record. Johnson Electric 179 HK Neutral 6.90 DCF with WACC of 8.3% Our target price is based on DCF valuation which implies FY15F 15.2x P/E (EPS: USD0.06) and 1.7x P/B (BVPS: USD0.53) Nexteer 1316 HK Buy x mid 15F P/E Instead of its own histrocal average, we benchmark our multiple to Nexteer's peer average for its short trading history. 4

5 Nomura China autos and auto parts 9 July 2014 PV sales volume growth - 5M14 at 11%; we raise our FY14F forecast to aboveconsensus 13% China s auto industry has enjoyed a satisfactory start to 2014, with passenger vehicle (PV) demand posting 11% y-y growth in 5M14, largely due to the continued strong demand for SUVs, increasing popularity of entry-level luxury models, and an overall rising affordability for passenger cars. In the beginning of the year, we introduced our FY14F PV sales volume growth forecast of 12%, at a time when consensus was looking at 10% (with some bears predicting single-digit growth). While some risks have materialised, including the introduction of new vehicle sales restriction in more cities (eg. Tianjin and Hangzhou) and a generally soft Chinese economy, PV sales volume growth has remained healthy at 11% YTD. Fig. 4: China PV unit sales by segment Fig. 5: China monthly PV sales 120% 100% 80% 60% 40% 20% Sedan SUV Others MPV 2% 3% 3% 3% 7% 9% 10% 19% 18% 16% 15% 9% 7% 7% 6% 10% 11% 13% 17% 20% 23% 72% 69% 70% 69% 67% 64% 60% (units mn) y-o-y % 13.7% % 0.8 YTD: 11.1% 7.9% 7.0% % 16% 12% 8% 4% 0% F 2015F 0.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 0% Source: China Auto Market, Nomura estimates Source: China Auto Market, Nomura research In our previous sector reported dated 13 th January 2014 (Anchor Report: China autos - Careful climbing), we argued a positive view on the longer-term growth outlook underpinned by a growing replacement demand and rising affordability. While sales momentum could taper during the summer months of the slow season for the industry, for 2014F and beyond, we believe end demand will branch out regionally into lower-tier cities that enjoy faster growth in consumer affordability. We also recognise a growing importance of replacement demand, which is also receiving some policy support as the central government is keen to phase out old vehicles that do not meet emission standards. We further argue in this report that the increasing availability of auto financing packages will underpin a faster auto penetration into lower tier cities. Hence, we raise our FY14F PV sales volume growth forecast to 13%, and also lift FY15F PV sales volume forecast slightly from 11% to 11.4%. For the long-term (for the next three to five years), we believe PV sales volume can continue to grow at high-single-digit to 10% level p.a. 5

6 Nomura China autos and auto parts 9 July 2014 Fig. 6: China annual PV sales and forecasts for F China auto sales forecast F 2015F Sedan 7,460,638 9,494,194 10,124,599 10,745,776 12,008,272 12,892,867 13,628,892 y-o-y 48.0% 27.3% 6.6% 6.1% 11.7% 7.4% 5.7% % of total 72.3% 69.1% 69.8% 69.4% 67.0% 63.7% 60.4% SUV 657,494 1,317,585 1,617,502 1,998,192 2,988,753 4,035,479 5,135,088 y-o-y 47.4% 100.4% 22.8% 23.5% 49.6% 35.0% 27.2% % of total 6.4% 9.6% 11.2% 12.9% 16.7% 19.9% 22.8% MPV 248, , , ,341 1,289,907 1,815,869 2,289,693 y-o-y 26.1% 78.9% 11.7% -0.8% 161.5% 40.8% 26.1% % of total 2.4% 3.2% 3.4% 3.2% 7.2% 9.0% 10.2% Others 1,948,277 2,491,704 2,258,436 2,256,260 1,641,065 1,495,163 1,495,163 y-o-y 83.2% 27.9% -9.4% -0.1% -27.3% -8.9% 0.0% % of total 18.9% 18.1% 15.6% 14.6% 9.2% 7.4% 6.6% PV sales 10,315,363 13,748,884 14,498,020 15,493,569 17,927,997 20,239,378 22,548,836 y-o-y 52.9% 33.3% 5.4% 6.9% 15.7% 12.9% 11.4% Source: China Auto Market, Nomura estimates For 2014F and beyond, we believe that end-demand will branch out regionally into lowertier cities which enjoy faster growth in consumer affordability. Despite near-term headwinds on potentially more cities adopting new car sale restrictions, we remain constructive on the long-term growth prospects of China s passenger vehicle market, with a growing importance of replacement demand and auto financing. In the near term, new car sales might actually benefit from the bringing-forward of demand from buyers on worries over more restrictions later. Any risk of a significant slowdown in 2H14F should be well-contained, owing to these structurally positive factors, as well as further macro policy easing as projected by the Nomura economics team, in our view. We expect the Street to start raising its forecasts around the interim results season in August. 6

7 Nomura China autos and auto parts 9 July 2014 Replacement demand: A long-term underpinning growth factor We believe a growing replacement demand will be a structural underpinning factor for China s PV sales in the mid-to-long term. Replacement demand is less affected by property sales (as opposed to first-time car buyers who typically purchase their cars after buying their homes). Its growing significance within the mix of new PV sales should reduce volatility (and hence, improve visibility) of future PV sales. We estimate replacement demand rising from our estimate of 23% of new PV sales in 2011 to 34% in 2015F. Fig. 7: Replacement demand and its proportion to total new PV sales (units mn) % % 4.0 Replacement demand (LHS) Proportion to total PV sales (RHS) 31.1% 28.7% % % 35% 30% 25% 20% 15% 10% 2 5% F 2015F 0% Source: China Auto Market, Nomura estimates At end-2012, there were approximately 103mn PVs registered in China. Based on an estimated c 5% replacement ratio (according to our estimates and checks with industry sources), this would imply approximately 5.1mn units as replacement demand for 2013F this coincides with a typical seven-year auto replacement cycle, as new PV sales in 2006 (i.e. seven years before 2013) was 5.15mn units. We note 5.1mn units out of a total estimated 17.8mn PVs sold in 2013F would imply that approximately 29% of China s new PV sales in 2013F were from replacement demand, with a majority of 71% from first-time new car registrations. If we do the same exercise for 2011 and 2012, we find that the replacement demand as a % of China s total new PV sales has gradually risen from our estimated 22.6% in 2011, to 25.6% in 2012, and further to 28.9% in 2013F. Based on the same methodology and retaining our assumption of a seven-year replacement cycle, we can assume that there could be 6.3mn units of replacement demand in 2014F (as 6.3mn units of new PVs were sold in 2007). As a result, replacement demand would further rise to 31.6% of total new PV sales volume. We expect replacement demand to contribute over half of new PVs sold in a year, similar to the global benchmark. This is an important structural development for the industry, as we believe replacement demand is less affected by property sales (as opposed to first-time car buyers who typically purchase their cars after buying their homes). This might explain the disconnect between China new property sales and PV sales volume growth this year. 7

8 Nomura China autos and auto parts 9 July 2014 Fig. 8: Replacement demand will be more important than new buyers as the source of PV sales volume growth, by our estimates Fig. 9: China property sales (GFA) growth vs. passenger vehicle sales volume growth the latter has been outperforming since 4Q13 New buyers Total y-o-y PV growth 15.7% Replacement demand 60% 50% 40% GFA PV sales 6.9% 8.1% 12.9% 6.5% 11.4% 4.6% 30% 20% 10% 0% 2.1% 7.6% 4.8% 6.4% 6.8% F 2015F -10% -20% -30% Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Source: China Auto Market, Nomura estimates Source: CEIC, CAAM, Nomura research We believe that the likely beneficiary of a rising replacement demand in coming years should be SUVs, which should be able to capture a large share of the future replacement demand given their rising popularity among car buyers in recent years and the availability of more choices (more auto makers diversifying their product line-up into SUVs, and also auto makers offering more SUV types, e.g. compact SUVs). We forecast above-industry average sales volume growth of 35% y-y for SUVs. Fig. 10: SUVs growing as a % of China s total PV sales volume, F (units mn) SUV (LHS) Proportion to total PV sales (RHS) % 25% % 6% % % % % % % 15% 10% 5% F 2015F 0% Source: China Auto Market, Nomura estimates 8

9 Nomura China autos and auto parts 9 July 2014 Auto financing fuelling further auto penetration in China Auto finance arises when the prices of cars are out of the reach of individual purchasers without any borrowing. In China, car buyers are becoming younger along with the continuous growth of the market. Different from those in the past who usually opted for lump-sum payment, young buyers nowadays are more open-minded towards personal finance options, making auto financing increasingly well-received among the general public. With the introduction of various auto finance packages, OEMs have become more capable of lowering the financial barrier of first-time car purchases, attracting more young buyers, and at the same time preserving their loyalty to the brands. The launch of different auto financing products and the enhancement of market penetration have become the key for OEMs to compete for market share, especially in the segment of younger consumers. While the penetration rate in overseas mature markets has reached approximately 70%, the average penetration rate in China is approximately 20%, with those of premium brands being marginally over 30%. The funding for personal car finance is provided either by a retail bank or a specialist car financing company. In the US, some car manufacturers own their own car financing arms, such as Ford with the Ford Motor Credit Company and General Motors with its GMAC Financial Services arm, which has now been renamed and rebranded as Ally Financial. The finance is typically arranged by the dealer which provides the car. In the case of Ford Motor Credit Company, it offers consumer loans and leases to car buyers, as well as business loans and lines of credit to dealerships selling Ford Motor Company products. In China, to take advantage of the booming market, banks and other well established OEMs are all setting their foot in the industry. Fig. 11: List of auto financing vehicles of Chinese OEMs OEM Auto finance vehicle Year of establishment in China Cooperative partner Registered Capital (CNY mn) Terms of years Shareholding structure Dongfeng Group Dongfeng Automotive Finance 1987 nil 1,319 nil 100% OEM SAIC GM SGM Auto Finance 2004 General Motor 500 n.a 60% GM; 40% SAIC Volkswagen VW Finance (China) 2004 Nil 500 n.a 100% OEM Toyota Toyota Auto Finance (China) 2005 Nil 1,800 n.a 100% OEM Ford Ford Automotive Finance (China) 2005 Nil 500 n.a 100% OEM Daimler-Chrysler DaimlerChrysler Auto Finance (China) 2005 Nil 500 n.a 100% OEM Dongfeng PSA DF PSA Auto Finance 2006 PSA Netherland Finance 500 n.a 50% OEM; 50% partner Volvo Volvo Auto Finance (China) 2006 Nil 500 n.a 100% OEM Dongfeng Nissan DF Nissan Automotive Finance 2007 Nissan Motor 1,200 n.a 65% Nissan; 35% DFM Fiat Fiat Automotive Finance 2007 Nil 500 n.a 100% OEM Chery Chery Motor Finance Service 2009 Huishang Bank 1,000 n.a 80% OEM, 20% partner BMW Brilliance BMW Auto Finance (China) 2010 BMW AG 500 n.a 42% OEM; 58% partner GAC GAC-SOFINCO Automobile Finance 2010 SOFINCO S.A 500 n.a 50% OEM; 50% partner Sany Sany Auto Finance 2010 Hunan Trust/ China Valin 800 n.a 92.5% OEM; 7.5% partners FAW Car FAW Car Auto Finance 2011 Bank of Jilin 1,000 n.a 66% OEM; 34% partner Beijing Hyundai Beijing Hyundai Auto Finance 2012 Hyundai 1,000 n.a 53% Hyundai; 47% BAIC Qingling Chongqing Auto Finance (CQAFC) 2012 CQ Rural Comm.Bank/Yufu Asset Mgt 500 n.a 41% OEM; 59% partners JAC Fortune Auto Finance 2013 Santander Consumer Finance 500 n.a 50% OEM; 50% partner Geely Geely Auto Finance 2013 BNP Paribas Personal Finance % OEM; 20% partner Greatwall Tianjin GreatWall Binyin Automotive Finance 2013 Tianjin Binhai Rural Comm.Bank 550 n.a 90% OEM; 10% partner Source: Companies data, Nomura research The auto financing industry has experienced rapid development in China since 1998, when it received the go-ahead from the central government. According to the PBOC, auto loan outstanding was at CNY43.6bn in 2001, and has grown to CNY158.3bn in 2008 and exceeded CNY300bn by In 2012, the industry grew by 30% y-y to CNY392bn and we expect its growth to continue exceeding the total new car sales volume growth in the foreseeable future. While traditionally a majority of the auto loans was granted through commercial banks directly, followed by credit card loans, we believe 9

10 Nomura China autos and auto parts 9 July 2014 auto financing vehicles established jointly by OEMs and banks will take an increasingly prominent role. Along with the emergence of younger car buyers, the enhancement of personal information system, the optimisation of auto financing regulation and a wider participation of OEMs, we expect the penetration rate of auto financing in China will continue to increase in coming years. The following are examples of some auto financing plans currently offered in the market. Fig. 12: Some auto financing packages currently offered in the market Name of auto finance company Downpayment Loan period End-payment Toyota Auto Finance (China) 30% or more of car price 12/24/36 months 50%-60% of original purchase price VW Finance (China) 20% or more of car price months 25-50% of original purchase price Audi Finance (China) 30% or more of car price months 25-50% of original purchase price DF Nissan Automotive Finance 20-50% of car price months Less than 25% of original purchase price Beijing Hyundai Auto Finance 20-50% of car price months up to 50% of original purchase price Fortune Auto Finance Flexible 12/24/36 months n.a Source: Companies data, Nomura research Fig. 13: Example of a typical package offered by Toyota Finance Services for buyers of Crown and Corolla in China Monthly instalment (CNY) Model Car price (CNY) Period Downpayment Final payment "wisdom" loan plan Fixed instalment Crown ,500 4,127 7,775 Crown , months 30% 50% 5,885 11,086 Corolla 142,800 1,794 3,380 Source: Companies data, Nomura research During the Beijing Auto Show in April 2014, Mercedes introduced a new auto financing product to its clients called the value-preserving hire purchase plan. The plan, which is different from traditional plans, does not require car buyers to pay huge upfront deposits, thereby lowering the entry requirement of purchasing premium vehicles. The plan offers an installment period of months, maximising customers choice on which model to purchase at the end of the hire purchase agreement. Take the purchase of an A180 model for CNY252,000 as an example. Should the buyer opt for the new plan, he is only required to pay CNY5,388 as the monthly rental after paying 10% of the vehicle price for each deposit and prepayment and to agree to drive 20,000 km mileage per annum within the 24-month contract period. With reference to the depreciation schedule of Mercedes, the residual value of the A180 would be CNY141,000 at the end of the contract. By then, the car buyer can choose to: 1) return the vehicle to the dealers, 2) buy the car at its residual value, or 3) pledge the vehicle for a new Mercedes model. Anecdotal evidence in overseas markets shows that most of the buyers would opt for the option of pledging the old vehicle for a new one. This would indirectly enhance the customer loyalty of the brand. From April 2013 to April 2014, the number of subscription to Mercedes Auto Finance rose 153% y-y, with contract activation rate up 118% y-y and total loan outstanding up 31% y-y, according to Mr. Alexandre Mallmann, CEO of Mercedes-Benz Auto Finance (China), who also targets to lift Mercedes auto-financing penetration rate to over 50% (which would exceed the typically 30%+ penetration rate enjoyed by premium brands in China during 2013). In the case of BMW in China, 99% of its existing dealers are already in partnership with BMW Auto Finance which enjoyed a market penetration rate of 30% in 2013 with an average loan per vehicle of CNY300,000, according to Mr. Liu Jun, head of sales of BMW Auto Finance (China). Some of the leading domestic brands have also started to take initiatives in auto financing. Great Wall made an announcement in June that its application for a business license for its financing company has been officially approved by Tianjin Binhai New Area's Administration for Industry and Commerce. The new company, known as the Tianjin Great Wall Binhai Banking Automobile Finance Company, possesses registered capital of CNY550 million (USD89.46mn) and is a 90/10 joint venture between Great 10

11 Nomura China autos and auto parts 9 July 2014 Wall, and the Tianjin Binhai Rural Commercial Bank. At this point, details are still lacking with respect to the services it will offer and how it will work together with other internal departments and dealerships. According to our channel survey, currently majority of Great Wall's financial services are done in cooperation with the China Construction Bank, whose loan application policies require over a week to complete, which delays the processing of manufacturers. In several cities the financial penetration rate for Great Wall's services is between 15% and 20%, lagging premium brands at 30%+. Now that Great Wall has established an independent financing company, its loan processing time should be reduced, thereby attracting more customers to use auto financing services as well as helping Great Wall boost its sales volume, in our view. The availability of more auto financing packages should further enhance affordability in lower-tier cities With car purchase restrictions mostly falling in Tier-1 cities, OEMs are likely to continue focusing their marketing efforts on lower-tier cities which are enjoying faster growth in income levels and consumer affordability. Take BMW for example -- 60% of its new 4S shops opened in 2013 were located in Tier-4 and -5 cities. Rising affordability in lower-tier markets is indeed an increasingly critical growth driver to our forecasts. Using the past as a learning guide, we believe China s auto industry typically witnessed a boom (or a recovery) when rising incomes intersect with a decline in car prices. Notably, the auto market experienced three up-trends in 2006, 2008 and 2011, which corresponded to an affordability threshold. We had projected the fourth boom to commence around the middle of 2013 and should continue for much of 2014F when the income band of tier-4 markets again reaches the threshold. Fig. 14: China auto sales growth and levels of income Disposalble income per capita (CNY) 45,000 40,000 35,000 30,000 25,000 20,000 15,000 Disposable income per capita in tier 1 band reached CNY18k, which triggered the first wave of strong auto sales Tier 1 Income Band (LHS) Tier 3 Income Band (LHS) Average car price (RHS) Disposable income per capita in tier 2 band reached CNY16k, this led to the 2nd up cycle Tier 2 Income Band (LHS) Tier 4 In come Ban d (LHS) Tier 3 region auto sales were pulled forward due to auto stimulus package together with increasing affordability (disposable income per capita reached CNY14k) Avg. car prices (CNY) 300, , , , ,000 10,000 5,000 0 We expect disposable income per capita in tier 4 band will reach the level that will drive next up cycle in F 2014F China PV y-y growth: 54% 30% 22% 7% 53% 33% 5% 7% 16% 13% 50,000 0 The sweet spot Source: China Auto Market, Nomura estimates Entry-level luxury models are best-positioned to capture the long-term growth trends We continue to prefer the mass mid-market / entry-level luxury segment (typically priced between CNY100,000 and CNY300,000), which should best capture these long-term trends of more auto financing and rising affordability. The market share gainers will likely be entry-level models of luxury brands (the low prices of which are approaching CNY250k only), in our view. We have seen very robust growth for luxury brands in China since 2009, with Germany s big three brands -- Audi, BMW and Mercedes -- taking the lion s share of the luxury segment. From 2009 to 2013, luxury brands new car sales volume has recorded a 11

12 Nomura China autos and auto parts 9 July 2014 CAGR of 37%, outperforming the total market s CAGR of 13%. Luxury brands combined market share in China has risen from 2.6% in 2009 to 5.7% in The luxury segment has reached a matured stage in the US, with its market share relatively stable over the past five years, standing at 6.9% in If we take 6.9% as the market share level, which luxury brands can also repeat in China, this would imply a CAGR of 17% for luxury brands sales volume during F. An upside surprise is possible if affordability and auto financing are to grow stronger than our expectations. Fig. 15: Luxury brands market share in China, US and Japan We expect luxury brands sales volume in China to record a 17% CAGR during F before matching the 6.9% market share level seen in the US 9% 8% 7% 6% China US Japan 17% CAGR 6.5% 6.1% 5.4% 5.7% 6.9% 5% 4.4% 4% 3% 2.6% 3.3% 2% 1% 0% F 2015F 2016F Source: JAMA, Autodata, China Auto Market, Nomura estimates Fig. 16: Luxury brands market share breakdown China, 2013 Fig. 17: Luxury brands market share breakdown US, 2013 Fig. 18: Luxury brands market share breakdown Japan, 2013 Lexus 6% Land Rover 6% Mercedes-Benz Merced es-benz 19% 19% Lexus 25% Land Rover 2% Merced es- Mercedes-Benz Benz 29% Lexus 26% Land Rover 2% Merced es- Benz Mercedes-Benz 30% 30% Audi 39% BMW 30% Audi 15% BMW 29% Audi 16% BMW 26% Source: China Auto Market, Nomura research Source: China Auto Market, Nomura research Source: China Auto Market, Nomura research We believe the local production of luxury models will help bring down ASP, making them more affordable to a bigger addressable market, especially in lower tier cities in China. Fig. 19: Local production of more luxury models in China, 2014F-16F Brand Model Domestic JV partner Expected year of commencement Audi A3 Sportback (HB) FAW 2014 Audi A3(NB) FAW 2014 Audi A4L 45 TFSI FAW 2014 Audi Q3 1.4T FAW 2014 Mercedes New C-Class BAIC 2014 Mercedes New E-Class BAIC 2014 BMW 2 series Brilliance 2015 BMW Another model Brilliance 2016 Infiniti Q50 LWB Dongfeng 2014 Land rover Range Rover Evoque Chery 2015 Source: China Auto Market, Nomura research 12

13 Nomura China autos and auto parts 9 July 2014 Valuations: Sector P/E likely to head higher from August onwards Since our last Anchor report in January 2014 (Anchor Report: China autos - Careful climbing), China s auto sector P/E valuation has remained range-bound between 8x-10x during 1H14 as we have predicted in our report. That said, the sector average P/E did not touch the trough valuation of 7.5x seen over the past two years, as China s new PV sales volume has continued to grow at a healthy pace of 11% y-y in 5M14, which remains solid when compared with the single-digit growth rates recorded in Currently, the sector average P/E stands at 8.8x. For 2H14F, we expect the sector valuation to be re-rated higher towards 10x-11x during 2H14F, as we forecast China s new PV sales growth to remain strong at double-digits (i.e. no visible slowdown when compared with 1H14) and as monthly sales volume starts to bottom out from August onwards (see our discussions on seasonality factor below). Fig. 20: China autos sector P/E Jan-05 May-05 Sep-05 China PV sales growth (RHS) Automaker P/E (exl. BYD) (LHS) Historical average since 2005 His. avg = 9.6x Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May % 80% 40% 0% -40% Source: Bloomberg, China Auto Market, Nomura research Fig. 21: 2014 OEM share price relative performance Fig. 22: 2014 parts makers share price relative performance Dongfeng Motor Geely Brilliance China GAC Great Wall Motor SAIC Johnson Electric Nexteers Minth Xinchen Dec = Rebased to Jan 15-Jan 29-Jan 12-Feb 26-Feb 12-Mar 26-Mar 9-Apr 23-Apr 7-May 21-May 4-Jun 18-Jun Dec = Rebased to Jan 15-Jan 29-Jan 12-Feb 26-Feb 12-Mar 26-Mar 9-Apr 23-Apr 7-May 21-May 4-Jun 18-Jun Source: Bloomberg, Nomura research Source: Bloomberg, Nomura research 13

14 Nomura China autos and auto parts 9 July 2014 Seasonality factor China s auto industry s seasonally slow summer sales (May-August) have, in our view, consistently provided investors with a good entry point since 2010, as car sales momentum typically picks up after summer and accelerates towards January (i.e. the month before Chinese New Year). Since 2010, China s auto sector s share prices have exhibited a positive correlation with this industry s seasonality with stronger performance during 2H of the year, especially from August onwards. The same course of events has repeated in 2H13; we have also seen a strong rally for the sector since July-2013, with sales rising by an average 37% until November. This was in line with our expectation and consistent with the sequentially improving monthly sales numbers during 2H13. Fig. 23: China monthly PV unit sales (units '000) ,000 1,800 1,600 1,400 Fig. 24: China auto stocks on an average better performed in 2H Index Jan 2010 = % 300% 250% 200% 150% 1, % 50% 1,000 0% 800 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan 10 May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 May 14 Source: China Auto Market, Nomura research Source: Bloomberg, Nomura research The share price performance was typically mixed during the first-half of an year. We have witnessed a similar pattern in 1H14. However, as monthly sales volume starts bottoming out from the slow season and sequentially improves towards January, we recommend investors start positioning in the China auto sector from the second half of July onwards, to capture the sequentially stronger sales volume from August till January next year that we are anticipating. 14

15 Nomura China autos and auto parts 9 July 2014 Fig. 25: China auto sector valuations Company Name Ticker Rating TP Up/ Downside Mkt Cap PE PB ROE EPS Growth Div yield Net Gearing Closing (USDmn) 2014F 2015F 2014F 2015F 2014F 2015F 2014F 2015F 2014F Brilliance China 1114 HK Equity NEUTRAL % 10, % 26% 29% 13% 1.1% 3.0% BYD 1211 HK Equity BUY % 17, % 10% 176% 61% n.a 97.1% Dongfeng Motor 489 HK Equity BUY % 15, % 19% 17% 17% 1.9% net cash Geely Automobile 175 HK Equity BUY % 3, % 14% -23% 30% 1.2% net cash Great Wall 2333 HK Equity BUY % 12, % 30% 13% 29% 3.2% net cash Guangzhou Auto 2238 HK Equity BUY % 8, % 14% 61% 28% 2.2% 0.3% Sector average % 19% 63% 32% 1.5% Sector average (excl. BYD) % 22% 23% 22% 2.1% A-share PV makers SAIC Motor CH Equity BUY % 27, % 15% 11% 11% 8.6% net cash Great Wall -A CH Equity Not rated n.a n.a 12, % 28% 22% 30% 3.4% net cash Chongqing Changan CH Equity Not rated n.a n.a 9, % 27% 93% 31% 1.3% 54.3% Guangzhou Auto -A CH Equity Not rated n.a n.a 8, % 14% 60% 32% 2.3% net cash Faw Car CH Equity Not rated n.a n.a 2, % 16% 53% 13% 0.2% 12.7% Beiqi Foton CH Equity Not rated n.a n.a 2, % 8% 30% 18% 2.9% 7.4% Haima Auto CH Equity Not rated n.a n.a 1, n.a 8% 9% 107% 47% n.a net cash Dongfeng Auto -A CH Equity Not rated n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a 18.6% Tianjin Faw Xiali CH Equity Not rated n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a 57.6% Liaoning SG Auto CH Equity Not rated n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a 62.9% Sector average % 18% 34% 21% 4.8% Dealers Zhongsheng Group 881 HK Equity NEUTRAL % 2, % 13% 20% 18% 1.6% 101.1% China Zhengtong 1728 HK Equity BUY % 1, % 14% 22% 22% 2.7% 40.1% Baoxin Auto 1293 HK Equity Not rated n.a n.a 2, % 28% 39% 32% 1.9% 203.7% Dah Chong Hong 1828 HK Equity Not rated n.a n.a 1, % 13% 21% 17% 4.8% 58.7% Yonda 3669 HK Equity Not rated n.a n.a 1, % 23% 38% 32% 1.8% 161.4% China Harmony 3836 HK Equity Not rated n.a n.a n.a 21% 22% 13% 34% 1.3% 92.5% Sunfonda 1771 HK Equity Not rated n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a 66.7% Meidong 1268 HK Equity Not rated n.a n.a n.a 34% 39% 64% 67% n.a 136.9% Sector average % 19% 27% 25% Auto-part makers Johnson Electric 179 HK Equity NEUTRAL % 3, % 12% 4% 7% 1.7% net cash Minth Group 425 HK Equity BUY % 2, % 15% 14% 16% 3.3% net cash Nexteer 1316 HK Equity BUY % 1, % 21% 11% 27% 1.8% 43.6% Xinchen 1148 HK Equity Not rated n.a n.a n.a n.a 4% 35% n.a net cash Xingda Intl 1899 HK Equity Not rated n.a n.a % 11% 19% 19% 3.9% 16.4% Sector average % 13% 9% 17% 2.1% CV makers Weichai Power 2338 HK Equity Not rated n.a n.a 6, % 15% 21% 14% 0.9% 3.8% Jiangling Motor CH Equity Not rated n.a n.a 3, % 22% 18% 39% 3.0% net cash Sinotruk HK 3808 HK Equity Not rated n.a n.a 1, % 3% 82% 31% 1.4% 27.6% Qingling Motor 1122 HK Equity Not rated n.a n.a % 6% 9% 6% 6.0% net cash Shenyang Jinbe CH Equity Not rated n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a n.a 125.4% Sector average % 15% 25% 22% 1.8% Source: Bloomberg, Nomura estimates. Bloomberg consensus for not rated companies. Note: For Johnson Electric, "14E" refers to the fiscal year ending in March 2015, and so on. Pricing as on 4 July

16 Nomura China autos and auto parts 9 July 2014 Fig. 26: Nomura Global Auto Research peer valuation comparisons Autos Mkt Cap Current Target Potential P/ E EV / EBITDA P / BV ROE Div Yield Company Ticker ($mn) Rating Price Price Upside 14E 15E 14E 15E 14E 15E 14E 15E 14E 15E US GM GM US 63,215 Reduce $ % 11.0x 10.3x 2.8x 2.6x 1.5x 1.6x 13.4% 14.8% 2.8% 2.9% Ford F US 66,076 Neutral $ % 13.7x 13.3x 7.5x 6.8x 2.6x 2.6x 18.8% 19.4% 2.5% 2.8% Average -14% 12.4x 11.8x 5.2x 4.7x 2.0x 2.1x 16.1% 17.1% 2.7% 2.8% Median -14% 12.4x 11.8x 5.2x 4.7x 2.0x 2.1x 16.1% 17.1% 2.7% 2.8% Europe BMW BMW GY 84,689 Buy % 11.5x 11.2x 4.0x 3.9x 1.6x 1.4x 14.4% 13.5% 2.8% 2.9% Daimler DAI GY 102,025 Neutral % 11.8x 11.1x 4.7x 4.4x 2.0x 1.8x 17.7% 16.9% 3.4% 3.4% Volkswagen VOW3 GY 121,236 Neutral % 9.4x 8.8x 3.7x 3.5x 1.0x 0.9x 10.8% 10.6% 2.6% 2.6% Fiat F IM 12,936 Reduce % 33.9x 9.2x 2.5x 2.6x 1.5x 1.3x 4.1% 15.6% 0.0% 0.0% Peugeot SA UG FP 4,917 Reduce % N/A 10.0x -0.8x -1.0x 0.4x 0.4x -0.9% 3.7% 0.0% 0.0% Renault RNO FP 26,098 Neutral % 10.5x 8.3x 4.2x 3.5x 1.1x 1.1x 10.5% 13.3% 2.4% 2.8% Volvo VOLVB SS 28,514 Neutral % 19.3x 15.8x 8.0x 7.1x 2.5x 2.3x 13.2% 15.1% 3.1% Average -20% 16.1x 10.6x 3.8x 3.4x 1.4x 1.3x 10.0% 12.7% 2.1% 2.0% Median -13% 11.7x 10.0x 4.0x 3.5x 1.5x 1.3x 10.8% 13.5% 2.6% 2.7% India Ashok Leyland AL IN 1,602 Buy INR INR % 358.2x 17.2x 17.6x 9.4x 2.1x 1.9x 0.6% 11.8% 0.0% 2.1% Bajaj Auto BJAUT IN 11,098 Neutral INR 2, INR 1, % 18.8x 17.5x 12.9x 11.8x 5.9x 5.0x 33.8% 30.9% 2.3% 2.5% Hero Motocorp HMCL IN 8,608 Neutral INR 2, INR 2, % 18.9x 16.9x 12.2x 11.1x 7.0x 5.8x 40.7% 37.5% 2.2% 2.5% Mahindra & Mahindra MM IN 11,534 Buy INR 1, INR 1, % 18.4x 15.9x 11.5x 9.6x 3.5x 3.0x 20.7% 20.5% 1.2% 1.3% Maruti Suzuki MSIL IN 13,312 Buy INR 2, INR 2, % 22.3x 17.3x 10.9x 8.4x 3.3x 2.8x 15.6% 17.4% 0.6% 0.7% Tata Motors TTMT IN 24,969 Buy INR INR % 10.4x 9.3x 4.7x 4.0x 1.9x 1.6x 20.1% 18.7% 0.4% 0.4% Average -3% 67.1x 15.7x 11.6x 9.0x 4.0x 3.4x 22.0% 22.8% 1.1% 1.6% Median -5% 18.9x 17.0x 11.8x 9.5x 3.5x 2.9x 20.7% 19.6% 1.1% 1.3% China Brilliance 1114 HK 10,012 Neutral HK$ HK$ % 14.2x 12.6x 13.6x 12.0x 3.7x 2.9x 29.2% 26.0% 1.1% 1.2% BYD 1211 HK 17,580 Buy HK$ HK$ % 56.9x 35.4x 16.7x 13.7x 3.7x 3.4x 6.8% 10.0% 0.0% 0.0% Dongfeng Motor 489 HK 15,853 Buy HK$ HK$ % 7.9x 6.8x 6.8x 5.4x 1.4x 1.2x 18.2% 18.6% 1.9% 2.2% Geely Auto 175 HK 3,373 Buy HK$ 2.97 HK$ % 10.1x 7.8x 6.0x 4.3x 1.1x 1.0x 12.1% 14.0% 1.2% 1.6% Great Wall 2333 HK 12,872 Buy HK$ HK$ % 8.2x 6.4x 1.3x 1.0x 2.2x 1.7x 29.6% 30.2% 3.2% 4.2% GAC 2238 HK 8,005 Buy HK$ 9.59 HK$ % 11.5x 8.9x 3.1x 2.4x 1.3x 1.2x 12.2% 14.2% 2.2% 2.8% ZhengTong Auto 1728 HK 1,297 Buy HK$ 4.55 HK$ % 7.8x 6.3x 6.2x 5.3x 1.0x 0.9x 12.8% 14.1% 2.7% 3.2% Zhongsheng 881 HK 2,831 Neutral HK$ HK$ % 12.8x 10.8x 11.6x 11.0x 1.5x 1.3x 13.6% 13.2% 1.6% 1.9% SAIC CH 27,650 Buy CNY CNY % 6.2x 5.6x 3.4x 3.3x 1.1x 1.0x 15.9% 15.4% 8.6% 9.6% Average 22% 15.1x 11.2x 7.6x 6.5x 1.9x 1.6x 16.7% 17.3% 2.5% 3.0% Median 26% 10.1x 7.8x 6.2x 5.3x 1.4x 1.2x 13.6% 14.2% 1.9% 2.2% Korea Hyundai Motor KS 61,257 Buy KRW 228,000 KRW 280,000 23% 7.5x 6.7x 8.8x 8.6x 1.0x 0.9x 14.2% 13.9% 0.8% 0.8% Kia Motors KS 21,792 Neutral KRW 54,500 KRW 60,000 10% 6.0x 5.4x 5.7x 5.3x 0.9x 0.8x 16.9% 16.0% 1.7% 1.8% Average 16% 6.8x 6.1x 7.2x 6.9x 1.0x 0.8x 15.5% 15.0% 1.3% 1.3% Median 16% 6.8x 6.1x 7.2x 6.9x 1.0x 0.8x 15.5% 15.0% 1.3% 1.3% Japan Nissan 7201 JT 40,680 Neutral JPY 991 JPY 1,000 1% 10.0x 9.3x 9.4x 8.4x 0.9x 0.8x 9.2% 9.4% 3.3% 3.6% Toyota 7203 JT 192,335 Buy JPY 6,201 JPY 8,000 29% 10.6x 9.3x 9.4x 8.0x 1.3x 1.2x 12.4% 13.0% 2.9% 3.4% Mazda 7261 JT 14,433 Buy JPY 493 JPY % 8.4x 8.8x 5.6x 4.7x 1.8x 1.5x 23.6% 18.7% 0.6% 2.0% Daihatsu 7262 JT 7,399 Neutral JPY 1,773 JPY 1,660-6% 10.2x 10.7x 2.8x 2.5x 1.3x 1.2x 12.9% 11.3% 3.2% 3.2% Honda 7267 JT 63,017 Buy JPY 3,570 JPY 4,900 37% 10.3x 9.4x 8.9x 8.0x 1.0x 0.9x 10.1% 10.3% 2.6% 3.0% Suzuki 7269 JT 18,652 Buy JPY 3,395 JPY 3,900 15% 14.9x 13.1x 4.0x 3.3x 1.3x 1.2x 9.2% 9.7% 0.8% 1.0% Fuji Heavy Inds 7270 JT 22,465 Buy JPY 2,939 JPY 3,800 29% 9.8x 9.4x 4.3x 3.8x 2.4x 2.1x 27.2% 23.8% 2.4% 3.1% Yamaha Motors 7272 JT 6,339 Neutral JPY 1,854 JPY 1,800-3% 13.1x 12.1x 7.6x 6.9x 1.5x 1.4x 12.2% 12.1% 1.6% 1.9% Average 17% 10.9x 10.3x 6.5x 5.7x 1.4x 1.3x 14.6% 13.5% 2.2% 2.7% Median 22% 10.3x 9.4x 6.6x 5.8x 1.3x 1.2x 12.3% 11.7% 2.5% 3.0% Source: Bloomberg, Nomura estimates. Bloomberg consensus for not rated companies. Note: For the Japanese stocks, non-automotive debt is included in the calculation of EV. Where the fiscal year does not end in December, "13E" refers to the fiscal year ending in March 2014, and so on; pricing as of 4 July

17 Nomura China autos and auto parts 9 July 2014 Fig. 27: Nomura Global Auto Research peer valuation comparisons (continued) Auto Parts Mkt Cap Current Target Potential P/ E EV / EBITDA P / BV ROE Div Yield Company Ticker ($mn) Rating Price Price Upside 14E 15E 14E 15E 14E 15E 14E 15E 14E 15E US BorgWarner BWA US 15,274 N/R $ N/A N/A 16.9x 14.2x 9.1x 7.5x 3.2x 2.5x 20.0% 19.8% 0.6% 0.5% Goodyear GT US 6,922 N/R $ N/A N/A 8.6x 8.0x 4.3x 3.9x 2.6x 2.0x 34.3% 28.5% 0.8% 0.9% Johnson Controls JCI US 35,206 N/R $ N/A N/A 13.8x 11.8x 9.6x 8.4x 2.5x 2.3x 19.5% 20.3% 1.8% 2.1% Magna International MGA US 24,411 N/R $ N/A N/A 11.4x 9.9x 6.9x 6.3x 2.2x 2.1x 20.6% 21.5% 1.6% 1.6% TRW Automotive TRW US 10,406 N/R $ N/A N/A 10.6x 9.5x 5.6x 5.0x 1.9x 1.5x 19.7% 18.0% N/A N/A Average N/A 12.3x 10.7x 7.1x 6.2x 2.5x 0.8x 22.8% 85.4% 1.2% 1.3% Median N/A 11.4x 9.9x 6.9x 6.3x 2.5x 2.1x 20.0% 6.6% 1.2% 1.2% Europe Autoliv ALV US 10,198 N/R $ N/A N/A 14.9x 13.1x 7.7x 6.7x 2.2x 1.9x 15.6% 15.5% 2.1% 2.3% Continental CON GY 46,489 N/R N/A N/A 11.9x 10.9x 6.0x 5.3x 2.5x 2.3x 23.4% 22.0% 2.1% 2.4% Faurecia EO FP 4,461 N/R N/A N/A 10.5x 7.5x 3.3x 2.7x 1.8x 1.4x 18.0% 20.9% 1.8% 2.3% Michelin ML FP 22,260 N/R N/A N/A 9.9x 9.1x 4.3x 3.8x 1.4x 1.3x 15.3% 15.1% 3.5% 3.9% Valeo FR FP 10,725 N/R N/A N/A 11.9x 10.7x 5.0x 4.5x 2.3x 2.0x 21.2% 20.1% 2.5% 2.7% Average N/A 11.8x 10.3x 5.2x 4.6x 2.1x 0.7x 18.7% 50.6% 2.4% 2.7% Median N/A 11.9x 10.7x 5.0x 4.5x 2.2x 1.9x 18.0% 8.0% 2.1% 2.4% Korea Hyundai Mobis KS 27,144 Buy KRW 281,500 KRW 360,000 28% 7.0x 6.5x 6.5x 5.9x 1.2x 1.0x 17.9% 16.4% 0.7% 0.7% Hankook Tire KS 7,166 Buy KRW 58,400 KRW 74,000 27% 9.0x 8.0x 6.1x 5.0x 1.6x 1.3x 18.6% 17.7% 0.7% 0.8% Mando KS 2,264 Neutral KRW 127,000 KRW 145,000 14% 10.6x 9.3x 5.9x 5.7x 1.2x 1.1x 12.1% 12.5% 0.9% 0.9% Nexen Tire KS 1,471 Neutral KRW 15,400 KRW 15,000-3% 9.3x N/A 6.7x N/A 1.6x N/A 18.0% NA 0.5% 0.0% Average 17% 8.8x 7.6x 6.2x 5.4x 1.4x 1.1x 16.8% 15.9% 0.7% 0.6% Median 20% 9.0x 7.4x 6.1x 5.4x 1.3x 1.1x 17.9% 16.8% 0.7% 0.7% Japan Toyota Boshoku 3116 JT 2,005 Neutral JPY 1,105 JPY 1,050-5% 13.9x 11.6x 3.1x 2.7x 0.9x 0.9x 6.9% 7.9% 2.0% 2.3% Yokohama Rubber 5101 JT 2,872 Neutral JPY 880 JPY 1,100 25% 8.0x 7.7x 4.7x 4.3x 1.1x 1.0x 14.4% 13.4% 2.7% 3.0% Bridgestone 5108 JT 28,546 Neutral JPY 3,724 JPY 4,300 15% 10.3x 9.7x 4.7x 4.3x 1.5x 1.3x 15.5% 14.5% 1.6% 1.7% Sumitomo Rubber Inds 5110 JT 3,821 Neutral JPY 1,487 JPY 1,550 4% 8.3x 7.9x 4.8x 4.4x 1.1x 1.0x 13.5% 12.7% 2.7% 2.8% Unipres Corp 5949 JT 1,116 Buy JPY 2,422 JPY 2,200-9% 11.5x 8.6x 3.4x 3.0x 0.9x 0.8x 8.4% 10.2% 1.2% 1.4% NHK Spring 5991 JT 2,347 Neutral JPY 1,020 JPY 1,200 18% 9.0x 8.4x 3.5x 3.0x 1.0x 1.0x 12.3% 11.9% 2.2% 2.4% Toyota Industries 6201 JT 16,552 Neutral JPY 5,420 JPY 5,300-2% 16.0x 15.0x 9.4x 8.6x 0.9x 0.8x 5.5% 5.6% 1.5% 1.6% GS Yuasa 6674 JT 2,745 Neutral JPY 679 JPY % 17.3x 14.8x 8.9x 7.8x 1.8x 1.7x 11.1% 11.8% 1.5% 1.8% Denso Corp 6902 JT 37,734 Buy JPY 4,805 JPY 5,550 16% 13.8x 12.8x 5.2x 4.5x 1.3x 1.2x 9.9% 10.0% 2.1% 2.3% Stanley Electric 6923 JT 4,481 Neutral JPY 2,696 JPY 2,450-9% 15.0x 13.1x 5.6x 4.8x 1.6x 1.5x 11.2% 11.7% 1.3% 1.5% Musashi Seimitsu 7220 JT 809 Buy JPY 2,649 JPY 3,000 13% 10.6x 9.7x 4.7x 4.2x 1.2x 1.1x 12.1% 11.9% 1.9% 2.1% Nissin Kogyo 7230 JT 1,306 Neutral JPY 2,059 JPY 2,400 17% 10.9x 10.1x 3.4x 2.9x 1.2x 1.1x 11.4% 11.3% 2.2% 2.4% Tachi-S 7239 JT 582 Buy JPY 1,753 JPY 1,800 3% 14.2x 9.0x 5.2x 3.4x 0.9x 0.8x 6.0% 9.4% 0.9% 1.1% NOK Corp 7240 JT 3,547 Neutral JPY 2,116 JPY 2,000-5% 12.4x 11.3x 4.6x 4.0x 1.0x 0.9x 8.5% 8.7% 1.2% 1.4% Keihin Corp 7251 JT 1,187 Neutral JPY 1,639 JPY 1,700 4% 9.9x 9.3x 2.6x 2.2x 0.7x 0.7x 7.8% 7.8% 2.1% 2.3% Aisin Seiki 7259 JT 11,124 Buy JPY 4,030 JPY 4,800 19% 11.8x 10.7x 3.1x 2.8x 1.1x 1.0x 9.3% 9.6% 2.5% 2.7% Koito Mfg 7276 JT 4,248 Neutral JPY 2,699 JPY 2,600-4% 14.4x 12.9x 4.7x 4.0x 1.8x 1.6x 13.0% 13.0% 1.3% 1.5% Exedy Corp 7278 JT 1,457 Buy JPY 3,090 JPY 3,200 4% 12.5x 11.4x 4.2x 3.8x 1.0x 0.9x 7.9% 8.2% 2.4% 2.6% Toyoda Gosei 7282 JT 2,703 Neutral JPY 2,133 JPY 2,100-2% 11.7x 11.1x 3.1x 2.9x 0.9x 0.9x 8.2% 8.2% 2.6% 2.7% Nifco 7988 JT 1,788 Buy JPY 3,455 JPY 3,400-2% 15.2x 13.1x 6.6x 5.7x 1.6x 1.5x 10.9% 11.7% 2.0% 2.5% F.C.C. Co. Ltd JT 959 Neutral JPY 1,951 JPY 2,000 3% 10.5x 9.9x 3.6x 3.4x 0.9x 0.8x 8.9% 8.8% 2.2% 2.3% Takata Corp 7312 JT 1,808 Neutral JPY 2,220 JPY 2,450 10% 9.5x 8.2x 3.5x 2.9x 1.0x 0.9x 10.6% 11.2% 1.6% 1.8% TS Tech Co 7313 JT 2,094 Buy JPY 3,145 JPY 3,100-1% 8.9x 8.4x 2.5x 2.1x 1.2x 1.1x 14.9% 14.0% 2.1% 2.2% Average 4% 12.0x 10.6x 4.6x 4.0x 1.2x 1.1x 10.4% 10.6% 1.9% 2.1% Median 3% 11.7x 10.1x 4.6x 3.8x 1.1x 1.0x 10.6% 11.2% 2.0% 2.3% Hong Kong Johnson Electric 179 HK 3,297 Neutral HKD 7.14 HKD % 15.2x 14.2x 8.8x 7.9x 1.7x 1.6x 12.0% 11.7% 1.7% 2.0% Minth Group 425 HK 2,194 Buy HKD HKD % 12.2x 10.5x 8.9x 7.7x 1.6x 1.5x 14.3% 15.1% 3.3% 3.8% Nexteer 1316 HK 1,769 Buy HKD 5.49 HKD % 10.9x 8.6x 5.6x 4.7x 2.0x 1.7x 19.6% 21.1% 1.8% 2.3% Average 18% 12.7x 11.1x 7.8x 6.8x 1.8x 1.6x 15.3% 16.0% 2.3% 2.7% Median 20% 12.2x 10.5x 8.8x 7.7x 1.7x 1.6x 14.3% 15.1% 1.8% 2.3% Taiwan Cheng Shin Rubber 2105 TT 8,232 Neutral TWD 76 TWD 92 21% 12.1x 11.3x 7.5x 6.9x 2.8x 2.4x 24.2% 22.7% 3.4% 3.6% Indonesia Astra International ASII IJ 25,448 N/R IDR 7,350 N/A N/A 12.4x 11.3x 10.5x 9.5x 2.7x 2.4x 23.4% 22.7% 3.5% 3.8% Indomobil Sukses International IMAS IJ 1,159 N/R IDR 4,900 N/A N/A 11.7x 10.3x 13.8x 11.6x 1.8x 1.6x 16.4% 16.4% 1.3% 2.4% Average N/A 12.1x 10.8x 12.1x 10.6x 2.3x 2.0x 19.9% 19.5% 2.4% 3.1% Median N/A 12.1x 10.8x 12.1x 10.6x 2.3x 2.0x 19.9% 19.5% 2.4% 3.1% Source: Bloomberg, Nomura estimates. Bloomberg consensus for not rated companies. Note: For the Japanese stocks, non-automotive debt is included in the calculation of EV. Where the fiscal year does not end in December, "13E" refers to the fiscal year ending in March 2014, and so on; for Johnson Electric, "14E" refers to the fiscal year ending in March 2015, and so on; pricing as of 4 July

18 Nomura China autos and auto parts 9 July 2014 Investment risks New car sales restrictions potentially more cities in 2H14F and 2015F but share price impact increasingly limited Currently, Beijing, Shanghai, Guangzhou, Tianjin and Guiyang have new car sales restrictions in place through a quota and/or bidding system for new car licence plates. Considering the government s focus on air pollution issues, along with increasing traffic congestion, we believe the risk of more cities adopting new car sales restriction has risen, which may pose downside risks to China s new car sales. The latest city to adopt new car sales restrictions has been Tianjin. According to a notice issued by the city government on 15 December, Tianjin will restrict traffic and issue new car license plates via bidding and lottery in a drive to fight traffic jams and air pollution. The city started to impose the quota on its new car plates on 16 December, requiring buyers to join the lottery or bid in auctions to win a plate. The notice did not give details on the quota or how many plates will go for lottery compared with auction. More details will be separately announced later. Measures suggested in the past include restricting the number of vehicles per household, limiting auto penetration growth, or reducing licence registration through a lottery system. Tianjin will also follow Beijing's step in adopting a similar traffic restriction scheme, which blocks cars from streets depending on the last digit of their plates, with two numbers banned each workday, said Miao Hongwei, head of the city s traffic management bureau. The ban has taken effect since 1 March Moreover, the city has also banned vehicles with non-local plates from driving into the city's outer ring road during morning and evening rush hours on workdays, Miao said. According to the MEP (Ministry of Environmental Protection), 34 of 74 major cities in China did not qualify under the MEP s AQI (Air Quality Index) survey in October We notice that within these 34 cities, most are tier-one and tier-two cities, and concentrated around the Hebei Province. Fig. 28: List of cities selected in EV program and their air quality status Most polluted Most polluted city city rank City name Total (units) rank City Total (units) 13 Beijing 北 京 35,020 Xiangyang 襄 阳 5,000 Shenzhen 深 圳 35, Taiyuan* 太 原 5,000 6 Tianjin 天 津 12,000 Jincheng* 晋 城 5, Xi an 西 安 11,000 Ningbo* 宁 波 5, Wuhan 武 汉 10,500 Zhangzhutan* 长 株 潭 5, Shanghai 上 海 10,000 Haikou* 海 口 5,000 Guangzhou 广 州 10, Chengdu* 成 都 5, Chongqing 重 庆 10,000 Kunming* 昆 明 5,000 9 Zhengzhou 郑 州 5,500 8 Lanzhou* 兰 州 5, Qingdao 青 岛 5,200 1, 2, 3, 5, 7, 10, Hebei 15, 20, 27 河 北 省 城 市 群 13,141 Guanhu 莞 湖 5,100 31, 34 Zhejiang 浙 江 省 城 市 群 10,100 Dalian 大 连 5,000 Fujian 福 建 省 城 市 群 10,000 Hefei 合 肥 5, Jiangxi 江 西 省 城 市 群 5,000 Xinxiang 新 乡 5,000 Guangdong 广 东 省 城 市 群 10,000 Total EV 257,561 Note: Ranked in order of most polluted city in China. Source: d1ev, MEP, Nomura research Tianjin accounted for 2% of China s total new car sales in Back in July 2013, the China Association of Automobile Manufacturers (CAAM) reported that there might be more cities in China planning to curb auto purchases to fight pollution and congestion, highlighting eight possibilities -- Tianjin, Chengdu, Chongqing, Hangzhou, Qingdao, Shenzhen, Shijiazhuang and Wuhan. We estimate that these eight cities account for 11% of China s total new car sales, and if we assume a 30% cut in sales in these cities (based on past experience), China s total new car sales could be reduced by 3.3%. 18

19 Nomura China autos and auto parts 9 July 2014 Over the next few months, we believe that the market will continue to anticipate and price in similar restrictions spreading into more cities (especially in Tier-1 and 2 cities in northern China where air pollution is more severe), thereby capping the valuation upside for the sector in the near-term at or below its long-term average of 10x P/E. Fig. 29: China PV sales volume by province Shandong 9% Chongqing 2% Jiangsu 8% Fujian 2% Guangdong 8% Guangxi 2% Zhejiang 7% Heilongjiang 2% Hebei 6% Inner Mongolia 2% Henan 5% Jiangxi 2% Beijing 4% Jilin 2% Sichuan 4% Tianjin 2% Anhui 3% Xinjiang 2% Hubei 3% Yunnan 2% Hunan 3% Gansu <1% Liaoning 3% Guizhou <1% Shaanxi 3% Hainan <1% Shanghai 3% Ningxia <1% Shanxi 3% Qinghai <1% Tibet <1% Source: China Auto Market, Nomura research Investors are aware of the possibility of more cities imposing new car sales restrictions based on our survey among investors. However, we believe the market might start to anticipate similar restrictions spreading into more cities (especially tier-one and tier-two cities in northern China, where air pollution is more severe), thereby creating an overhang on auto share prices in the very near term, i.e., the industry risk has risen. The impact to actual sales volume of OEMs and dealers should be manageable, since their sales efforts have been focusing on lower-tier cities where restriction possibility is much lower. In the near- term, new car sales might actually benefit from the bringing forward of demand from buyers on worries over likely more restrictions later. However, sales momentum might taper off during 2Q14F and through summer months, which also coincided with the industry s slow season. More extreme anti-corruption measures likely We have been cautious on the near- to medium-term sales outlook for the high-end luxury segment (see our last anchor report dated 30 July, 2013, Fork in the road), owing to the anti-corruption measures taken by China s new leadership. China's anti-waste battle started in December 2012, when the new leadership pledged to improve the Party work style and to end extravagance and bureaucracy. In June 2013, China's leaders launched a one-year "mass-line" campaign to boost ties between the Communist Party of China (CPC) members and the people, while cleaning up the undesirable work styles characterised by formalism, bureaucracy, hedonism and extravagance. We believe this initiative has legs and will likely persist into 2014F. Recently, on 25 November 2013, Chinese authorities announced that they will cancel all official cars for general use and only keep "necessary" official vehicles for law enforcement, confidential communications, emergency services and other uses under stipulation. The move comes as part of the latest written regulations to standardise fund management and ban Party and government extravagance. It regulated that general official travel will be carried out through public transportation, and officials may receive transportation subsidies. The regulation, issued by the CPC Central Committee and the State Council, China's cabinet, outlined the proper management of funds for various uses, including official travel, receptions, meetings and buildings. It is meant to guide the Party and government organs in practicing frugality and rejecting extravagance, and is 19

20 Nomura China autos and auto parts 9 July 2014 an important move in the spirit of the recently concluded Third Plenary Session of the 18th CPC Central Committee. Institutions have also been ordered to be transparent in their spending and publicise in detail their use of funds, assets and public resources, except in cases that involve national secrets. However, the November regulation is the first time the rules were issued as a legal document in order to rein in power and kill extravagance at its root. Do note that government purchases of vehicles should account for approximately 1% of total new car sales, based on industry estimates. Moreover, since we have already been cautious on our outlook on high-end luxury car sales, any further downside risks to our forecasts will come from further stringent anti-waste measures than we have already been anticipating. Potential impact of Sino-Japan tensions The controversial visit to the Yasukuni Shrine by Japanese Prime Minister Shinzo Abe on 26 December has renewed the geopolitical tensions between China and Japan. Given concerns over a possible disruption to Japanese brands auto sales, share prices of Dongfeng and GAC, the two major local JV partners for Japanese brands, both declined 4% in subsequent two trading days. Among the two, Dongfeng is the one with a relatively smaller exposure to Japanese brands thanks to its JV with PSA (UG FP) and larger commercial vehicle contribution (see figure below), although we would recommend GAC as the recovery play should tensions begin to fade. On the other hand, if the tensions worsen, we believe Great Wall Motor could be the biggest beneficiary. Fig. 30: Dongfeng s (LHS) and GAC s (RHS) sales volume breakdown, 5M14 Others 15% GAMC 13% Others 4% CV 15% DF Honda 11% DF Nissan 34% DF PSA 25% GAC Fiat 7% GAC Mitsubishi 5% GAC Toyota 36% GAC Honda 35% Source: Companies, Nomura research Looking back, the impact of previous political disputes on Japanese brands sales volume has been short-lived. Practical values such as quality, design, durability, and value-for-money remain the most influential factors in the decision-making process. Once the political tensions faded, Japanese brands sales volume typically managed to recover within a year. The latest example has been this year s recovery after the anti- Japan protests in September 2012 over disputed islands. 20