Oversold, strong earnings growth intact

Transcription

1 Deutsche Bank Markets Research Asia China Automobiles & Components Industry Chinese Auto Dealers Date 13 February 214 Forecast Change Oversold, strong earnings growth intact Market concern overdone, after-sales to drive growth; top pick Baoxin The share prices of Chinese auto dealership groups under DB coverage have dropped by 13-23% from their October 213 peak vs. HSCEI's 6% decline during the period. We reckon the underperformance is probably attributable to 1) the lack of a meaningful new car sales margin recovery in FY13E and 2) worries over short-term borrowing costs. Nonetheless, as we believe that the ever-increasing after-sales business contribution will still lead to strong sector earnings growth (FY13-15E CAGR of 26%), we see share price weakness as an opportunity to buy. Baoxin is our top pick. New car sales volume growth remains decent but margin recovery lacking Chinese auto dealers enjoyed a better 213 than 212, with improved auto consumption sentiment, particularly in the premium segment. However, as manufacturers have increased production amid a better market environment, there was a limited pricing rebound for car models and hence we do not expect much margin recovery in the foreseeable future. That being said, we think that premium new car sales growth will remain strong (15-2% growth in 214E) with more key new launches such as the BMW X5 SUV and Benz C Class sedan, eventually benefiting the after-sales service business. Regarding concerns around borrowing costs, dealers we met with said they could avoid SHIBOR volatility by using more short-term bank borrowing credit lines. After-sales still room to generate a greater income stream Besides striving to retain new car customers for accessories sales and future repair maintenance, the dealers we met recently are also aggressive in the following initiatives: 1) teaming up with insurance companies to become the suggested accident repair centers, 2) seeking insurance renewal services besides just helping customers find first-time insurance, and 3) enlarging the used car business amid increasing replacement demand. In the medium term, some dealership groups will also launch bigger non-brand-specific repair centers, as well as introducing operating leasing business. All in all, this should ensure exponential growth in after-sales business income (some being other income in P&L), in our view. FY13-15E earnings slightly trimmed; Baoxin still our top pick We have trimmed our FY13-15 forecasts for auto dealers in general on lower new car sales margin estimates. Our revised forecasts are slightly below consensus and we do not envision substantial consensus earnings downgrades in the near future. We use a DCF analysis to derive our target prices for dealers. Baoxin remains our top pick with a target price of HKD9.6, implying an FY14E P/E of 12.2x. We are optimistic that the company will be able to turn around the NCGA business (acquired in 212), which will contribute significant after-sales revenue. We maintain Buy on Zhongsheng with a target price of HKD13.5, implying an FY14E P/E of 16.2x, as we believe Zhongsheng s Japanese car business will recover further, while Benz s new product launches will further enhance its growth outlook. We also rate Zhengtong a Buy with a target price of HKD6.2, implying an FY14E P/E of 9.1x, mainly on attractive valuation and improving performance at its SCAS stores. Key sector risks: auto sales demand weakening, pricing weakness, and a decline in customer retention rates. Vincent Ha, CFA Fei Sun Research Analyst Research Associate (+852) (+852) vincent.ha@db.com fei.sun@db.com Key Changes Company Target Price Rating 881.HK 15.6 to (HKD) 1293.HK 1. to - 9.6(HKD) 1728.HK 6.5 to 6.2(HKD) - Source: Deutsche Bank Top picks Baoxin Auto Group (1293.HK),HKD6.66 Source: Deutsche Bank Companies Featured Buy Baoxin Auto Group (1293.HK),HKD6.66 Buy 212A 213E 214E P/E (x) EV/EBITDA (x) Price/book (x) Zhengtong Auto Services Buy (1728.HK),HKD A 213E 214E P/E (x) EV/EBITDA (x) Price/book (x) Zhongsheng Group (881.HK),HKD11.82 Buy 212A 213E 214E P/E (x) EV/EBITDA (x) Price/book (x) Source: Deutsche Bank The report changes target prices and estimates for several companies under our coverage. For a detailed listing of the changes, see Figure 14 on Page 1. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 54/4/213.

2 Robust new car business to drive after-sales Stable pricing amid decent demand and un-stretched inventory Sales of passenger vehicles, especially premium cars, in China stayed robust in 213. Despite a slow start for premium car sales in 1Q13, probably due to pullforward demand in 2H12 with aggressive price discounts to push sales, sales of premium brands have picked up since 2Q13 with the return of upgrade demand and availability of more new models. To elaborate, Germany s three major premium brands (Audi, BMW and Mercedes Benz) recorded 18.4% YoY sales growth in China in 213 vs. 15.7% for passenger vehicles as a whole. In addition to the strong demand, inventory levels at Chinese dealers also improved during most of 213. According to the China Automobile Dealers Association (CADA), auto dealers inventory in general eased to a healthy level of less than 1.5 months in 2H13, with a blended inventory level of merely one month as at December 213. We believe that the healthy inventory is attributable to a combination of buoyant auto demand and more disciplined production planning by OEMs (vs. 212). Without excessive inventory levels, selling prices of many popular car models appear to be relatively stable, with the exception of some retiring models (e.g. Mercedes Benz old generation S Class and pre-facelift E Class). We are less concerned about year-end price promotions as it has been a typical practice for dealers to clear up the older inventories and meet/beat OEMs assigned sales targets to get the OEM bonus. According to our channel checks in January, retail discounts on some popular models indeed narrowed at the beginning of the year as dealers attempted to monetize the strong pre-chinese New Year demand. Yet with only a stable price trend, we do not expect any meaningful new car sales margin enhancement in 2H13. Figure 1: China sales of Audi, BMW and Benz (Units) (YoY%) 1, 8, 6, 4, 2, Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 14% 12% 1% 8% 6% 4% 2% % -2% Figure 2: China auto dealers inventory index (x) May-12 JV brands Imports Local brands Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Source: Company data, Deutsche Bank Source: China Automobile Dealers Association (CADA) Page 2

3 Figure 3: China auto price index Figure 4: China retail prices of some premium cars (RMB ') Luxury All cars Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 *MSRP - Manufacturer's suggested retail price Aug-13 Oct-13 Dec-13 Benz S3L Business (MSRP* RMB93,) Audi Q5 2 TFSI Comfort (MSRP* RMB481,9) BMW 525Li Advance (MSRP* RMB466,6) Benz E26L CGI Classic MSRP* RMB438,) Audi A4L 3 TFSI Comfort (MSRP* RMB291,) Source: Cheshi.com Source: Company data, Deutsche Bank New car sales to stay robust, but unlikely to drive earnings For upcoming years, we remain bullish on China s luxury car sales growth. In brief, we think that demand growth for premium cars will remain at about 15-2% YoY in E, above overall market growth of about 1%. This is more or less in line with major premium auto brands target growth. We think that such demand will be driven by: Overall improvements in the macroeconomic environment; An increasing share of replacement within annual Chinese auto sales, partially stimulated by the possible implementation of purchase restrictions in more cities; Launches of numerous major new premium brand models (e.g. BMW X5 SUVs); The introduction of more entry-level premium brand models, such as the Audi A3 sedan and Mercedes Benz A Class sedan, to address a wider audience base. The solid demand for premium cars bodes well for the Chinese auto dealership groups under our coverage, as they are more focused on premium car sales and hence should register solid new car sales growth. Figure 5: Examples of premium auto brands upcoming new models in China Brand New models Audi A3 Sportback and A3 sedan BMW X5 SUV Mercedes Benz C Class sedan, CLA Class sedan and GLA Class SUV Source: Company data, Deutsche Bank Page 3

4 Figure 6: Chinese auto dealers new car sales volume YoY growth Baoxin Zhengtong Zhongsheng 8% 7% 6% 5% 4% 3% 2% 1% % E 214E 215E Figure 7: Chinese auto dealers new car sales revenue YoY growth Baoxin Zhengtong Zhongsheng 1% 8% 6% 4% 2% % E 214E 215E Source: Company data, Deutsche Bank estimates Source: Company data, Deutsche Bank estimates That being said, since we envision a balanced demand-supply environment for premium auto brands, with limited pricing upside going forward, we think that new car business gross profit margin is unlikely to improve from the current levels. Together with the interest expense for funding the inventory, we do not think that new car business will help drive dealers earnings much in future. Figure 8: Chinese auto dealers new car sales gross profit margin trend 9% Baoxin Zhengtong Zhongsheng 8% 7% 6% 5% 4% 3% E 214E 215E Source: Company data, Deutsche Bank estimates Recent short-term interest rate hike unlikely to have much impact At the beginning of 214, there was a spike in SHIBOR (the Shanghai Interbank Overnight Borrowing Rate). Since dealers regularly use notes payables to fund their inventory, and notes payables cost is based on SHIBOR, there have been market concerns about an unfavorable jump in dealers borrowing costs. When we approached various dealership groups about this topic, they did acknowledge their usage of notes payables and the SHIBOR hike issue. Nevertheless, they are not too concerned given that there is some flexibility in their short-term financing arrangements. To elaborate, they can also opt to use certain banks revolving credit lines, which are usually based on the less Page 4

5 volatile PBOC (People s Bank of China) rate plus a premium, and/or adopt manufacturers financing, which may carry some favorable terms such as zero interest for the first month. Figure 9: China 1-month SHIBOR vs. 1-month PBOC rate (%) Jan-12 Feb-12 PBOC 1-month bill yield (%) SHIBOR 1-month rate 5-day average (%) Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Source: Bloomberg Finance LP Page 5

6 After-sales business expansion is the key The obvious driver is the increasing auto population All three Chinese auto dealership groups under our coverage have put great emphasis on rapidly growing their after-sales businesses in order to increase the profit contribution from that segment in the upcoming years. After all, after-sales businesses, especially repair and maintenance, are less affected by macroeconomic conditions, especially considering China s expanding vehicle population, which is also aging at the same time. Furthermore, with the even faster enlargement of China s premium auto fleet (given exponential growth in premium car sales), after-sales service demand for this segment should grow even more, as proven by the increase in spare part sales of OEMs such as Brilliance BMW. Figure 1: China number of registered passenger cars (' units) YoY % 1, CAGR: 22.2% 3% 8, 25% 6, 2% 15% 4, 1% 2, 5% % Figure 11: Chinese auto dealers after-sales business revenue growth Baoxin Zhengtong Zhongsheng 14% 12% 1% 8% 6% 4% 2% % E 214E 215E Source: CEIC Source: Company data, Deutsche Bank estimates Profit contribution to further rise with decent margins After recently talking to the dealership groups under our coverage, it seems to us that there has been no derailing of growth in after-sales revenue or deterioration in gross margins in these businesses since 1H13 results. To elaborate, dealers are exploring incremental income streams such as promoting insurance renewal to after-sales service customers and teaming up with insurance companies as the designated accident repair provider. Indeed, accident repair is considered one of the higher-margin after-sales businesses. Apart from that, with increasing upgrade demand dealers also see more opportunities in used car sales. As the average age of 4S stores is still young for the dealership groups under our coverage, we believe that there is still plenty of room to grow the size of their after-sales businesses revenue and gross profit contributions. Furthermore, these dealership groups are going to open more new stores in the next couple of years, thus providing longer-term revenue and earnings Page 6

7 growth support beyond 215E. In addition, these groups are still going to explore more after-sales business concepts, such as setting up mega nonbrand maintenance outlets and introducing operating leases. Regarding profitability, we prudently expect the gross profit margin for aftersales services to be on a mild downtrend, given increasing competition among stores and less contribution from high-margin accessory sales. Nonetheless, by no means are we concerned that after-sales margin will deteriorate much since we believe that Mainland Chinese will still prefer to visit 4S stores for major and high-margin repair and maintenance considering their trustworthiness. All in all, with further increases in after-sales business contributions, Chinese auto dealership groups earnings growth should be smooth in the long run compared to the volatility seen in the previous few years due to new car margin fluctuations. Figure 12: Chinese auto dealers after-sales business gross profit contribution percentage Baoxin Zhengtong Zhongsheng 7% 6% 5% 4% 3% 2% E 214E 215E Figure 13: Chinese auto dealers after-sales business gross profit margin trend Baoxin Zhengtong Zhongsheng 51% 49% 47% 45% 43% 41% 39% 37% 35% E 214E 215E Source: Company data, Deutsche Bank estimates Source: Company data, Deutsche Bank estimates Page 7

8 Key takeaways from recent channel checks Baoxin Baoxin s management expects a stable overall new car sales margin in 2H13 on a HoH basis. While the company noticed a slight decline in 2H13 blended ASP due to a product mix shift towards more domestically produced premium models (e.g. Brilliance BMW 3 and 5 series sedans), Baoxin faced less pressure on price discounts vs. peers probably because it consistently monitors and manages inventory at an optimal level, thus avoiding excessive margin pressure. For 214, Baoxin aims to expand its 4S store network by adding about S stores with brand exposure mainly to Jaguar Land-Rover (JLR), BMW, Volvo, Maserati and Audi. Regarding after-sales business, management expects a stable gross margin in 214E with revenue growth of 3-4% YoY by increasing after-sales throughput and average customer spending. The integration of Yanjun (NCGA) stores has been progressing smoothly. SG&A and finance costs now account for roughly % of total revenue for the Yanjun stores, compared with over 12% before the acquisition. In addition, Baoxin is confident of further lowering this ratio in the coming years. Zhengtong With only three new 4S stores opened in 213, management explained that volume growth was mainly driven by same-store sales growth. With over 9% of Zhengtong s revenue already coming from premium brands, the company will continue to focus on premium auto brands, in particular BMW, JLR, Audi and Volvo. Apart from that, Zhengtong opened a Mercedes Benz 4S store in Shenzhen last year and management commented that sales momentum at that store has been strong. In 2H13, Zhengtong attained a relatively stable overall new car sales margin on a HoH basis, despite the retail price staying more or less soft as in 1H13. For 214E, management expects about 15-2% growth in new car sales volume, to be driven by both same-store sales and network expansion. In brief, the company targets about 15 new 4S stores in 214E, mainly in second- and third-tier cities with brand exposure including BMW, JLR, Volvo, Porsche and Mercedes Benz. Furthermore, Zhengtong is qualified as Volvo s strategic partner with the brand's authorization to add about 2 new stores in the next three years. Zhengtong believes that the earnings contribution from after-sales service business will continue to increase, since such business will continue to expand at a fast pace amid a widening customer base, with sustainably high gross margin. Page 8

9 Zhongsheng Looking back on 2H13, the company observed healthy inventory levels and narrowed retail price discounts in general for its auto brand portfolio. Moreover, most Japanese brands' new car sales and margins have recovered to normal levels. All in all, Zhongsheng expects 2H13 margins to remain stable HoH, given an increase in retail discount in 3Q13 followed by pricing improvement in 4Q13. For 214, Zhongsheng aims to expand its 4S store network by about 15-2 new stores via organic growth. The new stores, to be located in second- and third-tier cities, will sell luxury brand cars. Management is optimistic on the sales performance of Mercedes Benz due to a strong model portfolio. To elaborate, the facelift E-class, GLK and the new generation S-class have been well received by customers, while the new generation C-class will be launched this year. Although Zhongsheng acknowledged the concerns about Sino- Japanese relationships going forward, the company does not expect the extremely suppressed sales situation in 212 to recur. It is also upbeat on its Porsche outlets with the launch of the new Macan SUV. Zhongsheng s after-sales business continues to grow rapidly amid an expanding customer base and prime store locations, according to the company. Going forward, management appears confident of maintaining stable gross margins for this business with revenue growth possibly staying at around 3% on further maturing of the 4S stores. Page 9

10 Forecast changes, stock implications and risks Cutting FY13-15E forecasts for dealership groups After recent channel checks, we become more prudent on dealership groups ongoing new car sales margin trend. As such, we mildly trim our FY13 net profit forecast for the companies under our coverage by up to 3%. We also cut our FY14-15 net profit forecasts for Baoxin and Zhengtong by up to 7% on more prudent overall margin assumptions due to a pick-up in new store openings and the consequent drag on initial margins. For Zhongsheng, we increase our FY14-15 net profit forecasts by 3-4%, despite more prudent gross profit margin assumptions, given a lower finance cost estimate after the cash injection by Jardine Strategic (JSH.SI, Not Rated). That being said, we have cut our FY14-15 fully diluted EPS forecasts by 14% considering the new share and convertible bond issuance. Figure 14: Chinese auto dealership groups summary of forecast and target price changes Stock Ticker Rating New TP Up/down Old TP New net profit (RMBm) Old net profit (RMBm) (HKD) -side (HKD) 213E 214E 215E 213E 214E 215E Baoxin 1293.HK Buy % 1. 1,135 1,569 2,2 1,159 1,63 2,147 Zhengtong 1728.HK Buy % ,152 1, ,168 1,425 Zhongsheng 881.HK Buy % ,117 1,483 1,97 1,122 1,446 1,84 Note: Share price as of 12-Feb-214 Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Our forecasts are in general lower than consensus (except for Zhengtong in FY14E), probably due to our more prudent stance on the pace of store expansion and margin trends. However, since the gap between our numbers and consensus has narrowed significantly over the past year, we no longer expect much earnings downgrade risk as we did before. In other words, we think that dealership groups share prices should find better near-term support. Figure 15: DB s FY13-14 net profit forecasts vs. consensus for Chinese auto dealers (RMBm) Baoxin Zhengtong Zhongsheng DB FY13E net profit 1, ,117 Consensus FY13E net profit* 1, ,138 Difference -6% % -2% DB FY14E net profit 1,569 1,152 1,483 Consensus FY14E net profit* 1,627 1,119 1,587 Difference -4% 3% -7% Note*: Average net profit forecast after their latest financial results Source: Bloomberg Finance LP, Deutsche Bank estimates Page 1

11 Figure 16: US and China/Hong Kong auto dealer groups valuation comparison (as of 12 February 214) Name Ticker DB Rating USA TP Price Mkt cap PE (x) EPS growth (%) P/BV (x) EV/EBITDA (x) ROE (%) (Local $) (Local $) (USDm) 213E 214E 213E 214E 213E 214E 213E 214E 213E 214E AutoNation AN.N Hold , CarMax* KMX.N Hold , Asbury ABG.N Hold , Lithia LAD.N NR NA , Group1 GPI.N NR NA , Sonic SAH.N NR NA , Penske PAG.N NR NA , Unweighted average China/Hong Kong Pang Da SS NR NA , Baoxin Auto 1293.HK Buy , Zhengtong Auto 1728.HK Buy , Zhongsheng Auto 881.HK Buy , Dah Chong Hong 1828.HK NR NA , Yongda Motor 3669.HK NR NA , Unweighted average Note: * Fiscal years ended February 213, 214 are referenced instead. Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Stock picks, valuation and risks Baoxin Buy (target price cut to HKD9.6 from HKD1.) Baoxin s shares have underperformed the other two dealership stocks under coverage for the past three months, probably due to 1) some profit taking after a significant share price rebound from the 212 share price trough, 2) worries over its BMW sales growth as it already commands a sizable market share, and 3) a surge in gearing after the Yanjun acquisition. However, we are still upbeat on Baoxin s forward looking development. The company delivered impressive 53.5% YoY net profit growth in 1H13 on the successful integration of the Yanjun business and rapid growth in the aftersales service contribution. Going forward, we are still optimistic about Baoxin s capability to deliver strong earnings growth in FY14-15E, with continual margin enhancement at Yanjun and increasing earnings contributions from the highmargin JLR stores, which also helps to diversify Baoxin s income stream. Moreover, the incremental after-sales income from the mature Yanjun stores will provide addition cash inflow to ease Baoxin s gearing in FY14-15E. Given that Baoxin is trading at FY14E P/E of only 8x, with significant earnings growth potential, it is our top pick in the dealership segment. We use a DCF analysis to derive our target price for Baoxin (based on a WACC of 1.5% and terminal growth of 1%, reflecting our prudent expectation of a mature industry growth rate). Our target price of HKD9.6 implies a FY14E P/E of 12.2x, or about a 1% premium to the US auto dealer groups 11x mid-cycle forward P/E valuation. We think this premium is justified as we expect Baoxin to deliver an exponential 33% FY13-15 two-year EPS CAGR vs. lower growth for its US peers in general. In addition, the implied target FY14E P/BV of 3.2x does not appear to be stretched, with about 3% sustainable ROE. Page 11

12 Key company-specific downside risks include 1) execution risk for the integration of Yanjun s network, 2) its high sales dependence on BMW and JLR, and 3) a weaker-than-expected gross margin for luxury new car sales in 2H13-FY15E. Figure 17: Baoxin DCF analysis summary NPV of free cash flow 21,447 Less FY14E net debt (2,195) Add associates, investment 5 Less minorities (14) Equity value 19,198 Equity value (HKD/share) 9.6 Cost of capital assumptions Cost of equity 12.7% Risk-free rate 4.3% Market risk premium 5.6% Beta 1.5 After-tax cost of debt 5.3% Target debt/(debt+equity) 3.% WACC 1.5% Source: Deutsche Bank estimates Figure 18: Baoxin rolling forward P/E band PE Mean Mean - SD Mean + SD Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 EPS growth % CY12 CY13E CY14E 4% 57% 38% Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Zhengtong Buy (target price cut to HKD6.2 from HKD6.5) We have a Buy rating on Zhengtong because 1) its four core brands, BMW, Audi, JLR and Volvo, appear to have decent prospects on the ramp-up of recent launches and upcoming new launches, 2) its finance cost is now lower following its successful bond issuance, and 3) it is the cheapest Chinese auto dealership group under our coverage. Moreover, Zhengtong has more than 4% of its stores in second- and third-tier cities, where luxury car penetration is low and competition is less intense vs. coastal areas. As we expect auto sales growth to be robust in second- and third-tier regions with less constraints on road infrastructure, the company should continue to exhibit strong new car sales and after-sales growth when its stores further mature. We carry out a DCF analysis to derive our target price for Zhengtong (based on a WACC of 1.9% and terminal growth of 1%, based on the long-term dealer growth rates under mature market conditions, which we believe is prudent). Our target price of HKD6.2 implies a FY14E P/E of 9.1x, lower than the US auto dealer group s 11x mid-cycle forward P/E valuation. Even though the market tends to apply a valuation discount to Zhengtong due to its higher funding costs and relatively more frequent management changes in the past few year, we think that our valuation target is prudent enough, as we expect Zhengtong to deliver a respectable 26% FY13-15 two-year EPS CAGR, vs. slower growth for its US peers in general. On a forward P/BV basis, the implied target average FY14E P/BV of 1.2x does not appear to be stretched, in our view, with about 15% sustainable ROE. Key company-specific downside risks include 1) a failure to fully integrate SCAS s network and streamline costs, and 2) a weaker-than-expected gross profit margin from new car sales. Page 12

13 Figure 19: Zhengtong DCF analysis summary NPV of free cash flow 12,338 less FY13E net debt (1,697) Add associates, investment 174 Less minorities (176) Equity value 1,64 Equity value (HKD/share) 6.2 Cost of capital assumptions Cost of equity 12.7% Risk-free rate 4.3% Market risk premium 5.6% Beta 1.5 After-tax cost of debt 6.6% Target debt/(debt+equity) 3.% WACC 1.9% Source: Deutsche Bank estimates Figure 2: Zhengtong rolling forward P/E band PE Mean Mean -1 SD Mean + 1 SD Dec-1 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 EPS growth % CY11 CY12 CY13E CY14E 4% 9% 45% 32% Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Zhongsheng Buy (target price cut to HKD13.5 from HKD15.6) With the continuing Japanese auto brand sales recovery from the 4Q12 trough with a decent demand surge in 4Q13, and the Chinese sales uptick at Mercedes Benz amid more new model launches, we foresee an improving YoY sales performance at Zhongsheng in FY14E and a subsequent enhancement of the after-sales business outlook beyond FY14E. On 19 January, Zhongsheng announced that the company would issue 238.6m new shares to Jardine Strategic at HKD1.8/share. In addition, Zhongsheng also plans to issue a HKD3.9bn three-year convertible bond (with coupon rate of 2.85% and conversion price of HKD12.96) to Jardine Strategic, pending minority shareholders approval. Total net proceeds for the two transactions will be about HKD5.6bn and Zhongsheng will use the money for expansion and working capital need. If both transactions are successful and if Jardine Strategic converts the CB, it will hold 2% of Zhongsheng s enlarged number of shares. We think that the transaction could be a strategic positive since Jardine Strategic has experience in running dealerships in Asia, including China, and this experience can add value to Zhongsheng s operations in the long run. In addition, Zhongsheng s net gearing will be lower after Jardine Strategic s cash injection. Considering the upbeat outlook, we maintain our Buy recommendation. That being said, investors should note that the stock has the least share price upside potential when compared with the other two dealership groups under our coverage following the rally YTD. We use a DCF analysis to derive our target price for Zhongsheng (applying a WACC of 9.6% and terminal growth of 1%, based on long-term dealer growth expectations in a mature market). Our target price of HKD13.5 implies a FY14E P/E of 16.2x, at about a 47% premium to the US auto dealer groups 11x midcycle forward P/E valuation. We think that such a premium is justified since we expect Zhongsheng to deliver a 19% FY13-15E two-year fully diluted EPS CAGR (23% basic EPS CAGR), vs. slower growth for its US peers in general. In addition, the implied target FY14E P/BV of 1.9x does not appear to be stretched, with about 16% sustainable ROE. Page 13

14 Key company-specific downside risks include 1) weakening demand for Japanese OEM products on a re-escalation of Sino-Japanese tensions, and 2) further underperformance of Mercedes Benz s sales growth vs. its peers. Figure 21: Zhongsheng DCF analysis summary NPV of free cash flow 33,719 Less FY14E net debt (9,876) Add associates, investment 62 Less minorities (1,646) Equity value 22,259 Equity value (HKD/share) 13.3 Cost of capital assumptions Cost of equity 12.7% Risk-free rate 4.3% Market risk premium 5.6% Beta 1.5 After-tax cost of debt 4.9% Target debt/(debt+equity) 4.% WACC 9.6% Source: Deutsche Bank estimates Figure 22: Zhongsheng rolling forward P/E band PE Mean Mean - SD Mean + SD Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 EPS growth % CY1 CY11 CY12 CY13E CY14E 87% 32% -47% 49% 11% Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Page 14

15 Sector risks Weaker-than-expected auto purchase sentiment We cautiously expect 214 Chinese vehicle sales growth to normalize on a high base in 213. If the macroeconomic environment were to rebound more slowly than expected and thus depress consumption sentiment, we could easily see weaker vehicle sales growth. Apart from this, if anti-pollution and anti-congestion policies at some local government levels turned out to be harsher than our expectations, that would also lead to downside to our volume forecasts. Prolonged tightening in the Chinese economy As we expect 214 Chinese vehicle sales growth to remain healthy against a stable macroeconomic backdrop, if the macroeconomic environment were to remain weak for a longer-than-expected period, vehicle sales might become depressed again in the future. With even more capacity available in 214 and thereafter, a slowdown in sales would lead to more serious inventory pile-up concerns and would possibly be followed by more severe price cuts. This would inevitably hurt new car sales margins. Risks to after-sales service growth and margin At the moment, Chinese auto dealers in general maintain a high retention rate among their customers given a lack of customer trust in most non-brand auto maintenance outlets. However, when the market becomes more mature and more credible and scalable non-brand maintenance chains are set up, 4S stores may confront more competition, which could lead to downside in aftersales business growth and margins. Page 15

16 Model updated:1 February 214 Running the numbers Asia China Baoxin Auto Group Reuters: 1293.HK Buy Bloomberg: 1293 HK Price (13 Feb 14) HKD 6.66 Target Price HKD Week range HKD Market Cap (m) HKDm 17,32 USDm 2,196 Company Profile Baoxin is a leading luxury and ultra luxury auto dealership group in China. Most of Baoxin's dealership stores are located in affluent regions in China. Price Performance Dec 11Mar 12Jun 12Sep 12Dec 12Mar 13Jun 13Sep 13Dec 13 Margin Trends Baoxin Auto Group HANG SENG INDEX (Rebased) E 14E 15E EBITDA Margin Growth & Profitability Solvency EBIT Margin E 14E 15E Sales growth (LHS) ROE (RHS) E 14E 15E Fiscal year end 31-Dec E 214E 215E Financial Summary DB EPS (CNY) Reported EPS (CNY) DPS (CNY) BVPS (CNY) Weighted average shares (m) 2,2 2,216 2,529 2,557 2,557 2,557 Average market cap (CNYm) na 13,716 13,212 13,316 13,316 13,316 Enterprise value (CNYm) na 13,225 17,115 17,877 17,779 16,599 Valuation Metrics P/E (DB) (x) na P/E (Reported) (x) na P/BV (x) FCF Yield (%) na nm nm nm Dividend Yield (%) na EV/Sales (x) nm EV/EBITDA (x) nm EV/EBIT (x) nm Income Statement (CNYm) Sales revenue 7,717 12,11 18,93 31,77 38,363 43,473 Gross profit 688 1,29 1,583 3,131 4,9 4,773 EBITDA 5 1,2 1,526 2,54 3,318 4,45 Depreciation Amortisation EBIT ,26 1,977 2,635 3,233 Net interest income(expense) Associates/affiliates Exceptionals/extraordinaries Other pre-tax income/(expense) Profit before tax ,537 2,125 2,713 Income tax expense Minorities Other post-tax income/(expense) Net profit ,135 1,569 2,2 DB adjustments (including dilution) DB Net profit ,135 1,569 2,2 Cash Flow (CNYm) Cash flow from operations ,56 2,219 3,446 Net Capex ,255-1,95-1,3-1,35 Free cash flow , ,141 Equity raised/(bought back) 2,168 Dividends paid Net inc/(dec) in borrowings 259 1,713 2,651 1, Other investing/financing cash flows , Net cash flow 172 2, Change in working capital -1,183-1, , Balance Sheet (CNYm) Cash and other liquid assets 384 2,884 2,668 3,193 3,921 4,454 Tangible fixed assets ,72 3,18 3,727 4,154 Goodwill/intangible assets ,361 1,433 1,52 1,568 Associates/investments Other assets 2,17 3,97 9,799 11,3 12,73 13,491 Total assets 3,258 7,78 16,576 19,144 21,94 23,731 Interest bearing debt 87 2,371 6,538 7,714 8,332 7,665 Other liabilities 912 2,356 6,98 6,543 7,433 8,362 Total liabilities 1,719 4,727 12,635 14,258 15,764 16,27 Shareholders' equity 1,466 3,18 3,88 4,87 6,36 7,567 Minorities Total shareholders' equity 1,538 3,54 3,941 4,886 6,139 7,74 Net debt ,869 4,521 4,41 3,211 Key Company Metrics Sales growth (%) DB EPS growth (%) EBITDA Margin (%) EBIT Margin (%) Payout ratio (%) ROE (%) Capex/sales (%) Capex/depreciation (x) Net debt/equity (%) Net interest cover (x) Source: Company data, Deutsche Bank estimates Net debt/equity (LHS) Net interest cover (RHS) Vincent Ha, CFA vincent.ha@db.com Page 16

17 Model updated:1 February 214 Running the numbers Asia China Zhengtong Auto Services Reuters: 1728.HK Buy Bloomberg: 1728 HK Price (13 Feb 14) HKD 4.73 Target Price HKD Week range HKD Market Cap (m) HKDm 1,46 USDm 1,342 Company Profile Zhengtong is one of the largest BMW dealers in China and a major auto dealership group in China focusing on luxury brands such as BMW, JLR and Audi. Price Performance Feb May 11 Aug 11 Nov 11 Feb 11 May 12 Aug 12 Nov 12 Feb 12 May 13 Aug 13 Nov Margin Trends Zhengtong Auto Services HANG SENG INDEX (Rebased) E 14E 15E EBITDA Margin Growth & Profitability Solvency EBIT Margin E 14E 15E Sales growth (LHS) ROE (RHS) E 14E 15E Fiscal year end 31-Dec E 214E 215E Financial Summary DB EPS (CNY) Reported EPS (CNY) DPS (CNY) BVPS (CNY) Weighted average shares (m) 1,53 2,79 2,28 2,28 2,28 2,28 Average market cap (CNYm) 9,625 14,224 1,668 8,136 8,136 8,136 Enterprise value (CNYm) 6,852 17,318 14,315 11,617 11,261 1,556 Valuation Metrics P/E (DB) (x) P/E (Reported) (x) P/BV (x) FCF Yield (%) nm nm Dividend Yield (%) EV/Sales (x) EV/EBITDA (x) EV/EBIT (x) Income Statement (CNYm) Sales revenue 8,34 14,444 27,649 29,69 32,932 35,567 Gross profit 726 1,386 2,452 2,793 3,249 3,677 EBITDA ,646 1,984 2,424 2,843 Depreciation Amortisation EBIT ,283 1,667 2,72 2,465 Net interest income(expense) Associates/affiliates Exceptionals/extraordinaries Other pre-tax income/(expense) 3 Profit before tax ,276 1,633 1,996 Income tax expense Minorities Other post-tax income/(expense) Net profit ,152 1,418 DB adjustments (including dilution) DB Net profit ,152 1,418 Cash Flow (CNYm) Cash flow from operations ,228 1,468 1,853 Net Capex Free cash flow ,258 Equity raised/(bought back) 3,16 1,684 Dividends paid Net inc/(dec) in borrowings 456 2, Other investing/financing cash flows 84-6, Net cash flow 3,255-2, Change in working capital Balance Sheet (CNYm) Cash and other liquid assets 3,432 1,97 1,23 1,878 2,84 3,611 Tangible fixed assets ,646 2,4 2,4 2,728 Goodwill/intangible assets 75 6,199 6, 5,915 5,826 5,736 Associates/investments Other assets 2,7 7,568 7,953 8,46 9,31 9,919 Total assets 6,732 15,989 16,942 18,397 2,515 22,186 Interest bearing debt 721 4,22 4,899 5,389 5,928 5,987 Other liabilities 1,938 5,447 5,243 5,296 5,674 5,89 Total liabilities 2,659 9,668 1,142 1,685 11,62 11,796 Shareholders' equity 4,15 6,21 6,79 7,584 8,737 1,154 Minorities Total shareholders' equity 4,73 6,322 6,81 7,713 8,913 1,39 Net debt -2,711 3,124 3,696 3,511 3,123 2,376 Key Company Metrics Sales growth (%) DB EPS growth (%) EBITDA Margin (%) EBIT Margin (%) Payout ratio (%) ROE (%) Capex/sales (%) Capex/depreciation (x) Net debt/equity (%) Net interest cover (x) Source: Company data, Deutsche Bank estimates Net debt/equity (LHS) Net interest cover (RHS) Vincent Ha, CFA vincent.ha@db.com Page 17

18 Model updated:12 February 214 Running the numbers Asia China Zhongsheng Group Reuters: 881.HK Buy Bloomberg: 881 HK Price (13 Feb 14) HKD Target Price HKD Week range HKD Market Cap (m) HKDm 22,558 USDm 2,99 Company Profile Zhongsheng is a leading national auto dealership group in China, with more than 16 stores. The company has a diversified portfolio of luxury (mainly Benz, Audi and Lexus) and mid-to-high end automobile brands (mainly Toyota, Nissan and Honda). Price Performance Feb May 11 Aug 11 Nov 11 Feb 11 May 12 Aug 12 Nov 12 Feb 12 May 13 Aug 13 Nov Margin Trends Zhongsheng Group HANG SENG INDEX (Rebased) E 14E 15E EBITDA Margin Growth & Profitability Solvency EBIT Margin E 14E 15E Sales growth (LHS) ROE (RHS) E 14E 15E Fiscal year end 31-Dec E 214E 215E Financial Summary DB EPS (CNY) Reported EPS (CNY) DPS (CNY) BVPS (CNY) Weighted average shares (m) 1,828 1,98 1,98 1,98 2,127 2,147 Average market cap (CNYm) 22,125 22,984 18,276 17,636 17,636 17,636 Enterprise value (CNYm) 24,613 3,784 31,729 32,461 31,8 32,467 Valuation Metrics P/E (DB) (x) P/E (Reported) (x) P/BV (x) FCF Yield (%) nm nm nm nm Dividend Yield (%) EV/Sales (x) EV/EBITDA (x) EV/EBIT (x) Income Statement (CNYm) Sales revenue 24,43 41,93 5,48 55,37 62,25 68,792 Gross profit 2,293 4,38 4,284 5,59 5,962 6,94 EBITDA 1,729 3,58 2,636 3,32 4,114 4,975 Depreciation Amortisation EBIT 1,576 2,698 2,143 2,682 3,335 4,42 Net interest income(expense) ,94-1,16 Associates/affiliates Exceptionals/extraordinaries Other pre-tax income/(expense) Profit before tax 1,384 2,194 1,157 1,692 2,247 2,889 Income tax expense Minorities Other post-tax income/(expense) Net profit 1,31 1, ,117 1,483 1,97 DB adjustments (including dilution) DB Net profit 1,31 1, ,117 1,552 1,976 Cash Flow (CNYm) Cash flow from operations ,653 2, 2,843 Net Capex -1,112-1,955-1,469-1,73-1,84-1,8 Free cash flow -1,967-1,595-1, ,42 Equity raised/(bought back) 2,91 2,15 Dividends paid Net inc/(dec) in borrowings 2,48 4,273 4,3 2, ,126 Other investing/financing cash flows -1, , ,94-1,16 Net cash flow 1,959 1, , Change in working capital -2,284-2,364-2,197-1,223-1,533-1,393 Balance Sheet (CNYm) Cash and other liquid assets 2,99 4,488 4,97 5,169 5,992 6,74 Tangible fixed assets 2,489 4,971 6,487 7,516 8,623 9,591 Goodwill/intangible assets 2,173 3,939 4,55 4,671 4,731 4,742 Associates/investments Other assets 8,322 14,284 16,356 18,248 2,229 22,132 Total assets 16,2 27,86 31,495 35,659 39,637 43,238 Interest bearing debt 4,924 11,279 16,39 18,67 18,572 19,698 Other liabilities 4,561 8,33 6,356 7,16 7,641 8,246 Total liabilities 9,485 19,583 22,665 25,712 26,213 27,944 Shareholders' equity 5,936 7,92 7,539 8,53 11,778 13,388 Minorities 779 1,186 1,291 1,443 1,646 1,96 Total shareholders' equity 6,715 8,278 8,83 9,947 13,423 15,294 Net debt 1,935 6,791 12,212 13,437 12,58 12,994 Key Company Metrics Sales growth (%) DB EPS growth (%) EBITDA Margin (%) EBIT Margin (%) Payout ratio (%) ROE (%) Capex/sales (%) Capex/depreciation (x) Net debt/equity (%) Net interest cover (x) Source: Company data, Deutsche Bank estimates Net debt/equity (LHS) Net interest cover (RHS) Vincent Ha, CFA vincent.ha@db.com Page 18

19 Appendix 1 Important Disclosures Additional information available upon request Disclosure checklist Company Ticker Recent price* Disclosure Zhengtong Auto Services 1728.HK 4.73 (HKD) 13 Feb 14 NA Zhongsheng Group 881.HK (HKD) 13 Feb 14 NA Baoxin Auto Group 1293.HK 6.66 (HKD) 13 Feb 14 NA *Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Vincent Ha Historical recommendations and target price: Zhengtong Auto Services (1728.HK) (as of 2/13/214) 12. Previous Recommendations Security Price Strong Buy Buy Market Perform Underperform Not Rated Suspended Rating Current Recommendations Buy Hold Sell Not Rated Suspended Rating 2. *New Recommendation Structure as of September 9,22. Feb 11 May 11 Aug 11 Nov 11 Feb 12 May 12 Aug 12 Date Nov 12 Feb 13 May 13 Aug 13 Nov /11/212: Upgrade to Hold, Target Price Change HKD /5/213: Upgrade to Buy, Target Price Change HKD /1/213: Hold, Target Price Change HKD /1/213: Buy, Target Price Change HKD6.5 Page 19

20 Historical recommendations and target price: Zhongsheng Group (881.HK) (as of 2/13/214) 2. Previous Recommendations Security Price Strong Buy Buy Market Perform Underperform Not Rated Suspended Rating Current Recommendations Buy Hold Sell Not Rated Suspended Rating *New Recommendation Structure as of September 9,22. Feb 11 May 11 Aug 11 Nov 11 Feb 12 May 12 Aug 12 Date Nov 12 Feb 13 May 13 Aug 13 Nov /11/212: Upgrade to Buy, Target Price Change HKD /5/213: Buy, Target Price Change HKD /1/213: Buy, Target Price Change HKD /1/213: Buy, Target Price Change HKD15.6 Historical recommendations and target price: Baoxin Auto Group (1293.HK) (as of 2/13/214) 12. Previous Recommendations Security Price Strong Buy Buy Market Perform Underperform Not Rated Suspended Rating Current Recommendations Buy Hold Sell Not Rated Suspended Rating 2. *New Recommendation Structure as of September 9,22. Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Date Mar 13 Jun 13 Sep 13 Dec /11/212: Upgrade to Buy, Target Price Change HKD /5/213: Buy, Target Price Change HKD /1/213: Buy, Target Price Change HKD /1/213: Buy, Target Price Change HKD1. Page 2

21 Equity rating key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ), we recommend that investors buy the stock. Sell: Based on a current 12-month view of total shareholder return, we recommend that investors sell the stock Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell. Notes: 1. Newly issued research recommendations and target prices always supersede previously published research. 2. Ratings definitions prior to 27 January, 27 were: Buy: Expected total return (including dividends) of 1% or more over a 12-month period Hold: Expected total return (including dividends) between -1% and 1% over a 12- month period Sell: Expected total return (including dividends) of -1% or worse over a 12-month period % 38 % 27 % 21 % 7 % 17 % Buy Hold Sell Companies Covered Cos. w/ Banking Relationship Asia-Pacific Universe Page 21

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