China Auto Sector
Sustainable high-rev growth
ahead
Vincent Ha, CFA
Analyst
(+852) 2203 6247
vincent.ha@db.com
Many drivers of sector growth
With vehicle penetration still low, China auto sales volume is expected to grow at
a 12% CAGR (2007-1015) given the increase in wealth in China and the stronger
consumption appetite of the new generation of Chinese. We are optimistic that
such growth momentum can last for many years, given the progressive sales
explosion in Tier 1/2/3 markets and improving peripheral services. In sum, we
remain buyers of stocks with dominant market positions, namely Dongfeng and
Denway.

2008 outlook optimistic due to wealth effect and more potential buyers
Following the forecast 22% volume growth in 2007, the momentum, at least on
the passenger vehicle side, should continue in 2008 given the accelerating wealth
creation driven by salary increases and a robust stock market. Further, those born
in the late 70s and 80s tend to have a stronger propensity to spend and hence
should further fuel demand growth in coming years.
China’s auto market is still very young, and being young is good
Referenced against the development of the auto markets in Japan and Korea, we
believe that China could experience at least 10 years of solid growth. Such a boom
could be extended, with recent strength from Second Tier markets while Third Tier
markets have yet to be tapped. With further development of the used vehicle
market and auto financing, we expect a prolonged period of growth.
High utilization negates concerns over margin pressure
Despite common worries about overcapacity and margin pressure, we think that
these issues have been overstated given the high utilization ratio and stable
margin trend reflected by major auto assemblers recently. The Chinese
government generally puts out a conservative sales volume forecast each year,
possibly to avoid overheating and excessive capacity build-up. This partly explains
why the sector valuation trend tends to lag behind the actual release of
encouraging sales figures. As such, we try to downplay government expectations
in making our bullish sales forecasts.
Potential fuel price hike could stimulate small-engine car demand
Our sensitivity analysis shows that with the potential implementation of gasoline
tax and the higher gasoline price, absolute impact on car keeping costs should be
limited, with small-engine cars possibly subject to net savings because of the
resulting withdrawal of the mandatory road maintenance fees.
At 13x FY08E sector PE, we see room for the sector to outperform the market
We believe that the auto sector could test the recent peak valuation of 16x
forward PE, in part because relative valuation is below historic norms. We expect
the outperformers will be passenger vehicle plays with popular foreign brands,
given wealthier consumers’ preferences for those names. Our price targets are
generally based on P/E, backed by other methods such as DCF. Key sector risks
would be a sudden economic downturn and equity market correction, irrational
competition, and a stronger-than-expected retreat in commercial vehicle sales.

Table of Contents
Executive summary ........................................................................... 3
Sector valuation table....................................................................... 4
Sector running at full-throttle .......................................................... 5
Above-expectation volume growth ahead.................................... 10
Opportunities: Unique demographics & improving peripheral
markets............................................................................................. 12
More sensible competition expected ............................................ 20
Appealing valuation: Prefer strong-brand passenger car plays .. 26
Risks.................................................................................................. 31
Company update ............................................................................. 32
Dongfeng Motor .............................................................................. 33
Denway Motors ............................................................................... 38
Changan Auto .................................................................................. 41
Brilliance China ................................................................................ 44
Geely Auto........................................................................................ 47
Appendix A: How to buy/maintain/sell a car in China? ............... 50
Appendix B: More findings from our survey................................. 54