2009.11.26
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CIMB



Maintain OVERWEIGHT; sector re-rating on solid fundamentals. We maintain
our OVERWEIGHT rating on the auto sector, with Dongfeng as our top pick,
followed by Denway and Qingling. We upgrade our FY09-11 earnings projections
for our universe of auto stocks by 3-32% for higher volume and margins given the
strong demand from second and third tier cities, and acceleration of the
replacement cycle. In view of the sector’s expected improvement in ROE and strong
earnings CAGR for FY08-11, we now apply a higher target forward P/E of 13.5x
(12x previously) to the sector, based on one standard deviation above the sector’s
3-year historical average P/E. Downside risks are shielded by the likelihood of more
policy stimulus for the sector. Valuations remain attractive at 40% discount to the
3Q07 peak valuation and 39% discount to the HSI on a forward P/E basis.
• Improved fundamentals. Passenger vehicle sales soared 60.3% in 10M09.
Sedans with engine capacities above 1.6L to 2.0L reversed from a 16% yoy decline
in Jan 09 to 50% growth in Oct 09 while cars above 2.0L to 3.0L accelerated 34% in
Oct 09, a marked U-turn from a 28% yoy decline in Jan 09. As sedans above 1.6L
did not benefit from the 5% tax cut stimulus, we think that sedan sales would have
recovered even without the stimulus although it did reshape the product mix. We
also have more confidence in the underlying demand due to 1) economic recovery,
2) the acceleration of the first replacement cycle, 3) explosive growth in second- and
third-tier cities. These factors will continue to fuel sedan growth. Our assumption of
20% yoy volume growth in 2010 represents a CAGR of 26% in 2007-10, similar to
27% CAGR in 2006-09. We expect volume to rack up 15% growth in 2011 or 29%
CAGR in 2008-11, which appears reasonable compared with 35% CAGR in 2000-
08.
• Policies should remain supportive. Extension of the 5% cut in car purchase tax
for sedans up to 1.6L is on the government’s agenda. We expect the government to
extend the 5% cut in car purchase tax for sedans up to 1.6L to 2010 in order to
support 9.5-10% GDP growth as exports remain weak. The Ministry of Commerce
may also double the subsidies for scrapping old cars as the existing subsidies are
ineffective.
• Utilisation should remain high. Auto manufacturers have not been aggressively
building new capacity, which helped to keep selling prices stable in 2009. We
expect utilisation to remain high at 65-93%. Auto manufacturers generally saw
higher margins in 1H09 due to higher utilisation. But margins may trend down
slightly in 2010 due to higher raw material costs. However, margins are expected to
be higher than the 2007-08 levels as the recent hikes in steel prices are mild and
automakers may maintain high utilisation in 2010 and achieve economies of scale in
sourcing parts.