1、China Sector Deep-DiveIn-Depth Analysis Zeroing in on Key Sectors in China,from Infrastructure to DefenceResearch ReinventedSmartkarma unites Independent Research Providers,Investors,and Investor Relations in one network.At Smartkarma,We Do Things DifferentlyWelcome to another Smartkarma eBook-a sho

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7、e following pages,you will be able to see for yourself a sample of the efforts of Smartkarma and the Insight Providers publishing on our platform.If you want more such Insights delivered to you in real time on your desktop or mobile,visit .Table of ContentsCover Photo by Hanson Lu1.Chinese Video Sur

8、veillance Industry,Ming Lu4 2.China Auto Parts A Shares:Parts Of The Future,Victoria Li28 3.China Infrastructure Deep Dive:Gas Utilities H&A Shares,74 Osbert Tang,CFA4.China Aerospace&Defense A Shares:An In-Depth Walkthrough,143 Osbert Tang,CFA5.China Property Management-Sector Deep Dive and Evaluat

9、ion224 Framework,Sameer Taneja6.China Environment Sector Deep Dive:Solid Waste Treatment,247 Osbert Tang,CFA3Zhejiang Dahua Technology A|Equity Bottom-UpChinese VideoSurveillance IndustryBy Ming Lu|31 Jan 2020EXECUTIVE SUMMARYIntroductionThe video surveillance market is speeding up in China and glob

10、ally.Theworlds top two surveillance companies are both headquartered in China andthere are 4 Chinese companies in the global top-10 according to the A&Sranking.The“snow bright”project shows that the Chinese government aims to coversuburban areas with surveillance systems.The outbreak of the coronavi

11、rusconfirms the necessity of the“snow bright”project.However,there areconcerns on the industry particularly when the U.S.Entity List aims to blockthe supply of semiconductor chips to surveillance equipment providers inChina.Today investors outside mainland China can buy China-listed surveillancecomp

12、anies via the Northbound Shenzhen and Shanghai Connect.In this note,we deep dive into the video surveillance industry in China and try to find outinvestment opportunities in this industry.What is original in this report?1.A Chinese governmental committee wanted to cover suburban areaswith video surv

13、eillance via the“snow bright”project.In fact,localgovernments did not start the project until the State Council gave thesecond order in 2019.We believe most local governments will focus onfighting the coronavirus and have no spare capacity for“snow bright”inthe first half of 2020.However,we expect t

14、he governments will paymore attention to video surveillance after the epidemic event,because,millions of Wuhan residents left the viral epicenter sealed by themunicipal government by untracked vehicles.This huge securityloophole proves the importance of surveillance systems in suburbanareas.Chinese

15、Video Surveillance IndustryMing Lu4Ming LuOverseas Chinese Equities|Aequitas ResearchMing Lu has more than 17 years of experience in equity research,covering companies that operate in China but are listed in the US or Hong Kong,focusing on Chinese internet,consumer,and education firms.Areas of Exper

16、tise Primary Asset Class:Equities Geography:Asia Pacific Countries:China Sectors:Information TechnologyContent Verticals Equity Bottom-Up,Thematic(Sector/Industry)2.We believe the market undervalued Dahua merely based on its slowrevenue growth.However,we notice that,among the top-three Chinesevideo

17、surveillance companies,Dahua is the only one that improved itsoperating cash flows and margins.We believe earnings per share willgrow 22%in 2020 and 25%in 2021 due to the accelerating revenues andthe stable margin.ContentsA.Domestic Market Demand from“Snow Bright Project”1.China Market in Previous Y

18、ears2.Governmental Project “Snow Bright”3.Expected Influence in Suburban MarketB.Global Market and Leading Position of Chinese Companies1.Promising Market2.Rapidly Growing Chinese Companies3.International Exploration of Chinese Companies4.Concern for U.S.CompaniesC.Leading Chinese Companies1.Value C

19、hain of Surveillance Companies2.Background of Leading Companies3.Domestic vs.Overseas Revenues4.Growth and Margin5.Operating Cash FlowD.Risks1.U.S.Entity List2.The Competitor HiSilicon of Huawei3.CoronavirusE.ValuationF.ConclusionG.AppendixChinese Video Surveillance IndustryMing Lu5DETAILA.Domestic

20、Market “Snow BrightProject”to Drive the Growth1.China Market in Previous Years“China is by far the largest single market probably accounting for 35%to40%of world demand,”A&S commented in its 2019 security report.TheChina market is not only big,but also rapidly growing.The growth rate of themarket si

21、ze accelerated in 2017 and 2018(Exhibit 1).Exhibit 1:China Security Market SizeSource:China Security and Protection Industry Association(CSPIA)andAequitas Research.2.Governmental Project “Snow Bright”How about the years after 2019?The project“Snow Bright”comes.In 2016,the“Snow Bright”project(雪亮工程)wa

22、s launched by the Politicaland Legal Committee of China(in charge of the police,judicial courts,etc.).The project aims to extend the public video surveillance network intosuburban areas.However,provincial governments did not actively supportthe project.We believe it was because neither the committee

23、 nor provinceshad extra budgets at that time.In January 2018,the State Council of China imposed the order The Strategyon Prosperity in Suburbs(关于实施乡村振兴战略的意见),which formallymentioned the“Snow Bright”project for the first time.In February 2019,theState Council reiterated Snow Bright in the order The P

24、riority of Agriculture,Suburb,and Farmers(关于坚持农业农村优先发展做好“三农”工作的若干意见).Thereafter,provincial governments can spend budgets on the project.Since2019,more and more local governments called for biddings.It was a hugemarket as there are 2,016 counties in the suburbs of China.More importantly,we believe,wh

25、en local governments have budgets,they care about qualitymuch more than price.Chinese Video Surveillance IndustryMing Lu6We believe,in the first half of 2020,most local governments will focus onfighting the coronavirus and have no spare energy to follow the“snow bright”project.However,we also believ

26、e local governments will pay more attentionto video surveillance after the event,because,by vehicles,5 million out of14 million Wuhan residents left the viral epicenter sealed by the municipalgovernment.Many of them left by vehicles through suburban areas.The hugeloophole exactly proves the importan

27、ce of the“snow bright”project,whichaims to cover suburban areas.3.Expected Influence in Suburban Market“Snow Bright”only cover roads.However,we believe the project will educateinstitutions in the small city markets that cameras can help.Small cities are under the same threats as big cities.The cases

28、 belowhappened in China.(1)Patients families beat medical doctors.Therefore,hospitals needsurveillance.(2)Desperate adults killed pupils on campuses.Therefore,schools needsurveillance.(3)Gangsters blackmailed retailers.Bazaars need surveillance.(4)Theft.Office buildings and communities need surveill

29、ance.These are righteous surveillance,as so far Chinese citizens have neveraccused the police of privacy breach for the cameras in public places.Chinese Video Surveillance IndustryMing Lu7B.Global Market and Leading Positionof Chinese CompaniesExhibit 2:Global Market Size of Physical ProductsNote:At

30、 factory gate prices.Source:Memoori.1.Promising Market:Security solution is an accelerating market.According to Memoori(Exhibit 2),the global security market size willgrow by a CAGR of 10.7%in the following 5 years(2019 2024)versus aCAGR of 7.2%in the last 5 years(2012 2017).Exhibit 3:Top Global Sec

31、urity Companies(2018 Revenues in USDbillion)Source:A&S December 2019 and Aequitas Research.1.Rapidly Growing Chinese Companies:There are 4 Chinesecompanies in the global top-10(Exhibit 3)and 11 Chinese companies inthe global top-50 according to the A&S ranking.More importantly,theglobal top-2,Hikvis

32、ion(002415 CH)and Dahua(002236 CH),areheadquartered in China.(Exhibit 3).Chinese Video Surveillance IndustryMing Lu8Exhibit 4:Geographic Revenue Breakdown of Top Three Companies(RMB bn)Note:1H2019.Source:Company data and Aequitas Research.3.International Exploration of Chinese Companies:The top twoC

33、hinese companies gained a lot in the international market(Exhibit 4).However,so far,most revenues of Chinese companies are from thedomestic market.We believe Chinese companies will be able to gainmore global market share,although there were headwinds in 2019.Forexamples,U.S.Department of the forbids

34、 U.S.companies fromproviding parts to the Chinese surveillance companies on the EntityList(Exhibit 5).Exhibit 5:New Companies in U.S.Entity List in October 2019CompanyTickerA&S Global RankDahua002236 CH2Hikvision002415 CH1iFLYTEK002230 CHMegvii TechPrivate19SenseTimePrivateXiamen Meiya Pico300188 CH

35、YituPrivateYixinPrivateSource:U.S.Federal Register,A&S,and Aequitas Research.4.Concern for U.S.Companies:The largest U.S.security company,FlirSystems(FLIR US),is much smaller than Hikvision and Dahua(Exhibit3).To make things worse,only FLIR suffered a revenue decline amongthe top 10 global companies

36、(Exhibit 6).Therefore,we believe that thereal incentive behind the Entity List is the trade war rather than humanrights.(detailed in the risk chapter below.)We also believe the action ofthe U.S.government reflects the competitive advantage of Chinesecompanies in the global market.Chinese Video Surve

37、illance IndustryMing Lu9Exhibit 6:Top Global Security Companies(YoY Revenue Growth)Note 1:Orange for China and blue for the U.S.Source:A&S December 2019and Aequitas Research.C.Leading Chinese Companies1.Value Chain of Surveillance CompaniesExhibit 7:Video Surveillance Companies in Supply ChainSource

38、:Aequitas Research.There are three main types of companies,which call themselves“videosurveillance solution providers”(Exhibit 7).(1)Algorithm suppliers.They provide key software to surveillance systems.For example,Megvii Technology(1737211D HK)(旷世科技)on the U.S.blacklist(Exhibit 1)provides facial re

39、cognition.Equipment providers can dothe algorithm themselves,but some algorithm suppliers do have bettertechnologies.Chinese Video Surveillance IndustryMing Lu10Exhibit 8:Building SolutionSource:Hikvision(2)Equipment providers.They integrate the whole video surveillance system(Exhibit 8),from the fr

40、ont-end(such as camera and sensor)to the back-end(such as storage),from hardware to software.Of course,they can also sellthese parts separately(Exhibit 9).Typical companies are the top threeChinese companies,i.e.,Hangzhou Hikvision(002415 CH),Zhejiang DahuaTechnology A(002236 CH),and China Transinfo

41、 Technology(002373 CH).They are experienced in all parts and know how to integrate all partstogether.Therefore,they can hardly be substituted by companies,which aregood at one part.Chinese Video Surveillance IndustryMing Lu11Exhibit 9:CameraSource:Hikvision(3)System integrator.Typically,they install

42、 already-integrated systemsprovided by equipment suppliers according to clients requirements.However,they call themselves“system integrators”.The market is over-competitive due to a low technological entry barrier.A typical company isBeijing E Hualu Info Tech A(300212 CH).We believe that currently t

43、he barrier to entry is highest for equipmentproviders among others.Furthermore,the top-three Chinese surveillancecompanies are all equipment providers.Therefore,we focus on the top threebelow.2.Background of Leading Companies(1)HikvisionHikvision was founded in 2001 and was listed in the Shenzhen St

44、ockExchange(SZSE)in 2010.The company entered into the video surveillancemarket in 2003 and has had the global largest market share since 2011according to IHS Markit or since 2016 according to A&S.The state-ownedChina Electronics Technology Group Corporation(CETC)is the largestshareholder and has 41%

45、of Hikvisions shares.CETC is a supplier of thePeoples Liberation Army.We understand some securities authorities maypossibly ban investments in or recommendations on this kind of companies.However,many investment funds headquartered in North America and WestEurope hold shares of Hikvision.Please chec

46、k the exact rules with theauthorities in your country.Chinese Video Surveillance IndustryMing Lu12The technology trend is as follows:More data processing functions have beenmoved from control center to front-end.Cameras transmit processed data tothe control center.Therefore,camera has the key techno

47、logy and is the mostimportant equipment among all.As the worlds largest surveillance company,halves of Hikvisions revenues and gross profits are from the front-end,a.k.a.camera(Exhibit 10,11).For the same reason,the supply of core chip,the graphics processing unit,isthe key risk for surveillance equ

48、ipment providers.This will be detailed in therisk chapter below.(2)DahuaDahua was founded in 2001 and listed in SZSE in 2008.The company is thesecond largest market share in the world in accordance with the 2019 A&Slist.Mr.Fu Liquan(傅利泉)is the largest shareholder and owns 36%of Dahua.Furthermore,all

49、 shareholders,who own more than 1%shareholdings,arenatural persons.We believe the company is NOT state-owned.Dahua breaks down its business lines in a different manner from Hikvision(Exhibit 12,13).Leading equipment providers,such as Hikvision(Exhibit8)and Dahua(Exhibit 12)can provide the full surve

50、illance systems,whichare already integrated systems.Therefore,in many occasions,the equipmentproviders merely leave the installation jobs to the so-called“systemintegrators”.Chinese Video Surveillance IndustryMing Lu13(3)TransInfoTransInfo was founded in 2002 and listed in SZSE in 2010.In November20

51、17,TransInfo acquired 100%of Uniview,which is the 7thlargest securitycompany globally in 2019.Alibaba(BABA)acquired 15%shareholdings ofTransInfo in May 2019.Thereafter,the largest shareholder,Mr.Xia Shudong(夏署东)s shareholdings declined to 16%.This is not a state-owned companyeither.More importantly,

52、neither Uniview nor TransInfo is in the U.S.EntityList.We are impressed that Alibaba could foretell that the Trumpadministration will not add Uniview,the No.3 Chinese security company,tothe Entity List.TransInfo is a typical Chinese surveillance company,which focuses on thedomestic market(Exhibit 4)

53、.Below we compare domestic performance tooverseas performance for the top three companies.3.Domestic vs.Overseas Revenues(1)HikvisionIn December 2019,the board secretary(equivalent to investor relationsmanager)ofHikvision,Ms.Huang,acknowledgedthatHikvisionsperformance declined in the U.S.and She als

54、o expected the overseas growthwill just be“stable”,as there are“different obstacles in different countries”.Exhibit 14:Hikvision Domestic RevenuesSource:Hikvision and Aequitas Research.However,we believe Hikvisions total revenue performance will grow by two-digit in 2020.Domestic market will drive t

55、he growth,as domestic revenues were 2.5times overseas in 1H2019(Exhibit 14,15).The revenue growth in both domestic and overseas markets stoppeddeclining and started recovering in 1H19(Exhibit 14,15).We believedomestic revenues will grow by 18%in 2020,riding on the Snow BrightProject,but overseas rev

56、enues will grow by only 10%in 2020 accordingto the management comments.Chinese Video Surveillance IndustryMing Lu14Exhibit 15:Hikvision Overseas RevenuesSource:Hikvision and Aequitas Research.The domestic gross margin caught up with the overseas gross margin in2018 and was 1.6 percent points higher

57、than the overseas margin in1H19(Exhibit 16).Therefore,we believe overseas gross profits will beless important in 2020.Exhibit 16:Hikvision Gross Margins,Domestic vs.OverseasSource:Hikvision and Aequitas Research.(2)DahuaExhibit 17:Dahua Domestic RevenuesSource:Dahua and Aequitas Research.In 1H2019,D

58、ahuas revenues from overseas accounted for 34%of totalrevenues(Exhibit 17,18),compared to 29%for Hikvision.Chinese Video Surveillance IndustryMing Lu15Exhibit 18:Dahua Overseas RevenuesSource:Dahua and Aequitas Research.In Dahua,the gross margin of overseas business has been significantlyhigher than

59、 the gross margin of domestic business(Exhibit 19).Exhibit 19:Dahua Gross Margins,Domestic vs.OverseasSource:Dahua and Aequitas Research.Please note that the trade war started in June 2018.Dahuas recovery reflectsthat the U.S.is not significant to the whole overseas market for Chinesecompanies.(3)Tr

60、ansInfoExhibit 20:TransInfo Domestic and Overseas RevenuesSource:TransInfo and Aequitas Research.Chinese Video Surveillance IndustryMing Lu16For TransInfo,the overseas market is not important at all,despite the factsthat(1)revenue from overseas grew 64%YoY in 1H2019(Exhibit 20)and(2)gross margin fro

61、m overseas business improved 3 percentage points YoY in1H2019(Exhibit 21).After all,revenues from overseas accounted for only 13%of total revenues.Exhibit 21:TransInfo Gross Margins,Domestic vs.OverseasSource:TransInfo and Aequitas Research.We believe the insignificant overseas exposure is the key r

62、eason that Univiewand TransInfo are not in the Entity List,despite the fact that Uniview,subsidiary of TransInfo provided solutions to the police in XUAR(source: believe theU.S.Department of Commerce does not care whether a company helps violatehuman rights as long as the company does not export to

63、the U.S.4.Growth and MarginWe compared the top three security companies financial performance inthe first three quarters of 2019.For the financial performance below,“2019”represents“the first three quarters of 2019”and“2018”represents“the firstthree quarters of 2018”.Exhibit 22:Revenue Growth of Maj

64、or Chinese CompaniesSource:Company data and Aequitas Research.(1)HikvisionHikvisionhasachieveddouble-digitrevenuegrowth(Exhibit22),improvement in gross margins(Exhibit 23),and a stable operating margin(Exhibit 24).We believe the trends will continue.The companys salespersonscan always tell potential

65、 clients,we are the largest.Chinese Video Surveillance IndustryMing Lu17Exhibit 23:Gross Margins of Major Chinese CompaniesSource:Company data and Aequitas Research.Exhibit 24:Operating Margins of Chinese Major CompaniesSource:Company data and Aequitas Research.We believe Hikvision has an advantage

66、in the Snow Bright project becauseHikvision is a state-owned company.Government officials prefer state-ownedcompanies despite the public bidding processes because the officials whooperate the bidding will not be concerned that the opponents in the samelocalgovernmentwillimpeachthemforacceptingbriber

67、y.Suchimpeachment is equivalent to accusing another governmental department ofcommitting a crime.Additionally,Hangzhou Daily reported that Hikvision had sent 1,000 infraredthermometers to Wuhan,the epicenter of the coronavirus.Currently,Hikvision is working overtime to produce thermometers.We believ

68、e more“entrance”,such as railway stations and even office buildings,will needinfrared thermometers.(2)DahuaNon-state-owned Dahua and TransInfo chose the opposite strategies Dahua pursues high margin,while TransInfo pursues high growth.We believeboth of them are right for their own sizes.Chinese Vide

69、o Surveillance IndustryMing Lu18Exhibit 25:YoY Profits Growth Rates in 13Q2019 over 13Q2018Source:Company data and Aequitas Research.Dahua improved its margins at the expense of growth rate.Revenues grewby single-digit(Exhibit 22),but the gross margin improved 4.7 percentagepoints(Exhibit 23).As a r

70、esult,gross profits increased by 24%YoY in 2019,higher than 22%for Hikvision(Exhibit 25).Sales and marketing expenses asa percentage of total revenues rose 1.7 percentage points in 2019.Even so,operating profits increased by 16%YoY in 2019.The two-digit growth rates ofprofits were far from“slow”.We

71、believe margins are important for Dahua to compete with Hikvision inthe long run.Currently the market size is expanding.However,low margin isvulnerable to a potential price war when the market is mature in the future.(3)TransInfoOn the contrary,TransInfo boosted its growth at the expense of margins.

72、TransInfos revenues grew by 26%YoY in 2019(Exhibit 20),higher than18%for Hikvision and 9%for Dahua.Both of TransInfos gross margin andoperating margin declined.We believe“growing first”is the right decision,asTransInfos revenues were only 35%of Dahua and 14%of Hikvision.5.Operating Cash FlowsDahua i

73、mproved not only margins but also operating cash flows.Dahuasoperating cash outflows decreased by 68%YoY(Exhibit 26).We believe thecompany will stop cash bleeding in 2020.Exhibit 26:Operating Cash FlowsSource:Company data and Aequitas Research.Chinese Video Surveillance IndustryMing Lu19On the contr

74、ary,Hikvisions operating cash inflows plunged by 95%YoY(Exhibit 24).The company explained that it needed to reserve more parts(forthe supply ban from the U.S.).TransInfos operating cash outflows were stably negative.Furthermore,TransInfos revenues were only 1/3 of Dahuas,but cash outflows were 2/3 o

75、fDahuas.In summary,among the top three Chinese security companies,Dahua is theonly one that improved both the operating margin and operating cash flows.According to the valuation ratios below(Exhibit 26),we believe the marketoverly focuses on the revenue growth.D.Key Risks1.U.S.Entity ListThe U.S.De

76、partment of Commerce added 28 Chinese entities to the EntityList on October 9,2019.Most of the entities are Chinese government bureausin the Xinjiang Uighur Autonomous Region(XUAR)of China,but there arealso 8 Chinese surveillance companies in the List(Exhibit 1).The U.S.authority accused the surveil

77、lance companies above of posing“a significantrisk of being or becoming involved”in human rights violations againstUighurs,Kazakhs,and other members of Muslim minority groups in theXUAR area.On one hand,we believe surveillance companies should know theirequipment are used by the police in the XUAR ar

78、ea at the bidding stages.The companies should also know they cannot control how the police will usethe equipment.On the other hand,we believe it is unfair to hold doublestandards for different Chinese companies and companies from othercountries.(1)Uniview:We found the Chinese company Uniview(a subsi

79、diary ofTransInfo(002373 CH)provided surveillance equipment to 330 local policesof China,including at least polices in three cities of XUAR.These cities areUrumqi,Karamay,and Khotan.(source:http:/ U.S.did not add Uniview to the EntityList.We believe this exemption is because Uniview does not have si

80、gnificantoverseas sales(Exhibit 2)and does not impact the US market andsurveillance companies.(2)Bosch:In August 2018,Germany headquartered Bosch Security System,the fourth largest security company in the world,sold smart arms lockers(small gun warehouses with access control systems)to the police in

81、Shandong Province of China.(source:https:/ are more than half million of Muslinsin Shandong Province.Any criticism on Bosch Security?Chinese Video Surveillance IndustryMing Lu20(3)BMW:There are 160,000 Muslims in Shanghai.Many policemenmaintain order on every religious activity in Shanghai every yea

82、r.In 2010,the police in Shanghai purchased 22 sedans of BMW for the World Expo atthe total value of RMB11 million,equivalent to US$1.6 million(Exhibit 27,28).This time,Journalists from many countries can directly see the BMWsedans at the World Expo Shanghai instead of checking the governmentalprocur

83、ement lists.Has BMW been criticized in any media or by any U.S.ministry?(4)Sony and Samsung:No domestic companies were able to produce high-definition surveillance before Hikvision began to provide in 2002.So howcould the Chinese government monitor target people at any time whenpolicemen were not th

84、ere?The“Beijing Security 40 Years Exhibition”provided the answer.Sony,Samsung,and other imported products worked(Exhibit 29).Have the U.S.authorities punished them?Exhibit 29:Sony and Samsung Cameras Used in BeijingSource: police in China procure from many suppliers headquartered overseas,including

85、but not limited to Sony,Samsung,BMW,and Bosch Security.Forexample,the Korean SK Group is an investor of private Megvii in the EntityList(Exhibit 5).Chinese Video Surveillance IndustryMing Lu21Institutional investors can surely have their ethical standards and boycott allthe suppliers to the police i

86、n China.The China governments procurementsare public().Here we just hope investors to be fair to allthe suppliers,not merely to focus on what the U.S.government or the mediafocuses on.2.The Competitor-HiSilicon of HuaweiThe U.S.Entity List does not forbid U.S.corporations or persons from buyingsolut

87、ions from the blacklisted Chinese equipment providers but fromproviding parts to them.We believe the parts here suggests the SoC(System on Chip)chips,as theyhave the highest entry barrier among all technologies in video surveillanceequipment.There are three major producers in the U.S.,i.e.,Nvidia Co

88、rp(NVDA US),Ambarella Inc(AMBA US),and Texas Instruments(TXN US).As mentioned above,Hikvisions operating cash flows plunged 95%forhoarding parts from the U.S.in case the formal ban of parts supplies.Arethere any Chinese domestic providers?There is a big one:HiSilicon(海思)(Exhibit 30).HiSilicon is the

89、 largest surveillance chip supplier in China andHikvision is the largest external client of HiSilicon.However,there is a significant concern for HiSilicons Chinese clients.HiSilicon is 100%owned by Huawei and Huawei is also a surveillanceequipment provider.In May 2018,Mr.Peng Xiaodong(彭晓东),Huaweis h

90、eadof China Sales,told A&S,Huaweis security business planned to be GlobalNo.3 in 3 years.It should be realized in 2021.Huawei did not bluff.Huaweissecurity revenues increased 450%YoY in 1H2019,though we do not know theexact revenues.So,the current competitive situation is:(1)Huawei is the only part

91、provider of China that can produce the core chipswith the quality and the quantity closest to the U.S.peers.(2)All other Chinese equipment providers mainly use HiSilicon(Huawei)chips in China.(3)All other Chinese equipment providers import a small part of U.S.chipsto prevent potential price threat f

92、rom HiSilicon(Huawei).Chinese Video Surveillance IndustryMing Lu22(4)There are many small Chinese chip suppliers,but major equipmentproviders dare not risk them in the competition with Huawei.Huawei was on the U.S.Entity List earlier,but in the case of surveillance,webelieve,Huawei should deeply app

93、reciate the Trump administration.The newEntity List will tip the balance in the chip supply.Huawei may possibly takethe whole China surveillance market if other equipment providers lose thekey chip support from the U.S.“China is by far the largest single market probably accounting for 35 to 40percen

94、t of world demand”,A&S commented in its 2019 security report.Inshort,the new Entity List will help Huawei drive U.S.suppliers out of“thelargest single market”.As we know,Major equipment providers,such as Hikvision and Dahua,started developing the core chips by themselves.However,they may not liveto

95、see the self-sufficient day,if the U.S.continues to“help”Huawei to takethe market.Some good news came for Chinese surveillance companies.The U.S.andChina signed a phase-one deal on January 15,2020,which means a ceasefireof the trade war.The deal does not mention the Entity List,but it is a positives

96、ignal.We notice that Huawei was given a“temporary general license”afterthe company was blacklisted,so that Huawei can still“temporarily”obtainparts from U.S.suppliers.The precedent suggests that Chinese companies onthe Entity List may obtain de facto supplies.3.CoronavirusThe Wuhan coronavirus is sp

97、reading.According to the experience of theSARS(Severe acute respiratory syndrome)in 2002-2003,this kind of viralrespiratory disease will be contained when the temperature rises.On July 9th,2003,the WTO(World Health Organization)declared that the SARS,whichbroke out in November 2020,was completely co

98、ntained.Therefore,we expect most local governments will focus on fighting thecoronavirus and will not have spare energy to install more surveillancesystems in the first half of 2020.However,we expect local governments will attach more importance to videosurveillance after the event.The municipal gov

99、ernment of Wuhan,which isthe epicenter of the virus outbreak,is preventing citizens from leaving thecity.The government shut down the airport,railway stations,and highways.However,so far,the government finds 5 million citizens have left Wuhanversus 9 million staying in the city.On the ground,we know

100、 many driverscharged extremely high prices and took citizens out of Wuhan.These driversknow how to use rural roads and avoid the coverage of the existingsurveillance system.Many other municipal governments are facing the samesituation.The rural roads the drivers used are exactly what the bright snow

101、project aims to cover.Chinese Video Surveillance IndustryMing Lu23E.ValuationWe compare 7 video surveillance companies listed in mainland China(Exhibit 31).We believe Dahua is undervalued,as the market only focuses onhistorical revenue growth.Exhibit 32:Dahuas annual Growth RateSource:Dahua and Aequ

102、itas Research estimates.1.We believe Dahuas revenue growth will reverse in 2020 and2021(Exhibit 32).(1)“Snow Bright”:The governmental“snow bright”project will demandmore video surveillance equipment.However,please note that the demandwill start in 2H2019,but not 1H2019.We believe local government wi

103、ll bebusy fighting the coronavirus in 1H2019.We also believe local governmentswill be more than willing to follow“snow bright”to cover suburban areaswith video surveillance,because they must find it is hard to preventpopulation from flowing from city to city through suburban areas.(2)Market Position

104、:Dahua is the second largest surveillance company inChina(Exhibit 3).The 3rdChinese company Univiews revenues was only 17%of Dahua.We believe China is almost a duopoly market.In other words,webelieve the demand from“snow bright”will mainly be taken by HikvisionChinese Video Surveillance IndustryMing

105、 Lu24and Dahua.Overseas brands,such as Sony and Samsung,has already beensubstituted by domestic brands.We also believe the Chinese government willblock the re-entry of overseas brands for national security reason.Exhibit 33:Dahuas annual Growth RateSource:Dahua and Aequitas Research estimates.2.We b

106、elieve the net margin will be stable in 2020 and 2021(Exhibit 33).(1)Gross Marin:Dahuas gross margin improved 4.7 percentage points in13Q2019 over 13Q2020,as the company moved its focus from revenuegrowth to margin.We believe Dahuas gross margin will reach the level ofHikvision,i.e.,46%,in 34 years

107、versus the current level 40%(Exhibit 23)due to the revenue growth we expect above.Non-core parts are alwaysprocured at lower prices when the volumes become larger.(2)Sales and marketing expenses:We believe“sales and marketingexpenses as%of total revenues”will rise slightly in 2020 due to thecompetit

108、ion with Hikvision.However,we believe the competition will belimited,as China is almost a duology market.(3)Research and development expenses:Dahua is actively researchingand developing the core chips,or more accurately,the SoC(System on Chip)chips with high-quality GPU(Graphics Processing Unit)func

109、tions.Currentlythe chips are supplied by the competitor Huawei and the overseas suppliersthat will be or nominally have been banned by the U.S.government.Higherthe quality of the self-sufficient chips,the lower the costs in the long run.Therefore,we believe the“research and development expenses as%o

110、f totalrevenues”will also rise slightly in 2020.In summary,we believe earnings per share will grow 22%in 2020 and 25%in 2021 due to the accelerating revenues and the stable margin.We concludea P/E ratio of 16.2x for 2020 versus 15.8x from the market consensus.Whichever ratio is used,we believe Dahua

111、 is undervalued.F.ConclusionWe believe the Bright Snow project will provide Chinese surveillancecompanieswithapromisingdomesticmarket.Over2,000countygovernments need surveillance systems for public places.We believeChinese Video Surveillance IndustryMing Lu25governmental usage will educate non-gover

112、nment institutions in thesecounties that surveillance is a solution for safety.We also believe thecoronavirus event proves the necessity of“Bright Snow”.We believe the market undervalues Dahua,as the market bases the valueon its revenue growth.However,we notice that Dahua has the highestimprovements

113、 in margin and operating cash flows among the top-threeChinese companies.We found the U.S.Entity List only pays attention to the companies thatraise the U.S.trade deficits.We believe all investors have their own ethicalstandards,but none of them have to be the tools of a political election orcommerc

114、ial competition.G.AppendixExhibit 34:Comparison of Global Rank,Entity List,and MSCICompanyA&S Global RankNew in Entity ListMSCI China A-ShareTickerHikvision1YesYes002415 CHDahua2YesYes002236 CHUniview*7-Yes002373 CHTiandy*9-000836 CHInfinova14-002528 CHKedacom17-603660 CHMegvii19Yes-PrivateRaysharp2

115、2-833645 CHTVT Digital26-002835 CHWanjiaan32-834520 CHZeno44-837181 CHiFLYTEC-YesYes002230 CHGRG Banking-Yes002152 CHMeiya Pico-Yes-300188 CHSenseTime-Yes-PrivateYitu-Yes-PrivateYixin-Yes-Private*Subsidiary of TransInfo.*Subsidiary of Futong Xinmao.Source:A&Stop-50,U.S.Federal Register,and Aequitas

116、Research.Chinese Video Surveillance IndustryMing Lu26Disclosure&CertificationI/We have no position(s)in the any of securities referenced in this insightViews expressed in this insight accurately reflects my/our personal opinion(s)about the referenced securities and issuers and/orother subject matter

117、 as appropriate.This insight does not contain and is not based on any non-public,material information.To the best of my/our knowledge,the views expressed in this insight comply with Singapore law as well as applicable law in thecountry from which it is postedI/We have not been commissioned to write

118、this insight or hold any specific opinion on the securities referenced thereinI/We have signed the Insight Provider Agreement and this insight does not violate any of the terms specified therein.Ming Lu(31 Jan 2020)Chinese Video Surveillance IndustryMing Lu27Thematic(Sector/Industry)China Auto Parts

119、 AShares:Parts Of TheFutureBy Victoria Li|27 Mar 2020EXECUTIVE SUMMARYChina has been the fastest growing auto market in the world.Over the last2-3 years Chinas auto component industry is going through a tumultuousperiod-not only due to the volatility in demand(due to the auto downturnlast year and c

120、orona-related lockdowns this year),but also due to two mega-trends that are providing risks and opportunities to the industry-NEVs andautonomous driving.In addition,there are 3 other less-discussed driversof change in the industry(emerging localization requirements,junior JVpartners becoming leaders

121、 in their own right,international expansion).Welook at the key A-share(MSCI A-share)listed players in the industry throughthe lens of these five trends/drivers of change.We prefer Passenger vehicle(PV)part suppliers over commercial vehicle(CV)part suppliers.Among PV parts suppliers,our top buy is Ch

122、angzhouXingyu(601799.CH),followed by Ningbo JoysonElectronic(600699.CH),Fuyao Glass(600660.CH/3606.HK)and HuayuAuto(600741.CH).Our main underweight Wanfeng Auto Wheel(002085.CH).In Commercial vehicle(CV)part segment,we preferWanxiang Qianchao(000559.CH)and Linglong Tyre(601966.CH).Wesuggest investor

123、s to avoid Weifu High-Tech(000581.CH).Whats Original?The recent tumult in the auto sector creates significant opportunities andrisks for the companies involved-however companies/equities that aredriving these trends are largely listed in the A-share market.Lack of marketcommunication,limited financi

124、al and operational disclosure and low breadthof analyst coverage in these markets has meant that there are quite a fewunderappreciated companies in these markets which have been overlooked byinternational investors.WhilecompanieslikeNingboJoysonandFuyaoGlassenjoysomeinternational investor recognitio

125、n,we believe under-appreciated stocks likeWanxiang Qianchao and Linglong tyres are not well-covered by the marketand this report provides a rationale for investors to look further into thosenames.We also highlight the risks to(relatively)popular names like WeifuHi-tech(due to structural issues in th

126、e industry)and Wanfeng Auto wheel(due to management pursuing non-core acquisitions).China Auto Parts A Shares:Parts Of The FutureVictoria Li28Victoria LiChina Specialist,Auto and Industrial SpecialistVictoria has 18 years of experience as a sell-side equity analyst in China,focusing on Auto,Industri

127、als,and Energy.She has strong contacts in the machinery and automotive sectors,and can get into the thinking process of key industry players and decision makers through her experience in China and abroad.Areas of Expertise Primary Asset Class:Equities Geography:Asia Pacific Countries:China Sectors:C

128、onsumer Discretionary,IndustrialsContent Verticals Equity Bottom-Up,Thematic(Sector/Industry)Note that in this report,we do not include the possible impact fromCoronavirus on the industry and companies.This is because 1)its difficult toquantify the impact at current moment;2)even if coronavirus impa

129、ct mightlast for months,its still a relative short period compared to the 5-year timehorizon we focus on.In addition,once coronavirus is gone,market demandon autos and auto parts would rebound quickly.DETAILInvestment RationaleGrowths of passenger vehiclecomponents suppliers wouldoutperform those of

130、 commercialvehicle components suppliersIn 5 years horizon,we believe auto suppliers with big exposure to passengervehicles(PV)would outperform others exposed to commercial vehicles(CV).The key reasons are:1)Although Chinas PV sector had negative growth in 2019,annual PV salesstill have upside.This i

131、s because Chinas motorisation rate remains lowcompared with other major auto markets/countries.We estimate ChinasPV shipment will grow at a CAGR of 5%during 2020-2025E,withgrowing disposable income per capita and improving car autonomyfunctions.China Auto Parts A Shares:Parts Of The FutureVictoria L

132、i292)Commercial vehicle market,especially truck,is matured in China.Current market demand is mainly from replacement.In China,commercialvehicle demand is mainly from logistics(including cargos and passengers)and construction.China has already experienced peak period ofinfrastructure construction,whi

133、ch it would not be able to repeat over thenext 5 years.Vehicle demand from freight transport might be boosted in thenext two years due to Chinas new toll road charge policy which took effecton 1st Jan 2020(please refer to Sinotruk(3808.HK):New Engine,New Life).However,we estimate Chinas road freight

134、 transport might have peaked in2018,due to Central government encouraging on rail freight transport.Chinas road freight transport declined 13%yoy in 2019.Vehicle demandfrom passenger transport goes down y/y since Chinas HSR(High SpeedRailway)network is formed.China Auto Parts A Shares:Parts Of The F

135、utureVictoria Li30Demand on CV parts would be stablewith product upgrading driven by highernational emission standardsNEV,V2X and autonomous driving are also expected to happen incommercial vehicle sector,but their commercialization is far behind that ofPV sector.In the next few years,key change in

136、CV market is the upgrade ofexhaust emissions standard,which is triggering replacement demand onengines and related components.State Council requires non-road machinesto use National IV engines from 2021.Heavy duty vehicles shall use NationalVI diesel engines from July 2019.Light duty vehicles will u

137、se National VIdiesel engines from July 2020.This trend is driving ASP(and margins)ofrelated components suppliers,such as Weichai Power(000338.CH/2338.HK,heavy duty truck engines)and Weifu Hi-Tech(000581.CH,diesel engine fuel injection system).Key drivers of the auto componentsindustry:1)Increasing s

138、hare of New Energy Vehicles:With support from thegovernments of all major countries,its clear that NEV(New EnergyVehicle)would dominate the market in the future.Increasing salesproportion of NEV is leading to 1)Demand from engines,gearbox andemission control is changing to demand from batteries,moto

139、rs and relatedcontrol systems;2)Reducing car weight by using lighter alloy or non-metalmaterials,such as increasing the use of glasses,replacing steel parts withaluminum alloy parts and magnesium alloy parts,etc.In this environment;traditional OEMs have to reduce their in-house engine productions an

140、dpurchase batteries,motors and related management systems from third-party suppliers.Traditional steel parts suppliers would loss market to glasssuppliers and aluminium and magnesium alloy or other lighter partssuppliers.Typical beneficiaries include Fuyao Glass(600660.CH/3606.HK,auto glass),Huayu A

141、uto(600741.CH,motor and controlsystem),and Wanfeng Auto Wheels(002085.CH,aluminium andmagnesium alloy parts).China Auto Parts A Shares:Parts Of The FutureVictoria Li312)Rise of autonomous driving:China officially set a time line for autosectors autonomous driving,which requires mass production ofCon

142、ditional Automation(CA)cars,i.e.L3 level cars,and bringing to marketof High Automation(HA)cars,i.e.L4 level cars,by 2025.It also requires tocomplete LTE-V2X(vehicle to everything)coverage,and apply 5G-V2Xgradually in cities and expressways,by 2025.(please refer to China Auto:Autonomous Driving Is Of

143、ficially on the Way).In this trend,demand on newauto parts are created,such as sensors,cabin electronics and softwares.Typical beneficiaries include Changzhou Xingyu(601799.CH,smartauto light),Joyson(600699.CH,active auto safety system,car connect),Fuyao Glass(600660.CH/3606.HK,HUD glass),and Huayu

144、Auto(600741.CH,millimeter radar).Sources:nhtsa.gov3)Import substitution is opening auto automation parts market tolocal suppliers:2020 might be a milestone year for some local auto partssuppliers.Tesla Shanghai targets to raise its auto parts localisation rate from30%at end-2019 to 80%by mid-2020 an

145、d then 100%by the end of 2020.Tesla Shanghai came on steam at end-2019,and is expected to deliverChina Auto Parts A Shares:Parts Of The FutureVictoria Li32100,000 Model 3 cars.Based on related auto parts companiesannouncements by the end of the date,the biggest beneficiary of Teslaorders is Ningbo X

146、usheng(603305.CH).While suppliers who are already inTeslas supply chain include Joyson(600699.CH,auto safety products),Fuyao Glass(600660.CH/3606.HK,auto glass),Huayu Auto(600741.CH,car seats),Wanfeng Auto Wheels(002085.CH,magnesium alloy parts).4)JV partners becoming technology leaders in their own

147、 right:Companies that were junior JV partners of global component manufacturersbuying out their JV partners.Some are buying global technology leaders toleverage their technology in China.Joyson(600699.CH,auto safetyproducts),Fuyao Glass(600660.CH/3606.HK,auto glass),Huayu Auto(600741.CH,auto lights)

148、and Wanfeng Auto Wheels(002085.CH,magnesium alloy parts)are exposed to this theme5)International expansion:Chinese auto parts companies are using theirnew-found manufacturing prowess and technology expertise to expand intointernational markets.The companies that are exposed to this themeinclude Chan

149、gzhou Xingyu(601799.CH),Fuyao Glass(600660.CH/3606.HK),Wanxiang Qianchao(002085.CH)and Linglong Tyre(601966.CH),Company Investment RationaleSummaryChangzhou Xingyu(601799.CH):As a pure auto lights supplier in Chinawith 7.1%market share 2018,Xingyu is well positioned for the smart autolight trend in

150、the sector.In 2019,its new product,LED ADB(AdaptiveDriving Beam),started mass production with first order from FAW.Inaddition,pixel headlight(equivalent to Mercedess Digital Light)is availablefor ordering.We estimate smart auto lights penetration increase woulddrive Xingyus gross profit growth with

151、a CAGR of at least 32%during2018-2025E,assuming Xingyus market share unchanged in auto lightsmarket.Client base expansion/penetration increase might double Xingyusrevenue further.Overseas capacity expansion started with first plant beingbuilt in Serbia which would contribute Rmb117mn of pre-tax prof

152、it,equivalent to 13%of Bloomberg consensus pre-tax profit 2019E,in the nearfuture.Ningbo Joyson Electronic(600699.CH):Joyson is second largest auto safetysystem supplier in the world with 30%global market share,grew rapidlythrough M&A.It is well-positioned in L3 level autonomous drivingtechnologies.

153、It provides adaptive steering,driver management system innew steering system,first generation 5G-V2X product and latest IVI(In-Vehicle Infotainment)system which would drive Joysons auto electronicsales to grow with a CAGR of 50%during 2019-2025E.Consolidation ofrecent acquired KSS and Takata assets

154、would improve Joyson safety systemsegments margins and increase Joysons net profit by 30%.In addition,global active safety market size would double by 2025 from 2017,whichwould benefit Joyson.China Auto Parts A Shares:Parts Of The FutureVictoria Li33Fuyao Glass(600660.CH/3606.HK):Fuyao is the second

155、 largest auto glasssupplier in the world with 22%market share in 2017,and Chinas largestauto glass supplier with 63%market share.Wtih increasing penetration ofnew function glasses,we estimate Fuyaos auto glass ASP might increasefrom Rmb164/m2 in 2018 to Rmb195/m2 in 2025E,which would translateinto 1

156、9%sales increase with higher margins,assuming no sales volumeincrease.Overseas plant utilisation rate improvement would raise Fuyaosprofitability.In 2020,Fuyao estimates its US plants will sell 4.6-4.7mn setsof auto glass with same profitability of domestic plants.Fuyao enteredaluminium auto trim pa

157、rts business in 2019 by acquiring SAM(Germanyaluminium auto trim parts supplier),domestic metal moulding company andaluminium smelting company as suppliers to SAM.As a major supplier toVW in Europe,we estimate SAM would gain orders from VW China as anentry point of exploring China market.Huayu Auto(

158、600741.CH):We appreciate Huayus leading position andadvanced technology among peers.However,as Chinas largest auto partssupplier with most comprehensive products and biggest client bases,itsearnings growth rate will lag the three other peers mentioned above.This ismainly because all the fast growing

159、 product categories contribute only a verysmall percentage of the companys overall sales/profit.Also,Huayu hascustomer concentration risk due to non-compete with JV partners.Amongits major 28 business contributors,18 of them are JVs and associates withforeign partners.Wanfeng Auto Wheel(002085.CH):I

160、ndustry consolidation in the autowheel segment might be triggered by recent auto market weakness(including outbreak of Coronavirus)and benefit Wanfeng.Chinasmagnesium alloy per car remains low at 3kg per car in 2017.Assuming itreaches 20kg in 2025 and Wanfeng gains 20%market share,its annual salesfr

161、om magnesium alloy parts would be Rmb2.24b,or 20%of Wanfengsrevenue in 2018.In Jan 2020,Wanfeng bought an aircraft manufacturingbusiness from parent company.This worries us as it indicates that Wanfengmanagement might see limited upside on its alloy parts business,and wantto explore another business

162、 area with which the management has had noexperience before.Wanxiang Qianchao(000559.CH):We believe the market has beenunderappreciating the investment potential of Wanxiang.It is Chinasuniversal joint and wheel hub leader who has been suffering from capacitybottlenecks.Wanxiangs product quality is

163、well-known and appreciated butits production has been running behind the growth in customer demand.Wanxiang is expanding its wheel hub capacity to 50mn sets from 20mn setsby 2021,which could increase Wanxiangs revenue by 1.6 times with fullcapacity utilisation rate.Overseas capacity build started in

164、 2020 to coveroverseas demand.Capacity expansion might increase Wanxiangs debt load ifits private placement fails.The only negative is its valuation-2020E isdemanding after earnings decline in 2018-2019E.Linglong Tyre(601966.CH):With the market recognition on Linglongsproduct quality and attractive

165、prices,Linglong is entering supply chains ofJV OEMs such as VW,GM and Ford.As 85%of car owners choose sameChina Auto Parts A Shares:Parts Of The FutureVictoria Li34brands of tyres which are used on their new cars,entering OEMs supplychain would deliver upside to Linglongs sales growth and stability

166、over autosector cycles.PV tyres have higher margin,whereby improve Linglongsproduct mix and hence its profitability.Overseas capacity expansion avoidsnegative impact from trade war.Besides Thailand plant,Linglong started anew plant in Serbia with would increase Linglongs net profit by 40%once itsann

167、ual capacity is fully utilized.Weifu High-Tech(000581.CH):Chinas leader in diesel engine fuelinjection system faces downward risk as sector demand is structurallyshrinking.It heavily replies on profit contribution from associates,whosenet profit accounted for 63%of Weifus net profit in 2018.To offse

168、t its mainbusiness risk,Weifus exploring business opportunities in BEV powertrainsystem,in-wheel electric motor and fuel battery parts,which are still inearly stage.China Auto Parts A Shares:Parts Of The FutureVictoria Li35BackgroundNew Energy Vehicles are taking a bigger proportion of Chinas PV mar

169、ket.Autonomous driving became officially target for Chinas PV sector.Thesemean a period of fast change with plenty of opportunities and risks forChinas auto parts sector.In this report,we help overseas investors explorethe key auto parts suppliers in MSCI China A Index.ValuationIn A-share market,P/E

170、 ratio is still considered as the most commonvaluation methodology.Among these eight stocks we cover in this report,Xingyu and Joyson are the most expensive ones among PV parts suppliers,while Wanxiang is the most expensive one among CV parts suppliers.Xingyus valuation might look a little bit aggre

171、ssive compared to its peers.However,1)we believe the market significantly underestimated Xingyusearnings growths in the next few years.We estimate Xingyus net profitCAGR would be 40%during 2020-2021E(without impact from Coronavirus,which is difficult to quantify at current moment),which indicates 20

172、.8x P/Eon 2020E and 14.8x P/E on 2021E.2)Xingyus 5-year historical P/E range isat 15-52x with average of 28.8x,which indicate its current valuation is at lowrange.Joyson and Fuyaos P/E valuation looks attractive compared with its highearnings growth.Joyson trades at 19x P/E 2020E,vs.its 5-year range

173、 of12-39x.Fuyao trades at 12x P/E 2020E,vs.its 5-year historical range of10-24x.Some investors believe Huayu is significantly undervalued compared to itspeers,considering its unique market position.However,we believe valuationupside of Huayus is limit due to its huge sales base which is not sensitiv

174、e toany big earnings increase from any single products.In addition,its corporatestructure(having 18 JVs and associates with foreign partners out of its major28 business contributors)limit its client base expansion due to JV partnersrestriction on non-compete within same products segments.Huayu trade

175、s at8x P/E 2020E based on Bloomberg consensus,vs.its 5-year historical rangeof 6-14x P/E and 5-year average of 9.7x.We believe its current valuation isreasonable.Based on Bloomberg consensus,Wanfeng trades at 15x P/E 2020E,which isat sector average level.However,its expected earnings growths are wea

176、kerthan peers average.And we have concern on Wanfengs business growth inthe next 5 years.It might take long time to see PV wheel consolidationwhich might be the only driver of its aluminium alloy wheel business.Whileits Magnesium alloy part business is not big enough to drive earnings growthyet.Ente

177、ring aircraft business strengthen our concern.China Auto Parts A Shares:Parts Of The FutureVictoria Li36Wanxiang Qianchao is not a stock that is widely covered by analysts in themarket.We estimate its net profit CAGR would be 50%during 2020-2021Eonce its new capacity ramps up.But current valuation,1

178、8.7x P/E 2020E and11.3x P/E 2021E,is not attractive enough.Based on Bloomberg consensus,Linglong trades at 12.3x P/E 2020E,which isquite attractive,vs.its historical P/E range of 13-30 x P/E(average of 18.5x)and expected earnings growth in the next few years.Also,when Linglongssales exposure to PV g

179、oes above 75%,a valuation rerating would probably betriggeredWeifu trades at 7.9x P/E 2020E,which is fair,vs.its historical P/E range of6-26x P/E and expected earnings growth in the next few years,and long termconcern on its core business.Company nameTickerLastprice(Rmb)Bloomberg EPS(Rmb)EPSgrowthsP

180、/E(X)2018 2019E 2020E 2021E 2020E2021E 2019E 2020E 2021ECHANGZHOUXINGYUAUTOMOTIVE601799CH79.652.212.743.454.2926%24%29.023.118.6NINGBOJOYSONELECTRONIC600699CH19.21.020.841.021.3021%28%23.018.914.8FUYAO GLASSGROUP A600660CH17.931.641.271.441.6314%13%14.212.411.0HUAYU AUTOSYSTEM600741CH18.912.552.142.

181、332.569%10%8.88.17.4WANFENG AUTOWHEELS002085CH6.680.440.380.450.4818%7%17.614.813.9WANXIANGQIANCHAO*000559CH4.930.260.190.260.4440%65%26.118.711.3SHANDONGLINGLONG TYRE601966CH18.820.981.331.531.8116%18%14.212.310.4WEIFU HIGH-TECH000581CH17.952.372.182.282.505%10%8.37.97.2Sector average19%22%17.614.5

182、11.9Sources:Bloomberg,*Victoria LiestimatesKey RisksOn a sector wide base,the key risks include 1)weaker than expected NEVsales,especially right after government subsidies quit in 2021E;2)slowerthan expected technology development on autonomous driving functions;3)slower than expected car users acce

183、ptance on autonomous drivingfunctions,which has low possibility to happen;4)unexpected challenges onoverseas expansions,which might hurt companies earnings in short term;5)unexpected technology advantage loss after taking over JVs rights.;6)OEMs switching back to imported components due to quality i

184、ssue,whichhas low possibility.China Auto Parts A Shares:Parts Of The FutureVictoria Li37Key downside risks on buying our preferred stocks includes companystrategy change;lower than expected marketing capability;higher thanexpected raw material cost goes;unexpected product quality failure;capacity ex

185、pansion delay,etc.Key upside risks on unfavored stocks are:newly acquired non-core business grows faster than expected;newunexpected successful M&A;etc.ConclusionWe prefer Passenger vehicle(PV)part suppliers over commercial vehicle(CV)part suppliers.Among PV parts suppliers,our top buy is Changzhou

186、Xingyu(601799.CH),followed by Ningbo Joyson Electronic(600699.CH),Fuyao Glass(600660.CH/3606.HK)and Huayu Auto(600741.CH).Our mainunderweight Wanfeng Auto Wheel(002085.CH).In Commercial vehicle(CV)part segment,we prefer Wanxiang Qianchao(002085.CH)and Linglong Tyre(601966.CH).We suggest investors to

187、avoid Weifu High-Tech(000581.CH).Detailed Discussion of the CompaniesChangzhou Xingyu(601799.CH)Background:Controlled by Zhous family,Xingyu is pure autolights supplier in China with 7.1%market share 2018.It is theonly local brand among Top 6 suppliers.Xingyus productsinclude headlights,tail lights,

188、signal lights,fog lights,andothers.In 2019,its new product,LED ADB(Adaptive DrivingBeam),started mass production with first order from FAW.Moreover pixel headlight(equivalent to Mercedess digital light)is available for ordering.Xingyu has majority of its sales fromthe China market.In 2018,Xingyu has

189、 only 2.7%revenue fromoverseas.Smart auto lights penetration increasewould drive Xingyus gross profit growthwith a CAGR of at least 32%.Since 2019,Xingyu started mass production of LED headlights with firstorder from FAW.This means the companys headlights ASP would increasefrom currently estimated R

190、mb1,000 per car to Rmb11,000 per car or above inChina Auto Parts A Shares:Parts Of The FutureVictoria Li38the next 5-10 years.We estimate its gross profit to grow with a CAGR ofat least 32%during 2018-2025E,assuming Xingyus market shareunchanged in auto lights market.LED headlights penetration rise

191、would drive Xingyus autolight gross profit grow with a CAGR of 32%Auto lights segment201720182025E*CAGRSales(Rmb mn)3,7524,50524,57727%Numbers(mn units)5765670%ASP(Rmb/unit)667036927%Gross margin23%24%30%3%Gross profit(Rmb mn)8581,0647,37332%Sources:company data,Victoria Li estimates*assuming revenu

192、e and sales number increase is only fromheadlight upgrading to LEDAuto headlights prices comparisonHalogen XenonLEDOrdinaryAdaptiveLED(BMW)MultibeamLED(Mercedes)Matrixheadlight(Audi)Pixelheadlights(WEYVV6)(Rmb/car)-1000 1600-2000 7,50011,00014,50035,000Sources:autohomeAuto light sources ar

193、e being upgraded all the time since the invention ofautomobiles.1)Now LED light penetration is rising from previously usedhalogen and xenon lights.Key advantages of LED lights,compared to theothers,are:longevity,concentration of lights,energy saving,fast responseand wide light temperature range.It a

194、lso makes intelligent-ization of autolights possible.In 2019,Chinas LED auto headlight penetration is estimatedto be 40-45%,and is estimated to reach 60%by 2021E.The price gapbetween LED headlight and halogen/xenon lights are betweenRmb600-1,600 per car.Increasing penetration of LED lights would ben

195、efit allthe LED auto lights suppliers.China Auto Parts A Shares:Parts Of The FutureVictoria Li39Comparison of three types of auto lights in market55W Halogen35W Xenon40W LEDBrightness(lumens)1,0003,2006,200Service life(hours)50030,000100,000Lighting performanceDivergentConcentrated,but brightness re

196、duced at edge areas ConcentratedEnergy consumption55W35W40WResponseSlowrelatively slowfastLight temperature3000K4200-6000K3000-7000KSources:auto home2)Another key upgrade in auto light sector is intelligent light systemfor safety and rising levels of autonomous driving,which shall furtherincrease pr

197、oducts prices and margins.Currently,the most used are ADB(Adaptive Driving Beam)and AFS(Adaptive Front-light System).AdaptiveDriving Beam(ADB)is a headlamp system that ensures wide visibility fordrivers by enabling to drive with high-beams all the time while avoidingglaring to oncoming vehicles or v

198、ehicles ahead.The Adaptive Front-lightingSystem(AFS)optimizes distribution of light from the headlights accordingto driving circumstances.Depending on vehicle speed and steering input,the system points the low-beams headlights in the direction the driverintends to travel.AFS is already commonly used

199、 for car models priced atRmb150,000 and above.while ADB is under evolution.ADB penetration inChina is estimated to be around 2%.Initially ADB is achieved by dynamic lighting system,such as BMWsDynamic Xenon and Adaptive LED,which was first introduced in China in2006.In 2011,Audi introduced Matrix LE

200、D headlights,which produce thehigh beam with tiny light-emitting diodes that are bundled in commonreflectors or lenses.In 2014,Mercedes introduced MultibeamLED headlights,which enable high beam to be left on without dazzlingother road users.84 individually controllable LEDs direct the light precisel

201、yso as to blank out other vehicles whilst illuminating the surroundings withalmost daytime-level brightness.A total of four control units calculate theideal light pattern 100 times per second using information from a camerabehind the windscreen.Now the latest intelligent light system features chipsw

202、ork with over one million micromirrors,such as Audis Digital matrixLED headlights and Mercedess Digital Light.Client base expansion/penetrationincrease might double Xingyus revenuefurther.Currently Xingyu has about 40%revenue from FAW VW,followed by FAWToyota,Chery and SAIC VW.Top 4 clients,whose to

203、tal market share inChina was 25.6%in 2019,contribute nearly 77%of Xingyus revenue.Moreover Xingyus penetration in its existing clients is below 50%,exceptFAW VW.In recent years,Xingyu is gaining orders from new clients,including Japanese brands(21.3%total market share in China)and luxuryChina Auto P

204、arts A Shares:Parts Of The FutureVictoria Li40brands(such as BMW global and Beijing Mercedes Benz).If Xingyu gets50%of Japanese brands lights demand,its revenue would increase byadditional 150%.Overseas capacity expansion to exploreoverseas demand.In 2018,Xingyu had only 2.5%revenue from overseas.In

205、 2019,Xingyuannounced to build auto light factory by Jan 2023 in Serbia with capacity of5.7mn units.The new plants would cover demand from GM,Chrysler,VW,Mercedes Benz,BMW and Peugeot.Xingyu estimated that the new plantwould contribute Euro14.83m(or Rmb117mn)of pre-tax profit,equivalent to 13%of Blo

206、omberg consensus pre-tax profit 2019E.China Auto Parts A Shares:Parts Of The FutureVictoria Li41Xingyus Auto Lights productsSources:company dataChinas major auto light suppliersmarket shares are stable but industryconsolidation is still possible withproduct specification upgrade trend.In 2018,Xingyu

207、 was the only local company among Top 6 suppliers,andranked No.5 by market share in China.All the others have background withglobal leaders(HASCO Vision Tech used to be a JV between Huayu andKIOTO and became 100%owned subsidiary of Huayu).In the past few years,market shares of Top 6 has been quite s

208、table.However,with the technologyupgrade for smart auto lights,smaller suppliers might lose theirmarket shares to Top 6,including Xingyu.ValuationIn A-share market,P/E ratio is still considered as the most valuationmethodology.Xingyus valuation might look a little bit aggressive comparedto peers.How

209、ever,1)we believe the market significantly underestimatedXingyus earnings growths in the next few years.We estimate Xingyus netprofit CAGR would be 40%during 2020-2021E(without impact fromCoronavirus,which is difficult to quantify at current moment),whichChina Auto Parts A Shares:Parts Of The Future

210、Victoria Li42indicates 20.8x P/E on 2020E and 14.8x P/E on 2021E.2)Xingyus 5-yearhistorical P/E range is at 15-52x with average of 28.8x,which indicate itscurrent valuation is at low range.We suggest BUY on Xingyu due to itsexpected fast earnings growth driven by smart auto light penetration rise,co

211、nsensus upgrading possibility and relative attractive valuation.Xingyus Consensus Forecast(Rmb mn)20182019E2020E2021ERevenue5,0745,8817,0628,586Operating profit6228831,1141,392Net Income Adj+6117609531,187Net margin(%)12.0%12.9%13.5%13.8%Net income growth24%25%25%EPS Adj+2.212.743.454.29P/E36.0229.0

212、523.0918.57Sources:Bloomberg Last price on 23 March 2020Ningbo JoysonElectronic(600699.CH)Background:Controlled by Mr.Wang Jianfeng,Joyson is secondlargest auto safety system supplier in the world with 30%globalmarket share,grew rapidly through M&A.Key acquisitionsinclude Preh GmbH(auto electronic,2

213、011),Quin GmbH(steeringwheels etc,2014),IMA(industrial robot,2014),TS-Daun(modular information system,2016),Key Safety Systems(KSS,auto safety system,2016),Takata(auto airbag,2018).MajorChina Auto Parts A Shares:Parts Of The FutureVictoria Li43clients are OEMs in Europe and America,with 78%revenuefr

214、om overseas in 1H2019.Smart cabin system provider ready forL3 level autonomous driving commercialisation.Consolidation on KSS and Takada toimprove profitabilities and gain marketshare.In 2018,the company established Joyson Safety Systems(JSS)to integrateand restructure the recent acquired auto safet

215、y system assets-mainly byreducing redundant capacity and consolidating supply chain management,marketing and client management.The integration process is expected tocomplete by 2021,which would improve JSSs gross margin and net marginfrom 16.7%and 3.8%respectively in 1H2019 to 20%and 5%in 2021E.Marg

216、in improvement would increase Joysons net profit by 30%.Inaddition,passive auto safety system sales would be driven byincreasing safety consciousness in developing countries.IHS estimatesglobal active safety market size would double by 2025 from 2017.China Auto Parts A Shares:Parts Of The FutureVict

217、oria Li44Well positioned in L3 level autonomousdriving tech would translate intoearnings surge.Joysons auto electronic segment provides HMI,car connect and e-mobility,which have high penetration in VW,Mercedes and BMW in Europe.Wellknown car-connect products include BMWs i-drive and Audis MMI.Lately

218、,Joyson is combining active auto safety system with V2X forcommercialisation of L3/L4 level autonomous driving,and launched smartcabin integration.1)Its new steering system offers adaptive steering,driver managementsystem,etc for achieving L3 level automation.2)Its first generation 5G-V2X product wi

219、ll start mass production in 2021.China Auto Parts A Shares:Parts Of The FutureVictoria Li453)In Europe,latest IVI(In-vehicle infotainment)system based on Androidauto co-developed with Audi and VW starts mass production in 2020 withorder value of Rmb10b.IVI system for Benz MFA2 is started with order

220、valueof Rmb9b.During 9M2019,new orders on electronics above Rmb20b,vs.estimated Rmb10b sales in 2019E.4)R&D with global OEMs on L4 functions such as remote control driving,interaction among vehicles,pedestrians and facilities is in process.5)Moreover,Joysons BMS(battery management system for NEV)cli

221、ent baseis expanding from existing Benz,BMW and geely,to Nissan,Ford,SAIC GM,VW supply chain.Joyson has Rmb13.1b order on e-mobility at end June2019.We estimate Joysons auto electronic sales to grow with a CAGR of 50%during 2019-2025E.Joyson Launched first V2X Platform in the worldSources:company da

222、taJoysons Smart Cabin Integrated Solutionsources:company dataChina Auto Parts A Shares:Parts Of The FutureVictoria Li46Leveraging the key overseasacquisitions to increase penetration inthe China market and gaining marketshare quickly.As all the key assets previously based outside of China,Joysons ma

223、jorclients are OEMs in Europe and America,with 78%revenue from overseas in1H2019.Benefiting from solid client relationship with global OEMs,Joysonsorders from Chinese OEMs(JV brands)surges since 2018.In China,IVIsystem for MQB and MEB platforms of FAW VW and SAIC VW started massproduction in 2H2019

224、with estimated order value of Rmb19bn.Lately,itentered Teslas shanghais supply chain for auto safety products withestimated order value of Rmb1.5bn(Joyson is Tesla USs supplier withexisting orders from Tesla is Rmb7.5bn(6bn auto safety,1.5bn autoelectronics).ValuationSince the acquisition of Takata

225、assets,Joysons traded between 12-39x P/E.Based on Bloomberg consensus,Joyson trades at 19x P/E 2020E,which isquite attractive compared with its expected earnings growth in the next twoyears and its own historical P/E range.Joysons Consensus Forecast(Rmb mn)20182019E2020E2021ERevenue56,18162,01162,62

226、168,648Operating profit1,8732,6333,0933,748Net Income Adj+1,3181,0451,1831,539Net margin(%)2.3%1.7%1.9%2.2%Net income growth-21%13%30%EPS Adj+1.020.841.021.30P/E18.8122.9718.9214.77Sources:Bloomberg Last price on 23 March 2020China Auto Parts A Shares:Parts Of The FutureVictoria Li47Fuyao Glass(6006

227、60.CH/3606.HK)Background:Fuyao is a family controlled company controlled byMr.Cao Dewang.Fuyao got technology initially from Saint-gobain by founding JV in 1996,then Fuyaos parent companyacquired its partners shares and quit the co-operation in 1999.Now Fuyao is the second largest auto glass supplie

228、r in the worldwith 22%market share in 2017,and Chinas largest auto glasssupplier with 63%market share.In 2018,Fuyao has 41.8%revenue from overseas.In January 2019,Fuyao acquired SAM,Germany based bankrupt leading aluminium auto trim partssupplier and started auto trim parts business.Latest new funct

229、ion glasses for smartcar would raise Fuyaos ASP by 20%.HUD(head up display)glass would get popular in the next 5 years due tobetter driving safety and experience in our view.Antenna glass couldreceive GPS and other signals for autonomous driving.Lightweight glasscould further reduce the overall weig

230、ht of car,which is particularlyimportant to NEV models.Dimming glass provides easy switching betweentransparency and privacy.It can also be used as screen for in-vehicleentertainment system.All above would add value on Fuyaos glass productsand raise its ASP and margin.Panoramic Sunroof penetration w

231、ould go upfurther from current 40%to 70%in 2025E,which could increase Fuyaossunroof glass sales by 60%.We estimate Fuyaos auto glass ASP mightChina Auto Parts A Shares:Parts Of The FutureVictoria Li48increase from Rmb164/m2 in 2018 to Rmb195/m2 in 2025E,whichwould translate into 19%sales increase wi

232、th higher margins,assumingno sales volume increase.(Click here for Fuyao products)Sunroof glass and high-end glass have higher ASPsAuto glass typesAverage price(Rmb/sqm)Sunroof glass2253For luxury brands2585For JV/local brands2101Front windshield glass1155For luxury brands1374For JV/local brands1000

233、Sources:Wangqi Auto glass,Victoria Li estimatesThe glass used in high-end cars has more new functionsOverseas plant utilisation rateimprovement to raise profitability.Fuyao started US plant construction in 2014.Its plant in Ohio came onstream in 2016 and contributed positive earnings in 2017.In 1H20

234、19,FuyaosUS plants contributed 18.6%of Fuyaos total sales.In 2020,Fuyao estimatesits US plants to sell 4.6-4.7mn sets of auto glass with full capacity.Itsprofitability would reach the same level of domestic plants.It also has aRussian plant which would sell 1mn sets of auto glass,and its margin woul

235、dgo up further.China Auto Parts A Shares:Parts Of The FutureVictoria Li49Entering Tesla Shanghai supply chain.In 2020,Fuyao starts supplying side window glass to Tesla Shanghai.Thisorder might bring max Rmb70mn revenue in 2020E,which is not bigcompared to Fuyaos annual sales.However,Fuyao might get

236、chance to winTeslas orders on windshield glass,rear window glass or sunroof glass,whichhave much higher ASP and margins.Expanding into aluminum trim partsbusiness.Fuyao entered aluminium auto trim parts business in 2019 by acquiringSAM,Germany aluminium auto trim parts supplier.It also acquireddomes

237、tic metal moulding company and aluminium smelting company assuppliers to SAM,to maximize its aluminium trim parts profitability.In theshort term,these moves would lower Fuyaos margins since 2019 until SAMsmargin recovers.But in the long term,auto trim parts business could bringadditional earnings.As

238、 a major supplier to VW in Europe,we estimate SAMwould gain orders from VW China as an entry point of exploring Chinamarket.ValuationIn the past 5 years,Fuyao was traded between 10-24x P/E.Based onBloomberg consensus,Fuyao trades at 12x P/E 2020E,which is attractivecompared to its historical average

239、 of 16x.Fuyaos earnings growth is aboutto speed up in the next few years,while its valuation is still at low range.Fuyaos Consensus Forecast(Rmb mn)20182019E2020E2021ERevenue20,22521,34622,91924,868Operating profit4,1593,7114,1824,800Net Income Adj+4,1203,1643,5394,065Net margin(%)20.4%14.8%15.4%16.

240、3%Net income growth-23%12%15%China Auto Parts A Shares:Parts Of The FutureVictoria Li50EPS Adj+1.641.271.441.63P/E10.9314.1512.4310.99Sources:Bloomberg Last price on 23 March 2020Huayu Auto(600741.CH)Background:Owned by SAIC(600104.CH,SOE),Huayu is an autoparts conglomerate.Its the largest auto part

241、s supplier in Chinawith most comprehensive products and biggest client base.Ithas five business segments with dozens of subsidiaries and JVs.Decorative parts segment mainly produces auto seats,autolights,passive auto safety system,interior covering for panels,etc;and exterior parts such as bumper mo

242、dule,fender module,adaptive cruise control panel,etc.Chassis system segmentmainly provides chassis integration,suspension system,steering system,braking system and transmission system.Metalforming parts segment produces aluminium alloy car bodyparts.Auto electronic segment mainly provides E-drivesys

243、tem(integrated inverter,asynchronous/synchronous motorand gearbox),thermal management system and BMS(BatteryManagement System).Thermal processing parts segment offerscrankshaft,knuckle,exhaust pipes,etc.Lately,Huayu built upnew segment for car intelligence and connectivity.In 1H2019,ithas 24%revenue

244、 from overseas,which is mostly contributed byYanfeng Automotive Trim System who consolidated JohnsonControlss auto trim assets.In 2019,Huayu gained orders fromTesla Shanghai for car seats,car body parts and battery cases.China Auto Parts A Shares:Parts Of The FutureVictoria Li51Smart cabin seats wou

245、ld be the newdriver to raise ASP and margin.Yanfeng Automotive Trim Systems is the biggest revenue contributor ofHuayu.Car seat,produced by a JV with Adient,is one of this subsidiarys keyproducts with 30%market share in China.As an important part to providecomfortable driving experience,car seat is

246、being upgraded all the time.Recent high end car seat can offer heating,massaging,multi-directionadjustment,head neck production system,integrated child seat,etc.Upgrading demand is the key earnings driver of car seat business.Entrylevel car seat is priced at Rmb2000/car,while high-end car seat could

247、cost at least Rmb10,000/car.Lately,smart cabin becomes a new trend incar seat segment.By adding functions such as Driver Monitoring System,loT remote control system for L3 or higher level car autonomous driving,smart cabin seats price would hit a new high.Typical passenger vehicle structureSources:g

248、asgooChina Auto Parts A Shares:Parts Of The FutureVictoria Li52Benefiting from smart auto lightspenetration increase.Through its subsidiary,HASCO Vision Tech,Huayu is the largest auto lightssupplier in China with 23%market share in 2018.In 1H2019,HASCO VisionTech was third largest subsidiary contrib

249、uting 10%of Huayus revenue.Previously known as Shanghai KIOTO,HASCO Vision Tech was a JV ofHuayu and KIOTO,In March 2018,Huayu acquired its JV partners 50%stakeand turned it into 100%owned subsidiary.Benefiting from auto lightsupgrade,HASCO Vision Techs ASP increased to Rmb200/car from Rmb139/car in

250、 2011.In 2019,HASCO Vision Tech co-developed programmableinteractive headlight with Human Horizons,which is equivalent to MercedesBenzs digital light tech announced in 2018.Functions it could achieveinclude ADB(Adaptive Driving Beam),AFS(Adaptive Front-lighting System).Auto headlights prices compari

251、sonHalogen XenonLEDOrdinaryAdaptiveLED(BMW)MultibeamLED(Mercedes)Matrixheadlight(Audi)Pixelheadlights(WEYVV6)(Rmb/car)-1000 1600-2000 7,50013,50014,50035,000Sources:autohomeChina Auto Parts A Shares:Parts Of The FutureVictoria Li53Huayus programmable interactive headlightSources:Companydat

252、aEarly starter of supplying millimeterradars.Millimeter radar is necessary for autonomous driving cars to detectsurrounding information,such as speed,distance,etc.The higher levelautonomous driving technology is used,the more radars per car is needed.According to Shujubang,shipment of millimeter rad

253、ar for passenger vehiclewas 3.58mn units,up 54%yoy.Assuming 30%new cars have L3 functions(with 4 radars per car)and 60%new cars have L2 functions in 2025E(with 1radar per car),annual shipment of millimeter radar would be 50.4mn units,indicating a 46%CAGR.Huayu started R&D on millimeter radar in 2014

254、,and provides stable supplyof 24Hz millimeter radar to SAIC PV since 2018.77/79Hz millimeter radar isunder development.Assuming Huayu gets 20%market share,whichmeans Huayu supply all the radars SAIC needs,its annual millimeterradar sales would be Rmb5bn in 2025E,equivalent to 3%of Huayus2018 revenue

255、.China Auto Parts A Shares:Parts Of The FutureVictoria Li54NEV powertrain system is expanding quickly with key technology fromMagna.Huayu diandong is the main body of Huayus NEV related business,which has capacity of 260,000 driving motors and 60000 controllers.It isestimated that Huayu Diandong wou

256、ld sell 500,000 motors in 2023 with itsmarket share rising to 14%from 4.8%in 2018.In 2017,Huayu founded a JVwith Magna,HASCO Magna,to produce integrated eDrive powertrain systeminitially for MEB cars of SAIC VW and FAW VW.In 2019,it gained orders forGMs BEV3 platform cars.HASCO Magna would start con

257、tributing earningsfrom 2021 onwards.Customer concentration risk due tonon-compete with JV partners.Although Huayu is working hard on expanding its client base,SAIC remainsthe biggest client with 54%of revenue in 1H2019(vs.68%in 2006).Webelieve the reasons behind are:1)Large sales base which is less

258、sensitive toadditional orders from single new customer on single product.2)JVpartners restriction on non-compete within same products segments.Among its major 28 business contributors,18 of them are JVs and associateswith foreign partners.Taking over the stakes from JV partners might releasethe rest

259、riction in the long term,like what Huayu did to gain full control onits auto light business,HASCO Vision Tech.However that would also makethe company lose some technology advantage.China Auto Parts A Shares:Parts Of The FutureVictoria Li55ValuationHuayu trades at 8x P/E 2020E based on Bloomberg cons

260、ensus,vs.its 5-yearhistorical range of 6-14x P/E and 5-year average of 9.7x.We believe itscurrent valuation is reasonable.Some investors believe Huayu issignificantly undervalued compared to its peers,considering its uniquemarket position.However,valuation upside of Huayus is limit due to itshuge sa

261、les base which is not sensitive to any big earnings increase from anysingle products.In addition,its corporate structure(having 18 JVs andassociates with foreign partners out of its major 28 business contributors)limit its client base expansion due to JV partners restriction on non-compete within sa

262、me products segments.Huayus Consensus Forecast(Rmb mn)20182019E2020E2021ERevenue157,170146,207154,341166,640Operating profit5,7869,0639,11910,192Net Income Adj+8,0276,7307,2628,001Net margin(%)5.1%4.6%4.7%4.8%Net income growth-16%8%10%EPS Adj+2.552.142.332.56P/E7.438.828.137.38Sources:Bloomberg Last

263、 price on 23 March 2020China Auto Parts A Shares:Parts Of The FutureVictoria Li56Wanfeng Auto Wheel(002085.CH)Background:Top 3 aluminium auo wheel suppliers in China,controlled by Chen&Wu family.Its also the largest motorcyclewheel supplier in the world.In 2015,Wanfeng Auto acquiredWanfeng Meridian

264、and started magnesium alloy componentsbusiness.In 1H2019,it had 55%revenue from overseas.It had78%revenue from passenger vehicles sector,18%frommotorcycle sector and 4%from high speed rail and planesectors.Market share gain potential with clientbase extension.In China,majority PV wheels are aluminiu

265、m alloy wheels,which lead tolimit upside on market size increase.However,PV wheel market is quitediversified.Total market share of Top 3 is only 30%.Recent auto marketweakness,including outbreak of Coronavirus,might trigger industryconsolidation and benefit Wanfeng.On the other hand,Wanfengs majorcl

266、ients are European and American OEMs.Its supplier of Mercedes,BMW,VW,Ford,GM,Fiat,Toyota and PSA.It provides 80%of PSA Chinas autowheels.Its exclusive supplier of Land Rover China.Recently,Wanfeng isgaining orders from Japanese brands,which might help it gain market share.China Auto Parts A Shares:P

267、arts Of The FutureVictoria Li57China Auto Parts A Shares:Parts Of The FutureVictoria Li58Magnesium alloy parts might be theearnings driver in the long term.Wanfeng Meridian,the subsidiary producing magnesium alloy parts,had65%market share of North American magnesium alloy die-casting parts.Itsmajor

268、customers are Ford,GM and Tesla.In 2017,it set up branch in Chinaand explore domestic market.In North America,magnesium alloy per car is5.8kg-26.3kg,vs.Chinas 3kg per car in 2017.Assuming Chinas magnesiumalloy per car reaches 20kg in 2025,total magnesium alloy parts demandwould increase by a CAGR of

269、 29%during 2017-2025E.If Wanfeng gains20%market share in China,its annual sales from magnesium alloyparts would be Rmb2.24b,or 20%of Wanfengs revenue in 2018.Wanfengs Magnesium Alloy PartsSources:company dataEntering aircraft business.In Jan 2020,Wanfeng announced to acquire 55%stake of Wanfeng Aero

270、planefrom parent company.Wanfeng Aeroplane is a general aeroplanemanufacturer.Its world third largest fixed-wing aircraft manufacturer afteracquiring well known aerocraft companies in Austria and Canada.Thisbusiness might be a new earnings driver of Wanfeng in the future,considering Chinas encouragi

271、ng private aircraft use in low-altitude airspace.However,it also indicates Wanfeng management might have seen limitupside on its alloy parts business,and want to explore another area whichmanagement had no experience before.China Auto Parts A Shares:Parts Of The FutureVictoria Li59Valuation:In the p

272、ast 5 years,Wanfeng was traded between 15-55x P/E,withsignificantly de-rating trend in the past two years.In the past two years,Wanfengs valuation fluctuated around 15-20 x P/E.Based on Bloombergconsensus,Wanfeng trades at 15x P/E 2020E,which is not attractive enough.We have concern on Wanfengs busi

273、ness growth in the next 5 years.Becauseit might take long time to see PV wheel consolidation which might be theonly driver of its aluminium alloy wheel business.While its Magnesium alloypart business is not big enough to drive earnings growth yet.Enteringaircraft business strengthen our concern.Wanf

274、engs Consensus Forecast(Rmb mn)20182019E2020E2021ERevenue11,00510,44312,32213,105Operating profit1,149N.A.N.A.N.A.Net Income Adj+9598349811,043Net margin(%)8.7%8.0%8.0%8.0%Net income growth-13%18%6%EPS Adj+0.440.380.450.48P/E15.1817.5814.8413.92Sources:Bloomberg Last price on 23 March 2020China Auto

275、 Parts A Shares:Parts Of The FutureVictoria Li60Wanxiang Qianchao(000559.CH)Background:Owned by Lu family,Wanxiang is global largestuniversal joint manufacturer with above 35%market share(No.2s market share is 10%).65%of its products sell topassenger vehicle OEMs,and 35%of it sells to commercialvehi

276、cle manufacturers.In China,it has 55%market share ofuniversal joints for vehicles,mainly JV brands OEMs.Its Chinaslargest wheel hub supplier with 2%market share.Its also thesecond largest constant speed drive shift supplier in China with13%market share(Huayu Autos(600741.CH)SDS is the largestone).Wa

277、nxiang has four business segments:transmission(including universal joints,constant speed drive shift),bearing,after-treatment system and braking system.In 1H2019,Wanxiang had 13%sales from overseas.Capacity bottleneck release to doubleearnings.Wanxiang is the only Chinese manufacturer which can supp

278、ly thirdgeneration wheel hubs which is designed to work perfectly with ABS(Anti-lock Braking System).All the other local suppliers can only produce secondgeneration wheel hubs.Currently Wanxiang is suffering from capacitybottleneck,which forced the company turned down quite a few orders.Forexample,V

279、W wants to purchase all the universal joints,wheel hubs neededfrom Wanxiang,but Wanxiang had to take only 70%due to capacitybottleneck.In 2019,BMW Brilliance and Beijing Benz wanted parts for600,000 cars,but Wanxiang finally took an order for 100,000 cars.In 2018,China Auto Parts A Shares:Parts Of T

280、he FutureVictoria Li61Wanxiang had 20mn sets capacity of wheel hubs.Its building new capacityin Jiangsu,and plan to add additional 30mn sets by 2021.The new capacitywould start ramp up in 2020,and could increase Wanxiangs revenueby 1.6 times with full capacity utilisation rate.China Auto Parts A Sha

281、res:Parts Of The FutureVictoria Li62Expanding client base to luxury brandsfor better demand growth.VW is Wanxiangs biggest client in China,to which Wanxiang provides 70%of parts VW needs,followed by Shanghai GM,Hyundai,Shenlong and Ford.Recently,Wanxiang entered supply chains of Japan brands,such as

282、 Honda,Nissan and Mazda;and luxury brands such as Audi,BMW and Mercedes.Once capacity bottleneck is released,Wanxiang would increase supply toluxury brands,which would have better demand than mass market productsin the next 3 years.Overseas expansion is on the way.In Jan 2020,Wanxiang announced to b

283、uild capacity in Thailand for overseasdemand.This would be the companys first production base overseas.AsWanxiangs product quality is well-known by customers,we estimateThailand plant would become an important earnings contributor once itscapacity ramps up.Financing pressure.In 2017,Wanxiang propose

284、d a right issue for capacity expansion,which gotCSRCs approval,but failed to raise the money and the approval expired.InJan 2020,Wanxiang proposed a private placement instead to get Rmb3bnproceeds,and all the proceeds is planned to be used as operating cashflow,which doesnt look like a very good sta

285、rt to us.If this placement fails again,Wanxiang might have to slow down its capacity expansion and fund it withmore banking loans.China Auto Parts A Shares:Parts Of The FutureVictoria Li63Neither local broker nor international broker covered this company properlyin the past 2 years since the company

286、 got problem on right issue,which leadto its historical forward P/E is meaningless.We estimate Wanxiangsearnings to grow by 40%yoy in 2020E and 65%yoy in 2021E.Last price ofRmb4.93 indicates 18.7x P/E 2020E and 11x P/E 2021E.Wanxiangs Forecast(Rmb mn)20182019E2020E2021ERevenue11,36210,11213,14619,71

287、9Operating profit8026418471,312Net Income Adj+7235207281,202Net margin(%)6.4%5.1%5.5%6.1%Net income growth-28%40%65%EPS Adj+0.260.190.260.44P/E18.8226.1318.6711.31Sources:Victoria Li estimates Last price on 23 March 2020Linglong Tyre(601966.CH)Background:Top 4 tyre suppliers in China,owned by Wangsf

288、amily.It is the largest semi-steel radial tyre supplier(bycapacity)in China with best profitability among peers.Its totaltyre capacity ws 64.45mn sets.In 2018,Linglong had halfrevenue from overseas.Linglongs main productsSources:company dataChina Auto Parts A Shares:Parts Of The FutureVictoria Li64O

289、utstanding performance/price ratio isleading to market share gains fromforeign PV OEMs(including JVs).With the market recognition on Linglongs product quality and attractiveprices,Linglong is entering supply chains of JV OEMs.It is now the first localtyre supplier of VW cars.It has also been accepte

290、d by GM and Ford as one oftheir global tyre suppliers.In China,20%of auto tyre demand is from newcars,and 80%is from tyre replacement.In new car market,every new carneeds 5 tyres.While in tyre replacement market,every car in use needsreplace 1.5 tyres on average p.a.Media surveys shows that 85%of ca

291、r ownerschoose same brands of tyres which are used on their new cars.According toLinglong,margins of semi-steel radial tyres are better than those of othertyres.Gaining orders from PV OEMs would increase Linglongs salesupside and stability over auto sector cycles;improve Linglongsproduct mix and hen

292、ce its profitability.China Auto Parts A Shares:Parts Of The FutureVictoria Li65Overseas capacity expansion to avoidnegative impact from trade war.First overseas plant（16.8mn sets of annual capacity)came on steam inThailand in July 2015,which helped the company avoid the USs anti-dumping and counterv

293、ailing against Chinas tyres.In 2018,Thailand plantcontributed Rmb736mn net profit,or 61%of Linglongs overall net profit.InMarch 2019,Linglong started construction of new plant in Serbia withdesigned capacity of 13.62mn sets by 2025(12mn sets of semi-steel radialtyres,1.6mn sets of steel radial tyres

294、 and 20000 sets of bias tyres).Webelieve this new plant would increase Linglongs net profit by 40%onceits annual capacity is fully utilized.In China,Linglong is also building new capacity of 21.9mn sets.Oncefinished,Linglongs overall capacity would reach 100mn sets,includingdomestic plants and overs

295、eas plants.China Auto Parts A Shares:Parts Of The FutureVictoria Li66Domestic industry consolidation toaccelerate during weak demand period,low end suppliers to exit the market.Chinas auto tyre markets relatively fragmented.The market share of theTop-4 producers was only 18.5%in 2018.Since 2017,lots

296、 of small suppliershave started to exit the market,as they could not get into OEM market dueto weak brand recognition and poor product quality.This is leading toindustry consolidation,and would benefit leading companies like Linglong.Stable raw material cost to secureproduct profitability.Profitabil

297、ity in the tyre business is sensitive to changes of raw materialswhich accounted for 77%of COGS in 2018.Amongst all the raw materials,cost of rubber accounts for about 42%.Given the recent collapse in oil pricesand demand downturn due to Coronavirus,we see limited room for rubberprice increases and

298、see Linglongs tyre margins on a stable or improvingtrendValuationIn the past 5 years,Linglong was traded between 13-30 x P/E with average of18.5x.Based on Bloomberg consensus,Linglong trades at 12.3x P/E 2020E,which is quite attractive,vs.its historical P/E range and expected earningsgrowth in the n

299、ext few years.Also,when Linglongs sales exposure to PVgoes above 75%,a valuation rerating would probably be triggered.China Auto Parts A Shares:Parts Of The FutureVictoria Li67Linglongs Consensus Forecast(Rmb mn)20182019E2020E2021ERevenue15,30217,30619,54821,982Operating profit1,4931,6691,9352,285Ne

300、t Income Adj+1,1811,5891,8382,171Net margin(%)7.7%9.2%9.4%9.9%Net income growth35%16%18%EPS Adj+0.981.331.531.81P/E19.2014.2012.2910.40Sources:Bloomberg Last price on 23 March 2020Weifu High-Tech(000581.CH)Background:Owned by Wuxi SASAC,Weifu High-Tech is leaderof diesel engine fuel injection system

301、 in China.Weifu had 63%of net profit from associates,BADES(32.5%stake)and ChinaUnited Electronic(20%stake)in 2018.BADES,controlled byBosch,is the leader of high pressure common rail fuel injectionsystem of diesel engine segment.China United Electronicsmajor earnings contributor is its 50%owned JV wi

302、th Bosch,UAES,who produces gasoline engine management systems andtransmission control system.In 1H2019,Weifu has only 4%revenue from overseas.China Auto Parts A Shares:Parts Of The FutureVictoria Li68Main businesses structurally shrinking.In China,majority of vehicle diesel engines are used in truck

303、s,which isexpected to have stable annual sales volume in the long term.Weifudominates the market of fuel injection system for diesel engines in China,which leads to limit market share gain possibility.However demand for LNGtrucks is rising quickly in recent years,which would reduce demand onWeifus p

304、roducts.China Auto Parts A Shares:Parts Of The FutureVictoria Li69Exploring NEV business area for longterm development.To deal with the downside risk of its main business,Weifus exploringbusiness opportunities in BEV powertrain system,in-wheel electric motorand fuel battery parts.1)In 2018,Weifu pur

305、chased 9.61%stake of Protean(sold in 2019 whenProtean was 100%acquired by Virtue Surge)and founded a JV with Proteanto produce powertrain system and in-wheel electric motor for BEV(BatteryElectric Vehicle).As of 1H2019,the JV did not break-even.2)In 2019,Weifu acquired 66%stake of IRD,who develops a

306、nd produces keycomponents for fuel cells.In Nov 2019,Bosch China started building fuelcell R&D center and would start trail production in 2021.ConsideringWeifus close relationship with Bosch,its IRD would have close co-operationwith Bosch and might benefit once Bosch starts producing fuel cells.Chin

307、a Auto Parts A Shares:Parts Of The FutureVictoria Li70Bosch Automotive Diesel EngineSystem(BADES)is the biggest earningscontributor with mild earnings growthexpected.BADES is controlled by Bosch,Weifus second largest shareholder andstrategic partner.Weifu has 32.5%of BADES.In 2018,BADES contributed4

308、8%of Weifus net profit.BADESs high pressure common rail system ofdiesel engine dominates Chinas truck market with 70%market share,whichleads to limit upside on its product sales volume.That said,every time whena new national emission standard takes effective,an upgraded system isneeded.This is the k

309、ey driver of BADESs ASP and margins.China Auto Parts A Shares:Parts Of The FutureVictoria Li71UAES benefits from increasing carelectronic penetration in PV models.UAES(United Automotive Electronic Systems)is China United Electronics50-50 JV with Bosch.China United Electronic is 20%owned by Weifu,oth

310、ershareholders include Dongfeng Motor,SAIC and FAW.In 2018,UAES,through Zhonglian Electronic,contributed 15%of Weifus net profit.UAESskey products are engine management system and transmission controlsystem for passenger vehicles,NEV powertrain products,and car eletronics.SAIC is UAESs biggest custo

311、mer.It also supplies to FAW VW,Benz,Nissan,BMW and local brands.With the increasing penetration of auto electronic,UAESs earnings growth is faster than PV sales growth.Valuation:Weifu was traded between 6-26x P/E during past 5 years and the averagevaluation was about 9x in the past 3 years.Based on

312、Bloomberg consensus,Weifu trades at 7.9x P/E 2020E,which is fair,vs.its historical P/E range andexpected earnings growth in the next few years,and long term concern on itscore business.China Auto Parts A Shares:Parts Of The FutureVictoria Li72Weifus Consensus Forecast(Rmb mn)20182019E2020E2021EReven

313、ue8,7228,0768,2318,956Operating profit6381,9542,0402,160Net Income Adj+2,3962,2032,2982,546Net margin(%)27.5%27.3%27.9%28.4%Net income growth-8%4%11%EPS Adj+2.372.182.282.53P/E7.578.257.887.09Sources:Bloomberg Last price on 23 March 2020Disclosure&CertificationI/We have no position(s)in the any of s

314、ecurities referenced in this insightViews expressed in this insight accurately reflects my/our personal opinion(s)about the referenced securities and issuers and/orother subject matter as appropriate.This insight does not contain and is not based on any non-public,material information.To the best of

315、 my/our knowledge,the views expressed in this insight comply with Singapore law as well as applicable law in thecountry from which it is postedI/We have not been commissioned to write this insight or hold any specific opinion on the securities referenced thereinI/We have signed the Insight Provider

316、Agreement and this insight does not violate any of the terms specified therein.Victoria Li(09 Mar 2020)China Auto Parts A Shares:Parts Of The FutureVictoria Li73Thematic(Sector/Industry)China InfrastructureDeep Dive:Gas UtilitiesH&A SharesBy Osbert Tang,CFA|31 Mar 2020EXECUTIVE SUMMARYChinas Gas Uti

317、lities sector will continue to present a high growth story forinvestors,despite their significant outperformance over the last few years,inour view.The government may accelerate the push for natural gasdevelopment in its next five-year plan as an added driver for economicgrowth,complementing the per

318、sistent quest for environmentalimprovement.Meanwhile,there are challenges from margin squeeze andrise in competition,particularly induced by the change in operatinglandscape following the formation of China Oil&Gas Pipeline NetworkCorporation(PipeChina).The sector is highly fragmented and we analyse

319、 the individual companies bylooking at the opportunities,risks,Environmental,Social and Governance(ESG),financial strength,profitability and valuation to find the winners ofthe game.We conclude our analysis with a ranking of our preference on thestocks in the following order:ENN Energy(2688 HK),Chin

320、a Resources Gas(1193 HK),China Gas Holdings(384 HK),Kunlun Energy(135 HK),ShenzhenGas Corp Ltd A(601139 CH)and Bestsun Energy Co(600681 CH).Whats Original?This Smartkarma Original takes a deep look into the key revenue and margindrivers of the Chinese gas utilities companies and compares their respe

321、ctivestrengths and weaknesses,in addition to the discussion of the key driversand challenges of the sectors outlook.We also analyse the impact ofPipeChina on the sector and how individual companies will be affected.We attempt to assess the ESG performance of the gas utilities companies,given its ris

322、ing importance in todays investment decisions,and see howthey are doing.Besides the Hong Kong-listed gas companies,we investigatethe fundamentals and investment thesis of two A-shares,namely,ShenzhenGas Corp Ltd A(601139 CH)and Bestsun Energy Co(600681 CH).We willalso briefly discuss ENN Ecological

323、Holdings(600803 CH),an A-share listedin Shanghai currently under a proposed transaction to acquire a controlling32.83%stake in ENN Energy(2688 HK).China Infrastructure Deep Dive:Gas Utilities H&A SharesOsbert Tang,CFA74Osbert Tang,CFAChina Analyst-Onshore Credit,Equity Long-ShortOsbert Tang is an eq

324、uity analyst with over 20 years of experience focusing on Chinas transport,infrastructure,industrials,and utilities sectors.He has been based in Shanghai since 2003,accumulating more than 15 years of on-ground knowledge on the Chinese economy and financial markets,and has a wealth of contacts with C

325、hina corporates and government entities.Areas of Expertise Primary Asset Class:Equities Geography:Asia Pacific Countries:Hong Kong,China Sectors:Industrials,UtilitiesContent Verticals Equity Bottom-Up,Thematic(Sector/Industry)DETAILBackgroundIn this Smartkarma Original,we will explore the investment

326、 thesis of the gasutilities companies.To facilitate our analysis,we first introduce the valuechain of the natural gas business below(Figure 1).The key components ofthis value chain include:1.Upstream:Supply of natural gas from gas fields or through LNG import;2.Midstream:Transmission of natural gas

327、by long-distance pipelines;3.Downstream:Distribution of natural gas to end-users,and this is thefocus of this Smartkarma Original.Figure 1:The natural gas value chainSource:Tian Lun GasChina Infrastructure Deep Dive:Gas Utilities H&A SharesOsbert Tang,CFA75According to projections by China Petroleum

328、&Chemical(386 HK),naturalgas consumption will continue to grow at a rapid pace until peaking out in2045(Figure 2).Having said that,we believe natural gas utilities companiespresent very interesting investment thesis for investors.Figure 2:Projection of consumption of natural gasSource:SinopecWe now

329、move to analyse the key drivers and challenges,the impact of theformation of PipeChina,their relative valuations and the opportunities andrisks faced by each company.We will also address how they fare on ESGmeasure,given that this is of increasing importance in todays investmentdecision-making proce

330、ss.Key driversAcceleration of use of clean energy in next 5 year.The single mostimportant driver for the gas utilities companies is definitely thegovernments clean energy drive in view of the environmental concerns.Chinas consumption of natural gas has increased by a CAGR of 10.4%since2014 to reach

331、306.7Bcm in 2019(Figure 3),thanks to the governmentsvarious initiatives to boost demand.These include the push of coal-to-gasconversion,promotion of the use of clean energy vehicles and support of theuse of gas in power generation.China Infrastructure Deep Dive:Gas Utilities H&A SharesOsbert Tang,CF

332、A76Figure 3:Growth in Chinas natural gas consumptionSource:Eastmoney Choice databaseUnder the 13th Five-year Plan of China(2016-2020),the government targetsto have natural gas accounts for 8.3-10%of Chinas total primary energyconsumption by 2020.However,as of 2019,such proportion only stood at8.1%(F

333、igure 4).The pace is lower than the governments intention partlydue to the gas shortage in winter 2017 which has slowed the pace of coal-to-gas conversion.While there is room for natural gas consumption to catch upin this year,the Covid-19 outbreak has slowed down various relatedconstruction work.As a result,China is likely to end 2020 with the naturalgas-to-total primary energy ratio at the low e