Summary

GAC announced a 6.7% yoy rise on PRC GAAP based net profit at Rmb1.44 billion in its first quarter of 2011 on the back of a 32% yoy rise in its total income at RMB2.709 billion. While the profit before tax decreased by 25% to RMB1.445 billion in 2011Q1 from RMB1.914 in 2010Q1 due to the weak sales.

Impact of the earthquake, the sales of Guangqi Toyota and Quangqi Honda amounted to 108,000 units and 146,000 units with a decrease of 18.4% and 19.6% yoy respectively in 2011H1. Several models of the Company have started to promote on large discount to achieve the sales targets, which may weigh on the profit margin as we expect for this year.

New models of GAC Mitsubishi and GAC Fiat continue to maintain the Group's strategy on high-end image, and comply with the development trends for China auto market in the future, which will improve the Company's competitiveness in the long term and enlarge its imagination room for future development.

After two explosive years, the slowdown of China's auto industry is inevitable which is proved by the drop of growth ratio. The upgrading of auto demand trend is becoming apparent, that is, the proportion of high-and-medium models will be expanded. Although the Company's result will be affected by the earthquake significantly this year, the long-term competitiveness of the Company still can not be underestimated.

We forecast GAC's 2011E, 2012E net profit to RMB 4.19 billion(yoy-2.5%) and 5.38 billion(yoy+28.6%) respectively, EPS to RMB 0.68、0.88, equivalent to HK$ 0.83 and 1.08.

Our 12-months target price HK$9.2 is based on 8.5 P/E x 2012E EPS, hold rating for 7.8% upside.

Company profile

With the two main sources of income (Guangqi Honda and Guangqi Toyota), Guangzhou Automobile Group Co., Ltd. (hereinafter "GAC") ranks currently the sixth in China auto market with a total share of 3.9%. In particular, the Company is the leading automobile manufacturer in the mid-to-high-end sedan segment, and owned two classical B-class cars, Accord and Camry that located at the first two places in mid-to-high end sedan market for several years in terms of sales volume. GAC also gained a market share of 10.2% and 10.6% in SUV and MPV market respectively.

GAC Won nod for privatization of Denway Motors (203@HK) and list in HK on Aug 30, 2010.

1QFY2011 earnings affected by the drop in sales

GAC announced a 6.7% yoy rise on PRC GAAP based net profit at Rmb1.44 billion in its first quarter of 2011 on the back of a 32% yoy rise in its total income at RMB2.709 billion. While the profit before tax decreased by 25% to RMB1.445 billion in 2011Q1 from RMB1.914 in 2010Q1. In 2010, GAC's net profit achieved to RMB4.295 billion, up approximately by 114% significantly.

During 2011Q1, GAC sold 185,640 vehicles, down by 2% yoy, of which, Guangqi Honda and Guangqi Toyota sold 92,601 vehicles and 63,134 vehicles respectively, decreased by 11% and 8% yoy, far below the sector's average growth rate of 9%. We believe the main reasons were the downstream of industrial prosperity, fiercer competition on sub-industries, Beijing's new car restriction and the rising fuel price. Additionally, the prices of raw materials have increased since 2010Q4 and the new City Construction Tax and Education Tax adopted for foreign JVs grew, therefore net profits of Guangqi Honda and Guangqi Toyota dropped obviously, which caused the Group's investment incomes to decrease by 23% to RMB1.542 billion yoy in 2011Q1.

Considering the impacts caused by the Japan earthquake would continue to reflect on the Group's results on the second and third quarters of this year, we believe the performance of GAC would be much weaker this year.

Due to the low base and the recovery of relative sub-industries, the business of GAC's commercial vehicles performed well. In 2011Q1, the sales of commercial vehicles, mainly conducted through GAC Hino and GAC Bus, increased by 153% to 1,950 units in total, of which the sales of GAC Hino and GAC Bus achieved to over 1,500 units and 400 units with yoy growth of 264% and 19% respectively.

For GAC's self-owned sedan brands, the monthly sales of Everus currently maintains on 1,200 units approximately, which still needs further increase to contribute the profits to the Group.

The expecting cooperation with Mitsubishi and Fiat

The Changsha-project of GAC Fiat is currently planning to achieve the capacity of 140,000 units of vehicles and 200,000 units of engines, and will put to produce by the end of 2012. The fist launched model should be Mid-end sedan “C-medium”, equipped with a world advanced 1.4L turbo engine and Dry-type Dual Clutch Transmission (DDCT). The classic model of Fiat 500 will be introduced to China through the imports in September.

The 50:50 JV between GAC and Mitsubishi is expects to focuse on SUV, and use the existing Changfeng manufacturing base as produce base. The introducing of new models of GAC Mitsubishi will be faster than GAC Fiat. We expect there are two models coming next year, including an entry-level SUV “ASX” and the popular city SUV “OutlanderEX”, and the new “PAJERO” lately. Mitsubishi mentioned it might put the small sedan models into GAC Mitsubishi in the future.

New models of GAC Mitsubishi and GAC Fiat continue to maintain the Group's strategy on high-end image, and comply with the development trends for China auto market in the future, which will improve the Company's competitiveness in the long term and enlarge its imagination room for future development.

A tough year forward as the significant decrease of sales in 2011H1

Impact of the earthquake, the sales of Japanese automakers experienced the drop in varying degrees in the first half of this year, especially for Honda and Toyota. However, due to the lower localization rates of Guangqi Toyota and Guangqi Honda, some core auto parts need to be import from Japan, therefore GAC's JV affected by the earthquake more serious than other Japanese JVs of China.

In 2011H1, the sales of Guangqi Toyota and Quangqi Honda amounted to 108,000 units and 146,000 units with a decrease of 18.4% and 19.6% yoy respectively. Meanwhile the decrease rates of sales of other Japanese auto JVs were smaller, for instance, the sales of Dongfeng Honda dropped 8.6% yoy to 117,000 units, and FAW Toyota sold 210,000 units vehicles with a yoy decrease of 12.1%.

Now the supply of auto parts started to recover after Japanese local automakers announced to restart production one after another. The production of Guangqi Honda will return to normal level before the earthquake in this August or September, and the production of Guangqi Toyota has already recovered in June. However, considering slow growth of auto markets in 2011H1 and the increasing pressures of inventory for auto dealers, Guangqi Honda cut its sales target from 442,000 units to 386,000 units, and Guangqi Toyota still maintained its target on 280,000 units this year. Several models of the Company have started to promote on large discount, which may weigh on the profit margin as we expect for this year.

Valuation

After two explosive years, the slowdown of China's auto industry is inevitable which is proved by the drop of growth ratio. The upgrading of auto demand trend is becoming apparent, that is, the proportion of high-and-medium models will be expanded. Although the Company's result will be affected by the earthquake significantly this year, the long-term competitiveness of the Company still can not be underestimated.

We forecast GAC's 2011E, 2012E net profit to RMB 4.19 billion(yoy-2.5%) and 5.38 billion(yoy+28.6%) respectively, EPS to RMB 0.68、0.88, equivalent to HK$ 0.83 and 1.08.

Our 12-months target price HK$9.2 is based on 8.5 P/E x 2012E EPS, hold rating for 7.8% upside.

Risk

1），Continuing deteriorated economy dampens car demand.

2），Competition through price-cuts and new model launch may accelerate.

3），Raw material price may go up.

4)，Market acceptance of its new models.

Financial Forecast

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