Picking winners in a competitive sector

Please refer to page 103 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. CHINA/HONG KONG Source: autohome.com Inside Investment opportunity – going global 2 Auto parts supply chain in China 4 Exports surging, trade surplus widening 7 International suppliers all come to China 10 Overseas M&A and expansion 13 Fuyao Glass 15 Fuyao Glass (A-Share) 39 Minth Group 63 Huayu Automotive (A-Share) 90 Xinchen Power 94 Analyst(s) Leo Lin +852 3922 1098 leo.lin@macquarie.com Janet Lewis, CFA +852 3922 5417 janet.lewis@macquarie.com Zhixuan Lin +86 21 2412 9006 zhixuan.lin@macquarie.com Allen Yuan +86 21 2412 9009 allen.yuan@macquarie.com 8 December 2015 Macquarie Capital Securities Limited China auto parts Picking winners in a competitive sector A booming sector to post 8-10% growth p.a. in 2015-2020E We believe the auto parts sector is the meat in the sandwich for the auto industry, as they provide the core components that the OEMs then assemble into a finished vehicle. It is the critical source of value-add in the supply chain as evidenced by their consistently higher margins vs. the OEMs. The auto parts industry has been riding the boom in China auto sales over the past decade, with gross industry output posting a 16% CAGR in 2005-2014. We expect the industry can continue to post a solid growth of at least 8-10% p.a. in 2015-2020E, supported by continuing steady growth in the China auto market and the further recovery of the global auto market. Exports surging and contributing 35% industry output China has been the fastest growing auto parts exporting country with export value (in USD) posting a CAGR of 18% in 2005-2014. Exports now contribute 35% of the total industry output in China. The US is China’s largest export destination, and the trade surplus with the US alone contributed over 55% of the total China auto parts industry trade surplus in 2014. International suppliers raise market competitiveness Leading international auto parts suppliers have long been dominating the Tier 1 suppliers group. As there is no government requirement to form joint ventures (JVs) in the auto parts industry, major international suppliers have all established directly owned manufacturing plants in China, though some have chosen to establish JVs as well. They formerly mainly supplied international OEMs in China and are now expanding to partner with domestic OEMs. By the end of 2014, there were 2,611 auto parts companies in China, in contrast to 118 auto OEMs. This highlights the competitiveness of the industry, and leading international suppliers make it even more difficult for Chinese domestic suppliers to grow. Chinese suppliers focus on going global We have seen a big wave of Chinese companies investing overseas and China auto parts are going global. There is a group of successful Chinese suppliers who have established their brands and business relationships with international OEMs at home in China and they are aggressively acquiring/building new plants overseas. There is another group of Chinese companies conducting overseas M&A to acquire overseas technology and brands, such as Nexteer (1316 HK) and Pirelli (PC IM), but remaining passive on daily operations. We believe the former strategy is of higher risk and potentially higher return; and we identify two Chinese leaders that fall under this theme: Fuyao Glass and Minth Group. Initiating coverage on Fuyao Glass and Minth We believe the China auto parts sector will continue to post solid growth but may become further concentrated and dominated by international leading suppliers. We initiate coverage on Fuyao Glass (3606 HK, 600660 CH) and Minth Group (425 HK) with an Outperform rating. We believe overseas expansion will be the key driver for these two companies. Fuyao Glass is our top pick in the sector as we believe it is on track to become the global No.1 in the auto glass industry. Macquarie Research China auto parts 8 December 2015 2 Investment opportunity – going global Chinese suppliers focus on going global The China auto parts sector is a booming sector and we believe it will continue to post solid growth of at least 8-10% growth p.a. in 2015-2020E, supported by continuing steady growth in the China auto market and the further recovery of the global auto market. However, it is a competitive market with leading international auto parts suppliers dominating the Tier 1 suppliers group and making it difficult for Chinese domestic players to grow. We believe the key investment opportunity in the China auto parts sector is to identify domestic winners with a clear overseas expansion strategy for further penetration into the global auto parts supply chain. Fig 1 Total deal size of Chinese companies overseas M&A in auto parts Source: Dealogic, Macquarie Research, December 2015 One theme, two routes China has the largest new vehicle market in the world, and the absence of a JV requirem