Further inroads into pre-owned vehicle market
- 1H22 revenue and net earnings fell 1.5% and 7.3% y-o-y respectively, slightly below expectations
- Expansion into new energy segment to improve gross margins; securing contracts with NEV startups
- Opened8 new centers for pre-owned vehicles in 1H22; pre-owned car sales benefited from favourable policies
- TP HK$60 pegged to 13x FY22F PE; maintain BUY
Due to pandemic lockdown and supply chain disruption, Zhongsheng’s total revenue was down by 1.5% y-o-y to Rmb86bn in 1H22. New car sales revenue dropped 5.2% y-o-y as new car sales volume fell 12.1% y-o-y to 242,280 units. Revenue from after-sales business and pre-owned car sales rose 13.4% and 25.5% y-o-y to Rmb13bn and Rmb4.4bn respectively. Gross profit for 1H22 was Rmb8.5bn, similar to 1H21, while gross margin saw a slight improvement of 0.1ppt to 9.8%. Net earnings in 1H22 declined by 7.3% y-o-y to Rmb3.4bn, slightly below expectations.
In the new car sales segment, luxury car sales volume declined 11.1% to 143,857 units. This segment has been a major contributor to revenue. Sales volume of Mercedes Benz increased by 16% y-o-y to 64,513 units and contributed 41% of new car sales revenue. As the brand moves into electrification, EV models EQ and EQE should have a greater presence. As of 30-Jun 22, 417 dealership stores were in operation, of which 63% were luxury brand stores. Zhongsheng has been expanding its premium brand network, and after the acquisition of the Mercedes Benz stores from Zung Fu, the company added some 10 new luxury stores in 1H, covering Mercedes Benz, Lexus and BMW.
After-sales business segment accounted for 71% of gross profit in 1H22, with gross margin of 47.1%, down 1.1ppts y-o-y. This is an important pillar for business and growth has been steady in the past 10 years. Revenue from this segment is expected to grow by 120% y-o-y in 2H22. Gross margin is also expected to increase in 2H22 as repair volume pick up post lockdown.
Commission income decreased 4.4% y-o-y to Rmb1.5bn in 1H22, primarily reflecting the drop in vehicle sales volume. Income from the segment is expected to increase in 2H22, as new car sales recover, during demand for new insurance plans and auto financing services. Financial services penetration rate increased 5.4ppts to 70.2%.
As for the pre-owned automobile segment, sale volume dropped by 1.7% y-o-y to 65,606 units. Gross profit margin declined by 2ppts y-o-y to 5.1%. With the new policies to remove all restrictions on secondhand vehicle trade, starting from 3Q22, Zhongsheng has set up 8 Used-Car Centers (UCC) in 1H22 to create a more standardized sales channel for used cars. Higher profit margin is anticipated.
Due to rise of NEV startups and electrification of traditional brands, Zhongsheng commenced the delivery centers and superstores for Xpeng and a LEXUS electrification showroom was also set up in 1H. The company is in discussions with other NEV startups for future authorization, expanding the group’s competitive landscape to both high-end vehicles and NEVs, which should improve overall gross margins on new car sales. NEV sales volume from traditional brands increased by 54% in 1H22.
Healthy financial position in 1H22. Operating cash flow was Rmb3.7bn in 1H22, while capex was Rmb897.9m. Net gearing ratio decreased from 41% in end-FY21 to 33% in 1H22. Inventory turnover increased 9.2 days to 30 days due to pandemic lockdown and logistics disruption which caused a temporary imbalance of vehicle supply and demand. Stable supply is expected in 2H22.
BUY rating maintained on better 2H outlook and attractive valuation. The recovery of the dealership business post lockdown is expected to support share price performance. We tweaked FY22/23F net earnings lower by 3/6% to factor in slightly weaker-than-expected earnings in 1H. However, the volatile stock market has dragged the auto sector valuation and the auto dealerships were also affected. Although we cut target PE to 13x FY22F, benchmarked to its 5-year historical average, we reiterate our BUY rating.
The stock is currently trading around 1SD below mean.