UOB KayHian: China auto play selloff is a buying opportunity

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China automobile plays with joint ventures sold off sharply on Wednesday amid fears the removal of foreign-ownership restrictions would hurt them, but the correction is a buying opportunity, UOB KayHian said in a note on Thursday.

Earlier this week, China’s National Development and Reform Commission (NDRC) said it would remove foreign-ownership limits for manufacturers of alternative- or new-energy vehicles, such as electric or hybrids, this year, and provided a timeline for removing the limits for commercial vehicles in 2020 and the rest of the car market by 2022.

That will remove an irritant in trade relations between China and other countries, including Germany and the U.S. China had prevented foreign companies from owning more than 50 percent of a local venture, essentially forcing them to sign on with a local joint-venture partner.

“It will not impact them much given the NDRC’s ceasing approval for new internal combustion engine-car projects and the global OEMs’ strong commitment in their local JVs in China,” UOB KayHian said.

“The market is worried that foreign parties, e.g. BMW and Mercedes-Benz, will go ahead with their new fully-owned subsidiaries in China after 2022, and let go of their Chinese partners, e.g. Brilliance and BAIC,” the brokerage noted. “We believe this market perception is misguided. Foreign carmakers will continue to work closely with their domestic partners in developing China’s market.”

Watch the sunk costs

UOB KayHian said that even if the NDRC were to approve new ICE-car projects, which it viewed as unlikely, foreign automakers would likely still stick to their existing JVs instead of forming new fully-owned subsidiaries because of the huge sunk costs, the existing large-scale production with JVs and because the global players already reap the majority share of the JVs’ profits.

“The new 100 percent-owned subsidiaries may not generate as much profit for the global OEMs as the JVs do,” it said.

It also noted that global carmakers recently renewed their JV contracts with local partners and they won’t expire to around 2030.

However, the brokerage noted that large Chinese electric-vehicle makers, such as BYD, could be hit hard by the removal of the foreign-ownership limit, with Tesla reportedly interested in establishing a mainland plant, as that would bring increased competition.

UOB KayHian kept Buy calls on BAIC, Brilliance and GAC. It also kept Buy calls on auto dealers Zhengtong, Yongda and Meidong, citing appealing valuations after the selloff and that they won’t be affected by the policy change and could even benefit if car import tariffs are lowered.

Top China auto pick

It tipped Geely, rated Buy, as its top pick among the Chinese carmakers.

“We expect Geely to continue to gain market share in China and penetrate into overseas markets given the full support from the state and technology from Volvo,” it said. “The potential cuts in vehicle import tariff will not impact Geely much as Geely, along with other Chinese carmakers, has been facing red-hot competition from JVs right from the beginning.”

It kept a Sell call on Great Wall on a potential margin squeeze and a price war in the SUV market.

It also rates BYD as Sell on headwinds from EV subsidy cuts and potential competition from opening China’s EV industry.