EUR 850.00 For Business Accounts Only

Morningstar | After Fresh Look at Dongfeng, We Are Lowering our FVE to HKD 9.50; Uncertainty Raised to Extreme. See Updated Analyst Note from 10 Dec 2018

After transferring coverage of Dongfeng Motor to a new analyst, we are lowering our fair value estimate to HKD 9.50 per share from HKD 12.20. While maintaining our no-moat, negative trend ratings, we have raised uncertainty to Extreme and lowered the stewardship rating to Poor. With China set to scrap the foreign auto rule by 2022, there is a high level of uncertainty around potential disposals of current ownership stakes in joint ventures, lending to our Extreme risk rating. Our Poor stewardship for Dongfeng reflects its historically low dividend payout ratio, management’s lack of foresight in making investment decisions, and majority government shareholding structure.

Over the past few decades, government regulations have shielded Chinese automakers, often state-owned-enterprises (SOEs), from overseas competition by forbidding foreign automakers from solely operating manufacturing plants in China. As a result, foreign carmakers resort to running joint ventures (JVs) with Chinese SOEs like Dongfeng Motor, to produce vehicles domestically to avoid import tariffs. However, the Chinese government is in the process of gradually easing existing JV rules over the next couple of years. By 2022, all international automakers will be allowed to take on production and sales activities in China solely.

Being a beneficiary of the government’s past protectionist policy, Dongfeng is currently the designated Chinese partner for Nissan, Honda, Peugeot Citroën, and Renault. Vehicles rolled out of Dongfeng’s JV brands account for 70% of total sales volume and almost 100% of the company’s earnings. While Dongfeng is keen on developing and nurturing its own brands like Fengshen, it has not managed to generate profits from them. The fact that Dongfeng can make decent profits off its joint ventures with reputable foreign brands disincentivizes the automaker to put much effort into crafting its own products.

We think the upcoming removal of the foreign ownership cap will prompt Dongfeng’s JV partners to review respective shareholding structures and push for stake changes. Upon reviewing German automaker BMW’s proposed acquisition of an additional 25% stake in its China JV, we think potential selling prices for Dongfeng’s partnership stakes might be more favorable to international automakers. This is not to say that the firm will lose its stakes in joint ventures overnight, as it still plays a crucial role in managing sales and after-sales activities. Therefore, Dongfeng’s long-term prospects hinge on elevating the profitability of its own brands to offset reduced consolidated earnings from reductions in its JV stakes.