EUR 850.00 For Business Accounts Only

Morningstar | 00489 Updated Forecasts and Estimates from 09 May 2019

Our long-term assumptions for no-moat Dongfeng remain largely intact after the firm reported second-half 2018 earnings that are in line with our estimates. The state-owned automaker’s weak top-line performance was offset by stronger-than-expected joint venture (JV) profits. We stand by our fair value estimate of HKD 9.50 and maintain our 3-star rating on Dongfeng. With China set to scrap the foreign ownership cap on automakers over the next few years, Dongfeng is under much pressure to turn its own passenger car profitable, leading to our Extreme uncertainty rating.

As expected, the firm’s sales started to go on a double-digit percentage free-fall in the second half of 2018. The underwhelming performance is partly due to various macro factors in China. In our recently published Automotive Observer, we highlighted that 2018 was a lackluster year for Chinese light-vehicle demand, with total sales down 2.7% year over year. We attribute underperformance versus our expectations to negative wealth effects resulting from the sluggish Chinese stock market, a Sino-U.S. trade conflict, and a crackdown in the person-to-person loan market.

During the second half, the automaker booked more than CNY 800 million impairment related to its auto financing unit. This is due to tightening financial regulations that require the firm to provision a higher percentage of loans outstanding. For the second half, the new policy applied retroactively to all Dongfeng’s entire loan book, which is why we do not expect a similar level of provision going forward. According to PSA’s 2018 annual report, Dongfeng’s joint venture with Peugeot Citroën booked CNY 2.1 billion in impairment, with half attributable to Dongfeng. The impairment was related to the shutting down of a manufacturing plant located in Wuhan. We remain pessimistic in the future performance of Dongfeng Peugeot-Citroën, and the brand has not demonstrated its ability to connect with Chinese consumers.

Despite Dongfeng management guiding a flat 2019 in terms of sales volume for the entire Chinese auto market, we expect the market to decline by 1%-3%. But for Dongfeng, it’s near-term outlook should remain relatively stable, supported by its joint ventures with Nissan and Honda. While management was not willing to comment on the likelihood of losing some stakes in these JVs, we continue to think Dongfeng will be “pursued” to sell its stakes and invest proceeds from divestitures back into brands of its own.

At the meantime, Dongfeng’s own passenger vehicle line, Fengshen, remains loss-making. Instead of focusing on turning profits, the firm chooses to prioritize on maintaining its market share. While we believe keeping production and sales volume at high levels is crucial to strengthen both suppliers’ and dealers’ confidence in Dongfeng during an industry downturn, it all comes at a cost to the value of the brand in the eyes of consumers. For this reason, we do not expect Fengshen to turn profitable in the foreseeable future.

The state-owned automaker is certainly not shy of spending. The management is committed to spending more on developing new vehicle models, especially on electric vehicle front, and building out new businesses such as ride-hailing. We lifted our capital expenditure assumptions for the next few years but believe these investments will pay off over the longer term.