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Morningstar | Great Wall Is Not So Great: Slashing FVE to HKD 6.60 as Competition in SUVs Continues to Intensify. See Updated Analyst Note from 13 Aug 2018

We are slashing fair value estimate for Great Wall Motor to HKD 6.60 from HKD 13.50 after reducing our near- and long-term sales forecasts. We now think China's sports utility vehicle, or SUV, space is becoming increasingly crowded, with both local producers and joint ventures, or JVs, aggressively bring new models to market. We previously believed that through quickly transforming itself into a mass-market SUV maker, Great Wall Motor would attain significant first-mover advantages over competitors, leading to excess economic returns over the years to come. Sadly, Great Wall has not achieved any sustained advantages, either strong brands or intellectual property, over other automakers. Even though Great Wall is known for offering fine SUVs at friendly prices, we are worried that other Chinese competitors will be able to achieve the same perceived value propositions among consumers. Coupled with international automakers are also burgeoning into the budget SUV space that has historically been dominated by Chinese brands, the competitive landscape is becoming more challenging for Great Wall. Lastly, elevated oil price and expectations for the economic downturn in China will continue to have adverse impacts on consumer appetite for gas-guzzling SUVs. Over the longer term, we think growth in demand for SUVs will gradually trend toward passenger car growth at mid-single digits, evidenced by the narrowing gap between growths of SUV sales and overall car sales as penetration reaches saturation point.

GWM's past dominance in China’s domestic SUV space relied on its products offered more bang for the buck. The company’s client base, the Chinese middle-class, are known for their lack of brand loyalty when it comes to cars. For them, a reliable transportation at an affordable price is all that's required, and they will not hesitate to buy from a different brand if it offers a better deal. In fact, Great Wall is facing a level of competition in the SUV market that it has never seen before. Domestic automakers such as GAC Motor, Geely, and SAIC-GM-Wuling (SGMW) are gradually taking market share away from Great Wall, as evidenced by an almost 20% decline in sales of the Haval series (~80 of total volume sold in 2017) when compared to last year, while sales of competitor SGMW and Geely’s best-selling SUV models were up 66% and 39%. Going forward, we now forecast sales volume for Haval to decline at a five-year CAGR of 5%, versus our previous flat assumption.

We once believed the firm’s premium Wey product lines would step into the rescue, but the company has disappointed us with its lackluster sales on its more premium offerings so far. Company CEO overpromised shareholders that the company will sell 250,000 Wey vehicles in 2018, while merely 85,000 unit sales were recorded more than half way into the year. We think rising number of both international and local automakers launching more affordable vehicle models, competing directly with Great Wall’s Wey. Volkswagen and Nissan, for example, have both come out with SUVs at comparable prices to Great Wall’s Wey series. Nissan China JV's Qashqai and Volkswagen's Tiguan, for example, are both SUVs priced in line with Wey. Furthermore, international JVs also have several affordable SUVs (Toyota's C-HR and Hyundai’s Kona) that are scheduled to come to the market in second half of 2018, making it harder for Great Wall to gain market shares. Previously, we thought the international automobile manufacturers would not be able to go toe to toe with local players. But in reality, we believe some consumers will prefer reputable international automakers’ base models over domestic Chinese brands’ premium models. The recently announced tariff reduction on imported auto parts further helps international players in cutting down costs, as their vehicles carry proportionally more imported parts than their Chinese counterparts like Great Wall Motor. As a result, we are now forecasting 156,000 (versus 242,000 previously) Wey vehicles sold in 2018, more in line with 85,000 units already sold this year from January to July. Over the next five years, we now see Wey volume picking up at a CAGR of 27%, versus 39% assumed previously.

Overall, we think Great Wall Motor’s top line will expand at an annual growth rate of 5.3%, and bottom line to grow at 4.8% CAGR from 2018 to 2022. We still believe Great Wall’s lean production lines and standardized manufacturing process relative to Chinese peers will continue to benefit the firm. These factors, however, will not translate into a sustainable competitive advantage. GWM’s annual production scale is merely a fraction of that of the leading global OEMs, making it very difficult for the firm to establish strong bargaining power against auto-part suppliers. In the meantime, with the margin for error shrinking, the firm must keep investing in new facilities and designs to maintain its market position. For the past 50 years, automakers worldwide generated a median return on invested capital of less than 10%. In Morningstar's coverage universe, we think only two automakers, BMW and Ferrari, will be able to consistently earn above the cost of capital returns over the next decade to come. Given automakers' capital intensity and stiff competition often destroy economic value, we see Great Wall’s return on invested capital to hover below its weighted average cost of capital of 10.6% over the next five years, in line with our no-moat rating on the firm.