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Morningstar | Solid First-Half Result From Great Motor; FVE Maintained at HKD 6.60

We are not surprised that Great Wall Motor reported a 44% jump in first-half net profit, as the company already preannounced this profit surprise back in July 2018. Roughly half of the jump in profit resulted from the company’s decision to capitalize a portion of its research and development expenses. Holding everything constant and excluding several one-off items, Great Wall’s core earnings increased by 26% year over year. While improvement in margins during the first half also played some role in lifting the bottom line, management’s goal of maintaining the current level of profitability does not paint an optimistic outlook for the company. While our current forecast has the firm’s operating margin shrinking by a total of 230 basis points over the next five years, we maintain our fair value estimate of HKD 6.60 per share.

The group’s previous announcement of profit surge revealed little about the overall business. In reality, Great Wall merely changed its accounting treatment of research and development expenses, of which it will capitalize around 50% going forward. While this will undoubtedly give a facelift to the income statement, it has a negligible impact on our free cash flow assumption.

Even though Great Wall remains the largest player in China’s SUV market, the group is facing a level of competition it has never seen before. With both local producers and joint ventures aggressively bringing out new models to market, Great Wall is trying to maintain its dominance in the SUV by staying one step ahead of the competition. The recent launch of its sporty and fashion-forward Haval F series is Great Wall’s attempt to capture demand from Chinese millennials. The F series SUVs are upgrades from the H series with slightly higher average selling prices of around CNY 10,000 (USD 1,500). Since both series are branded under Haval, some cannibalization will be inevitable.

While we applaud management’s efforts in thinking one step ahead, there is nothing particularly innovative about the group’s current strategy. The company is fairly late to the electric vehicle space, as its first model wasn’t released until August 2018. We are keeping our eyes on the group’s joint venture with BMW in manufacturing electric Mini Coopers and believe this could be a longer-term catalyst for Great Wall’s future earnings.

On the guidance front, management believes it will be “challenging” to achieve the previously set target of 1.1 million vehicles sales in 2018. We expect 2018 volume to be around the ballpark of 1 million, leading to a full-year revenue growth rate of 9.2%. Underlying our outlook for Great Wall is the belief that the company is gradually losing its first-mover advantage against peers. Over the next five years, we see Great Wall Motor’s top line expanding at an annual growth rate of 6.8%, and its bottom line expanding at a 7.1% CAGR.