Summary

Qingling Motors Co, Ltd reported 13.4% and 37% yoy growth respectively in revenue and net profit in FY2009, mainly due to price cutting strategies. The Company continues to adjust the price of middle to high end segment in order to capture share. We remain optimistic on Qingling's profitability and expect its BVPS in 2010 and 2011 will reach HK$ 3.295 and 3.375 respectively. Our 12-M target price is HK$2.31, HOLD rating.

2009 net profit grew 37%

Qingling Motors makes Isuzu trucks, pick-ups, multi-purposes vehicles and other vehicles and automobile parts and accessories such as diesel and petrol engines. It's mainly production, Isuzu light trucks is the most popular high-end light truck throughout China.

Thanks to 23.6% increased sales volume in 2009, Qingling's revenue and net profit grew 13.4% yoy and 37% respectively to RMB4.49 and 0.24 billion. EPS stood RMB 0.10，better than the consensus；the Company declared a final DPS of RMB0.08 for 2009, higher than the 0.05 for 2008

Gross margin declined, operating margin grew

The Company's cost of sales in 2009 increased by 16%, faster than the 13.4% rise in sales. This made gross profit of 683 million over last year declined slightly by 0.3% to 681 million. Gross margins also narrowed by 2 ppts to 15.2% mainly due to price cut in the Company's 100P light truck of Euro III emission in order to capture share for medium-class light trucks. The ASP of light trucks decreased by 11.0%, dragging down the overall ASP by 5.8%.

To boost sales, the Company reduced ex-factory price directly, rather than gave distributors “profit return” for promotions, thus effectively reducing the cost of selling and distribution. The selling and distribution/sales ratio declined significantly by 3 ppts yoy and the operating margin also rose from 2.4% of last year to 4.3%. In addition, the net foreign exchange loss decreased by about 22.14 million due to the stagnation of RMB appreciation. Eventually the FY09 pre-tax profit increased by 42.3% yoy.

Pricing strategies from “ high quality, high-price” to “high-quality mid-price”

Qingling sold out 43506 vehicles in 2009, representing an remarkable 23.56% yoy growth over the 35209 vehicles in 2008, which is mainly due to the pricing strategies from “high quality, high-price” to “high-quality mid-price”.

In early 2009, Qingling conducted a large-scale light truck price cut: reducing the price of 100p light truck of Euro III emission from the previous range of RMB 100-150 thousand to nearly 80- 90 thousand, which is 25% lower than its previous Euro II emission light truck. This marketing strategy proved to be effective from the sales volume as the light truck sales unit increased 16% in 2009 to 21038 units. But the total incomes of light truck only rose 3.21% slightly.

As early as early 2008, Qingling had reduced by as much as RMB23 thousand to RMB35 thousand the sales price of its 30 categories of gasoline and diesel oil pick-ups. Thus for the first time it entered into the medium-end market with sales price under RMB100 thousand. As a result, the Company's sales units and incomes of pick-ups had both increased by more than 40% and around 30% respectively in each year of 2008 and 2009.

We believe the price cut rely on the higher location ratio and lower cost as the Company had grasped the opportunity offered by the substantial decline in the raw material price such as cast iron and coke during 4Q2008 effected by the financial crisis and had purchased major raw material, meanwhile, built up inventories of raw materials.

New models continued to contribute to earnings

A total of 3248 units for the new medium truck model 700P, jointly developed with Isuzu, were sold. Thus, the total incomes and operating profit of heavy and medium trucks jumped greatly by 47% and 364% respectively to RMB 852 million and 4.452 million.

From the industry perspective, along with the gradual implementation of investment programs and macroeconomic recovery, the domestic commercial vehicle market has warmed up, especially the heavy trucks and medium trucks segments. Due to the obvious cost advantages, Qingling's heavy and medium trucks sales are expected to continue to expand, and as production increases, the Company's result will benefit from economies of scale.

Risk

As it belongs to investment goods, the consumption of the commercial vehicle was in high correlation with the business cycle. The growth opportunity of company will be very high in economic prosperity cycle for the robust downstream demand. Contrarily, the risk should be on guard in time of economy recession.

Valuation

The profitability of Qingling was stable and remained at relatively high level over the past years. Though ASP was decreased, the scale effect, a higher location ratio and efficient cost-control will help to offset the negative influence of price cut. The Company has started to cooperate with Isuzu to establish an affiliated company specialized in engines manufacture with a sales target of 175000 engines a year by the end of 2010. At that time, the cost of engines is forecasted to be reduced, which will help to alleviate the reduction in gross margin by the price cut. Thus, we estimate, in the coming two years, the Company's gross margin will still maintain a stable level.

We estimate its BVPS in 2010 and 2011 will reach RMB 2.90 and RMB 2.97 respectively (corresponding to HK$ 3.295 and HK$ 3.375). Considering the optimistic forecast for the Company's performance in 2010, we give its 12-month target price at HK$2.31 on 0.7x P/B of 2010E BVPS. Our 12-M target price is 9% higher than the last close price and hold rating.

Financial forecast

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