Investment Summary

Increase by 60% yoy in Q2, Verifying the Industry's Prosperity

In H1 of 2020, there was a V-shaped curve of China's heavy truck market: In January, the sales volume hit a record high with a growth of 18.2% yoy, which was a good start. In February and March, due to the impact of the COVID-19 pandemic, it plunged by 51.8% and 19.3%, respectively. In April, the sales volume showed a rapid recovery, setting a new record by reaching 191,000 units, up 61% yoy. In May, nearly 180,000 (179,000) heavy trucks were sold, up 66% yoy. In June, the heavy truck market continued to show a strong momentum of production and sales. Although the monthly sales volume declined slightly by 8% mom, it continued to grow by 59% yoy, reaching 165,000 units. In H1 of 2020, the total number of heavy truck reached about 816,200, up 24% yoy, which proves that the high prosperity of heavy truck industry continues.

The reason why the heavy truck industry exceeded expectations in Q2 was that, in addition to the delay in vehicle purchase demand during the pandemic, the strong policy of the early phasing out of the trucks under or below the China III emission standard, which caused the sales volume to increase greatly yoy. Meanwhile, the resumption of work and production in Q2 prompted a blowout of heavy truck orders, and the policies of overload treatment in different places have become stricter, which also boosted the sales volume.

Countercyclical Policy to Support High Demand of Heavy Truck

Facing the grim economic situation after the pandemic, the government authorities have strengthened the countercyclical adjustment policies. The Ministry of Finance has expanded the issuance scale of local government special bonds, and multiple provinces and municipalities have introduced an intensive range of investment plans. According to the financing arrangements for government bonds of this year and the requirement of the executive meeting of the State Council on June 17 to "strengthen monetary and financial policies to support the real economy", it is expected that the growth rate of social financing will have further upward space in H2. Infrastructure investment growth is expected to pick up, and will boost the development of engineering heavy truck later.

At the end of March, the State Council announced a policy of bonus for compensation from the central budget for supporting the phasing out of the diesel cargo trucks under or below the China III emission standard in key areas such as Beijing-Tianjin-Hebei. Meanwhile, a value added tax at the rate of 0.5% based on the sales revenue will be imposed from May 1 to the end of 2023 for the used vehicle sales of second-hand automobile dealers. A high drive of heavy truck sales is expected from the demand upgrade caused by the phasing out of diesel trucks and gears falling on or below the China III emission standard.

We estimated that with the continuous prosperity of heavy truck industry in H2, the sales volume of heavy truck in 2020 is expected to reach about 1.4 million units.

Resilience in Q1 under the Pandemic, and Accelerated Recovery to Be Expected in Q2

According to the 2020Q1 Result, Weichai recorded revenue of RMB39 billion, down by 14% yoy, and a net profit attributable to the parent company of RMB2.06 billion, down by 20% yoy, mainly due to the disruption of production caused by the pandemic in Q1. Overall gross margin reached 22.44%, up by 0.78 ppts yoy and 1.3 ppts qoq, respectively, which showed the better mix of products with higher gross profit margin. In Q1, the headquarter still recorded a revenue growth of 3%, showing strong resilience. The net profit declined by 12% yoy, and the gross profit margin was about 25%, down by 3.8 ppts yoy and up by 4 ppts qoq, which, we estimated, was mainly due to the changes in the raw materials of precious metals. In addition, Kion Group, the overseas subsidiary, recorded a revenue down by 2.7%. The net profit declined by 24% yoy, which was a drag on overall profits. Since the end of April, almost all overseas factories have resumed production, and the business conditions are expected to improve significantly in Q2.

Investment Thesis

From the perspective of the current heavy truck industry structure, Sinotruk Group, Shaanxi Heavy Duty, like other leading enterprises continue to expand their market share, the two accounting for 28% on aggregate in H1, which is conducive to the steady growth of heavy truck engine business of Weichai. From the middle term, the company has a clear strategic framework of "power engine+hydraulics+new energy" and the access to both the foreign and domestic market. Its profitability is expected to rise further.

We revise the profit forecast of the company in 2020/2021 to EPS of RMB 1.29/1.49. We will also revise target price to 20 HKD (14/12.1x for 2020/2021 P/E) and Accumulate rating. (Closing price as at 24 July)

Financials

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