Investment summary

Benefited by the rapid growth of domestic heavy-duty truck industry and its own technology advantage, Sinotruk recorded robust growth these years, with increasing market share and continually improved performance. In the coming two years, the implementation of China Emission III Standard will have impacts on the industry, but thanks to the advantages such as export business, the heavy-duty truck industry will still maintain stable growth. According to estimation, the EPS of Sinotruk in 07-08 will reach RMB0.51、0.71 respectively. However, because we think the security market is only discreetly optimistic , so we lower 12 month target price at HK$ 10.76.

Sinotruk gets outstanding competitive position

Sinotruk is specialized in research, development and manufacturing of heavy-duty trucks and related key parts and components, including cabins, engines and axles. Sinotruk is currently one of the largest heavy-duty truck manufacturers in China mainland. Depending on the rapid growth of heavy-duty truck industry, its own technology advantage (its parent company holds 578 registered patents) and upgrade of its sales structure (sales of relatively high-price HOWO accounted for a significantly larger proportion of total sales), the company witnessed rapid growth these years, its market share continually expanded, profitability enhanced and performance continually improved.

Figure 1: Sinotruks sales growth and weight of HOWO (unit: vehicle)

Data sources: company report

Figure 2: Market share and gross profit margin of Sinotruk

Data sources: company report

Domestic sales growth of heavy-duty trucks: optimistic but with prudence

Chinas heavy-duty truck market expands excessively in 2007, with the growth rate at 58.6%. One of the important factors is China Emission III Standard will be implemented, and this drives the consumption rush. In 2008, the factor will be weakening, but we believe the sales for heavy-duty truck would maintain steady growth, the key factors lie in: First, at the end of 2007, SEPA (State Environmental Protection Administration) issued “Reply Letter on the Implementation of China III Emission Standard for Diesel Vehicle”, which actually postponed the implementation for China III Emission Standard from January 1 to July 1; Second, the growth for domestic economy, fixed assets investment is estimated to remain at a high level;

Third, in 2008, the railway transport capacity is still in tension, while government on truck overloading and high oil price factors remain effective, and implementation of the charge-by-weight policy will expand from current 21 provinces to the whole country, all of the factors would stimulate the structure conversion demand of quasi-heavy-duty truck and medium truck into heavy-duty truck, and this demand may last for years. The total number for the demand may be hundreds of thousands, while the heavy-duty truck sales in 2007 was only about 500,000;

Finally, the domestic massive consumption on heavy-duty truck started at 2004, after 4-5 years depreciation, the upgrade and replacement demand in 2008 will increase. Estimated at the replacement rate of 25%, the demand will be at least 30,000 vehicles. Particularly worth mentioning is that the implementation of China III Emission Standard will only generally increase the costs by RMB 20,000-30,000, while the fines on truck overloading and oil prices in transportation costs will jump by more than RMB 100,000 each year. Therefore, the maintenance costs would attract car owners more concern. Consequently, the implementation of China III Emission Standard will affect the sales of heavy-duty truck, but this is not the decisive factor. The rigid demand on heavy-duty truck is the driving force of industry growth.

Table 1: Burden increase comparison for general truck owners under different factors

Data sources: Haitong Securities, Phillip Securities

With regard to Sinotruk, it has already prepared products conform to China Emission III Standard, around 300 types in line with this standard and over 7000 unites equipped and sold already. Meanwhile, the company has signed the consuming credit cooperation agreement with four commercial banks like Everbright bank, providing terminal user with credit capital in the nationwide scale. Under the above factor, the group company recently announced that, 08 year the pre-order forms on heavy-duty truck have reached as high as 140,000 vehicles, compares for 07 years to increase 60,000. And in January, the commercial vehicle companys order form has grown 100%, the truck companys 60%. Whats more, the high price HOWO series accounts for the total sales volume above 70%. Obviously, Sinotruk has gotten a good openning in 2008.

Export growth and internal expansion support company growth

Though domestic heavy-duty truck industry only keeps growing prudently, exports of heavy-duty trucks and companys expansion can still support the growth. With its good price/performance ratio, export of domestic heavy-duty trucks maintained rapid growth. Sinotruk has gotten nearly half of the export market share, and this trend will still continue in future. Currently, the overseas export contract of Sinotruk has exceeded 10K units, among which 7600 units for Russia, 2500 units for Vietnam, 2000 units for Ethiopia, accounting for the total export in 2007. By comprehensive consideration, we think the Sinotruk sales in 2008 will be optimistic, may reaching nearly 120,000 vehicles.

Figure 3: Heavy-duty truck exports in 2004-2007: China & Sinotruk (unit:: vehicle)

Data sources: company report, Phillip Securities

Note: Data of Truck (weight>14T) and Tractor truck are as of first 8 months

In addition, by offering H shares in November, Sinotruk has raised more than 7 billion fund for the use of expansion and newly built trucks, engines, R&D and overseas market, to ensure the companys growth in the intermediate and long term. In short term, the company has acquired transmission assets from the parent company, the internalization of core parts will help enhance the companys earning capability by forecast. With scale effect and price rise (amounting to RMB20,000 to 30,000) of trucks complying with China Emission III Standard, which will offset the steel price rise in 2008, the companys gross profit margin will keep at as high as 16% above.

Share price still has room to rise

By estimation, benefited by the continuing increase of sales, the net profit of Sinotruk in 2007 and 2008 will reach RMB1,171 million and RMB1,620 million respectively, EPS at RMB 0.51and 0.71 respectively (corresponding to HK$ 0.53 and HK$ 0.80 respectively).

On evaluation side, as of Feb 27th, the expected average P/E ratio for H share automobile companies is 11.08, for international automob