China Auto Drivers:Tips to outperform in 4Q14

Laggards likely to catch up near-term: Chinas auto sector, asmeasured by the MSCI China Auto & Component Index, is down 2%YTD. The weakness or consolidation seen in the past few months couldwell linger in 4Q14 as PV sales decelerate further, to only ~5% YoY, onour estimate. While the latest datapoints (e.g., inventory, sales volumeand store traffic) suggest a moderate sequential improvement, they maynot excite investors much. On the contrary, we believe the stocks forwhich investors have the lowest expectations or that have exhibited poorYTD performance may see upside surprise:

    1. Geely Auto (OW): We upgraded the stock to OW in July (Timefor a reversal) on anticipation that its five new models coming in4Q14-2015 will lead its turnaround vs. very poor sales and earningsin 2014. Geely has underperformed the China auto sector by 8%YTD, but has outperformed by 14% in the last month thanks to therevised EC7 sedan model. Other coming new models, designed byVolvos ex-chief designer, should carry the momentum forward.

    2. Great Wall (N): The company will report 3Q14 results tomorrow;we believe they will meet, if not miss slightly. But this could markthe bottom of its quarterly earnings for the next six to nine months.GWM plans to launch six new models by Dec-15, and the stock isthe worst-performing China OEM YTD. We recently test-drove itshighest-end SUV, H9 (scheduled to launch early-15), at 180km/hourand were impressed by its performance (here). Can sales of one ofGWMs six new models beat expectations Not entirely impossible

    October 1-17 PV sales improved to 3% YoY vs. 7% slippage duringOctober 1-10, though they are still down 12% MoM due to the longholiday in early October. We believe the rest of the month will continueto see a sequential rebound, bringing October or 4Q14 back toseasonality (-6% MoM and +18% QoQ).

    Inventory up slightly on seasonality in 1H-October: Industry-wideinventory (OEMs plus dealers) stood at 2.01 months in 1H-October, amoderate increase from 1.97 months at end-September, but an absolutedecline from the peak of 2.3 months in July. We believe the moderateinventory increase in 1H-October was due to seasonality when China hada long holiday. The same pattern was seen last year.

    Store traffic has turned up since late August, as we entered peak seasonin September. Overall traffic was up 5% MoM in 1H-October.

    Recommendations: We retain our long-term OW conviction calls onDongFeng Motor and Brilliance China. DongFengs recent correctionreflected most concerns over slow sales and inventory at Nissan/Honda,while we see upside to come from its PSA JV, which is not priced in. Webelieve Brilliance should continue to deliver strong volume in 2015. OurBMW analyst, Jose Asumendi, recently upgraded BMW to OW (here).