Fuyao Glass:Fair valuation;downgrade rating to Neutral

Fair valuation; downgrade rating to Neutral

    Year to date, Fuyao's stock price has risen 19% and it is trading at 12.9x 2017E PE,which is at the high end of historical valuation range. Given: 1) domestic passengervehicle industry growth may slow in 2017; 2) progress of its US factory capacity rampuphas been slower than expected; and 3) foreign glass manufacturers haveaggressively expanded their capacity in China, we believe the current valuation hasfairly reflected its growth outlook (11.3% EPS CAGR in 2015-18) and are downgradingour rating to Neutral from Buy.

    Increasingly intense competition in glass industry

    We believe starting in 2017, passenger vehicle sales growth will slow substantially dueto the fadeout of the preferential purchase tax and a high base. We estimate PV salesgrowth will drop sharply to 2% in 2017 from 16% in 2016. In the past 18 months,foreign glass manufacturers increased their capacity in China by 2.58m sets (AsahiGlass 1.58m, PGW 1m). We believe Fuyao will maintain its industry leadership, butcapacity expansion by its rivals may disrupt its future price hike.

    US factory revenue lower than expected in H116, ongoing output ramp-up

    US factory sold 250,000 sets and contributed Rmb192m revenue in H116, c30% lowerthan our expectation, and it incurred a loss of Rmb168m. Equipment debugging at thenew factory is the major cause of slower-than-expected progress of US factory capacityrampup. We estimate US factory will incur Rmb200m loss in 2016, but will contributeRmb230m profit (7% of Fuyao's total net profit) in 2017 with capacity ramping up to2m sets. We estimate the operating margin of its US factory will be on par with that ofits domestic business, as savings on natural gas and raw materials can offset higherlabour cost and depreciation.

    Valuation: Downgrading rating to Neutral; raising PT to Rmb19.2

    We are raising our 2016-18E EPS by 9%/10%/3% considering domestic revenuegrowth and better-than-expected gross margin and FX gains. We are also raising ourmedium-term ROIC assumption to 6.6% from 4.7% and lowering WACC to 7.5%from 7.7%. Our new DCF-based PT is Rmb19.2, implying 13.8x/13.4x 2017/18E PE. Webelieve the major upside risk is Rmb depreciation and natural gas price drop. Weestimate Fuyao's net profit will increase 13% for every 5% Rmb depreciation.