Guoxuan High-Tech:Draft subsidies imply more margin pressure;downgrading to Hold

Reduced subsidies imply margin pressure on Guoxuan

    Drafts of new Chinese EV subsidy policies have recently been made public. Thepotential new policy would lead to a reduction in subsidies for Chinese EVs,especially E-buses; the government’s intention is to ensure that subsidies go toquality EV/battery producers. We believe that with the policy change, EVbattery producers like Guoxuan will likely face more margin pressure, at leastin 2017. As such, we downgrade Guoxuan to Hold based on a 19% FY17DBeEPS cut resulting from its recent dilutive private placement and concerns abouta margin squeeze. Nevertheless, as a market leader Guoxuan might be abeneficiary in the long run after the short-term pain.

    Key thrust of potential new subsidies: lower but focused on quality producers

    After reviewing the draft of the potential new

    subsidies, we believe this newplan would 1) significantly increase the barrier to receiving subsidies, with 40%of current salable models disqualified from subsidies in 2017; 2) furtheraccelerate the development of higher energy density NMC (over LFP) in thecoming years; and 3) cut the average subsidy per EV bus from an originalexpectation of c.RMB330k to c.RMB170k, almost a 50% cut. Industry contactstold us that automakers might need to redesign/re-register for the new policyand thus EV sales momentum in early 2017might be affected.

    EV battery supply chain implications: margin pressure on battery producers

    The potential new subsidy scheme is likely to hurt low quality batteryproducers the most. Even for good quality producers such as Guoxuan, neartermmargin pressure seems inevitable given a potential sales slowdown in1Q17and lower subsidies for EV buyers. In the long run, however, qualityproducers should be able to gain market share. Producers in the battery supplychain with high exposure to NMA/NCA might be the net beneficiaries as EVbuses will be allowed to adopt NMC/NCA instead of LFP.

    Downgrading Guoxuan to Hold; swing in Chinese EV policy is major risk

    We cut our 2017DBe EPS by 19% to factor in 4ppt YoY operating marginerosion resulting from the subsidy cut and also the 12% dilution fromGuoxuan’s recently announced private placement. We maintain our target PExmultiple at 25x 2017DBe EPS, so Guoxuan’s new TP is set at RMB32.7. Withthe current share price at RMB32.6, we downgrade Guoxuan to Hold. A majorrisk is the finalized subsidy policy varying materially from the drafts.