Shenzhen Inovance:NEV powertrain trip reaffirms our positive stance

Huge potential for China's NEV market and Inovance is well positioned.

    We visited major NEV (new energy vehicles) powertrain OEMs in Chinarecently, which strengthened our confidence in Inovance. Most powertrainOEMs are upbeat about China's long-term NEV growth potential, despite shorttermheadwinds. While third-party OEMs and automakers equally share thepowertrain market at the moment, OEMs will likely gradually gain market shareas NEV sales rise. We like Inovance's strategic positioning in the NEVpowertrain market, which we believe will be a major growth driver from 2018.

    Powertrain OEMs remain positive on China’s NEV market.

    Most OEMs believe China’s NEV market is intact, despite a subsidy cheatingissue. The fall in NEV subsidies creates short-term headwinds but many view itas a long-term positive that will help accelerate industry consolidation. OEMsfocusing on passenger NEV are more bullish, guiding 70-100% sales growthfor 2017, while commercial NEV-focused OEMs (including Inovance) expect30-50% growth, driven by logistics NEVs. Margins are under downwardpressure in 2017 on ASP cuts (10-20%), but rising economies of scale andproduction process upgrades could potentially mitigate this.

    External sourcing vs. in-house production.

    The current market share split is 50%/50%, but third-party OEMs are likely toprevail over automakers, going forward. Automakers’ intention to master thecore technology is obvious but most local NEV automakers are final assemblersthat lack the R&D capability to support in-house production. Moreover, whenproduction volume ramps up significantly, substantial quality risk and costpressure would emerge, which would make in-house production less optimal.

    By building a world-class supply-chain system, partnering with Brusa tostrengthen its technology in motors and reduction drive, and leveraging on itssharp market insights, Inovance is well positioned for the rising NEV market.

    Reiterating Buy; risks.

    We retain our earnings forecasts and our DCF-based target price of Rmb26.8(WACC: 8% and TGR: 2%). We reiterate Buy as Inovance’s medium-term growthoutlook has strengthened with a continuing recovery in China’s IA market and anemerging passenger NEV drive business (c.25% of sales by 2020). Downsiderisks: slower-than-expected NEV growth and an IA demand recovery.