China Auto Electronics - DBS Group Research

ONE of the largest wire harness tier-1 suppliers in China, China Auto Electronics designs, assembles and manufactures wire harnesses, connectors, moulds, crimping machines, and electronic modules for the automobile industry. It has a strong 10 per cent market share as a provider of wire harness to automobile manufacturers in China, and is probably the fourth largest in the country.


China Auto's management team, including executive chairman Wang Lai Sheng, has an average of over 30 years of industry experience. CEO Rudy Schlais formerly worked for or led US-based automobile and automobile parts companies. Thus, China Auto is poised to benefit from his strategic insights into the automobile components sector and wide industry networking.

Demand for China Auto's wire harness service is expected to grow rapidly: We believe China Auto is well exposed to the growing demand for its wire harness services and other automobile component products in China, which will come from: 1) growing domestic and export markets for China-made cars; 2) riding with the faster-growing Chinese brand automakers; 3) market share gain for supply of wire harness to existing customers; and 4) participation in growing electronisation of the automobile industry.

China's motor vehicle industry continues to grow rapidly, with both production and sales rising by around 25 per cent year-on-year in the first eight months of 2007.

Specifically, China Auto's top two customers in China, Chery Automobile and BYD Automobile, both enjoyed market share gain in H1 2007.

We believe investors will be buying into a sweet spot in China Auto's strong earnings growth momentum, backed by expected huge margin improvement for wire harness business in FY2007-2009. This is due to: 1) strategic switching to a better pricing formula for wire harness; 2) rapid ramping up of capacity that requires more internal consumption of higher margin connectors; and 3) possibility of using mergers and acquisitions to enhance business potential.

Structures are in place to support positive business outlook: We expect China to increase its wire harness capacity by 72 per cent year-on-year in FY2007 and 60 per cent year-on-year in FY2008, so as to ride on the positive business outlook for the automobile component industry in the country. China Auto has also strategically switched to a new pricing formula for wire harness with its automobile clients, where there will be straight- through cost pass-on to customers should the raw material prices deviate 3 per cent or more from those initially contracted.

We believe China Auto's sales growth is to be sustainable at 67 per cent CAGR in FY2007-2009. We expect sales in H2 2007 to be stronger half-on-half, after the company posted a robust 98 per cent year-on-year sales growth to an interim sales record of 164.7 million yuan (S$32.2 million) in a seasonally slower H1 2007.

We project China Auto's net profit to rocket 283 per cent year-on- year to 117.2 million yuan in FY2007, due to strong operating leverage. Its net profit in FY2008 is expected to be further boosted by the reduction in tax from 33 per cent to 25 per cent for Chinese companies. We expect China Auto to achieve high net profit CAGR of 136 per cent in our FY2007-2009 forecast period.

China Auto's peers comparable listed on the stock exchanges in Singapore, China, and Hong Kong are trading at an average FY2008 PE of 16 times.

We believe that China Auto should trade at a premium to the average industry PE of SGX-listed automobile component stocks, due to: 1) its stronger earnings growth momentum and higher operating profit margin compared with peers; and 2) wider exposure to China's fast-rising automobile market that deserves a share price valuation closer to China-listed automobile parts players' forward PE of 26 times.

We are initiating coverage on China Auto with a 'buy' rating. Our fair value for the counter is $1.16, using 15 times FY2008 PE and implying 0.1 times PEG.
BUY

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