At the end of 2019, we put BUY recommendations of two Chinese companies operating in the Luxury auto market segment, being the largest independent Luxury car dealer CHINA ZHENG TONG (2817 HK) and its auto financing subsidiary Shanghai Dongzheng Automotive Finance (1728 HK).
In 2020, the two companies were hit by the lockdowns and the sharp fall in Automobile Sales in China (-74 % in February 2020 ) and by a scandal as CHINA ZHENG TONG had ordered its financial subsidiary to finance its dealerships across the country in contravention to the banking and finance regulation.
In October 2020, both stocks were suspended and the regulators ordered CHINA ZHENG TONG to divest from Shanghai Dong Zheng AFC and to be replaced by state-backed Xiamen Xindeco for US$ 181 million.
The same operation was done with the shareholding structure of the mother company CHINA ZHENG TONG, effectively making both companies state-controlled.
The stock of both companies were suspended for most of the fourth quarter of 2020 and have now resumed normal trading and operations.
Despite COVID-19 and a lost quarter of sales and cash and debt crisis the business of the mother company China Zheng Tong has picked up significantly in the second half of the year with the recovery of the luxury auto market and its debt-refinancing operations went well thanks to the support of its new state-backed controlling shareholder.
At the Financing subsidiary Shanghai Zheng Tong, business was less affected as most car loans keep going with only a relatively minor increase in default rates and the sorting out of the car dealership loans.
BUY SHANGHAI DONGZHENG AFC 1728 HK @ HKD 0.90
Earnings and Financials
Both companies should be reporting their 2020 results on March 31st 2021 and give indications on the extent of their recovery in the Q1 2021.
We expect Shanghai Dong Zheng to generate CNY 350 Million of net profits in 2020, putting the company on a 5.5 x earnings 2020 and more than 420 million of Net revenues in 2021 or 4.5x P/E.
The company is extremely well capitalised with 49 % tier 1 capital and a Net Asset Value of 4.9 Billion CNY against a market capitalisation of only 1.9 Billion, making it an extremely cheap investment.
Earnings yield at this level are in excess of 24 % per annum, a rare occurence in what is an extremely stable business with very low default rates.
Moreover, the strong economic growth expected in 2021 means that the luxury segment market should continue to perform well, as testified by Mercedes Benz extremely strong numbers posted for 2020 despite COVID and the explosion of the market in January 2021 with 68’000 vehicles old in that month alone.
Daimler Benz Annual Sale in China
The strong push of the luxury auto makers, VW, Porsche, Audi, and Mercedes in the Electric Vehicle segment and the incentives granted by the Chinese authorities to switch to EVs are also extremely positive for the business growth of Shanghai Dong Zheng in the long run.
Technically, after the damage of COVID and the fourth quarter change of shareholding structure and debt-refinancing, the stock is ready to fly and just broke out of a lengthy consolidation triangle in place since the beginning of 2021 with a target price at HKD 1.35
Once investors will feel comfortable with the stability and growth of the business, the stock is bound to close the 2019 gap at HKD 1.90, a 110 % increase from current levels, a re-ratin that would put the company on an undemanding P/E ratio of juts 10 x earnings.
In a nutshell, the current situation is one of a significant recovery ahead and a great opportunity to invest extremely cheaply in the high growth segment of the Chinese auto sector for the long term.
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