Weichai’s share price has dropped 8% since the release of 2019 results. We see the correction a good buying opportunity as we believe the growth drivers are well intact: (1) the inclusion of more Shandong SOEs under SHIG, parent company of Weichai, will help boost Weichai’s sales; (2) the diversification into non-road machinery engine is on track; (3) macro policy to support infrastructure spending should boost the demand for construction trucks. We trimmed our 2020E/21E earnings estimates by 7%/4% on lower margin projection and lower sales estimates on overseas business that operated by KION (KGX GR). Our SOTP-based TP is adjusted to HK$16.0 from HK$17.9.
- Gross margin contraction should not be an ongoing trend. Gross margin in 4Q19 narrowed 3.2ppt YoY and 1.8ppt QoQ to 21.1%. Management explained that the reason for the lower margin in 4Q19 was due to a change in product mix. The strong sales of certain type of logistic trucks in China boosted the demand for Weichai’s WP10H product (which carried lower margin compared with that of the high margin 12L engines). That said, we do not expect a continuous margin contraction, given Weichai’s strong bargaining power on the back of consolidating industry.
- More opportunities following the consolidation of Sinotruk and Lovol Heavy Industry by SHIG. In Oct 2019, SHIG was granted in Oct 2019 20.8% state-owned shares of Lovol Heavy Industry, a company that manufactures construction and agricultural machinery. This opens up a new opportunity to Weichai. Weichai targets to achieve annual sales of 100k units of continuously variable transmission (CVT) powertrain to Lovol in future. Meanwhile, given the consolidation and management reshuffle of Sinotruk have largely been completed, we expect Sinotruk will focus on sales volume growth going forward. Weichai targets to achieve annual sales of 100k-200k units of MDT and LDT engines in future. All these, together with the expansion in hydraulic powertrain and high-speed large-bore engine, will help Weichai achieve much higher level of diversification over the coming few years.
- Risk factors: (1) weakness in HDT and engine demand; (2) further downside risk on overseas business; (3) technology risk.
