Dongfeng Motor Group ("DFG" or the "Company") announced that its JV partner PSA Group (“PSA”) willmerge with Fiat Chrysler Automobiles N.V. (“FCA”) (NYSE: FCAU) to form a New Entity (the “New Entity”).
Upon completion, the New Entity will become the 4th largest global OEM by volume and 3rd largest by revenue withannual sales of 8.7 million units and combined annual revenues of nearly EURO170 billion. The Company’s shares willresume trading today.
We expect the effect to be immaterial in the short term. There are two dimension in this transaction.
1. Financial impact. For DFG, there will be a change in interest in its investment in associate. The Companycurrently holds 110,622,220 shares of PSA or 12.23%, with book value of approximately RMB15.3 billion as at30th June 2019. In the transaction, the Company will first sell 30,700,000 shares back to PSA, reducing itsholdings to 9.14%. Upon completion of the transaction, the Company will then hold 139,224,507 shares of theNew Entity, representing approximately 4.5% of the New Entity’s equity. These changes will create aninvestment gain or loss which will be recognized in the financial year when the transaction is completed. Weexpect the investment gain or loss will be insignificant to the financials of the Company.
2. Investment in JV. The JV agreement with PSA will continue in effect. To further expand global strategicpartnership, the JV agreement will extend to 2037, which includes introducing new brands and new vehicles tothe JV as well as financial support. Despite holding a smaller shareholding in the New Entity, the share of profitis newly derived from a much larger entity. Therefore, the investment income could be much higher in the longterm.
The Company’s stock has generated a 6-month return of 24.3%. We believe that investors bought on low valuation.Despite low valuation, currently trading at 4.4x 12M forward PER, we do not expect a re-rating in the future as thereis still a lack of growth catalyst for the Company. Growth of Japanese brands (Nissan and Honda) has stabilized dueto higher base. However, Dongfeng PSA has seen some restructuring in 2019. We expect the loss of the brand willnarrow in the future, and thus the Company’s profitability should improve. We have increased earnings forecast inour last Company Report and have also upgraded investment rating to “Neutral”, with TP of HK$7.75, representing4.3x 2020 PER and 3.9x 2021 PER.