2021 results beat our expectations
　　Zhongsheng Group Holdings announced its 2021 results: Revenue grew 18.0% YoY to Rmb175.1bn and attributable net profit rose 50.3% YoY to Rmb8.33bn. 2H21 revenue fell 2.7% YoY but grew 0.4% HoH to Rmb87.74bn, and attributable net profit rose 42.6% YoY or 25.4% HoH to Rmb4.63bn. The firm’s 2H21 results beat our expectations thanks to improved profitability of new car business on narrowed price discounts in end markets.
　　Trends to watch
　　Distribution channels of luxury brands continue to expand; narrowed end-market price discounts enhance earnings upside. The number of the firm’s distribution stores increased 10.5% YoY to 412 in 2021, including 254 luxury brand stores, up 16.5% YoY. The firm’s full-year new car sales of luxury brands grew 8.7% YoY to 299,000 units, thanks to store expansion, optimized brand structure and narrowing end-market discounts. Therefore, the firm’s revenue from new car sales rose 13.5% YoY to Rmb142.47bn. Gross margin of new car sales reached a new high of 4.9% in 2H21, up 2.0ppt YoY or 1.1ppt HoH. In addition, the firm’s after-sale business grew solidly in 2021, with revenue rising 21.0% YoY to Rmb24.51bn, gross margin improving 0.8ppt YoY to 48.1%, and gross profit representing 54% of the total gross profit.
　　Refined management creates an edge; financials improve steadily. The firm maintained its efficient management while expanding its store network, with inventory turnover days falling further to 23.3 days in 2021 from a low base in 2020. In addition, 2021 expense ratio dropped 0.02ppt to 6.2%, with financial expense ratio falling 0.21ppt YoY to 0.6%. We attribute this to lower financing costs due to improved overseas ratings, and reduced working capital outstanding resulting from high inventory turnover. We expect the firm to keep improving its overall operational efficiency and strengthen economies of scale, thanks to its industry-leading digitalization of stores.
　　Continuing to focus on the core brands of Mercedes-Benz and Lexus; used car retail business a new growth driver. The firm has increased its market share in the Mercedes-Benz brand to around 18% since it completed the acquisition of Zung Fu （China） Limited. We believe that the firm, as the second largest dealer of Mercedes-Benz, enjoys clear leading advantages in South China and West China markets. We expect the firm to further improve its profitability by generating greater synergies through the integration of offline stores. In addition, the firm’s used car business under the distribution model grew rapidly in 2021, with full-year revenue soaring 216% to Rmb8.13bn and a gross margin of 6.0%. We see better profitability of the firm’s used car business than new car business, and we expect it to become a new growth driver for the firm.
　　Financials and valuation
　　We raise our 2022 and 2023 net profit forecasts 17.0% and 18.7% to Rmb10.5bn and Rmb12.5bn, to reflect an expanding store network and synergies from the acquisition of Zung Fu. The stock is trading at 10.2x 2022e and 8.6x 2023e P/E. We maintain an OUTPERFORM rating and a TP of HK$72.00, implying 14.3x 2022e and 12.0x 2023e P/E with 39.4% upside.
　　Risks
　　Chip shortage affecting vehicle supply; widening price discounts in end markets; disappointing store integration.