1H22 results in line with our forecast
　　Zhongsheng Group Holdings announced 1H22 results: Revenue fell 1.5% YoY (down 2.0% HoH) to Rmb86.03bn, attributable net profit dropped 7.3% YoY (down 26.1% HoH) to Rmb3.43bn, and recurring attributable net profit slid 6.2% YoY to Rmb3.43bn, in line with our forecast.
　　Trends to watch
　　COVID-19 and supply chain disruptions weigh on sales of mid-range and high-end models; optimized brand structure offsets impact of falling sales volume in short term. The firm’s new car sales came under pressure due to the COVID-19 resurgence and supply chain disruptions. In 1H22, new car sales volume fell 12.1% YoY to around 242,000 units, with sales volume of luxury brands down 11.1% YoY to around 144,000 units. The firm attributed its optimized brand structure to offsetting some of the impact of falling sales volume. For example, Mercedes-Benz's contribution to the firm’s new car sales revenue (highest profitability among the firm’s brands) rose 9.6ppt YoY to 41.3% in 1H22.
　　Revenue from new car sales fell 5.2% YoY to Rmb68.81bn, with per-vehicle income up 8% YoY to around Rmb284,000. In addition, the firm’s upgraded insurance products complemented the after-sale business, which maintained double-digit growth in 1H22, with revenue rising 13.4% YoY to Rmb12.82bn, and its contribution to revenue up 2ppt YoY to 14.9%. Meanwhile, the firm’s used car business under the distribution model continued robust growth momentum in 1H22, with revenue up 25.5% YoY to Rmb4.4bn, contributing to steady revenue growth.
　　Industry-leading digital management remains a competitive edge; profitability stable. GM of new car sales edged down 0.6ppt YoY in 1H22. Overall GM rose slightly YoY to 9.8% in 1H22 due to a rising contribution of high-margin after-sale business. Given the impacts of the COVID-19 pandemic and more store openings, the firm’s business operations were stable in 1H22. Inventory turnover days grew to 30.0 days in 1H22, the period expense ratio increased 0.45ppt YoY to 6.4%, and recurring attributable net margin fell 6.2% YoY. As supply-demand dynamics recover in the automobile market, we expect profitability will improve supported by industry-leading digital management of stores, and economies of scale that may be achieved through improving inventory structure and boosting operational efficiency.
　　Store expansion continues; increasing cooperation to enhance AFV business. In 1H22, the firm had 417 distribution stores, up by 31 vs. 1H21. Among these stores, the number of luxury brand stores grew 14% YoY to 261, mainly due to the firm’s previous efforts in acquisition. The firm believes it is tracking trends in electrification of traditional original equipment manufacturers, and is collaborating with companies producing alternative-fuel vehicles (AFV). The firm’s exhibition hall for Lexus’ electrified vehicles in Shenzhen commenced operations in 1H22, and the delivery centers for XPeng cars and dealerships, set up in Shenzhen and Qingdao, have also opened. We believe the firm boasts leading sales experience in more than 90 cities in China, which is conducive to cooperation with AFV brands. The firm’s AFV sales volume grew 54% YoY in 1H22, and the new energy business is likely to contribute to growth with steady progress being made in this business, in our view.
　　Financials and valuation
　　We lower our net profit forecast for 2022 by 12.4% to Rmb9.18bn, and for 2023 by 13.3% to Rmb10.79bn, to reflect the impacts of the COVID-19 pandemic, possible weaker demand in 2023 due to China’s supportive policies for vehicles with internal combustion engines launched this year, and competition traditional luxury cars face from high-end AFVs. The stock is trading at 8.4x 2022e and 7.2x 2023e P/E. Maintain OUTPERFORM. Given the factors above and a sector-wide downward valuation, we cut our TP 33.3% to HK$48.00, implying 10.8x 2022e and 9.2x 2023e P/E with 28.9% upside.
　　Risks
　　Disappointing progress of the used car business and/or sales of core brands.