Initiate with BUY. We initiate coverage of China Meidong Auto with a BUY rating and a target price of HK$ 48.00, based on 20x FY23E P/E. Despite possible shrinking dealership market size, we believe such business is still justified. We are of the view that Meidong is best positioned to outrun its peers amid more challenging industry landscape with its superb operational efficiency. The company culture, as a fundamental differentiator, is almost impossible to mimic.
　　Industry margin dent has been priced in. The overall outlook for dealership　of Porsche, BMW and Lexus in 2022 still looks positive, based on our channel checks. As investors have lowered new-car gross margin estimates for dealers in 2022, we are of the view that margins for dealers may exceed expectation, since supply chain challenges are still lingering, which supports dealers’ new-car margins.
　　Meidong’s management execution potential could still be undervalued.After its unique high inventory turnover approach, Meidong now has showcased its capabilities in M&As. We expect the acquired Porsche stores from StarChase (14x FY21E P/E) to contribute about RMB 350mn during 2Q- 4Q22 and we project Meidong to double net margin of these stores in FY23 versus that in FY21. We believe Meidong’s customer return ratio (CRR) program is a replica of inventory turnover and its positive impact on long-term profit growth could be larger than what investors currently expect.
　　FY21E earnings preview. We project Meidong’s FY21E net profit to rise 58% YoY to RMB 1.18bn, slightly lower than consensus, largely due to chip shortage. We forecast its net profit to surge 65% YoY to RMB 1.95bn in FY22E, aided by the StarChase acquisition.
　　Valuation/Key risks. Our target price is based on 20x our FY23E P/E, as we believe FY23E could better reflect the contribution from the StarChase acquisition. Our valuation is in line with forward 12-month P/E in the past 12 months. We believe that Meidong’s higher-than-peer valuation is still justified given its higher earnings growth. Key risks to our rating and target price include lower sales and/or margins, slower store expansion than our expectation, as well as a sector de-rating.