We believe satisfactory integration with StarChase bolsters management confidence in acquisition strategy. Following the recent placement, we deem Meidong is well prepared for potential M&A deals with a healthier balance sheet. In addition, we feel management becomes more active towards engagement in NEV field than before.The company would first try after-sales services such as cooperation with Tesla, while other partnerships (Li Auto and Huawei) are under close negotiations. Over the short term, given the lower-than-expected earnings in 2H22 and downside risk of consensus forecasts, we anticipate its share price may face volatility. However, over the mid-to- long run, we believe Meidong is well positioned to cope with industry transformation and prove its intrinsic value for OEM. Maintain BUY with lower TP of HK$20 (20x 2023E P/E).
　　Key Factors for Rating
　　2H22 results preview. We expect new-car sales volume likely to turn to positive growth of c.20% YoY in 2H22, against decline of 8% YoY in 1H22, thanks to the contribution of StarChase which also helped Meidong to become the largest dealer of Porsche in China with sales volume of over 13,000 units in 2022. However, margins of Meidong’s core brands were severely hit by sluggish demand amid the COVID-19 lockdowns, and we estimate new-car sales margin may dip to historical low level (below 4%) in 2H22. In addition, after-sales service also performed weaker in 2H22 due to much lower traffic amid the lockdowns. Therefore, if excluding non-operating expenses related to the acquisition of StarChase, we anticipate core earnings in 2H22 may be lower than that in 1H22 at RMB500m, below expectations. As for non-operating items, we estimate non-operating expenses related to acquisition at RMB120m in 2H22, including amortisation of dealership rights of RMB77m and CB interest expenses of RMB44m.
　　Recent placement targets at potential M&A deals as well as better cash management from the multi-currency perspective. Recently, Meidong undertook a placement to raise around HK$1.0bn at the price of HK$15.05 per share, which slightly surprised the street. Per our discussion with management, we reckon the placement seems reasonable from the operational considerations: i). potential M&A deals given rich pipeline from an increasing number of potential sellers after a tough year in 2022; ii) to enhance balance sheet management from a multi-currency perspective. Given the fund flow limitations, management aims to maintain net cash not only at the company level but also at both levels of on-shore RMB and off-shore foreign currency.
　　Successful post-M&A integration with StarChase bolsters management confidence in acquisition strategy to secure long-term growth. According to management, Meidong has achieved preliminary success in integration with StarChase in 2H22. At the operational level, the inventory level and profitability of StarChase are both improved to close to that of Meidong in 2H22. Looking into 2023, management looks positive towards the potential earnings contributions from StarChase, especially after-sales services given that most StarChase’s stores are located in higher-tier cities with old store age. Management expressed great openness to potential selective M&A deals, no matter small-sized targets mostly controlled by Chinese capital or large-sized ones mostly held by foreign capitals.
　　In terms of criteria for M&A targets, in addition to three principles of attractive price, suitable location, strong premium brand awareness, management now adds a new consideration of potential impact from EV trend.
　　Direct sales vs. Dealership
In terms of sales model, the debate over direct sales and dealership has been widely discussed among investors, with the accelerated electrification across the industry. The fast-growing NEV players, represented by Tesla as well as Chinese start-ups NIO, XPeng and Li Auto adopt direct-to-consumer sales model from the very beginning, which led to some bearish opinions towards the value of dealership in NEV era. On the other hand, we notice there are still some NEV players sticking with dealership model, no matter NEV leader BYD or new comer Huawei-backed AITO.
　　In our view, direct sales model and dealership model both have unique advantages and differ in popularity amongst automakers by the overall industry development stage and automaker’s specific business progression. Direct sales model did gain wide popularity in China’s automotive market in last two years.
　　Firstly, it offers better user reachability for automakers to respond effectively and timely. Therefore, it’s a wise choice for NEV start-ups with small-scale deliveries to adopt such distribution tactic to strengthen consumer contact rapidly. Secondly, it ensures more cost-effective transaction while the EV industry ramps up at the early introduction stage with short supply. However, things have changed since 2H22 as the crowded market supplies and intense competition brought the shortcomings of direct sales to light, such as Li Auto’s inventory issue during product-switch stage and Tesla’s consumer rights defence event triggered by dramatic price cuts.
　　Therefore, we reckon when the market becomes mature with excess supply over demand, dealership mode has started to present its value for OEM as it could work as a buffer to mitigate OEMs’ inventory management burdens and coordinate pricing issues in a more efficient and effective way compared with direct sales mode.
　　For Meidong, we feel that management becomes more active towards engagement in NEV field than before. The management indicated that the company would first try after-sales services business rather than new-car sales business given the meager profitability of most NEV makers at current stage.
　　For instance, its first Tesla after-sales store in Shantou will start operation before the Chinese New Year, while other partnerships (such as Li Auto and Huawei) are under close negotiations.
　　Earnings Forecast and Valuation
　　We slightly nudged up 2022E-24E revenue forecasts by 2%-3% to reflect higher ASP assumptions driven by greater Porsche sales mix despite sales volume slashes of other luxury brands. We significantly chopped down 2022E-24E net profit forecasts by 26%-39% to RMB732m/RMB1.1bn/RMB1.4bn, to reflect weaker-than-expected new-car sales margin in 2H22. Our current forecasts have not taken into account the potential M&A deals given the invisibility of timing and detailed targets at current stage.
　　Looking into 2023, we expect the company to see strong earnings recovery along with the deepening post-acquisition synergy with StarChase, against the uncertainty of traditional luxury brands’ demand recovery. We reckon its profitability will also see a certain improvement with the reopening of automotive market and higher Porsche sales volume contribution.
　　Currently, the stock is trading at 18.2x 2023E P/E, below historical average level of 20x over the past five years. Although Meidong’s shares still trade at a valuation premium above that of two peers Zhongsheng and Yongda, we noticed the gap has been narrowing significantly over the past year. We revise down our TP to HK$20.00 from HK$25.00 by adopting 20x 2023E P/E (previously 23x 2022E P/E). Maintain BUY.
　　In the near horizon, we reckon its stock price may see volatility given its lower- than-expected 2H22 earnings and downside risk of street consensus. Yet, we anticipate the street may re-examine the long-term investment value of dealership from previous over-pessimism. Meanwhile, we anticipate good- quality dealers representative of Meidong is well positioned to cope with industry transformation and prove its intrinsic value for OEM over the long run.