Company description

Brilliance China Auto’s key business lies in the joint venture with BMW for the production of BMW 1, 2, 3 and 5-series sedans and X1 SUVs in China. The Group also manufactures and sells minibuses and automotive components under its own brands, namely “JinBei” and “Granse”. Other businesses include the manufacture of diesel and gasoline engines for use in minibuses, sedans, SUVs, and light duty trucks.

Brilliance China Auto - Buttonwood Capital

Investment thesis

BMW is in the midst of a new product cycle since 2016 which should drive market share gain. Rising localization further lowers unit content costs and improving profitability. The second generation X1 SUV was launched in 2016, followed by new 1 series in Mar17 and 5 series in mid-2017. The new X3 is likely to be launched in 3Q18, followed by next generation 3 series and potential all-new X2 in 2019. Loss-making own brand remains a drag on profitability but could improve with the formation of a new light vehicle JV with Renault.

Investment summary

Sharp stock correction on potential BMW stake increase in JV – Following a German news report that BMW may be looking to increase its stake in the BMW-Brilliance JV, stock corrected by as much as 20% intraday as a lower JV stake could mean lower future profit growth for Brilliance. Both companies are reportedly in the negotiation stage without any final conclusion.

Stake increase likely applies to new investment – No official comments from the companies yet but press reports indicated the chairman dismissed the above as speculation. We think any larger stake by BMW if adopted, is likely to apply to new investment and not existing JV. Lifting of auto sector foreign ownership restriction takes effect from 2022 and the JV agreement expires in 2028. Hence change to existing JV before this is probably unlikely. With USChina trade war and around half of BMW’s China imports from its US plant, there is indeed incentive for BMW to localize more production (eg. X5).

2 recent events highlight strong JV relationship – BMW recently announced ~15.5% annual capacity increase for the JV to 520K units. BMW also confirmed the all-electric iX3 will be produced by the JV for global sales from 2020. We think the new investment/capacity with larger BMW stake could be for a new JV just for electric vehicles. If this is true, we would view this positively as BMW could have set up a wholly owned EV JV based on the new rules. With these recent events, a change to existing JV which hurts Brilliance would be surprising.

Attractive risk-reward – Fundamentals remain solid with June sales up 20% and 1H sales 13% y/y vs sector sales +3%. Valuations are attractive with current 6.5% 12m forward P/E close to trough. In a worst case where BMW does increase its stake in the JV, back of the envelope calculation suggests potential cost at €4-5bn for 25% stake which will require Brilliance’s shareholder’s approval and is not priced in, in our view.

Stronger than expected sales of higher margin models (eg. 5 series, upcoming X3 SUV).

Localisation of more new models (eg. X5 SUV) could be new profit drivers.

Earlier than expected profit turnaround in minibus business with new Renault JV.

Brilliance China Auto - Buttonwood Capital