Weichai Power: Emission Standard Upgrade Likely to Hurt Margin

www.chinatrucks.com:

2012 results down around 47% YoY; 13% below consensus

Weichai issued a profit warning, estimating a sharp decline in 2012 earnings (similar to 1-3Q12’s 47% YoY drop), worse than consensus’ 39% YoY drop. Key downside surprise was bigger-than-expected sales drop – diesel engine / gearbox/ heavy truck down 36% / 36% / 15% YoY to 310,000/ 450,000/ 85,000unit. In order to factor in Weichai’s weaker-than-expected sales, we revise-down our 2013/14E earnings by 5%/2% to Rmb3.67bn / 4.13bn, and lower our PO by 4% from HK$16.7 to HK$16.0, considering 6% / 3% lower engine volume assumption.

Upcoming emission standard upgrade likely to hurt margin

The long-waiting emission standard upgrade (from China III to China IV) for heavyduty truck is likely to implement on schedule (since July 1st 2013), after recentterrible toxic smog in north China (including Beijing, the capital city), in our view. Against some investors’speculation on potential short-term sales spike on frontloaddemand, we highlight net-net actually negatives for truck and engine makers- Margin squeezed by cost hike for incremental parts (about Rmb15,000).

Experience of both Sinotruk and Weichai during last around emission standard upgrade (China II to China III on July 1st 2008) proved margin drop - Demand to hurt due to higher truck price. The emission standard upgradewill hurt full year demand, as higher truck price will hurt truck owner’s profitabilityand result in a sales drop post-upgrade in 2H13, offsetting the pre-buy in 1H2013.

Structural risk - engine client loss - to intensify since 2014

We believe Weichai’s pricy valuation - 14.1x /12.5x 2013/14e P/E is hard to justifyits long-term structural headwinds from on-going share loss due to down-streamcustomers’ vertical integration moves by establishing in-house engine operations,as major of which will kick off production since 2014.

Views:0