3Q21 results missing our expectation

China Grand Auto (CGA) has announced that its 3Q21 revenue was Rmb37.21bn (-11.71% YoY and -11.00% QoQ), and attributable net profit was Rmb120mn (-85.19% YoY and -85.96% QoQ). 1-3Q21 revenue and attributable net profit rose 12.04% and 24.03% YoY to Rmb121.25bn and Rmb1.63bn. 3Q21 results missed our expectation due to downside surprise in profitability.

Trends to watch Gross margin declined QoQ for various segments and earnings were pressured by OEM’s business policy and stores’ increased spending for customer maintenance. 3Q21 gross margin fell 0.03ppt YoY or 1.70ppt QoQ to 8.45%. Gross margin was 2.8% for new car sales (-2.04ppt QoQ), 33.7% for maintenance service (-4.24ppt QoQ), 72.2% for commission and agency services (-1.54ppt QoQ) and 46.9% for car rental service (-3.39ppt QoQ). While narrowed end-market discount boosted sales prices in 3Q21, we think that refunds from OEMs declined as select OEMs did not revise their business policy regarding sales volume targets.

This likely offset the gross margin boost from higher sales prices in 3Q21, in our view. We think the refunds may still face uncertainty if OEMs do not timely adjust their business policy in 4Q21.

Expense ratio rose sharply YoY and QoQ due to weaker economies of scale and fixed store operating expenses. 3Q21 sales expense ratio rose 1.0ppt YoY to 5.2%, probably because: 1) store operating cost increased as the firm launched several service activities during the pandemic; 2) 3Q21 revenue fell YoY and QoQ, but labor and rent cost was relatively fixed and this affected expense ratio. In addition, CGA had a relatively high financing cost with 3Q21 issuance rate of USD bonds at 9.125%, which pushed up 3Q21 financial expense ratio by 0.1ppt YoY or 0.37ppt QoQ to 1.9%.

Store structure further improved; watch upside potential ahead. CGA built and acquired a total of 14 stores in 1-3Q21, mainly in Southwest China and Northwest China. Meanwhile, the firm also closed 35 stores due to strategy adjustment, including 22 self-owned stores and 13 leased stores. We expect adjustment in store deployment to continue, which should enable the firm to strengthen its advantages in various regions.

Financials and valuation Due to falling profitability, we lower our net profit forecast 38.4% to Rmb2.03bn for 2021 and 26.1% to Rmb2.84bn for 2022. CGA is trading at 11.5x 2021e and 8.2x 2022e P/E. Given a likely inventory restocking in the auto sector, we maintain our OUTPERFORM rating and TP of Rmb3.30 (13.2x 2021e and 9.4x 2022e P/E with 15.0% upside).

Risks

Unexpected decline in profitability; financing pressure.