BRILLIANCE CHI:Marketing expenses hurt profits

Rising sales momentum: As expected 2015 has been a challenging yearfrom a volume perspective, with BBA’s aging model line-up facing increasedcompetition, especially from the recently launched C-Class and GLA fromMercedes-Benz. This should begin to reverse in 2016 as BBA begins to addthe first of 3 new models to its China line-up as well as the renewal of itsexisting line-up. This should propel volume growth of 16%, 23% and 21% in2016-18E.

Margins are harder to forecast: Profit margins have come under evengreater pressure than we expected, primarily it would appear from greatersupport to dealers in the form of rebates and supplementary commission.

With a long list of capital projects, we believe costs have mounted, withnumerous production stoppages. We now assume that marketing expensesremain high, declining only slightly as a percent of sales.

Positive margin factors as well: There are numerous positive margin factorsthat could manifest themselves over the next couple of years. Due to the useof rolling hedges, there should be more benefit from the weak Euro in 2016 –and the rolling hedges should help to offset recent RMB weakness. With twobig capex projects being completed in 2016 – the new front-wheel-drive line atTiexi and new engine factory – and the completion of the new Dadong factoryin 2017, one-off expansion costs should ease by 2018.

Range extension is critical to future: The new Active Tourer 2 Seriescoming in early 2016 and the new 1 Series sedan in 2017 coupled with the allnewX1 SUV provides a solid base for the BMW brand to attract China’syoung rising middle-class, the prime demographic buying cars. Capturingthese customers when they are young is critical to longer-term growth.