BYD Co:Subsidy cut for NEV bus impacts earnings outlook;down to Neutral

What happened

We lower our TP and downgrade BYD to Neutral (from Buy) following thereduced 2017subsidies for new energy vehicles (particularly NEV bus),announced on Dec 30. Our revised TP implies 2% upside vs. -1% coverageavg. and we find current valuation fair given(1) its 1.9X 12m forward P/B iswithin historical median -1std;(2) the NEV business (incl. EV battery) tradesat 1.4X P/S and 14.4X P/E 2020E, vs. Tesla’s 1.5X and 25.0X; and(3) weakergrowth outlook post 2017NEV policy announcement. Since reinstatingcoverage of BYD at Buy on Aug 31, 2016, the stock is -20% vs. the HSCEI+2% as a result of uncertainties surrounding the NEV subsidy policy.

Current view

As per the latest NEV subsidy policy for 2017:(1) maximum centralgovernment subsidy for NEV bus is to be cut by 25%-70%;(2) localgovernment subsidy not to exceed 50% of central government subsidy;(3) NEV passenger car subsidy to be cut by 20% as expected, maximumNEV truck/special purpose vehicle subsidy to be increased, and fuel cellvehicle subsidy to stay unchanged;(4) technology qualification standard tobe hiked (battery energy density, mileage, fast charge ratio, etc.).

We lower our 2017E-2019E EPS by 15%/9%/9% respectively. We estimatethat BYD’s NEV bus OPM will fall from 25.7% in 2016E to 16.2% in 2017E,and its overall NEV OPM will decline from 18.5% to 14.9%, with thesubsidy cut partly offset by NEV credit income (estimated at 4.0%/ 3.5%/3.0% of 2018-2020NEV passenger car revenues).

Valuation: Our 12-month target price for BYD of HK$44.52(down 25%from HK$59.45) is based on a sum-of-the-parts valuation methodology.

Key risks: Higher/lower total NEV market size/BYD market share in theNEV space; higher/lower NEV credit income; higher/lower cost saving esp.on the battery side; higher ASP/OPM for NEV bus if BYD is able to pass onsome subsidy reduction to the buyers; quicker/slower sales ramp-up in thenew monorail business.