潍柴动力：Correction offers buying opportunity;Diversification strategy on track

Weichai’s share price has dropped 6% since the release of 2019results. Wesee the correction a buying opportunity as we believe the growth drivers arewell intact:

(1) the inclusion of more Shandong SOEs under SHIG, parentcompany of Weichai, will help boost Weichai’s sales;

(2) the diversification intonon-road machinery engine is on track;

(3) macro policy to supportinfrastructure spending should boost the demand for construction trucks. Wetrimmed our 2020E/21E earnings estimates by 7%/4% on lower marginprojection and lower sales estimates on overseas business that operated byKION (KGX GR). Our SOTP-based TP is adjusted to RMB14.3from RMB15.9.n Gross margin contraction should not be an ongoing trend. Grossmargin in 4Q19narrowed 3.2ppt YoY and 1.8ppt QoQ to 21.1%.Management explained that the reason for the lower margin in 4Q19wasdue to a change in product mix. The strong sales of certain type of logistictrucks in China boosted the demand for Weichai’s WP10H product (whichcarried lower margin compared with that of the high margin 12L engines).That said, we do not expect a continuous margin contraction, givenWeichai’s strong bargaining power on the back of consolidating industry.n More opportunities following the consolidation of Sinotruk and LovolHeavy Industry by SHIG. In Oct 2019, SHIG was granted in Oct 201920.8%state-owned shares of Lovol Heavy Industry, a company that manufacturesconstruction and agricultural machinery. This opens up a new opportunity toWeichai. Weichai targets to achieve annual sales of 100k units ofcontinuously variable transmission (CVT) powertrain to Lovol in future.Meanwhile, given the consolidation and management reshuffle of Sinotrukhave largely been completed, we expect Sinotruk will focus on sales volumegrowth going forward. Weichai targets to achieve annual sales of 100k-200kunits of MDT and LDT engines in future. All these, together with theexpansion in hydraulic powertrain and high-speed large-bore engine, willhelp Weichai achieve much higher level of diversification over the comingfew years.n Risk factors:

(1) weakness in HDT and engine demand;

(2) furtherdownside risk on overseas business;

(3) technology risk.