China Wheel Holdings Ltd - A proxy to China’s booming auto sector

China’s auto sector maintains strong growth momentum in 1st half of 2007. Total vehicle sales rose 23% YoY to 4.4 million units while total vehicle production grew 22% YoY to 4.5 million units (see Annex 1). Both vehicle sales and production are on track to reach the widely expected record figure of 8.5 million units by the end of the year. China Wheel Holdings (“CWH”), which generates more than 70% of total revenue from the sale of aluminium alloy wheels to the domestic OEM and retail markets, is in a sweet spot to ride on the robust demand driven by China’s booming auto sector.
Stable aluminium price should reduce downside risks to gross margin. CWH’s gross margin is highly vulnerable to a sustained hike in the price of aluminium (~70% of COGS). The price of aluminium in China has remained stable around the RMB20,000 level since the start of the year, compared with an average price of RMB20,400 in 2006 (see Annex 2). This trend is expected to continue for the rest of 2007, due to an estimated surplus in domestic supply of primary aluminum - the December 07 contract traded on Shanghai Futures Exchange settled at RMB19,290 per tonne yesterday.
Re-rate stock based on 12x FY08 PER; raise Fair Value Estimate to S$1.23. We remain positive over CWH’s medium term prospects and expect its EPS to increase at a 3-year CAGR of 25% (after adjusting for our share base dilution assumptions), underpinned by additional capacity from the new Tianjin plant. CWH is among a handful of Singapore-listed China companies that can offer investors substantial exposure to China’s auto sector. Over recent months, its value proposition as an appealing proxy to China’s booming auto sector has been attracting greater attention from the market, judging by the higher liquidity and steady uptrend in share price (+50% since our initiation on 2 April 2007). Compared to China auto parts makers listed in Hong Kong, which trade at an average FY08 PER of 14x (see Annex 3), our previous valuation of CWH (based on 9x FY08 PER) now looks overly conservative. We therefore raise our Fair Value Estimate from S$0.89 to S$1.23, based on a re-rated but still undemanding valuation of 12x FY08 PER. Maintain Buy.