Geely Profit Warning: Red Alert From Mother Russia

| About: Geely Automobile (GELYY)
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Summary

Geely reported a profit warning expecting FY2014 net profit down -50% on FX loss and soft shipment.

Improving product mix from Xindihao and GX SUVs was unable to offset the Russian weakness.

I remain positive despite recent weakness. Volvo assets continue to be attractive.

Event

Geely (OTCPK:GELYY) issued a profit warning given its exposure to Russia and Ukraine and the current weakness with the Russian Ruble. The company now expects net profit for the full-year 2014 to come in at Rmb2.66b (-50% y/y) mainly on unrealized FX loss from its Russian subsidiary. Weak volume also contributed to the shortfall. Recall that the November shipments were down -22% on weak exports and a tougher y/y comp.

The stock has been down -27% over the past month as the market reflects on the negative headwinds from Ukraine and Russia, where exports dropped -75% y/y to 3k units. As I have mentioned in my prior note, the near-term crisis in Ukraine and Russia will likely put further headwinds on Geely's monthly figures. That said, I believe that investors should look at the long-term potential of the company given its Volvo assets, whose technology could be leveraged on Geely's local brand to make it more competitive against other local brands.

Implications

From Russia with no love. Russia is Geely's largest export market and accounted for close to 30% of the company's export volume last year. The company previously stated that the FX does not pose a significant risk to the group in that its business are mostly conducted in Hong Kong or Mainland China. In addition, the company's biggest FX exposure is the US dollar. However, Geely still has a large FX exposure to the US dollar in that much of its sales is denominated in USD. The minimal FX-exposure and the profit warning seems to contradict each other so that the likely explanation for the FX risk is mostly coming from the unsold inventory from Geely's Russian subsidiary.

Improving product mix unable to offset Russian weakness. Despite the improving product mix with the ramp up of Xindihao and the GX-series SUV, the weakness in Russia and Ukraine continues to weigh on the overall result. For long-term investors, I would remain constructive on the name for 1) a favourable product mix from Xindihao and SUVs and 2) long-term growth potential of its Volvo assets. Volvo aims to double its marketing spend over the next five years and focus on improving customer service to win back customers. In addition, the automaker hopes to increase its sales volume from 470k to 800k over the next five years. Both the dealership and online network have been upgraded, and should improve the overall customer experience, in my view.

Conclusion

I remain positive on Geely. However, management needs to take its FX exposure more seriously and disclose its FX risk properly in the filing. The latest profit warning is a clear indication that management had poor understanding of its FX risk.

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