1) Investment highlights
- We expect 2Q earnings to miss our expectations and the consensus on slowing sales in major markets (Korea, the US, and China), higher incentives in the US, and an unfavorable product mix.
- Domestically, Stinger sales are strong and we expect total domestic sales to return to growth YoY from July as the new small SUV Stonic and Sorento facelift are added to the lineup. The Western European market is benefitting from solid demand and new model effects and we expect Stonic to contribute to retail sales as early as September.
- The US market, which represents over a third of consolidated sales, will likely remain sluggish for some time due to the aging of key models as well as weak demand. However, we find it positive that inventory has declined to 3.9 months as of end-June. We expect the Sorento facelift to be released in early 2018 and a new Soul at end-2018.
2) Major issues and earnings outlook
- In 2Q, ex-China global shipments inched up 0.2% YoY but ex-China retail sales dipped 0.3%. (Retail YoY sales growth by region in 2Q: -10% in Korea, -7.7% in the US, +6.2% in Western Europe, +10.5% in other markets).
- Shipments and retail sales volume in 2Q were flat YoY but the sales volume drop was more pronounced in regions with higher ASP such as the US. The US market was also hit by bigger incentives and a deteriorating product mix (e.g., greater percentage of the K2 and K3 shipped out of the Mexican plant). In all, we estimate 2Q consolidated sales missed the consensus by 4% to stand at KRW13.6tn (-6.1% YoY).
- Operating profit will likely come in at KRW491.8bn (-36.2% YoY), 18.4% below the consensus.
- In 2H, earnings should grow slightly YoY, helped by a low base, recovering domestic sales, upbeat demand in Europe, and continued sales growth in emerging markets. We also believe US inventory burdens will ease gradually.
- Sales in China remain weak but Chinese inventory is continuing to decline. A string of new releases in 2H should help sales recover moderately. However, equity-method income from Chinese plants will likely be negative in 2Q-3Q.
3) Share price outlook and valuation
- Stock corrections may continue for a while given the lackluster 2Q results, ongoing legal battle over ordinary wages, and looming management-labor negotiations. However, trading at 0.54x 2017F P/B, downside pressure for shares is limited, in our view. The costs for the ordinary wage lawsuit are difficult to calculate at this point and excluding this, 2017F P/E has come down to 6.0x.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.