格力电器(000651)

Key points

Air-conditioner sales growth to moderate on shortfall in demand growth.

Investors likely to focus on end-demand rather than reported revenues.

We raise FY18 and FY19 EPS estimates by 11% and 4%, but downgradethe stock to Neutral and cut our PER-based TP by 24% Rmb38.80.

Conclusion

We downgrade Gree to Neutral post 1H18 as we are increasingly cautious onthe air-conditioner industry in 2H18-1H19, given the high YoY base. We raiseour earnings est for FY18 by 11% and for FY19 by 4% in view of the strongreported sales for 1H18 that we believe are due to strong sell-in. However, wecut the target PER from 13.5x FY18E to 9x FY19E. Accordingly, we lower ourTP by 24% to RMB38.80/sh, as we expect growth to normalise followingstrong earnings growth in the past 24 months. Our FY18-19 earnings are 4% &7% below consensus, respectively. Dividend uncertainty remains a concern.

Impact

Air-conditioner sales growth to normalise from 2H18. Gree’s ACshipments in China have risen 16% YoY YTD. We expect air-conditionerrevenue growth to moderate to 8% YoY in 2H18 after last year’s unusuallyhigh 49% YoY growth, which we believe was partly due to AC demand beingmet earlier than expected. Our channel checks indicate that weaker-thanexpected July retail sales have led to higher channel inventory for the industry,which will take time to digest. This, we believe, will cause shipment growth tomoderate, to relieve pressure on channels.

Would it matter if management can hit RMB 200bn sales target for FY18?

Even if the company meets its FY18 sales target of RMB200bn, we doubt itwill be a share price catalyst, as it will only increase the market’s scepticism onwhether there is channel stuffing in air-conditioners, given the strong salesrevenue growth in the past 24 months. We see end-consumer demandmeasured by either AC installations or retail sell-through as a much moreimportant catalyst to the share price than Gree’s sales to channels.

Investment in chipset design at what cost? A key reason for the cut individend is Gree’s intention to invest in chipset design. Its inverter airconditioners use mainly imported chipsets that cost RMB4-5bn annually. Asthe chipset is the only air-conditioner component that Gree does not only makeitself, it is investing in chipset technology R&D to increase its pricing powerand control costs. Gree has set up a subsidiary with RMB1bn of share capital.

Earnings and target price revision

We raise our reported estimates for FY18 and FY19 by 11% and 4%respectively, but cut our target price by 24% to RMB38.80/sh.

Price catalyst

12-month price target: Rmb38.80 based on a PER methodology.

Catalyst: 3QFY18 results, 3rd party industry data on AC

Action and recommendation

Downgrade to Neutral.