格力电器(000651)

Event 1 - Clarification of potential investment in Luoyang LYC and Tianjin FAW

On 19 Sep 2017, Gree confirmed it had teamed up with Luoyang LocalGovernment and IIT Committee of Henan province, to participate in the “Luoyangintelligent equipment manufacturing production base project”, reported by thepress on 15 Sep 2017. Total investment of this project is around RMB15bnincluding a site area of 5000mu, and the estimated production value will reachRMB30bn per annum after completion. Gree will also participate in the stateowned enterprise Reform of LYC Bearing; the investment amount from Gree hasyet to be defined. The company will make a further announcement if necessary.

Meanwhile, Gree denied it intended to acquire Tianjin FAW Xiali as Souhu.comreported on 16 Sep 2017. Gree clarified that it has never discussed the acquisitionof Xiali with Tianjin FAW.

Event 2 - Acquisition of 5% stake in Shanghai Highly Group

Gree resumed trading on 19 Sep and announced on 20 Sep 2017 that it hadsuccessfully bid for 43m shares of Shanghai Highly Group (600619.SS, NR)between 29 Aug 2017 and 19 Sep 2017 from its controlling shareholder, ShanghaiElectric Group (601727.SS, NR). Following the purchase, Gree owns a 5% stakein Shanghai Highly.Rationale for the purchase �C to be an international company with well-roundedsupply chain capability. Through this acquisition, Gree targets to expand itssupply chain base and consolidate quality capacity and resources in the market.

It will also leverage on its international vision as a Shanghai company, on humanresources, information and innovation.

I t also mentioned the possibility of increasing its stake in Shanghai Highly in thenext 12 months, although it does not intend to be the controlling shareholder ofHighly at the moment. It stated that: 1) it will not sell the purchased shares in thenext 12 months; 2) it will continue to participate in the bidding for Highly’s sharesin the next 12 months should Highly’s controlling shareholder, Shanghai Electric,plan to sell its stake in Highly.

Deutsche Bank view �C maintaining Buy

We believe that business diversification remains as one of the key strategies forGree, and is in line with what it mentioned in its 2016 annual report. Automationin the manufacturing process is one of the focuses for all upstream players. In 1H17, Gree's manufacturing equipment business sales grew by 270%. As theinvestment of RMB15bn will be contributed by various partners, we believe Gree'sinvestment in Luoyang LYC can be funded from internal resources and will notaffect Gree's cashflow or dividend payout. To recap, as of end-2016, Gree hasnet cash of RMB84bn including net working capital. In 2016, its dividend payoutratio was 59%.

Gree bought its interest in Highly at a price of RMB11.6-15.5/share (withinHighly's trading range during the period), which indicates Gree’s total investmentinto Highly is around RMB556-578m. The consideration implies a 2016 PE of63-66x, EV/EBITDA of 11~12x, PB of 2.8-2.9x. The impact on the P&L should bevery minimal, in our view. The reason for this acquisition is mainly to verticallyintegrate its supply chain, as explained by Gree. Shanghai Highly is the leadingcompressor manufacturer in China with a 31.4% share of non-self-supportingcompressors in 1H17, according to Highly's interim report. As the largest clientfor Highly, Gree purchased 6m sets of compressors from Highly (total productionof 25m sets) in 2016. Other air conditioners, e.g., Midea and Haier, are all clientsof Highly. Gree also owns a compressor manufacturer, i.e., Zhuhai Landa, asubsidiary of Gree. We believe the investment in Highly will further secure Gree’scompressor supply and help it to gain market share and strengthen its dominantposition in the air-conditioner market, particularly in a high demand market.