HONG KONG, 7 May 2021. Pengyuan International has affirmed Dongfeng Motor Group Company Limited’s (DFMG) global scale long-term issuer credit rating (LTICR) at ‘A’. The outlook is stable.
The Company’s issuer credit rating is supported by its leading position in China as amongst the largest commercial vehicle (CV) manufacturers, its successful joint ventures (JVs) with Nissan and Honda that provide consistently high dividend pay-out, and the consequently strong leverage and profitability profile. The rating is, however, constrained by the earnings drag from some other loss-making passenger vehicle (PV) business, ongoing research and development (R&D) investment needs and uncertainties in the JV structures.
DFMG mainly engages in the R&D, manufacturing and sales of CVs, PVs, engines and other auto parts. The Company also has financing business and other auto-related businesses. In 2020, DFMG recorded sales of 2.9 million vehicles and ranked the third amongst Chinese vehicle original equipment manufacturers (OEMs).
KEY RATING RATIONALES
Leading position in China’s vehicle manufacturing industry. DFMG is the third largest vehicle OEM in China with a volume-based market share of 11% in 2020, behind Shanghai Auto’s (SAIC) 22% and First Auto’s (FAW) 15%. Founded in 1969 as Second Auto Works with a focus on CVs, the Company is still amongst China’s largest CV OEMs with 11% market share in 2020. In that year, DFMG managed to record 18.5% year-on-year (YoY) increase in CV sales volume, in line with the industry growth in China, despite the coronavirus pandemic. With 2.3 million units of aggregate sales from various brands in 2020, the Company is also one of the leading PV OEMs in China. Last but not least, DFMG’s economy of scale also implies strong bargaining power along the supply chain for effective cost control.
Robust cash inflow from JVs with Nissan and Honda. DFMG’s largest earnings contributors are the two 50-50 JVs, namely Dongfeng Motor Company Limited (DFL, a JV with Nissan) and Dongfeng Honda Automobile Company Limited (DHAC, a JV with Honda). In 2020, these two JVs accounted for 80% of DFMG’s total vehicles sold (vs. 60% in 2016) while their earnings contribution made up 91% of the Company’s net profit (vs. 74% in 2016). High dividend pay-out ratios from DFL and DHAC also provide strong cash inflow for DFMG over the years. To elaborate, the Company was entitled to an average of RMB10.7 billion dividends from DFL and DHAC each year between 2016 and 2020. Considering the well-diversified product line-ups, good brand image of Dongfeng Nissan and Dongfeng Honda, and their sales resilience even in 2020 amid the pandemic, we believe that these two JVs will continue to achieve healthy earnings going forward.
Robust leverage and profitability profile. Despite the losses from other businesses such as the own brand PV business and the PSA JV, DFMG has a strong overall leverage and profitability profile bolstered by the profitability of the CV business, auto financing business and the DFL/DHAC JVs. To elaborate, the Company has an average adjusted EBITDA margin of 12% in 2016-20 after including dividends from JVs and associates. While DFMG’s leverage appears to be on the rise from a net cash position before 2018, partly due to investments on R&D, development of its own brand business and expansion of auto financing services, the debt-to-equity ratio is expected to stay below 20% in the foreseeable future, let alone the fact that DFL and DHAC are both in strong net cash position.
Uncertainties in future JV ownership structure. Since DFMG’s profitability mainly hinges on its lucrative JVs, the Company is exposed to the risk of reduction in JV stake and even termination of JV agreements. To elaborate, China did not allow foreign vehicle OEMs to own more than 50% of any local OEM entity and that led to set-ups of many Sino-foreign OEM JVs. However, the rule was scrapped for new energy vehicle (NEV) OEMs in 2018, for CV OEMs in 2020 and will be scrapped for PV OEMs by 2022. DFMG’s key OEM JV partners, namely Nissan, Honda, Stellantis and Volvo AB, have hitherto expressed no intention in changing the stake-holding status quo. However, the possibility of buying back stake by the JV partners cannot be fully ruled out, especially considering the high profitability of DFL and DHAC. If this happens, DFMG’s financial profile could be negatively impacted.
Profit drag from loss-making businesses. Apart from the profitable CVs and the Japanese OEM JV businesses, DFMG also has its own brand PV business and the Dongfeng Peugeot Citroen Automobile Company Limited (DPCA) JV, which are both incurring losses. To elaborate, the Company’s own brand PV business and Dongfeng Peugeot Citroen Automobile Sales Company Limited (the selling arm of DPCA) made operating losses of RMB3.5 billion, RMB3.9 billion and RMB4.3 billion, respectively, in 2018, 2019 and 2020 amid declining sales, while DPCA contributed to RMB885 million, RMB1.3 billion and RMB1.0 billion losses, respectively, in 2018, 2019 and 2020. Apparently, both of DFMG’s own local brands and DPCA have not gained traction in China’s PV market and we do not expect the loss-making trend to revert in the foreseeable future given a lack of popular new models.
More R&D investments on the way. According to DFMG, the Company will accelerate the development for NEV business, including the development of NEVs and intelligent connectivity vehicles. DFMG has established a new standalone NEV brand VOYAH and we think that more financial resources will be put aside for R&D. Since the Company’s current NEV sales contribution is less than its peers such as SAIC and BYD, let alone the competitions from NEV start-ups, the catching-up efforts could lead to a rise in cash expenditure and rising leverage, in our view.
The rating outlook is stable, which reflects our expectations that DFMG’s CV business and its two highly profitable JVs (with Nissan and Honda) will continue to deliver stable financial support while the Company’s moderately strong tie with the government, through the parent Dongfeng Motor Corporation (DFMC), will sustain and that the State-owned Asset Supervision and Administration Commission of the State Council (SASAC) will continue to support DFMC, and hence DFMG, in case of financial distress.
We would consider downgrading DFMG’s issuer credit rating if its credit profile deteriorates substantially due to the following situations: 1) Nissan and Honda raise the stake in their respective JVs with DFMG; 2) there is a substantial drop in Nissan and Honda JVs’ profitability that makes the high dividend pay-out policy unsustainable; 3) the profitability of the CV business deteriorates materially; and 4) the loss in its own brand and/or PSA JV’s PV business worsens, possibly due to further investment in NEV initiatives.
We would consider upgrading DFMG’s issuer credit rating if its credit profile improves substantially due to the following situations: 1) The loss-making situation of its own brand and PSA JV’s PV business significantly improves; and 2) there is a rapid increase in auto financing business’s profit contribution.
Note: ratings mentioned in this press release are unsolicited.
Vincent Ha, CFA
+852 3615 8307
Jonathan Joseph Tai, CFA
+852 3615 8276
Ke Chen, PhD
+852 3615 8316
+852 3615 8296
RATING SERVICES ENQUIRIES
+852 3615 8324
Date of Relevant Rating Committee: 27 April 2021
Additional information is available on www.pyrating.com
General Corporate Rating Criteria (15 March 2018)
Corporate Financial Adjustments and Ratio Definitions (7 May 2018)
Government-Related Entities Rating Criteria (31 August 2018)
Unsolicited ratings – non-participative rating – not disclosed
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