DBS Group Research analysts Woon Bing Yong and Derek Tan have initiated “buy” on Hong Leong Asia with a target price of $1.14 due to its “promising” long-term growth story.

This is supported mainly by three factors, write the analysts in their June 7 report.

First, sales volumes in Hong Leong Asia’s subsidiary, China Yuchai, could see a surprise on the upside in the 1HFY2021. This is due to the implementation of National VI(a) and Tier-4 emission standards that are expected to elevate purchases of diesel engines in the 1HFY2021 and 2HFY2022.

“While expectations of a strong 1HFY2021 due to pre-buying may have been baked in to some extent, we think Yuchai’s 1HFY2021 sales volumes could surprise further to the upside with growth of around 20-30% y-o-y and have projected FY2021 volumes to hit 457,849 units,” write the analysts.

Overall, the analysts have estimated China Yuchai to record 25.2% higher profit after tax of $194.7 million in the FY2021 from $155.5 million in FY2020.

Want our latest Singapore corporate news stories for FREE

Follow our Telegram, Facebook for the latest updates round the clock

The analysts have also projected China Yuchai to reach a profit after tax of $225.5 million in the FY2022.

On concerns over the viability of Hong Leong Asia’s diesel engine business in light of the traction gained in terms of sales of pure electric vehicles (EVs) in China, Woon and Tan have found that the growth in EV sales in China has been restricted to buses and light and mini trucks.

Furthermore, while pure electric passenger vehicle sales have increased, the sale volume of pure electric commercial vehicles have been on the decline since 2018, say the analysts.

“Indeed, the proportion of commercial vehicles sold with diesel engines reversed its declining trend in 2020, rising to 67.9% from 65.6% a year ago,” they add.

“On this front, we think Yuchai is well positioned to reap rewards from its research and development efforts. The segment already boasts a portfolio of engines that are National VI(b) standard compliant, a standard not expected to be implemented until July 2023.”

Second, China Yuchai’s long-term transformation to being a new energy player in the market is “on track”.

The company has upped its research and development (R&D) spending by a compound annual growth rate (CAGR) of 33% over the past two years to $230 million in FY2020.

This, say the analysts, is “well-timed” with Hong Leong Asia’s testing of a 90kW fuel cell system prototype in mid-2021.

The group has also announced a partnership with Sunlong Bus to develop EVs.

“A successful venture by Yuchai into the new energy commercial vehicle space could drive a re-rating of the stock closer to its electric vehicle peers,” say the analysts.

Finally, the group is expected to address the construction backlog of over $5.8 billion in FY2022. The backlog came about due to the disruption and delays in construction caused by the Covid-19 pandemic.

To Woon and Tan, FY2022 will be a “key year” in addressing the backlog. They have also projected the group’s building materials segment revenue to rise by 23.6% y-o-y to $489.1 million.

That said, a faster-than-expected adoption of commercial EVs, intense industry competition, a surge in raw material costs, and a resurgence in the Covid-19 pandemic could pose key risks to the counter.

The analysts’ target price is based on a sum-of-the-parts (SOTP) valuation where they have pegged Hong Leong Asia’s diesel engines and building materials segments to 10.0 times FY2022 price-to-earnings (P/E) and 12.0 times FY2022 P/E.

Shares in Hong Leong Asia closed 3 cents higher or 3.1% up at 99.5 cents on June 7, or 0.8 times P/B, according to DBS’s estimates.

Cover photo: Stock photo