Dah Chong Hong Holdings faces 2 speed bumps in car dealership business

The return of the Bentley distributorship in China seen to impact largely.

Here's from Macquarie Equities Research:

Leveraging rising consumer tastes in cars and food

Over the past few years, Dah Chong Hong (DCH) has leveraged rising demand for high-end cars in China through expansion of its auto dealer network that includes a mix of mid- to high-end, luxury and ultra-luxury brands. Its food business has generated strong growth from the expanding popularity of high-end imported food, including fresh and frozen meats and vegetables as well as a wide range of other products. We believe both businesses will continue to be profit growth drivers and reiterate our Outperform rating on DCH. We raise our target price to HK$9.60 from HK$9.00 based on 11x FY13E PER.

Hitting a couple of speed bumps in car dealer business

DCH is facing two speed bumps in its car dealer business that are depressing profit growth rates in FY12 and FY13. The recent territorial dispute between China and Japan led to a sharp decline in volumes of Japanese cars, impacting 41 of its 66 dealerships that account for around a quarter of revenue.
DCH management told us that sales are recovering steadily. Test drives and showroom traffic are almost back to normal, though as of early November, sales were still about 30% below normal.

The second speed bump is the return of the Bentley distributorship in China to the OEM from 2013. This will hurt revenues more than profit due to the low margins on this business. In return, DCH has received 5 more Bentley dealerships in addition to the 4 it already has in China. Given the high margins on sales of Bentley cars, this will contribute to an improvement in profitability for the dealer business in the future.

Tapping demand for imported foodstuffs and FMCG

DCH’s food and consumer products business continues to expand at a double-digit pace in both HK/Macau and mainland China. In recent years, growth in China has surpassed HK/Macau, and we estimate that by 2014, China will surpass HK/Macau in sales. Just as rising incomes in China has stimulated demand for high-end cars, it is also leading to increased appetite for imported food, including fresh and frozen meats and vegetables as well as processed food and fast-moving consumer goods (FMCG).

Not quite like the other dealers

DCH’s business model is somewhat different from the other HK-listed dealers. It has a meaningful distribution business in Hong Kong/Macau, where it will have 14 dealerships by the end of 2012. Combined with the food business, 20% of revenues and 27% of pre-tax profit in 2011 came from HK/Macau. The HK/Macau business offers less growth but is both higher margin and less volatile, which some investors view favourably. On the other hand, the conglomerate nature and more opaque earnings compared with the other dealers leads us to ascribe a discount to our target PER, which we put at 11x vs 13x for other China-focused dealers.