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Lentuo International Inc. (Lentuo) recently announced its financial results for the third quarter ended September 30, 2011, with revenue of RMB747.6 million and net income of RMB10.8 million. The revenue figure represented a 21.0% decline over the corresponding period in 2010 but was in-line with our forecast and met management’s guidance. The decline was because, for the two corresponding periods, Beijing’s automobile market has moved from an environment that was helped by a series of policies favorable to the industry to one that is negatively impacted by the new traffic control measures introduced in December 2010. In fact, Lentuo sold 3,162 vehicles in 3Q11, down 35.1% from 4,871 vehicles sold in 3Q10. At the bottom line, net income for 3Q11 amounted to RMB10.8 million, a decrease of 76.0% from RMB45.0 million in 3Q10 and was 44.9% below our estimate of RMB19.6 million. The net income figure was a bit disappointing and was mainly due to management’s continuing aggressive pricing effort aimed at retaining old customers and capturing additional market share during times of a difficult market in Beijing. Overall gross margin at 9.1% and operating margin at 4.1% for 3Q11 represented their lowest levels in two years, while net margin at 1.4% was an all time low level.
On the more positive side, we are happy to see signs of sequential improvement in Lentuo’s core businesses, with quarter-over-quarter increases in the number of vehicle sold and the number of vehicles serviced. Specifically, Lentuo sold 3,162 vehicles during 3Q11, up 13.6% over 2,784 vehicles sold in 2Q11. The Company serviced 37,894 vehicles during 3Q11, up 8.8% from 34,818 vehciles serviced in 2Q11. On the cost side, management indicated that aggressive marketing expenses related to the Honda Dealership in Tianjin and the car leasing business had bolstered overall selling, marketing and distribution expenses as a percentage of revenue to an all time high level of 3.4% in 3Q11, as compared to just 1.1% in 3Q10 and 3.0% in 2Q11. However, with revenue from Honda Dealership and car leasing businesses coming on stream, such expenses as a percentage of revenue will decline to below 3% of total revenue in 4Q11 and in 2012 and would help improve operating and net margins ahead.
The Company completed the acquisition of the Toyota Dealership in Zhejiang in early November. This is the third dealership opened outside Beijing this year. This dealership, together with the Honda Dealership in Tianjin and the FAW-Volkswagen Dealership in Guangdong acquired earlier, represents management’s continued focus on geographic expansion that will help mitigate the negative impact of the Beijing government’s traffic control measures established in December 2010. Longer term, the expected completion of the Audi Dealership in Zhejiang and the ongoing discussions to add dealerships for Mercedes Benz, Lexus and Porsche will further broaden Lentuo’s product portfolio and geographic diversification and thus should help drive long-term revenue and net income growth.
Even though the weak bottom line figure for 3Q11 has prompted us to revise our cost and margin assumptions for the 4Q11 and 2012 and caused a downward revision of 2011 and 2012 net income estimates by 15.8% and 25.5%, respectively, the long term growth story of Lentuo in China’s burgeoning automobile market remains intact. Based on our revised revenue and net income forecasts, the stock is trading at a very attractive P/E valuation of just 6.3 times for 2011 and 3.6 times for 2012, compared to the average P/E of 12.1 times for 2011 and 8.9 times for 2012 for its Chinese peers and average P/E of 13.9 times for 2011 and 12.5 times for 2012 for its US peers. We believe such a deep discount in P/E valuation relative to its Chinese and US peers is excessive given its more attractive ROE of 26.7%, operating margin of 7.6% and price/book ratio of just 0.75 times. Applying a multiple of 7.0 times earnings per ADS for 2012, which represents approximately a 21% discount to the average P/E of its Chinese peers and 44% discount to its US peers, we arrive at a 12-month target price of $5.68 per ADS (down from $7.63). With over 80% upside potential, we rate the stock a BUY.
If you need more information, visit at www.redchip.com or call 800-733-2447.
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