Core Pacific-Yamaichi sees three downside risks for Denway Motors, which has recently announced a net profit of HK$924.22 million for the first six months, up 37.1 per cent year on year.
It says China's motor industry has had three rounds of price reductions since May because of the supply-demand imbalance, and does not think Denway's strong sales momentum is sustainable, especially as competitors have lowered prices.
Earnings are expected to peak this year as its sales target of 200,000 units is close to capacity of 240,000 units a year. The company is likely to cut prices by 5 to 10 per cent in the first half of next year due to rising competition.
The government is to suspend its tax break for companies that produce sedans to European emission standards, which will lead to reduction in turnover for Guangzhou Honda, 47.5 per cent owned by Denway.
The broker has maintained its net profit forecast of $2.28 billion for 2004 but has recommended investors sell the stock.
DBS Vickers Securities, on the other hand, recommends Denway as a 'buy'' and sets a 12-month price target of $3.40.
The broker says although pricing pressure is looming it expects Denway to outperform its peers on the back of superior cost efficiency and marketing. It appears Guangzhou Honda's margin expansion has continued despite increasing sales of low-margin economy cars. This implies better economies of scale and the ability to pass on the cost to suppliers. It believes Guangzhou Honda will probably maintain its prices this year, but pressure will mount next year.
Denway's sales target this year is daunting but not impossible because of the launch of new products. The broker maintains its net profit forecast of $2.20 billion.
The counter closed at $2.725 on Friday.