Highlights

Vertical integration. XCPsuggests the recent acquisition ofBrilliance’s (1114 HK, HKD13.22,Hold [3]) connecting-rod businesswill allow it to increase its verticalintegration into the upstreambusiness, potentially allowing it tocut production costs at a later stagefor both its E30 and N20 engines.

Operations. The company expectsthe 2H13 gross margin to be similarto that for 1H13 and says the totalinvestment for its new BMW N20engine-production plant is likely tobe around CNY500m. XCP plans toincur capex of about CNY390m for2013. The company is currentlyrunning at a 90% utilisation rate andexpects 2013 engine sales of about285,000 units (flat HoH). Accordingto the company, XCP’s currentproduct mix is likely to face a marginsqueeze in 1H14, as well as higherthan-expected SG&A spending.

BMW N20 engine productionoutlook. XCP expects the N20engine plant to commenceproduction in June 2014, with a fullyearproduction capacity of 50,000units and initial shipments of lessthan 10,000 units in 2014, rising to50,000 shipments in 2015. XCPexpects to supply 90% of theseengines to Brilliance-BMW and therest to Brilliance’s mini-vanbusiness. Due to these plans, XCPexpects R&D costs to increasesignificantly in 2014. It expects theaverage transportation cost (roundtrip) between the Shenyang andSichuan factories to cost aboutCNY600 per engine, but the averagelabour cost is likely to be about 40%cheaper in Sichuan than it is inShenyang.

Valuation

There are no Bloomberg-consensusnumbers for the stock. By assuminga blended ASP for BMW’s N20engine of CNY30,000, and a grossmargin of 25%, the 10,000/50,000shipments cited earlier wouldgenerate CNY75m and CNY375m inadditional gross profit for XCP in2014/15E, respectively, comparedwith XCP’s 1H13 gross profit ofCNY237m.

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