BAIC's net profit for the third quarter of 2019 fell 7.3% year over year to 914 million yuan, lower than our expectations.

All three major brands were affected by some negative factors that led to a decline in performance in the 3rd quarter of 2019. The profit of Beijing Mercedes-Benz fell 4.8% year over year, due to lower profit margins due to higher costs associated with engine upgrades. Meanwhile, Beijing brands are at a loss because the decline in subsidies for new energy vehicles harms profitability. Beijing Hyundai is still in the inventory removal stage, and sales recovery is still slow. Overall, net profit margin for the third quarter of 2019 fell 1.8 percentage points year over year and 1.1 percentage points month over month.

We lowered our net profit forecast for 2019 to 2021 by 4.9%/16.9%/13.0%, respectively. Although we raised our sales expectations, the downward adjustment was mainly due to the expected decline in gross margin and the decline in profits attributable to joint ventures.

Similar to other auto stocks, the company's valuation has returned to a more reasonable level. The company's current 12-month forecast price-earnings ratio is 8.1 times, which we think is roughly reasonable. Further increases in valuations will require stronger improvements from all brands, and we think this is challenging. This is because the profitability of Beijing Mercedes-Benz and the Beijing brand both declined in the 3rd quarter of 2019.

We maintain a “neutral” rating for BAIC. Although we lowered our earnings forecast, we raised our target price to HK$4.74 due to higher valuations. Our target price is equivalent to 8.1 times the 2019 price-earnings ratio and 7.0 times the 2020 price-earnings ratio.