Upgrade to BUY. Meidong's share price has fallen 65% since our downgrade on 1 Apr 2023. We are of the view that its new-car gross margin probably hit bottom in 1H23, although recovery may take a while. Porsche's new-car gross margin appears to recover the fastest among traditional luxury brands and Meidong could benefit the most among its peers. In our view, the company may buy back some of its convertible bonds to lower its debts, as it distributed earnings from its onshore subsidiaries to offshore. That could be a positive catalyst for the share price.

1H23 earnings miss on new-car GPM. Meidong's 1H23 revenue and SG&A expenses were largely in line with our prior forecast, whereas the largest surprise came from its 0.2% new-car gross margin (vs. our 2.2%). We attribute such miss partially to the company's strategy to sacrifice profit in order to keep a healthy balance sheet. While it is difficult to find a balance between profit and survival risk during the downturn period, Meidong chooses to prioritize its survival and be prepared for potential M&A opportunities with handy resources when industry environment resumes normal.

Commission income in 1H23 was also below our expectation, partly due to its different accounting policies compared with its peers. Excluding non-operating items (amortization, impairment, withholding tax etc.), adjusted net profit in 1H23 was RMB 254mn, still about RMB 100mn lower than our adjusted estimates.

Industry headwinds could be priced in, as new-car gross margin likely hit bottom. We project Porsche's new-car gross margin at Meidong to widen to 3% in 2H23E and 3.5% in FY24E, given Porsche's decision to cut sales target in China. Meidong's net profit could lift by about RMB 80mn with every 1 ppt increase of Porsche's new-car gross margin. Accordingly, we project net profit of RMB 300mn for 2H23E and RMB 749mn for FY24E.

We also project the company to turn to the net cash position at the end of FY23E, with more-than-enough cash to repay its convertible bonds in 2025.

Valuation/Key risks. Our new target price of HK$ 7.20 (cut from HK$ 11.00) is based on 12x (previously 13x) our revised FY24E EPS, as the valuation premium from its management could narrow during tough times. Key risks to our rating and target price include lower sales and/or margins than our expectation, as well as a sector de-rating.