Maintain BUY. We estimate that Meidong's net profit excluding impairment and withholding tax impact in 2H23E could be a similar level to that in 1H23, as the higher portion of after-sales service profit and cost cuts could offset the HoH decline for new-car GPM. However, we are of the view that impairment for goodwill and/or intangible assets is likely in 2H23E. We project FY24E net profit to be RMB371mn, as Porsche's new-car GPM is likely to improve from 2Q24E. We expect BMW and Lexus to continue facing headwinds in FY24E, which could force Meidong to adopt a more conservative approach in new-car sales.

2H23 earnings under pressure on lower new-car margins and goodwill impairment risk. We project Meidong's new-car sales volume to rise 1% HoH in 2H23E to about 32,000 units (Porsche: ~5,200 units, BMW: ~11,700 units). However, we expect new-car revenue to fall 8% HoH due to lower average selling prices (ASP), as we estimate the ASP for Porsche to fall by RMB13,000 HoH and BMW to decline by RMB7,500 HoH. We expect after-sales service revenue to rise 11% YoY and 5% HoH to RMB2.1bn.

We project Meidong's new-car GPM to turn negative (-0.4%) in 2H23E, as we expect new-car GPM to remain the same HoH for Porsche and drop by 1ppt HoH for BMW and rise by 0.4ppt for Lexus. Accordingly, we expect Meidong's overall GPM to widen 0.4ppt HoH to 7.5% in 2H23E due to the larger contribution from after-sales services.

We see the possibility for goodwill and intangible assets impairment in 2H23, but it is quite difficult for us to quantify. We assume an impairment loss of RMB100mn in 2H23E, which will also result in a higher effective tax rate, as impairment is not deductible for taxes. We estimate Meidong's net profit to be RMB41mn under such assumptions. It would imply that net profit excluding impairment in 2H23E would be about RMB65mn higher than that in 1H23.

Porsche has the highest chance of posting a better new-car GPM in FY24 among all the brands. Based on our channel checks, Porsche's sales targets for Jan and Feb 2024 are quite low in a bid to cut inventories. We expect its new-car GPM to improve from 2Q24 amid a reasonable inventory level and the launch of the new Panamera. We project Porsche's retail sales volume to drop 13% YoY to about 70,000 units in China in 2024 and Meidong to account for 15% of it. We also project Porsche's new-car GPM at Meidong to widen by 0.5ppt YoY to 2.5% in FY24E. That would increase Meidong's new-car gross profit by about RMB24mn YoY in FY24E.

BMW and Lexus still face challenges in FY24E. Based on our estimates, BMW's new-car gross profit fell by RMB3,500 per vehicle HoH in 2H23E, despite HoH subsidy increase of RMB4,000 per vehicle. The new-car margin deterioration has been continuing in 1Q24, based on our channel checks. BMW targets 6% YoY growth for retail sales volume in China, which is too aggressive in our view, despite its new- generation 5 Series launched in Jan 2024. The new Mercedes-Benz E Class, which was rolled out about one month ago, has already started to provide discounts, based on our channel checks. BMW also targets 20% of its China retail sales volume to be NEVs in 2024, which could also lower its dealers' margins, given the i5's less competitive pricing than its peers, in our view.

We are of the view that new-car GPM for Lexus' dealers in 2024 could largely depend on subsidies, which makes our forecasting more difficult. Lexus targets retail sales volume of 0.18mn units in China in 2024, or flat YoY. We project BMW's and Lexus' new-car GPM to be -2% and -1.5% in FY24E, respectively.

We expect Meidong to adopt a conservative approach in new-car sales and cut costs aggressively. We do not expect new store openings for FY24E and we cannot rule out a possibility to close more stores after closing two in FY23E. We are of the view that Meidong still takes a cautious approach and is selective in partnering with NEV start-ups. We project Meidong's new-car sales volume and revenue to drop 8% YoY and 9% YoY in FY24E, respectively, as negative new-car GPM could force dealers to sell fewer cars in order to cut loss.

We project after-sales service revenue to rise 9% YoY in FY24E, which would make after-sales services account for 17% of Meidong's total revenue in FY24E. That would lift its overall GPM to 8.6% in FY24E on our estimates, despite limited improvement from new-car GPM.

We estimate SG&A ratio to drop from 6.3% in FY23E to 6.1% in FY24E, despite continuous amortization from intangible assets, as Meidong has been quite aggressive in cost reduction. We assume no impairment loss in FY24E, as the situation for Porsche is likely to improve. We still expect a high effective tax rate amid the withholding tax from the internal dividends to offshore subsidiaries in order to make the repayment ready for the convertible bond redemption in Jan 2025. Such redemption would reduce finance costs significantly in FY25E, which is likely to result in YoY growth for net profit in FY25E, although the visibility is still very low now.

Valuation/Key risks. Accordingly, we project FY24E net profit to be RMB371mn, or 50% lower than our prior forecast. We maintain our BUY rating but cut our target price from HK$7.20 to HK$4.00, which is still based on 13x our revised FY24E EPS, as the valuation premium for 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.