Demand likely to surprise to the upside in 2021. We expect China passenger vehicle demand to increase 15% YoY in 2021, well above auto makers and industry associations’ relatively conservative forecast of 7.5-9% YoY growth. Key drivers are (a) cyclical demand recovery after three years of continuous volume decline in 2018-20, which is estimated to boost 2021 PV annual demand by ~6 pp. (b) low-base effect amid COVID-19—volume down 45% YoY in 1Q20, which stand-alone offers ~12pp annual growth for full year 2021.

We also factored in the negative impact from the removal of some local government cash subsidies for vehicle purchase, which is likely to reduce demand by ~3pp.

Margin to improve on car makers’ disciplined supply. During the continuous demand decline in the past three years, most auto makers suffered notable profit decline or even loss-making. Amid the painful backdrop, auto makers and industry associations are relatively conservative on 2021 sector demand outlook, result in a disciplined supply. This will reduce car makers’ cash support to dealers, and result in a stable ex-factory price. Thus we expected auto makers’ 2021 margin to increase due to stable retail price, lower per unit fixed cost on operating leverage (on 15% YoY volume rise), and on-going cost cutting effort.

Bullish on intelligent vehicle players’ structural growth. Two mega-trends— electrification and intelligent car—will transform entire auto industry. Unlike commoditized EV technology, we expected intelligent vehicle (esp. autonomous driving) will create notable competitive advantage for leading players (like NIO, Xpeng and Li auto).

Stock Calls: prefer Dongfeng and intelligent vehicle players. Our pecking order, based on both target price upside and catalysts, is Dongfeng > NIO > Xpeng > Li auto > Great Wall > BYD > Geely > GAC > BAIC > Brilliance. We upgrade Li auto from Neutral to OUTPERFORM and raise Geely TP to HK$33 (from HK$18.50). We lower the target prices for BAIC (from HK$3.50 to HK$3.20) and Brilliance (from HK$8.00 to HK$7.30).