比亚迪股份(01211) 　　Increasing NEV revenue drives gross margins and profitability. On theback of the strong NEV sales growth momentum in both its PV and CVsegments in the past two years, we forecast BYD’s NEV sales to grow at aCAGR of 50% during FY16E-FY18E, with the PV segment registeringstronger growth than the CV segment, as the latter might be dragged bya cut of subsidies post the subsidy fraud probe. Since 2015, the GPM ofNEVs has risen to more than 30%, significantly higher as compared with15%-20% for the ICE (Internal Combustion Engine) models, bolsteringBYD’s overall GPM as a result. In addition, we expect BYD’s overall GPMto be further enhanced when its NEV sales exceed 100k units on risingeconomies of scale. 　　Vertical integration secures cost advantages. BYD has planned to rampup its battery production capacity which currently stands at 10Gwh,comprising 2Gwh in Huizhou and 8Gwh in Kengzi. The company targetsto invest RMB6bn (with funding from private placement) in its Kengziplant to add additional 6Gwh capacity over the coming three years. BYD’sbattery capacity is estimated to reach 12Gwh by end-17 in a full load,which would satisfy the demand of 200k units of PVs and 12k units ofbuses. In addition, BYD has signed a framework agreement to take part inlithium resource mining in Salt Lake in Qinghai province in a bid tocement its cost advantages over peers going forward, in our view. 　　Stable growth of handset segment, though margin pressure to remain.As BYD’s second-largest business segment by revenue, the handsetbusiness will maintain mid-teens annual revenue growth rates over thecoming 2-3 years, underpinned by stable orders from several renownedglobal smartphone brands. Despite so, handset gross margins maycontinue to decline as revenue contribution from the low-marginassembly business has exceeded the higher-margin components businessin both FY15 and 1H16. 　　Valuation: Assuming 7.0x FY17E PER for the ICE segment, 2.2x FY17Eprice-to-sales for NEVs (30% discount to Tesla’s), and 9.6x and 6.0x FY17EPER for BYDE (285 HK) and the rechargeable battery and PV segment,respectively, our SOTP valuation generates a PT of HKD64.2, implying24.5x PER and 2.5x PBR for FY17E and 39% potential upside. Initiatecoverage with a BUY rating.