Following Better-Than-Expected Second-Quarter Margins, the Focus for China's Auto Industry Shifts to Earnings Resilience in the Second Half

Overview

The report reviews reported 2Q26 and 1H26 results across China's autos and shared mobility sector. Its central conclusion is that industry margins are healthier than revenue trends imply. However, as sales expectations gradually stabilize, market attention is shifting from sales risk to whether margins can be sustained in 3Q and could shift further toward the policy outlook in 4Q.

Core views

Reported 2Q26 and 1H26 results show that auto-sector margins remained stable or improved despite domestic pricing and input-cost pressures. Morgan Stanley believes underlying industry profitability is better than revenue trends suggest, mainly because overseas expansion, improved product mix, procurement optimization, scale benefits, and cost control offset some domestic pricing pressure. Among automakers, Geely provided a more constructive earnings signal; among component suppliers, Fuyao and Nexteer benefited from overseas exposure and higher-value-content products. Margins were the clearest positive surprise of this earnings cycle. Geely's 2Q gross margin rose to 18.4%, while core profit per vehicle increased 59% YoY; Fuyao's gross margin reached 40.2%, its highest level since 2021; Yutong's gross margin reached 25%, up 2.1 percentage points YoY; Hesai's gross margin reached 40.1%; and Desay SV's margin improved sequentially despite memory cost pressure. Most, if not all, relevant companies exceeded previously lowered market expectations. However, the report emphasizes that not all improvement should be regarded as sustainable operating performance. Factors such as tax rebates and investment income are one-off in nature, so core profit should be distinguished from non-operating contributions. Overseas business is both a structural growth driver and a source of income-statement volatility. Strong exports can provide additional margin support, but foreign exchange movements may reduce or disrupt net profit below the operating-profit line. Morgan Stanley recommends prioritizing core earnings when assessing this earnings season, while also arguing that foreign exchange effects cannot be dismissed entirely as irrelevant noise. Overseas expansion will remain the industry's most prominent structural growth driver over the coming years, and foreign exchange, tariffs, geopolitics, and the cost of building overseas capacity will remain integral to that process. Entering the second half, the main debate is shifting from sales to margins. The market has largely priced in strong overseas sales, while domestic sales are also nearing a bottom. However, rigid input costs, rising overseas selling costs, a potential peak in the contribution from overseas product mix, and early signs of a plateau in sales of large premium five-/six-seat SUVs could weaken the tailwind from product mix. The report believes the benefits of improving sales may be outweighed by these cost and mix pressures. Therefore, the key issue in 3Q is not simply whether sales fall short of expectations, but the quality and sustainability of margins; by 4Q, the discussion may shift further toward the policy outlook. For major electric vehicle companies yet to report results, including BYD, EV start-ups, and Leapmotor, market expectations have largely converged. Attention will center on the margin trajectory amid bottoming domestic sales and inflation in overseas selling costs. Morgan Stanley continues to prefer BYD and Geely in the early stage of the industry's beta recovery and remains positive on XPeng and NIO ahead of their 2Q results; it expects SAIC to benefit from higher investment income in the second half, improving full-year results. In the autonomous driving and artificial intelligence supply chain, the report remains positive on "picks-and-shovels" names such as Hesai, Minth, and PMX. Assessments of future company results should focus on margin quality, sustainability, and overseas guidance rather than backward-looking 2Q EPS beats or misses.

Analysis framework

The report first compares reported companies' 2Q26 and 1H26 margins horizontally against prior expectations, then attributes the improvements to product mix, procurement, scale, cost control, overseas business, and one-off items. It subsequently distinguishes core operating profit from non-operating volatility caused by foreign exchange, taxes, and investment income. Finally, it extends the analysis from historical results into the second half, assessing how input costs, overseas expansion, premium-product sales, and policy changes could affect the 3Q and 4Q margin trajectory and using this assessment to select opportunities among automakers and component suppliers.

Methodology notes

• Corporate Fundamentals and Financial FrameworkEarnings Quality Analysis

  Distinguishing Core Earnings from Non-Operating Items

  The report separates profit improvements driven by product mix, procurement, scale, and cost control from tax rebates, investment income, and foreign exchange effects to determine whether margin improvement stems from sustainable operating capabilities.

• Event-Driven Strategy and Behavioral FinanceExpectation Gaps/Expectation Management

  Results Relative to Lowered Expectations

  The report notes that margins at most companies exceeded previously lowered expectations, but believes forward-looking margin and overseas guidance will be more important in the next stage than judgments based solely on second-quarter EPS beats or misses.

• (Out-of-Vocabulary Method)

  Margin Driver Decomposition

  The report attributes gross-margin performance to product mix, procurement, scale, cost control, overseas business, and one-off items, and further assesses whether these factors can persist in the second half.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Geely Automobile (0175.HK)

  The report believes it provided a more constructive earnings signal among automakers and continues to prefer the company in the early stage of the industry's beta recovery.

  Strengths

  2Q gross margin rose to 18.4%, core profit per vehicle increased 59% YoY, and product mix and operating efficiency supported earnings.

  Weaknesses

  It continues to face industry-wide pressures from domestic pricing, rising input costs, and diminishing product-mix benefits in the second half.

  Comparison

  It provided a more positive earnings read-through among automakers.

  Risks

  A peak in the overseas mix contribution, slowing premium-model sales, or rising costs could depress future margins.

• Fuyao Glass (600660.SS, 3606.HK)

  As a supplier with overseas exposure and higher-value-content products, the report views it as a beneficiary of overseas expansion and product upgrades.

  Strengths

  Gross margin reached 40.2%, its highest level since 2021.

  Weaknesses

  Overseas operations create volatility from foreign exchange and expansion costs.

  Comparison

  Its margin performance was a notable positive signal among supplier results in this earnings cycle.

  Risks

  Foreign exchange, tariffs, geopolitics, and overseas production expansion could weaken its profit contribution.

• Nexteer Automotive Systems (1316.HK)

  The report believes it could benefit from overseas business exposure and higher-value-content products.

  Strengths

  Its overseas footprint and product value content provide structural support.

  Weaknesses

  The report provides no standalone margin data.

  Comparison

  Together with Fuyao, it is identified as a supplier with advantages in overseas exposure and high-value products.

  Risks

  Foreign exchange, tariffs, and cost pressures related to overseas expansion.

• Yutong Bus (600066.SS)

  Its results are used to demonstrate margin resilience in the auto sector.

  Strengths

  Gross margin reached 25%, up 2.1 percentage points YoY.

  Weaknesses

  The report does not further break down the company-specific sources of margin improvement.

  Comparison

  It is one of the representative companies with better-than-expected margins in this earnings cycle.

  Risks

  Industry input-cost and margin-sustainability risks.

• Desay SV (002920.SZ)

  Its margin improved sequentially despite memory cost pressure, demonstrating some resilience in cost control and product mix.

  Strengths

  It achieved sequential margin improvement despite memory cost pressure.

  Weaknesses

  Memory cost pressure remains.

  Comparison

  The improvement occurred amid a clear cost headwind, reinforcing the assessment of industry margin resilience.

  Risks

  Further increases in memory and other input costs could erode margins.

• BYD (002594.SZ, 1211.HK)

  Morgan Stanley continues to prefer BYD in the early stage of the industry's beta recovery.

  Strengths

  It is identified as a preferred automaker during the industry's initial recovery stage.

  Weaknesses

  The report provides no specific financial metrics for this period.

  Comparison

  Together with Geely, it represents the report's preferred automaker exposure in the early stage of the industry recovery.

  Risks

  Domestic pricing, input costs, overseas selling costs, and margin sustainability pressures.

• XPeng (9868.HK, XPEV.N) and NIO (9866.HK, NIO.N)

  The report remains positive ahead of their 2Q results, with the focus on the margin trajectory rather than largely converged sales expectations.

  Strengths

  Domestic sales are approaching a bottom, providing a potential foundation for subsequent operational improvement.

  Weaknesses

  The report provides no specific margin or earnings data for this period.

  Comparison

  Both are identified as positive opportunities ahead of earnings releases by major electric vehicle companies.

  Risks

  Inflation in overseas selling costs, input costs, and margin improvement falling short of expectations.

• SAIC Motor (600104.SS)

  The report expects higher investment income in the second half to improve its full-year results.

  Strengths

  Higher 2H investment income is expected to support full-year profit.

  Weaknesses

  Investment income is not core operating profit, and its sustainability differs from operating improvement.

  Comparison

  Its full-year earnings improvement thesis depends more heavily on non-operating investment income.

  Risks

  Investment income could fall short of expectations, or margins in the core automotive business could come under pressure.

• Hesai (HSAl.O), Minth Group (0425.HK), and PMX

  The report remains positive on these "picks-and-shovels" names in the autonomous driving and artificial intelligence supply chain.

  Strengths

  They benefit from higher-value-content products and the development of related technology supply chains; Hesai's gross margin reached 40.1%.

  Weaknesses

  The report does not provide separate operating data for Minth and PMX for this period.

  Comparison

  Compared with companies that rely solely on vehicle sales, these names participate in industry growth through critical components and technology products.

  Risks

  Input costs, changes in customer product mix, and industry margin pressure could affect earnings.

Key data

• Geely 2Q Gross Margin18.4%2Q26 gross margin improvement
• Geely Core Profit per Vehicle+59% YoY2Q26 year-over-year growth
• Fuyao Gross Margin40.2%Highest level since 2021
• Yutong Gross Margin25%Up 2.1 percentage points YoY
• Hesai Gross Margin40.1%Margin performance in 2Q26 results
• Desay SV MarginImproved QoQImproved despite memory cost pressure
• Industry ViewIn-LineExpected to perform broadly in line with the relevant broad-market benchmark over the next 12-18 months

Impact & implications

The report believes this earnings cycle has reduced market concerns about the industry's underlying profitability, but second-quarter outperformance cannot be directly extrapolated into the second half. As domestic sales approach a bottom and overseas sales expectations become more fully priced in, companies' relative performance will depend more on their ability to withstand input costs and overseas expansion expenses, maintain a favorable product mix, and provide credible overseas business guidance. The policy outlook's impact on industry expectations must also be considered in 4Q.

Risks

• Rigid input costs, a potential peak in the overseas product-mix contribution, and stagnant premium-model sales could outweigh the profit benefits from improving sales.
• Geopolitics, tariffs, and overseas capacity expansion costs could weaken the profit contribution from exports and overseas operations.
• Early signs of a plateau in sales of large premium five-/six-seat SUVs could erode the margin tailwind from product-mix improvement.
• Foreign exchange movements could disrupt net profit below the operating-profit line and become an inherent risk of overseas expansion.
• One-off factors such as tax rebates and investment income could cause reported profit to overstate sustainable core earnings.
• After entering 4Q, the policy outlook could become the industry's new primary risk.

What to watch

• Monitor the quality and sustainability of 3Q margins, rather than sales performance alone.
• Watch guidance from major automakers and suppliers on overseas sales, costs, capacity expansion, and foreign exchange impacts.
• Track whether improving sales after the domestic auto market bottoms can translate into actual profit growth.
• Watch whether sales of large premium five-/six-seat SUVs continue to slow and the resulting changes in product mix.
• Monitor whether the policy outlook replaces margins as the primary focus of market discussion in 4Q.
• Assess the margin trajectory of major electric vehicle companies yet to report amid inflation in overseas selling costs.