Vehicle sales in China were 22.6% higher in February than one year ago.
Winter economic activity and data are always distorted by the changing timing of the Lunar New Year which fell on February 8 in 2016 and January 28 in 2017. Despite the uncertainty introduced by the holiday, two trends stood out:
- Passenger vehicle sales remained fairly strong despite the change in the tax rate on small vehicles from 5% in 2016 to 7.5% in 2017
- Truck sales remained very strong, especially Heavy Duty Trucks which rose 147% from a year ago. The outlook for the remainder of the year is bright due to replacement of aging fleet, emissions controls, strong infrastructure investment, and strict enforcement of vehicle weight restrictions.
The US listed auto suppliers have varying exposure to these segments:
- CXDC: China XD Plastics makes modified plastic compounds tailored to satisfy customer requirements for flexibility/rigidity, strength, and resistance to heat/cold and corrosion. In many applications plastic parts can replace metal components at lower cost and lighter weight (example). For detailed comments about recent developments see CXDC Receives An Unfair Buyout Offer When It Is Over 80% Cheaper Than Comparable China-Listed Companies
- ZX: China Zenix Auto is the country’s leading producer of commercial vehicle wheel rims. The company made a considerable investment in a new facility capable of producing forged aluminum wheels. Alcoa estimates that such wheels will eventually capture 50% of the international market due to their lower maintenance cost and the fuel savings created by their lower weight. Diesel exhaust from commercial vehicles is one of the largest factors in China’s smog problem and the government currently provides significant incentives for “new energy” vehicles incorporating a full range of energy efficient components (including aluminum wheels). The company noted that its 2016 sales lagged the overall truck market because demand has been weighted towards trailers (where ZX has lower penetration) rather than construction trucks (where ZX is dominant), but the strong infrastructure spending (+27% in 2M17), new weight regulations, and replacement demand all bode well for ZX. Investors should note that the company settled a lawsuit filed by its largest independent shareholder (QVT Financial) over the 2013 restructuring offer and QVT subsequently sold its entire position of 6.1mm shares in an off-market transaction. No buyer has filed a 13 D/G to disclose ownership of this 11.8% stake. It would not be surprising to see a buyout offer or new corporate transaction announced soon.
- CAAS: China Automotive Systems is the country’s leading producer of steering systems. Most of the company’s operating subsidiaries were developed as joint ventures with major auto companies ensuring close corporate relationships. The company also has a strong supplier relationship with Chrysler North America. The company will benefit from a long-term shift from hydraulic steering to electric power steering systems which cost about 50% more per vehicle. 3Q16 results showed revenues up 4.1% (in USD) vs 3Q15. The company said production level is at an all-time high and gross margins have rebounded. They expect industry sales to increase about 10% in 2017 and mentioned strong demand for new cars in China’s Tier 3/4 cities. Export sales to North America may have some political risk with the new administration.
- CYD: China Yuchai International is a leading domestic producer of diesel engines (primarily for commercial vehicles) and has an emerging product line of natural gas-powered engines. The company sees opportunity through continually improving the emissions control of its engines to exceed increasingly strict standards in China. The company has paid a large annual dividend for 8 consecutive years – a highly admirable record of delivering value to shareholders. 3Q16 results showed revenues -4% vs 3Q15. The company noted weakness in the bus and agricultural markets partially offset by a shift towards higher value engines.
- SORL: SORL Auto Parts (English site – Chinese site) is a leading domestic producer of braking systems. Related party transactions raise concerns over the whether public shareholders will ever benefit from the earnings and value of the company’s business. In 2010 the Chairman’s private company sold a group of businesses to SORL at a premium to their book value (LINK). In 2015 the Chairman offered to acquire the entire company for just 28% of book value (LINK). In 2016 the Chairman’s private company has just sold a large land parcel to the company at its full market value (LINK) – a price approximately equal to all of SORL’s cash and short-term investments. The company has never paid a dividend, repurchased shares, and insiders have never bought stock. SORL’s cash has been extracted through related party acquisitions at full value, but the Chairman offered to acquire the businesses back only at a huge discount to fair value. Commentary on trends in the company’s business will be meaningless until the company demonstrates that shareholders will benefit from its achievements.
Share prices of the US-listed suppliers show rising investor awareness and interest in these companies:
ZX and CYD should benefit from surging truck sales in 2017. Strength in SORL’s brake sales for commercial vehicles is offset by governance problems.
CXDC management made an unfair buyout offer which would pay shareholders a small premium to recent market prices, but deprive them of most of the company’s fair value. I would not be surprised to see an offer from ZX within 3 months; hopefully the terms will be more realistic.