China Yuchai: A Mixed View (Rating Downgrade)

seekingalpha03-30

A review of the management commentary provided by China Yuchai and its peer suggests that there is a risk that CYD's 2024 financial performance doesn't meet the market's expectations.On the flip side,...

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Asia-Pacific Images Studio Elevator Pitch  I rate China Yuchai International Limited (NYSE:CYD) as a Hold. My earlier January 15, 2024 update drew attention to the Mainland Chinese HDT (Heavy Duty Truck) industry's actual December 2023 sales data and 2024 growth outlook. In this latest article, I make the decision to downgrade my rating for CYD to a Hold, considering the risk associated with below-expectations revenue and margins. But I don't think that CYD is deserving of a Sell rating, taking into account its attractive valuations and potential policy tailwinds. Peer's Latest Earnings Call Commentary Has Unfavorable Read-Throughs Weichai Power Co., Ltd. (OTCPK:WEICF) [2338:HK], CYD's peer, recently announced its full-year fiscal 2023 financial results on March 25, 2024. According to a March 27, 2024 research report issued by equity research firm CMB International, Weichai Power's management anticipates a -2% decline in demand (in terms of number of units sold) for China's HDT sector in 2024. At its fiscal 2023 results briefing, WEICF added that \"construction truck demand will continue to be affected by weak property investment\" in China as highlighted in CMB International's late-March report.  In contrast, China Yuchai predicted at its FY 2023 earnings briefing in late February this year that \"the market for vehicle engines, especially for the heavy-duty and medium-duty market\" will expand by \"10%-15%\" this year. This is consistent with the analysts' consensus FY 2024 top line growth forecast of +10.5% for CYD as per S&P Capital IQ data. At the company's most recent fiscal year earnings call, CYD stressed that it expects to have a \"more complete set of products to offer\" in the current year which should \"help to improve the company's sales.\" While it is encouraging to know that China Yuchai is expanding its product portfolio to boost its future revenue, a decrease in demand for HDTs in Mainland China this year might pose downside risks to CYD's actual FY 2024 top line. The Market's Assumption Of Margin Expansion Might Be Too Optimistic The sell side sees China Yuchai's pretax profit margin improving from 3.2% in fiscal 2023 to 3.4% (source: S&P Capital IQ) for FY 2024. I am of the opinion that the market could have been overly bullish about the company's profitability improvement potential in the current year. China Yuchai highlighted two key factors that might limit the company's profit margin expansion at its FY 2023 results briefing. The first factor is the sales mix. CYD shared at the latest fiscal year results call that the lower-margin off-road vehicle engines' sales have grown at a faster pace as compared to that for the higher-margin on-road vehicle engines in recent times. The demand for off-road and on-road vehicles is affected by market-specific demand factors to a large extent. As such, the potential change in China Yuchai's revenue mix that could drive margins higher is not really within the company's control. The second factor is the bargaining power with its clients. At its FY 2023 earnings call, China Yuchai emphasized that \"pricing is \"an ongoing dispensation or discussion which we have with the customer every year.\" CYD might potentially have less bargaining power with the company's customers due to its lack of scale. As a comparison, Weichai Power's FY 2023 revenue is more than 10 times China Yuchai's sales last year. In the March 27, 2024 CMB International report referred to earlier, Weichai Power is described as a leading player with a \"65% market share in (China's) HDT gas engine\" market. Potential Policy Tailwinds Bloomberg reported on March 13, 2024 that \"China pledged central government funds to encourage consumers and businesses to replace old equipment.\"  Assuming that the Chinese government is willing to allocate a substantial amount of monies to HDT replacement subsidies, this could translates into higher-than-expected HDT sales and better-than-expected revenue growth for China Yuchai. It is reasonable to assume that a meaningful number of businesses are holding back on new HDT purchases, due to the weak economic environment as evidenced by Chjna's below-expectations Q4 2023 GDP growth. As such, subsidies could potentially drive stronger demand for HDTs and HDT engines, which will benefit CYD.  However, it is also noted in the same Bloomberg article that \"an amount for the (government) support\" has yet to be determined or finalized. There is the risk that the actual government subsidies pertaining to HDT replacement turn out to be less significant. Undemanding P/E Valuations And High Dividend Yield Offer Downside Support In the earlier part of this article, I cited downside risks for China Yuchai relating to slower-than-expected sales growth and weaker-than-expected profit margin improvement.  But it is necessary to note that CYD's valuations aren't particularly demanding, so that limits the downside for the company's shares in the event of a FY 2024 results miss. China Yuchai is now valued by the market at 7.4 times consensus next twelve months' normalized P/E and offers a consensus next twelve months' dividend yield of 4.7%. As a comparison, its peer Weichai Power is trading at consensus next twelve months' normalized P/E and dividend yield of 10.7 times and 3.9%, respectively. CYD's valuations are also pretty enticing on an absolute basis. These valuation metrics are sourced from S&P Capital IQ. Closing Thoughts  My view of CYD is mixed which implies that the company's shares are worthy of a Hold rating. On one hand, I am concerned that China Yuchai's results for this year might fall short of expectations, considering CYD's and its peer's management comments. On the other hand, I recognize that actual HDT and HDT engine sales in China might surprise on the upside if policy tailwinds are realized.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2423284816"}