CAAS - China Automotive Systems: Strong Growth Drivers And Business-Friendly Ambience Provide Great Confidence

Summary

• The negative consequences of Covid-19 made 2022 a challenging year for CAAS and the Chinese economy.
• Following the reopening of the Chinese economy, the company rebounded well, and its future is auspicious, courtesy of favorable government policies and improved consumer ability.
• The falling cost of battery raw materials is good news for the company's bottom line because it means lower operating expenses and higher profit margins.

Investment Thesis

China Automotive Systems, Inc. (CAAS), through its subsidiaries, produces and distributes automobile systems and components in China. It also markets automotive components in North America and Brazil and offers after-sales and R&D support services. Shares of the company have been falling precipitously since the beginning of the Covid-19 pandemic to around August of 2022. Travel was restricted, and people's ability to spend money was stifled due to China's tight protective measures. All of these factors contribute to CAAS's dismal stock performance.

Late in 2022, however, the company's stock price rose sharply, leading to a year-over-year increase of around 182%. This strong increase resulted from China's reopening and favorable government measures. These aspects resulted in solid sales growth, with the company's sales growing by about 25% in the third quarter alone. Looking forward, these tailwinds are still present in the economy, which bodes well for the company's future prosperity. Thus, I have a positive outlook on this stock. The falling cost of battery components bolsters my bullish case.

Purchase Tax Relief: Supportive Government Policies Steers Sales Up

With the government's policy to half the purchase tax on vehicles and other policies targeting stimulating consumer activity, automobile production and sales in China in 2022 increased from the previous year. According to the China Association of Automobile Manufacturers [CAAM], in 2022, Chinese automakers increased production by 3.4% yearly to 27.02 million vehicles, while sales increased by 2.1% to 26.86 million units. This was the general trend, but CAAS outperformed the market with double-digit sales growth.

Kevin Theiss ," Total vehicle sales in the third quarter of 2022 increased by 24.9% year-over-year with passenger vehicles up 36.6% year-over-year and commercial vehicles down 10.6% year-over-year."

Production and sales in China's auto sector grew last year despite challenges such as the return of Covid-19, a lack of semiconductor chips, expensive battery raw materials, and an uncertain political climate, according to CAAM. Between June 1 and December 31, 2022, the Chinese Ministry of Finance lowered the purchase tax on automobiles with 2-liter or smaller engines from 10% to 5% of the sticker price. This applied to vehicles valued at less than 300,000 Yuan ($45,000).

Downward Trend In Battery Materials: Lower Production Costs Increase Profit Margin

In the preceding section, the high cost of battery raw materials was one of the headwinds in the automotive industry in 2022. However, the prices of the battery raw materials are now on a downward trajectory, which I believe will go a long way in controlling the cost of production, resulting in increased profitability margins.

Lithium salts' the primary component in battery production, saw their price continue to fall throughout December due to low demand and a pessimistic market attitude. On January 12, 2023, Fastmarkets estimated that the spot price range exw domestic China for lithium carbonate 99.5% Li2CO3 min, battery grade was 470,000-500,000 Yuan per tonne, down 20,000 Yuan per tonne from the previous week's estimate of 490,000-520,000 Yuan per tonne. As of December 1, the price ranged from 570,000 to 585,000 Yuan per tonne.

Lithium hydroxide monohydrate [LiOH.H2O] 56.5% LiOH min, battery grade, spot price range exw domestic China was 470,000-500,000 Yuan per tonne on January 12. This was also down by 20,000 Yuan per tonne from a week earlier, when it was 490,000-520,000 Yuan per tonne. On December 1, the price was between 570,000 and 580,000 Yuan per tonne.

Prices for cobalt sulfate, also a key raw material for batteries, kept going down in China last month because there wasn't much demand from the downstream market and enough supply. So far, in 2023, this downward trend has not changed.

Meanwhile, throughout December, nickel sulfate prices in China consistently declined, adding to the list of battery raw materials whose prices trended downward.

As a result of the market's persistent discounting of these components, I have optimism about the future of this company's profit margins and the sector as a whole. This development, I believe, will help the enterprises in this sector dramatically rein in their production costs. Along with the positive effects of tax cuts and higher consumer spending that will be discussed in more detail subsequently, this bodes well for the future.

Consumers And Government Role In Cementing This Company's Growth

The Chinese economy was severely impacted by the country's decision to maintain Covid lockdowns for nearly 2022, long after the rest of the world had lifted them. Unfortunately, it was only partially closed but is now fully open again. The government is anticipating a significant economic recovery, owing to a jolt of confidence in consumer spending. China may achieve its growth goal of approximately 5.5% this year with this spending and a reasonable contribution from the government's investments without even having to export more than it imports.

Due to the harm done to household finances and confidence by last year's steep collapse in housing values, Chinese consumers may be more wary than their American counterparts were in 2021. Yet, Chinese consumers did manage to save heavily throughout the pandemic , which means that a lot of latent demand is waiting to be released. In addition, since the global economy is weakening and supply chains are operating smoothly, China's reopening is less likely to be met by a jump in inflation.

This is a positive sign for Chinese corporations' bottom lines, which are expected to increase by double digits this year , a rate significantly higher than in nearly any other region. According to investment banks such as Goldman Sachs and Morgan Stanley, even if companies only meet the market's profits expectations, investors may still see favorable returns.

Lockdowns were not the only reason Chinese stocks fell over the past two years. Geopolitical tensions and the government's crackdown on tech and property also played a role. Good news: the administration is returning to pro-growth measures on numerous fronts. It has supported rather than strangled the property sector, taken active stakes in some tech companies. Additionally, China is improving its diplomatic ties internationally . For example, its relationship with India is getting better, which is good for business because it opens up new markets and demand.

When the Chinese economy has been fully reopened, enhanced diplomatic connections may create chances in China that draw foreigners for business or tourism. If this occurs, more people will travel, raising demand for automobiles, which will be good for CAAS.

Against this backdrop, it's impossible to deny the Chinese government's and consumers' importance to the development of Chinese business. Given this context, I believe increased demand for CAAS will primarily be driven by consumers' rising self-assurance and spending capacity. The government's responsibility is to foster a prosperous business climate by fostering inclusive and cooperative diplomatic ties and enacting policies that encourage economic expansion. According to the data, both consumers and the government are doing their part, which bodes well for the future of CAAS.

Following China's reopening, its population will again engage in travel, increasing demand for automobiles, complementing these significant tailwinds. To add to my previous projection, this will be an income generator for CAAS.

Valuation

Based on the relative valuation metrics, CAAS seems to be undervalued, as almost all of them are below the industry median. The current price allows investors to buy into a promising company in a promising economy at a discount.

I anticipate that the company's share price will continue rising in light of the many positives in its business environment. It sums up the returns investors can expect from a stake in this exciting business.

Risks

This stock has much going for it, but that doesn't make it a perfect buy. Putting money into this organization is not without peril. The energy problem poses the greatest threat. Since Russia's invasion of Ukraine, the energy sector, which is crucial for the auto industry, has been in disarray worldwide. Oil prices are extremely high, and supply chain problems have continued. That's a pretty big barrier to entry if you're thinking about buying stock in the company.

Conclusion

Following a challenging 2022, CAAS appears to benefit from a prosperous marketplace with expansion opportunities. Since the firm's revenues and profit margins are anticipated to increase in the following quarters, I expect the company will continue its high growth trajectory. I recommend buying the stock since the company has a lot of potential and is now priced at a discount, but investors should be aware of the risks involved.

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