CYD - China Yuchai: A Better Year Ahead

Summary

• The YoY decrease in China's heavy duty truck sales narrowed from -23% in Q3 2022 to -6% for December 2022, which raises hopes of a recovery in 2023.
• China Yuchai should record strong revenue growth and decent profit margin expansion in 2023.
• I raise my rating for China Yuchai to a Buy, considering my positive expectations regarding China's heavy duty truck sales and the company's financial performance this year.

Elevator Pitch

I rate China Yuchai International Limited (CYD) as a Buy.

I touched on China Yuchai's recent announcements and its peer's sales data with my prior update for the stock written on October 27, 2022.

I upgrade my rating for China Yuchai from a Hold to a Buy, after analyzing Chinese heavy duty truck sales data and previewing the company's future results. In my opinion, 2023 will a better year for China Yuchai which justifies my Buy rating.

Heavy Duty Truck Sales In China Might Have Bottomed

According to data taken from Chinese automotive industry research firm CV World , approximately 54,000 heavy duty trucks were sold in China for the month of December 2022. For full year 2022, the sales volume of heavy duty trucks fell by roughly -55% to around 670,000 units.

Heavy duty truck sales in China were poor last year as a result of multiple factors. These include weak demand due to a sluggish economy, supply chain disruptions driven by COVID-19 restrictions, and the overhang from demand pulled forward in 2021 as result of the introduction of new "China VI emission standards" .

China's heavy duty truck sales volume contracted by -6% YoY in the final month of 2022 as compared to the 57,500 heavy duty trucks sold in December 2021. But this was equivalent to a +16% growth in MoM (Month-on-Month) terms. More significantly, the -6% YoY decline in China's December 2022 heavy duty truck sales represented a vast improvement from the -23% YoY drop in heavy duty truck sales volume for the third quarter of last year.

As such, it is very likely that Chinese heavy duty truck sales have already reached its bottom at the end of 2022. Given that China Yuchai is mainly engaged in the sale of engines for heavy duty trucks, recent industry data suggests that the company should see an improvement in its financial performance.

Financial Results Preview

The sell-side's consensus financial estimates for China Yuchai taken from S&P Capital IQ imply that the company should register better top line growth and profitability metrics for the second half of 2022 and 2023.

With respect to revenue growth, the analysts predict that China Yuchai's top line decline (in USD terms) will narrow significantly from -34.8% YoY in 1H 2022 to a mere -1.9% YoY for 2H 2022. In fact, the market sees China Yuchai returning to positive top line expansion 1H 2023 with a +14.9% YoY revenue increase.

In terms of profitability, the sell-side analysts estimate that China Yuchai's EBIT margin will increase from 3.4% for 1H 2022 to 3.5% in 2H 2022, before rising further to 4.7% for 1H 2023. China Yuchai's normalized net profit margin is also projected to expand from 1.1% in 1H 2022 to 1.7% and 2.5% for 2H 2022 and 1H 2023, respectively.

On a full-year basis, the consensus points to China Yuchai delivering a +70.1% jump in normalized net income (in USD terms) for 2023, as a result of accelerated revenue growth and positive operating leverage.

I hold the view that the market's consensus financial projections for CYD are pretty realistic.

In the preceding section, I highlighted that China's heavy duty truck sales grew strongly by +16% MoM in December 2022, and noted the YoY contraction in sales volume for the recent month is less severe than that for Q3 2022. This explains why it should be easy for China Yuchai to record a narrower revenue contraction and a mild improvement in operating profit margin in the second half of the prior year.

Separately, I think that there are three drivers of higher heavy duty truck (and engine) sales in China this year, which provide support for expectations of China Yuchai's robust revenue growth and meaningful profit margin expansion in 2023.

The first driver is an economic recovery in China. Heavy duty truck sales are positively correlated with economic growth. With China relaxing pandemic restrictions and reopening its borders as part of its pivot away from the COVID-zero policy, it is reasonable to expect the Chinese economy to perform well in 2023. Most analysts are forecasting a healthy mid single-digit percentage GDP growth for China in the current year, which should be supportive of a recovery in heavy duty truck sales.

The second driver is that the Chinese heavy duty truck industry is entering a new replacement cycle. Heavy duty trucks are usually replaced once every five to seven years. Based on data provided by Chinese automotive industry research firm CV World , the previous surge in China's heavy duty truck sales occurred when heavy duty trucks sold jumped from 730,000 units in 2016 to 1.12 million units for 2017. China's heavy duty truck sales volume subsequently expanded slightly to 1.15 million units and 1.17 million units in 2018 and 2019, respectively. Therefore, there is a high probability that 2023 (six years have passed since the strong sales recorded in 2017) will be the year which sees a huge jump in heavy duty truck replacement sales based on the replacement cycle.

The third driver is policy tailwinds. According to China's Ministry Of Ecology And Environment's press release issued in November 2022, Chinese policymakers have set an ambitious target of achieving a 40% penetration rate for National VI heavy duty trucks (equipped with new engines to meet the relevant emissions standards) and new energy vehicles in three years' time. This should be another driver of higher heavy duty truck sales volume in 2023.

Concluding Thoughts

The worst should be over for the Chinese heavy duty truck industry and China Yuchai. I view China Yuchai as a Buy-rated stock in view of its recovery prospects.

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