CYD - China Yuchai: Market Hasn't Priced In Favorable Outlook

2023-03-27 13:00:10 ET

Summary

• China Yuchai International Limited is expected to resume positive top line expansion and witness meaningful profitability improvement for this year.
• But China Yuchai's current market capitalization is less than the company's net cash position.
• I have left my Buy rating for China Yuchai International Limited unchanged, as the favorable 2023 prospects for the company haven't been factored into its valuations.

Elevator Pitch

I continue to award a Buy rating to China Yuchai International Limited (CYD) stock. In my earlier January 10, 2023, write-up for CYD, I reviewed industry- and company-specific data relating to China Yuchai.

The focus of my latest article on China Yuchai is the misalignment between the company's financial outlook and valuations, which supports a Buy rating for CYD. CYD is expected to return to positive revenue growth and achieve significant margin expansion for the company in the current fiscal year, but the stock is still currently trading below net cash.

Top Line Growth Prospects For China Yuchai

I see China Yuchai delivering top line growth again for FY 2023, after the company's revenue fell by -25% YoY to RMB16,031 million in the previous year.

My favorable opinion about CYD's 2023 revenue outlook is supported by a number of factors.

China Yuchai's management team is confident about the company's top line performance for the current year following China's reopening, even though CYD didn't provide specific financial guidance for 2023. At the company's earlier fiscal 2022 earnings call on February 27, 2023, CYD noted that it is "cautiously optimistic for 2023" considering that "reduced COVID-19 lockdowns and travel restrictions" should boost "the business and investment activities" in China this year.

In recent weeks, both The Goldman Sachs Group, Inc. ( GS ) and UBS Group AG ( UBS ) have revised their GDP estimates for China upwards by +50 basis points, which is consistent with CYD's expectations of improving economic conditions in the country for 2023. CYD's heavy duty truck engine sales are most probably going to rise significantly for the current year in tandem with the Chinese economy's recovery.

Also, heavy duty truck sales in China increased by +58% MoM (Month on Month) and +29% YoY to roughly 77,000 units in February 2023, as per auto research firm CV World's data. This was the first time in coming close to two years (or 22 months to be exact) that the Chinese heavy duty truck market witnessed a YoY growth in sales volume. The most recent monthly heavy duty truck sales data for the Chinese market has positive read-throughs for heavy duty engine maker China Yuchai.

Specifically, the sell-side analysts project that China Yuchai's revenue in USD terms will expand by +12.9% in 2023. The current market consensus 2023 top line growth forecast for CYD is pretty reasonable; China Yuchai's historical 2018-2021 sales CAGR was close at 11.5% (source: S&P Capital IQ ), and there are multiple drivers supporting a revenue recovery for CYD this year, as detailed above.

CYD's Profitability Improvement Expectations

China Yuchai has already exhibited signs of improving profitability in the most recent interim period or 2H 2022 (CYD reports its financial performance twice every year), and the company should be able to achieve higher margins for the current year.

Gross profit margin for China Yuchai went up from 15.4% for 2H 2021 and 15.9% for 1H 2022 to 17.0% in 2H 2022. CYD's operating profit margin also widened by +120 basis points YoY from 1.9% for 2H 2021 to 3.1% for the second half of last year.

The company mentioned at its prior FY 2022 results briefing that "cost reductions, especially materials and production-related expenses, and lower sales rebate" were the main reasons for its profit margin improvement in 2H 2022.

In my view, demand for heavy duty truck engines should be reasonably strong for 2023. I noted in the preceding section of the article that recent industry sales volume metrics and the company management's bullish commentary suggest that CYD will be able to register solid engine sales in the current year. Higher revenue for China Yuchai in 2023 should translate into positive operating leverage, a reduced reliance on rebates to drive sales volume, and a decline in expenses related to larger purchasing volumes (i.e., volume-based discounts for parts purchases). Simply put, CYD should report higher profit margins this year.

The current analysts' consensus FY 2023 normalized EPS growth estimate of +49.8% for China Yuchai is based on assumptions of the company's full-year operating profit margin expanding by +0.4 percentage points, from 3.2% last year to 3.6% (source: S&P Capital IQ ) in this year, which seems realistic. As a point of reference, CYD's average annual operating margin for the FY 2018-2021 period was 5.7%.

China Yuchai's Valuations

China Yuchai International Limited's current market capitalization is approximately $299 million based on its last traded stock price of $7.32 as of March 24, 2023. As a comparison, China Yuchai's net cash position as of the end of 2022 was around $360 million, calculated by deducting the company's debt of $336 million from its cash balance of $696 million.

In other words, the market is now valuing China Yuchai at below net cash.

Assuming one completely discounts China Yuchai's net cash position, CYD's consensus forward next twelve months' normalized P/E and dividend yield are 6.3 times and 4.8%, respectively, as per S&P Capital IQ data. These are also reasonably attractive.

Closing Thoughts

Expectations of China Yuchai International Limited's positive top line growth and robust earnings expansion for the current year haven't been adequately reflected in the stock's valuations. I expect China Yuchai International Limited's valuations to re-rate positively in time to come, as the company's financial performance improves.

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