CYD - China Yuchai: Shares Are Mispriced

2024-01-15 09:44:34 ET

Summary

• Heavy duty truck sales in Mainland China are expected to grow by a mid-teens percentage this year based on third-party projections.
• The analysts are too bearish on CYD's prospects, forecasting a +9.9% top-line expansion in FY 2024 which is way below that of the industry's expected growth rate.
• I think that CYD stock is undervalued, as it currently trades at low-single-digit EV/EBITDA and mid-single-digit EV/EBIT multiples.

Elevator Pitch

I continue to assign a Buy investment rating to China Yuchai International Limited ( CYD ) stock. In my prior article published on October 26, 2023, I wrote about the key factors that support my bullish view of CYD.

For the current write-up, I draw attention to the performance and outlook of China's heavy duty truck industry. In my opinion, CYD stock is mispriced by the market which warrants a Buy rating. Heavy duty truck sales in Mainland China are projected to expand by a reasonably healthy mid-teens percentage growth rate in 2024. In comparison, China Yuchai's consensus FY 2024 top line growth is lower at +9.9%, and CYD trades at very undemanding EV/Revenue, EV/EBITDA, and EV/EBIT valuation metrics.

Weak December 2023 Heavy Duty Truck Sales Aren't A Cause For Concern

Heavy duty truck sales in Mainland China decreased by -30% MoM (Month-on-Month) to 50,000 units in December 2023, according to data sourced from Chinese automotive research portal CVWorld .

Given that China Yuchai is engaged in the business of selling heavy duty truck engines in Mainland China, heavy duty truck sales are viewed as an indicator of CYD's future revenue performance. However, I don't think that investors should be too worried about China's lackluster MoM heavy truck sales volume growth in the final month of the prior year.

Firstly, it might be a lack of motivation, rather than poor demand, that has hurt the Chinese heavy duty truck industry's sales performance in December last year. For full-year 2023, heavy duty truck sales in Mainland China grew significantly by +35% YoY to around 910,000 units. As such, it is reasonable to assume that the leading heavy duty truck makers in China would have already met or even exceeded their respective internal sales targets by November 2023 or even earlier. This means that there was less pressure for heavy duty truck makers to push for stronger sales in December 2023.

Secondly, there are seasonal factors at play as evidenced by a YoY comparison of sales numbers. In December 2023, Mainland China's heavy duty truck sales declined by a more modest -7% YoY as compared to the substantial -30% MoM drop. Therefore, it is no surprise that heavy duty truck sales for December were weak as this is the off-peak season for the Chinese heavy duty truck industry.

Thirdly, sales of LNG (Liquefied Natural Gas) heavy duty trucks in Mainland China for December 2023 were likely to have been negatively affected by a temporary increase in LNG prices driven by the "winter heating season" in the country. I had noted in my October 26, 2023, update that "heavy duty trucks in the natural gas category have become increasingly popular with Chinese drivers" and account for close to a third of total heavy duty truck sales. In that respect, lower LNG heavy duty truck sales would have had a meaningful impact on the heavy duty truck industry's overall sales volume.

In a nutshell, there is no need to be overly concerned about the significant MoM fall in heavy duty truck sales in Mainland China for December 2023 that was impacted by one-off and seasonal factors. I touch on the prospects of China's heavy duty truck industry in the next section.

Heavy Duty Truck Industry's 2024 Outlook Is Favorable

China's heavy duty truck industry delivered an exceptionally high +35% sales growth rate in 2023 as outlined in the prior section, which was largely attributable to a strong recovery from the negative effects of the COVID-zero policy implemented in the country for 2022. Looking forward, there are expectations of a healthy growth in heavy duty truck sales for the Chinese market this year.

Mainland Chinese sell-side research firm CMB International issued a market strategy research report titled "A Silver Lining Ahead" on December 18, 2023. In this report, CMB International forecasted that heavy duty truck sales in Mainland China will increase by a reasonably decent +15% for the current year. CMB International sees "solid export growth" and "strong replacement demand" as the major drivers for its projection of a mid-teens percentage increase in heavy duty truck sales in 2024.

As per Chinese automotive research portal CVWorld data referred to above, China's heavy duty truck exports are estimated to have grown significantly by +25% for December 2023, and this provides support for the expectations of robust export demand for the heavy duty truck industry in 2024. Separately, the Mainland Chinese heavy duty truck market will likely benefit from higher replacement sales in the coming years on the assumption that heavy duty trucks usually have a lifespan of a couple of years, as China witnessed its prior peak in heavy duty truck sales of roughly 1.6 million units in 2020.

Earlier, McKinsey also published a report in August 2023 titled "The Road Ahead" highlighting that it expects the "Chinese HDT (Heavy Duty Truck) industry to rebound and retain a significant and stable commercial base." Specifically, "premiumization, electrification, autonomous driving" have been identified by McKinsey as the most significant secular growth trends for China's heavy duty truck industry that will support future sales growth.

In summary, it is realistic to assume that the Mainland Chinese heavy duty truck market will perform pretty well in 2024 and beyond, and this should boost the short-to-medium term growth prospects of heavy duty engine maker China Yuchai.

Market Is Way Too Pessimistic About CYD's Prospects

Investors haven't factored in the favorable outlook for China's heavy duty truck industry into China Yuchai's financial projections and valuation metrics.

Based on S&P Capital IQ data, China Yuchai's current consensus FY 2024 revenue growth rate is +9.9%. This is 510 basis points lower than CMB International's +15% sales growth forecast for the Chinese heavy duty truck market as mentioned in the previous section.

Also, the market is now valuing CYD at depressed consensus next twelve months' EV/Revenue, EV/EBITDA, and EV/EBIT multiples of 0.16 times, 2.4 times, and 4.2 times (source: S&P Capital IQ ), respectively.

China Yuchai's shares are likely to re-rate in a positive manner with an upward revision in consensus top line forecasts and a meaningful valuation multiple expansion, if the actual sales of heavy duty trucks in China are as good as what third-party research firms like CMB International and McKinsey expect.

Final Thoughts

I view CYD's shares as undervalued. Taking into account the decent 2024 Mainland Chinese heavy duty truck sales growth expectations of +15%, China Yuchai deserves to trade at a higher EV/Revenue ratio in my view. CYD's current consensus next twelve months' EV/Revenue metric of 0.16 times is also below its all-time historical mean EV/Revenue multiple of 0.26 times (source: S&P Capital IQ ). I expect China Yuchai stock to command a superior valuation multiple in time to come, when the market realizes that it is too pessimistic about CYD's revenue outlook.

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