I've been enthralled with China Yuchai, despite the company's second quarter financial results, which showed a significant decrease in revenue and net income. Because of the second quarter results I've been waiting for the third quarter results to confirm what I thought would be the case, that there was an upward trend for China Yuchai's business. I believe that China Yuchai will be the primary beneficiary of a huge and growing market for diesel and natural gas engines in China.
When I last wrote about China Yuchai on October 5th, the company's shares were in the $13.23 range, and its P/E was around 4.67. On Friday, the company's shares closed at $15.05 and its P/E was 4.92.
China Yuchai's recently announced third quarter results indicate that there may in fact be the beginning of an upward trend, as China's economy appears to have started improving. During China Yuchai's third quarter earnings call, while the company indicated that it was cautious for the short-term, management did indicate that they saw a huge increase in demand likely starting in the second quarter of next year.
My view of China Yuchai is that it's a basic industry investment opportunity, one tied directly to China's continuing economic growth. I see the company's future as linked to the improvement of China's economy, an economy that I and others see as the "engine of global economic growth."
In September, China announced a new economic stimulus program. This program primarily targeted infrastructure spending. As this stimulus kicks in, my conclusion is that China Yuchai will directly benefit.
China announced the country's new leadership on November 7th. It is widely believed that the new leadership will implement additional economic stimulus measures as the transition of power progresses. China Yuchai will also likely be a beneficiary of these additional stimulus measures.
With China Yuchai's shares trading on the NYSE, there is no question that the company is on the radar screen of many institutional investors. The NYSE listing should also provide a certain level of comfort for investors as to China Yuchai's financials, disclosure and overall transparency.
One key fact that I believe is important was indicated in the third quarter earnings conference call. Based on unit sales for the first nine months of this year, it was stated that China Yuchai remained the market leader in China's diesel engine industry. This statement, by itself, is sufficient to warrant investor interest. Being the market leader in the manufacturer of diesel engines in a country of 1.344 billion is incredibly significant by itself.
China Yuchai's Business
China Yuchai's business consists of the manufacture of light-duty, medium-sized and heavy duty engines. While the company manufactures a variety of engines including natural gas and diesel engines, my interest in the company is primarily based on the company's diesel engines. China Yuchai manufactured over 500,000 diesel engines last year.
A key market for the company is the growing bus market in China. As a leading supplier of engines to this market, the company will benefit as bus sales continue to grow. The company manufactures diesel engines for buses of all sizes, including long-distance coaches. The company has underway a program to diversify its product line by augmenting its offering of diesel engines with natural gas engines to complement most of the diesel engine models it manufactures, for both the truck and bus markets. The Chinese market for natural gas engines, I believe will be increasingly important.
China Yuchai's joint ventures are also significant for the company's growth. One of these joint venture relationships is with Chery Automobile Co., China's seventh largest automobile manufacturer, and a state-owned enterprise. One of these joint ventures with Chery, "Chery Yuchai" is developing and producing a diesel engine for passenger cars. I believe that the Chinese market for diesel engines for automobiles, could be huge and lucrative for both China Yuchai and Chery Automobile.
China Yuchai also has an engine remanufacturing joint venture with Caterpillar (NYSE:CAT), which is designed to provide a service to customers and help the company achieve certain environmental mandates.
A Quick Look at Third Quarter and Nine Month Results
Let's take a quick look at China Yuchai's third quarter results. For the third quarter, the company's operating profit increased 28.9% to $33.9 million from the same period last year.
For the third quarter of this year the company's revenues were $485 compared with $445 million in the third quarter of 2011. The company's gross profit for the quarter was $98 million, compared to a gross profit of $69 million for last year. Gross profit margins were essentially the same for the quarters of this year and last year, at around 20%.
The company's operating profit was $33.9 million, compared $26.78 million for the same quarter of 2011. Most importantly, China Yuchai's net income was $17.5 million, an almost 42% increase from the $10.2 million of net income for the same quarter last year.
For the nine months ended September 30, 2012, net revenue was $ 1.61 billion compared with $1.88 billion for the same period last year. Focusing on this decline is significant, but if it's considered in light of the overall business and economic climate in China this year, to me it's not an important metric. More important to me are the three month results, which I believe are likely to foretell continuing growth in the company's sales and net income.
When one looks at data provided by The China Association of Automotive Manufacturers, CAAM, China Yuchai's three month and even nine month results are even more impressive. CAAM indicated that industry-wide sales of diesel-powered commercial vehicles declined 8% in the third quarter of this year, and sales of heavy duty diesel-powered trucks and trailers declined by almost 29% in the quarter compared to the second quarter. CAAM also reported that during the first nine months of this year overall sales of diesel-powered commercial vehicles declined by slightly over 12%. The decline of 31% on diesel-powered trucks and trailers during the first nine months of this year was even more significant. When one takes another look at China Yuchai's three month and nine month results in light of this industry data, China Yuchai's financial results are even more impressive.
As discussed in the company's earnings call, despite depressed market conditions for commercial vehicles in China, the company's bus sales were resilient. Total unit sales rose by .8% in the third quarter, compared to the same quarter of last year. Total bus unit sales for the first nine months of this year rose 3.8% as compared with the same period last year.
A focus of mine has been to discuss here at Seeking Alpha companies tied to China's automobile industry, now the world's largest. China Yuchai is on my list of companies who are key participants in this growing industry, who are performing well, and who are showing good growth prospects.
Last week I discussed two other companies tied to China's auto industry and their third quarter results, China Automotive Systems (NASDAQ:CAAS) and Asia Carbon Industries (OTCPK:ACRB). Both of these companies, as well as China Yuchai will likely benefit from the improvement of China's economy, and the continuing growth of the country's auto industry.
The announcement in September of an infrastructure stimulus program in China totaling US$158 billion, with its focus on the domestic economy, should stimulate consumer spending, the country's important manufacturing sector, and specifically companies in China's auto sector.
China watchers, myself included, are optimistic that the country's recently chosen seven-member Politburo Standing Committee and its new senior leadership will push ahead with critical private sector and consumer growth policies essential to the future of the world's second largest economy. With these leadership changes, I expect additional measures will be taken to stimulate China's economy starting early next year.
A beneficiary of the current as well as new economic stimulus programs will be China's auto industry, including the companies I've been discussing here at Seeking Alpha.
Investing in smaller-capitalization companies, as well as investing in companies in emerging markets, is not suitable for all investors, and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risk.
China Yuchai International , while a smaller-capitalization company, even though it trades on the NYSE, has operations in China. All other companies mentioned in this article are U.S. reporting issuers, and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.
Additional disclosure: Some currency conversions to U.S. dollars are based on current exchange rates and may not accurately reflect the exact and appropriate exchange rate for the Chinese Yuan amount.