Earlier this year, I was fortunate to have invested in China Auto Logistics Inc. (CALI) before the company's shares rose in mid-November. My research on Lentuo International (LAS) leads me to believe that LAS, a larger company in the same sector, is an undervalued stock which is set to grow in 2013 on the back of China's burgeoning luxury car demand.
CALI is a small but growing seller of imported luxury cars, operates China's largest auto mall in Tianjin and operates several leading Chinese automotive websites. CALI generates the majority of its revenue from the sale of luxury cars, focusing on the Toyota, BMW and Mercedes Benz brands. I chose to invest in CALI for several reasons:
1. The company's auditor, Marcum LLP, is well-reputed.
2. Given the above, I could take CALI's numbers seriously - and it appeared to be tremendously undervalued (earlier this year, CALI was trading at a book value of $40 per share).
3. Several strong quarterly reports showing growth in revenues and income.
4. My own research indicating that China's luxury auto market has been growing rapidly and is set to grow much higher. See for example, this Reuters article describing BMW's excellent sales growth in China and its anticipated double-digit growth next year. Furthermore, according to a forecast report issued by IHS Automotive on April 28, 2012, growth rates for the luxury auto market in China should exceed those for the non-luxury auto market. IHS expects that luxury car sales will increase 139.5% through 2015.
Of course, I did not anticipate just how much CALI shares would soar in the near term, but it is not really surprising given that company's key statistics. The specific catalyst was CALI's reporting fantastic revenue growth in mid-November,
Causing a jump in share price from the mid-$1 range to the mid-$7 range. CALI now trades in the mid-$4 range.
After CALI's strong performance, I decided to find another undervalued company set to benefit from China's luxury car boom. My research indicates that Lentuo International is a very strong investment for the sector.
Lentuo operates eleven franchise dealerships, ten automobile showrooms, one automobile repair shop and one car leasing company. Its brand lineup includes Audi, Volkswagen, Toyota, Honda and Mazda. Lentuo is the largest non-state-owned automobile retailer in Beijing.
Since its IPO (Cowen & Co. + HSBC) at $8 in December 2010, LAS' stock has performed very poorly, hitting what appears to be a price floor of 79 cents on August 15 of this year. There are likely three reasons for LAS' low valuation.
1. The Company has major capex related to its aggressive FY 2012 expansion plans.
2. The Company has had to leverage itself in order to meet its goals.
3. LAS is a Chinese small-cap.
I expect LAS' capex costs to pay off big time next year, and expect their 3Q quarterly report to be strong. If CALI's recent report was any indication. From their last quarterly, the Company enjoyed a substantial boost in revenue from outside Beijing for the first time. And, compared to LAS' substantial assets, debt is not too high for a profitable company.
Also, given that LAS' book runners are Cowen and HSBC and their auditor is Ernst and Young, they lack the sketchy factor of so many other Chinese small-caps. Especially given their sector, cars, it is not something so easy to falsify as certain Chinese biomeds (AOBI, CMED) or Longtop Financial Technologies, for example.
I also believe that LAS has suffered depressed share prices in the late summer/early autumn because Knight Capital Group (KCG) the largest holder sold off the bulk of its shares, given Knight's own many problems (another story).
Strong Quarterlies for LAS
Their last quarterly report was very respectable, even if not reflected by the market:
- Revenues increased 21.2% to RMB792.5 million ($124.7 million) in the second quarter 2012 from RMB653.8 million in the second quarter 2011.
- Vehicles sold increased 54.5% to 4,301 vehicles in the second quarter 2012 from 2,784 vehicles in the second quarter 2011.
- Vehicles serviced increased 31.7% to 45,843 vehicles in the second quarter 2012 from 34,818 vehicles in the second quarter 2011.
"The successful implementation of our expansion and diversification strategy continued with strong sequential and year-over-year revenue growth during the second quarter of 2012," said Mr. Hetong Guo, Founder and Chairman of Lentuo. "The new green field Audi dealership and the FAW-Volkswagen flagship store in Beijing following the five new dealerships added in the second half of 2011 will be significant steps in our expansion strategy and will provide increased momentum. Our recent partnerships with First Automobile Finance and its two subsidiaries represent a strong vote of confidence that validates and further supports our growth strategy. Among other benefits, it will help us finance dealership expansions, improve our competitive position, provide insurance services and strengthen our brand recognition in the luxury car market. We are very proud to be the first automobile retailer in China to sign such an agreement with FAW Auto Finance.
Net income, although high, has essentially been impacted by Lentuo's major expansion plans. Once they are realized (soon), I expect NI to increase substantially.
Joint Venture Action & New Director
On October 22 of this year, LAS announced a potentially very lucrative JV with "A Fortune Global 500 Company based in Asia." The JV will focus on the expansion of LAS' high-end 4S dealerships across China, starting with the new South Beijing Audi 4S dealership that the Company announced on July 23, 2012. The JV will scale up its higher margin repair and maintenance services. The JV Partner will invest RMB300 million and take a 40% stake in the JV.
Moreover, the ex-CFO of 10 years for Lithia Motors (LAD), Jeffrey B. DeBoer, was appointed as an Independent Director for LAS effective October 1, 2012. LAD is a billion dollar market cap American company operating in a similar sector to LAS. His substantial experience will likely benefit Lentuo as it expands.
These are very positive catalysts for the Company in the near term.
I expect Lentuo International to be an excellent growth story moving forward. The Company offers excellent luxury imported brands, particularly Audi. Given Audi's well-deserved popularity in China - where it is especially popular with the upper middle class and government officials - LAS is in a key position to benefit. LAS has spent substantial capex on building new dealerships and showrooms already; revenues are set to increase and expansion costs will pay off.
Even so, with its very low P/E, Lentuo trades at a substantial discount to its peers in the automotive dealership industry, which trade on average at 17x P/E.
Disclaimer: Any stock is risky, so please do your due diligence.