China Zenix Auto International's (ZX) CEO Junqiu Gao on Q3 2016 Results - Earnings Call Transcript

| About: China Zenix (ZX)

China Zenix Auto International Limited (NYSE:ZX)

Q3 2016 Earnings Conference Call

November 17, 2016, 08:00 AM ET

Executives

Martin Cheung - CFO

Junqiu Gao - Deputy CEO, Chief Sales and Marketing Officer, Director

Dixon Chen - IR, Managing Director and Co-Founder at Grayling

Analysts

Michael Rosenthal - QVT Financials

Operator

Greetings, and welcome to the China Zenix Auto International Third Quarter 2016 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Dixon Chen, Investor Relations for China Zenix Auto International. Thank you. You may begin.

Dixon Chen

Thank you. Thank you for joining us today. And welcome to Zenix Auto's 2016 third quarter and nine months financial results earnings conference call. My name is Dixon Chen. Joining us today are Deputy CEO, Junqiu Gao; and Martin Cheung, CFO.

Today’s earnings conference call script contains forward-looking statements. These statements are made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminologies such as aim, anticipate, believe, continue, estimate, expect, going forward, intend, ought to, plan, potential, project, seek, may, might, can, could, will, would, shall, should, is likely and the negative forms of these words or other expressions.

Among other things, the quotations from management in this announcement in the conference call, as well as China Zenix Auto's strategic and operational plan contain forward-looking statements. Zenix Auto may also make written or oral forward-looking statements in its periodic reports to the SEC and its annual report to shareholders, in press releases and other written materials and in oral statements made by its officials, directors or employees.

Statements that are not historical facts, including statements about Zenix Auto's beliefs and expectations, are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in any forward-looking statements, including but not limited to the following.

Our growth strategies, our future business development, including our ability to successfully develop new tubeless wheel and ongoing introduction of aluminum wheels, our ability to expand our distribution network, overall growth in the aftermarket and OEM markets in China and elsewhere, which depend upon a number of factors beyond our control, including economic growth rates and vehicle sales and changes in our revenues and certain costs, expense items as a percentage of a revenue.

In particular, readers should consider risks outlined under the heading Risk Factors in our most recent annual report on Form 20-F and in our recent report filed from time-to-time on Form 6-K.

Zenix Auto does not undertake any obligation to update any forward-looking statements except as required under applicable law or information provided in this press release script, or any attachments as of this date and Zenix Auto undertakes no obligation to update such information except as required under applicable law.

Mr. Martin Cheung will provide a brief overview and then he will review the 2016 third quarter and nine months financial results. Thereafter, we will conduct a question-and-answer session.

For the purposes of today's call, all financial results are unaudited and they will be presented in RMB and U.S. dollars. Zenix Auto prepares its financial results in accordance to the International Financial Reporting Standards, IFRS, as issued by the International Accounting Standards Board.

Mr. Cheung, now you can start with your prepared remarks.

Martin Cheung

Thank you, Dixon. Now let me start with a brief discussion on the performance of 2016 third quarter. The third quarter of 2016 experienced continuing low economic growth with the Chinese GDP annual growth rate at 6.7% according to the National Bureau of Statistics. This growth rate is consistent with both the first and second quarters of 2016 and represented the slowest growth rate in 29 years.

According to the China Association of Automobile Manufacturers statistics, commercial vehicle sales reflected a slow growth with only a 6.1% gain year-on-year in the third quarter of 2016. Total unit sales in the OEM market segment increased by 14.9% year-over-year, as a result of strong truck sales with heavy and medium-duty truck sales increasing at a higher rate during the third quarter of 2016.

However, sales in the small bus market segment declined by over 13% with the heavy-duty bus sector declining almost 30% in the third quarter of 2016. Our revenue for the 2016 third quarter was RMB492.7 million or US$73.9 million, up from RMB478.6 million last year. Due to the higher growth in Chinese truck sales, especially heavy and medium-duty trucks, our sales to the Chinese OEM market increased by 21.7%.

Our international sales also grew by 4.2%.

Mitigating this growth was an 8.7% decline in our aftermarket sales in the Chinese market, as the logistic-used truck market remains sluggish. We continue to invest in our research and development, R&D, activities as our expenditures increased by 44% to RMB19.7 million or US$3.0 million, or 4% of revenue.

For the nine months of 2016, we invested RMB61.1 million or US$9.2 million. Our R&D focuses on new higher margin steel, new alloys and materials and to expand our promising aluminum wheel to reach more vehicle models and capture additional market share. Aluminum wheels will help maintain our leadership position as more customers realize their advantages in the OEM and aftermarket segments, particularly in the Chinese best markets. We expect aluminum wheels will tap [ph] more opportunity for the future.

We have continued to focus on our financial strength, balance sheet and cash flow generation. As of September 30, 2016, we increased our bank balances and cash to RMB951.8 million or US$142.7 million with fixed bank deposits with a maturity period over three months at RMB290 million or US$43.5 million.

At September 30, 2016, we recorded nine months cash inflows from operating activities of RMB220.5 million or US$33.1 million compared with capital expenditures to purchase of property, plant and equipment of RMB11.4 million or US$1.7 million. We continue to use our generated free cash to build our operations and financial strength.

With our broadening line of advanced tubed and tubeless steel wheels and emerging aluminum wheel model, we are better positioned to expand sales as the truck market growth expands [ph]. With higher sales, we have enhanced our production efficiencies and combined with our cost controls, we expect this ongoing strong gross margins in the future and positive cash flow from operating activities.

With the growth in the large Chinese truck market in the third quarter, we believe there are several factors that provide optimism for the future. In 2015, the Chinese government approved a large number of new infrastructure projects in public housing and railway expansion. In 2016, the revised property market also bolstered the demand for trucks, especially in the heavy-duty and medium-duty segments. The increasingly more stringent emission standard also helped propel the solid replacement cycle for all kinds of trucks.

Now let me go over the third quarter results for 2016. Revenue for the third quarter ended September 30, 2016 was RMB492.7 million or US$73.9 million from RMB478.6 million for the third quarter of 2015. The increase in revenue on a year-over-year basis was mainly driven by the renewed growth in truck sales in China, especially heavy-duty and medium-duty trucks.

Aftermarket sales in China decreased by 8.7% year-over-year to RMB227.9 million or US$34.2 million in the third quarter of 2016 from RMB249.5 million in the third quarter of 2015. Total unit sales in the aftermarket decreased by 12.4% year-over-year while pricing started to stabilize. The aftermarket wheel segment remained weak as the logistic-used truck market remained sluggish and price competition stayed intense.

Sales to the Chinese OEM market increased by 21.7% year-over-year to RMB181.7 million or US$27.2 million in the third quarter of 2016 compared to RMB149.3 million in the same quarter of 2015. Total unit sales in the OEM market increased by 14.9% year-over-year as a result of strong truck sales, especially heavy and medium-duty trucks, during the third quarter of 2016.

International sales increased by 4.2% year-over-year to RMB83.1 million or US$12.5 million in the third quarter of 2016 compared to sales of RMB79.8 million in the third quarter of 2015. Total unit sales in the international sales also increased by 8.6% year-over-year in the third quarter of 2016, as the company adjusted pricing and increased its marketing campaign in Southeastern Asian countries.

In the third quarter of 2016, domestic aftermarket sales, domestic OEM sales and international sales contributed 46.2%, 36.9% and 16.9% of revenue, respectively. Sales of tubed steel wheels comprised 54.9% of 2016 third quarter revenue compared to 55.4% in the same quarter in 2015.

Tubeless steel wheel sales represented 35.7% of third quarter revenue compared to 39.2% in the same quarter of 2015. Tubed and tubeless steel wheel sales remain the main sources of revenue for the company. However, sales of aluminum wheels increased and accounted for 4.9% of third quarter revenue as compared to zero in the same quarter a year ago.

Third quarter gross profit increased by 36.1% to RMB81.1 million or US$12.2 million compared to RMB59.6 million in the same quarter in 2015. Gross margin was 16.5% compared with 12.5% in the third quarter of 2015. The increase in gross margin on a year-over-year basis was mainly driven by the improvement of tubed wheel sales in the Chinese OEM market and tubeless wheel sales in the international market.

Selling and distribution expenses decreased by 11% to RMB41.4 million or US$6.2 million from RMB46.5 million in the third quarter of 2015. The decrease in selling and distribution costs was primarily attributable to central procurement that led to lower transportation costs. As a percentage of revenue, selling and distribution costs were 8.4% in the third quarter of 2016 compared to 9.7% in the same quarter a year ago.

R&D expenses increased by 44% to RMB19.7 million or US$3 million compared to RMB13.7 million in the third quarter of 2015. R&D as a percentage of revenue was 4% in the third quarter of 2016 compared to 2.9% in last year's third quarter.

Administrative expenses increased by 15.7% to RMB36.4 million or US$5.5 million from RMB31.5 million in the third quarter of 2015, mainly due to the depreciation of an office building in the aluminum wheel production facility completed in October 2015. As a percentage of revenue, administrative expenses were 7.4% compared to 6.6% of revenue in the third quarter of 2015.

Net loss and total comprehensive loss for the third quarter of 2016 were RMB16 million or US$2.4 million compared to net loss and total comprehensive loss of RMB23.8 million in the same quarter of 2015. Basic and diluted loss per ADS in the third quarter of 2016 was RMB0.31 or US$0.05 compared to basic and diluted loss per ADS of RMB0.46 in the same quarter of 2015.

In the third quarter of 2016, the company recorded cash inflows from operating activities of RMB104 million or US$15.6 million. Capital expenditures for the purchase of property, plant and equipment in the third quarter were RMB3.0 million or US$0.5 million. Deposits paid for acquisition of property, plant and equipment in the third quarter were RMB6.4 million or US$1.0 million.

During the third quarter of 2016 and 2015, the weighted average number of ordinary shares was 206.5 million and the weighted average number of ADSs was 51.6 million.

Now let us review the 2016 first nine months results. Revenue for the first nine months ended September 30, 2016 was RMB1,657.6 million or US$248.6 million compared with RMB1,858.3 million in the first nine months in 2015. Aftermarket sales decreased by 14.8% to RMB772.9 million or US$115.9 million in the first nine months of 2016 and represented 46.6% of total nine-month revenue.

Sales to the Chinese OEM market decreased by 0.2% to RMB601.0 million or US$90.1 million and represented 36.3% of revenue. International sales decreased by 18.7% to RMB283.7 million or US$42.6 million compared to the same period last year and represented 17.1% of revenue.

Tubed steel wheel sales for the first nine months ended September 30, 2016 accounted for 55.4% of revenue compared with 56.9% the same period in 2015. Tubeless steel wheel sales accounted for 36.7% of revenue compared with 37.9% the same period in 2015. Sales of aluminum wheels accounted for 3.4% of revenue for the first nine months ended September 30, 2016, as compared to zero in the same period last year.

Gross profit for the first nine months ended September 30, 2016 was RMB298.7 million or US$44.8 million compared with RMB250.9 million during the same period in 2015. Gross margin increased to 18% from 13.5% in the same period last year. Loss before taxation was RMB12.2 million or US$1.8 million compared with loss before taxation of RMB43.3 million during the first nine months in 2015.

Net loss and total comprehensive loss for the first nine months ended September 30, 2016 was RMB14.3 million or US$2.1 million compared with net loss and total comprehensive loss of RMB37.2 million during the same period in 2015. Basic and diluted loss per ordinary share and per ADS for the first nine months ended September 30, 2016 were RMB0.07 or US$0.01 and RMB0.28 or US$0.04, respectively.

Now let us look briefly on some highlights of our balance sheet and cash flow statement. As of September 30, 2016, Zenix Auto had bank balances and cash of RMB951.8 million or US$142.7 million and fixed bank deposits with a maturity over three months of RMB290 million or US$43.5 million. Total bank loans were RMB558 million or US$83.7 million. Total equity attributable to the owners of the company was RMB2,549.2 million or US$382.3 million.

For the first nine months ended September 30, 2016, the company recorded cash inflows from operating activities of RMB220.5 million or US$33.1 million. Capital expenditures for the purchase of property, plant and equipment for the first nine months were RMB11.4 million or US$1.7 million. Deposits paid for acquisition of property, plant and equipment for the nine months were RMB11.7 million or US$1.8 million.

Now that basically sums up my presentation. Now to Dixon.

Dixon Chen

Operator, we’re now ready for questions.

Question-and-Answer Session

Operator

Thank you. At this time, I’ll be conducting a question-and-answer session. [Operator Instructions]. Thank you. Our first question comes from the line of John Sheehy [ph], a private investor. Please proceed with your question.

Unidentified Analyst

Hello, everybody. Thank you for taking my call. Can you comment on sales activity after the late September announcement about enforcement of lower vehicle weight limits for trucks?

Junqiu Gao

The month of September, right?

Unidentified Analyst

That’s right. I think it was a September 21 announcement.

Junqiu Gao

Okay. [Foreign Language] On September 21, the Chinese government introduced two new policies to further regulate the semi-trailer and truck market for the widespread overloading situation. And these two policies tend to be very strict and we see it’s going to accelerate the old – especially the old trucks replacement cycle further. [Foreign Language] And the second impact we’re seeing, these new policies are going to boost more demand for heavy-duty trucks due to the bad efficiency problem.

[Foreign Language] And also because of this trend to require the OEM to introduce some type of vehicles, especially for lighter weight but for the same – the capability to carry the weights. The steel wheel supplier like us will play an important role in this trend. We are – starting the month of September, we are seeing an increase in particular in aluminum wheel demand. And also even in the traditional steel wheel market, we’re also seeing a strong growth in the 37-kilogram category, tubeless steel wheel. In the market, a lot of heavy-duty use 48-kilogram tubed wheel and now we’re receiving more interest or more order from end users for those 37-kilogram tubeless wheel. So this trend is definitely helping our business and we’re benefiting from the general overloading, more stringent overloading and anti-overloading regulations.

[Foreign Language] In the past, our aluminum wheels are receiving more order or interest from light-duty vehicles in the commercial vehicle category. However, in recent months we’re seeing a strong growth for aluminum wheel order from heavy-duty truck space. So this is definitely encouraging for us to see. And going into 2017, we will have continued growth in the aluminum wheel space. [Foreign Language] And overall, we believe this can be an irreversible trend for the aftermarket commercial vehicle wheel category more and more those traditional heavier weight steel wheel will be replaced by lighter weight tubeless steel wheel or even just this more increase in the aluminum wheel.

Unidentified Analyst

That’s great. Thank you for all of that detail. And then a simple question. About how much of your business is for buses compared to trucks?

Junqiu Gao

[Foreign Language] Actually, we don’t have that number – [Foreign Language] so unfortunately we don’t have that data at hand. We would like to come back to you with more details in terms of sales breakdown by the end user vehicles.

Unidentified Analyst

Okay, that’s good. I’ll follow up with you for that. Thanks a lot for the detailed response and that’s all my questions.

Junqiu Gao

Thank you.

Operator

Thank you. [Operator Instructions]. Thank you. Our next question comes from the line of Michael Rosenthal with QVT Financials. Please proceed with your questions.

Michael Rosenthal

Hi. Good evening. I wanted to ask you, this year in the heavy-duty OEM market there’s been a big divergence in sales results amongst some of the major competitors, and I just wanted to get an update on how the logistics truck versus [indiscernible] and heavy industry relates? Was it macro factors that are affecting your sales relative to the overall heavy-duty truck sales?

Junqiu Gao

Okay. Thank you. [Foreign Language] In the past the construction or mining-related trucks traditionally have quite a high proportion in the total heavy-duty segment. It were once at 45% of total heavy-duty vehicles in the mining and construction-related heavy-duty trucks and now this year they have dropped to 17% in total of the total heavy-duty market. However, the logistic-use truck has gone up proportionately. Now there are over 80% of heavy-duty vehicles. [Foreign Language] Due to this decline in the construction and mining-related trucks are generally impacted by the weakened real estate market, construction market. As a result of all that, we’re seeing aftermarket space and the demand for the steel wheel for the construction-related truck has come down quite a lot.

Michael Rosenthal

And have we had any success in penetrating some new customers in the OEM market in the logistics space, for example, maybe FAW?

Junqiu Gao

[Foreign Language] So FAW has posted a tremendous growth in the third quarter and their increase is over 60%, and that led the overall heavy-duty segment growth. And thankfully, we started to increase our market share in FAW as well, starting last year. We believe our relationship has continued to grow and we’re going to increase more shipment to FAW, and we’re going to increase our market share in FAW system. [Foreign Language] In the aluminum wheel category, we are the exclusive supplier to FAW.

Michael Rosenthal

Thank you. Last question just on steel price, which I think continued to rise to the third quarter; just curious if the decline in gross margin percentage versus the second quarter was related to commodity prices or any other factor?

Martin Cheung

We would expect the steel price to remain stable for the coming quarter, so we believe we can still maintain the margin for the coming quarters. And if the steel price would rise, I think we are in a position to command a better pricing going forward. That’s what we understand from our customers.

Michael Rosenthal

Okay. Thank you.

Martin Cheung

Thank you.

Operator

Thank you. [Operator Instructions]. Ladies and gentlemen, thank you for your participation. I’d now like to turn the floor back to management for closing remarks.

Martin Cheung

All right. Thank you all for participating in 2016’s third quarter conference call, and we look forward to speaking with you again. And we wish you all a good day. Thank you.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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