China Provides Opportunity For Auto Stocks

| About: China XD (CXDC)

The Asian middle class is slowly expanding and is beginning to partake in some of the financial experiences already shared by the middle class of developed countries. One such experience is car ownership. Let's check out the numbers; they are indeed staggering.

First, some background. The average US worker makes roughly $48,000 as of 2009. This probably hasn't changed appreciably due to the slowdown in US growth. The lowest price of a new automobile in the US is around $12,000 (Nissan Versa, many others in close range). The average Chinese worker makes about $5,000 while the lowest priced car in China is roughly $4,000 (probably the Chery QQ, though there are plenty in this range). The US can be a taken as a prototype for a developed nation; China is the same for a developing nation. Even if the standard of living is not equivalent, it is blatantly obvious that the Chinese worker is much more worried about covering essential expenses rather than purchasing a car, which most would agree is a discretionary expense.

The strong recent growth in China and India is making it much more affordable, and logical, for middle class workers to purchase cars. One company that will likely benefit greatly from this is China XD plastics (CXDC). This company produces specialized plastics parts such as bumpers, interior dashboards and door panels. These are used by a suite of companies that assemble cars in China, including high-end companies like Audi or BMW, as well as Chinese companies, Chery and Geely, that focus on bargain-minded consumers.

In their past annual report on 3/26/2012, CXDC states that auto production in China has tripled from 2005-2011, yielding an 18% compounded annual growth rate. The figure below was taken from CXDC's latest 10-K (3.26.2012) and shows the past and projected growth. Given the US has 800 cars per 1000 people while China only has ~40 (even including the incredible recent growth), an investor should be pleased to see that CXDC's business model is based on a fairly conservative 5% annual growth in auto production. This may be exceeded barring deep, unexpected recessions.

Auto growth

Source: CXDC 10-K through EDGAR Online

Apart from the robust anticipated growth in personal income to fuel car demand, another aspect of CXDC's business is appealing. The company requires specialized plants, creating a niche that reduces competition due to large start-up costs. In fact, 51% of all modified plastics used by Chinese manufacturing is obtained oversees due to more developed plants. As CXDC expands production (a new plant opened in December 2011 to boost production 33%), it is probable that many auto companies in China will switch to buying plastic from "local" companies to reduce shipping cost.

If one feels like CXDC is too specialized, investing in Ford (F), General Motors (GM) is also a reasonable option given the increasing exposure to Asian markets. For example, Ford notes a doubling in production of automobiles for sale in China since 2007.

What are the downsides to investing in CXDC or the automakers? Clearly, the price of oil seems to be the biggest concern. CXDC relies on hedged contracts for petroleum as a base material. Oil spikes can certainly chomp at the bottom line. Similarly, even if the Asian middle class income rises, rising oil prices will subdue the craving to own a car. However, the absurdly cheap valuations of most automakers, a bit of careful research will suggest the weighting of risk-reward is certainly in the investor's favor.

Sources: The World Bank, CXDC 10-K report from March 26, 2012, International Monetary Fund

Disclosure: I am long (CXDC), (GM).

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Tagged: , , , Rubber & Plastics, China
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