China Yuchai International: An Undiscovered Jewel

China Yuchai International (CYD) is a holding company based in Singapore which owns 76% of the largest diesel engine manufacturer (Guangxi Yuchai) in China. The stock currently has a market cap of approximately $290 million. The company also owns two other public investments in Singapore that account for about $100 million. Taking this out of market cap, the Chinese operating company is only trading at $190 million. For 2007, according to the announcement of the Chinese operating unit, the company generated about 10 billion RMB of revenue, an equivalent of about $1.3 billion. The price/sales of the diesel engine maker is only 0.15.

Yuchai has been the number one diesel engine maker in China for almost a decade with above average growth rate. Its dominance of the vehicle diesel engine market in China is supported by its technology advantage, largest sales and service network and highest quality of service. It is the first company in China to achieve Euro III, Euro IV and Euro V emission standard. As of today, it is still the only company offering commercial Euro IV engines. It is also the only Chinese diesel engine maker being able to compete with foreign suppliers in high end bus market. Yuchai has gained market share from Cummins in the high-profile Beijing Olympic bus contract. Yuchai is also the only Chinese company which has a diesel engine solution for passenger cars.

The underperformance of the stock was caused by a long term lack of communication with Wall Street, and a short term issue relating to the audit of the company’s 2005 and 2006 results. CYD is most likely the only company with revenue over one billion dollars trading on NYSE without any sell side coverage. Their change of auditor from KPMG Hong Kong to KPMG Singapore led to a dispute of $22.5 million spread over 2005 and 2006 and delayed their announcement of 2007 financial result. However, it is very likely the situation will improve in the near future, due to mounting pressure from public shareholders. The company retained an IR representative late last year and made the announcement the completion of an independent audit relating to the adjustments to the 2005 and 2006 financials which found no intentional wrong doing on January 22nd.

CYD was the second Chinese IPO in the U.S. Since its IPO in 1994, Yuchai has become the Flagship of the Chinese diesel engine industry. During this period the company’s revenue grew almost 7 times. The stock is trading below the IPO price of 10. The stock did respond to positive operating results back in 2004 and hit a high of $35. From China’s industry statistics and the Guangxi Yuchai’s announcement in Chinese language, it is clear 2007 has been a great year for CYD. Its revenue grew to approximately $1.3 billion, an over 40% growth over 2006. This information is not yet formally released by the management in English. According to CYD’s press release in English, the volume shipment in 2007 was 383,000 up 35% from 285,000 units in 2006, well above the industry growth rate of 25%. The higher mix of heavy engines in addition, should lead to improved operating margin and earnings. Once the company announce their financial result for 2007, it is very likely the stock will respond positively.

Disclosure: Author has a long position in CYD.

Comments

[NotaComplet...:]

Adding an old article on CYD taken for the Motley Fool Web site. It discusses CYD's ownership structure. Has this situation been corrected?
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Chinese Diesel Torture
By Stephen D. Simpson, CFA March 10, 2005

0 Recommendations

When is a value stock not a value stock? How about when you can't understand who's really in charge of the freakin' company!

On the surface, China Yuchai (NYSE: CYD) looks like it should be a slam-dunk stock for those wanting a little China in their portfolio. After all, the underlying business of diesel engines is profitable, growing, cheap, and well-positioned to take advantage of the growth in the Chinese heavy-truck market.

So why, then, does the stock trade for only six times earnings? Why do institutions have virtually no interest in it at all? Why are more than 10% of the company's outstanding shares shorted? Shouldn't this be the next Cummins (NYSE: CMI) or Daimler Chrysler's (NYSE: DCX) Detroit Diesel?

Dig deeper and you begin to see why the stock trades at the level it does. Oh, and get ready for some confusion.

When you buy shares in China Yuchai, you're not exactly buying shares in a Chinese diesel engine maker. What you're buying is shares of a Bermuda company that owns upwards of three-quarters of the stock of a Chinese diesel maker, Yuchai. China Yuchai itself is more than 20% owned by Hong Leong Asia (HLA), and HLA has a "golden share" that allows it to do pretty much whatever it pleases, including controlling the board of directors.

That remaining 25% or so of Yuchai is the sticky part. It's owned by an entity called the State Holding Company, which is basically the Yulin city government -- Yulin is where Yuchai is located. What's more, Yulin, through Coomber Investments, owns almost 25% of China Yuchai.

Got all that?

Wait, there's more.

Even though China Yuchai owns a huge chunk of Yuchai, it's more or less in the position of a nonoperating partner. That is, it doesn't (and, frankly, can't) make any day-to-day decisions about the company or its financial structure, including dividends or capital expenditures.

Recently, this has been a problem. The Chinese management of Yuchai and the management of China Yuchai have not been seeing eye-to-eye on matters. Not only have dividends been withheld from China Yuchai but also Yuchai has attempted to pull stunts such as not permitting board meetings to be held, not implementing board decisions, and even attempting to give a sweetheart loan to another Coomber-controlled company.

When China Yuchai began to complain about these goings-on, the State Holding Company tried to bring the whole thing crashing down by having China Yuchai's ownership stake declared illegal. This is a time-tested practice in China -- if the foreign partner gets a little too big for his britches and doesn't let the locals do what they please, the government tries to pressure him with threats of invalidating the whole shebang.

To its credit, China Yuchai tried to resolve the mess in a July 2003 agreement (called "the July 2003 agreement") whereby both groups essentially pledged to play nice and cooperate. Well, it's been 18 months, and the agreement has yet to be implemented. What's more, the CEO of Yuchai, who is essentially a State Holding Company ally, threatened in December 2004 that the agreement may not be implemented at all. And then in February, Coombers again asserted that China Yuchai was in violation of various Chinese laws and was interfering in Yuchai's operations.

To make matters even more interesting, it appears as though Coombers has been contemplating an increase in its holdings of China Yuchai -- perhaps in an effort to throw off the ownership structure in such a way that HLA would loose its "golden share" and therefore lose control of China Yuchai. But then, you expected that, right?

If anybody has followed this far and doesn't yet have a headache, they're a stronger person than I.

While I really love the inherent idea of China Yuchai -- a growing Chinese maker of diesel engines that trades at a single-digit price-to-earnings ratio -- the reality would give me nightmares if I tried to own this thing. True, the squabbling hasn't really hurt the operations of the underlying company yet, but there's just too much turmoil here for my comfort

2008 Mar 01 11:14 AM

[denaliguide:]

we will have to see if the GOLDEN SHARE is eliminated. Its presence is a problem, but when such an overhanging cloud is removed, the stock may be able to move well

It was a recommendation I did last week for short term and am still following.

DG

denaliguidesummit.blog.../

Jul 21 05:06 PM