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I must admit that I've been looking at China Yuchai International Limited (NYSE:CYD) for quite some time. I've been enthralled with the company, and despite its significant decrease in revenue and net income for the second quarter of this year, I haven't lost my enthusiasm for it.

The shares of the company, whose operations are in China, trade on the NYSE. This by itself should provide a certain level of comfort for investors.

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 based on one simple fact. The company manufactured over 500,000 diesel engines in 2011.

To me China Yuchai is a basic industry investment opportunity tied not only to an increase in business activity in China, but specifically to the China market continuing to be a huge and growing market for diesel and natural gas engines. In September China announced a new economic stimulus program, targeted to infrastructure projects. When it kicks in, China Yuchai is, I believe, a direct beneficiary.

China Yuchai's shares closed at $13.23 Thursday. The company has a market cap of $493 million and a P/E of around 4.67.

The company's financial results for the second quarter of this year are indicative of the general global slowdown that has impacted most Chinese businesses. For the second quarter, the company's revenues were $540 million, a decline from $647 million in 2011. For the second quarter, the company's net income was $10.6 million, substantially off from $24.6 million in 2011.

It's unusual to find Chinese companies that pay dividends. In July, China Yuchai paid a dividend of $.90 per share.

China Yuchai International's Natural Gas Engine Strategy

At first glance it may not appear appropriate to classify an engine manufacturer such as China Yuchai as a "green company," but the company definitely has a strategy underway to become a beneficiary of government actions intended to counter what has been described as China's environmental time bomb.

In recent years Chinese government policies have encouraged energy conservation and a reduction of emissions. China's 12th Five-Year Plan, which was enacted in 2011, targets a 16% reduction in energy consumption and a 17% reduction in carbon dioxide emissions per unit of economic output by 2015. Three of the seven strategic investment areas identified in the plan related to energy, specifically clean energy, energy conservation, and clean energy vehicles. Natural gas as an energy source has a primary role in the plan, which stated a goal of natural gas providing 3.3% of the country's primary energy mix by 2015.

In 2011 China Yuchai sold approximately 13,000 natural gas engines. The company, in its second quarter earnings call, indicated that it intends to produce a full portfolio of natural gas powered engines as a compliment to its existing product line of diesel engines.

The market for the company's natural gas engines is for two key markets, trucks and buses. China Yuchai has stated that its natural gas engine strategy is a key driver of future growth and that the company will continue as the leading engine supplier to China's bus market, a market that the company believes is well suited for natural gas engines. The company has projected 8% of its total sales deriving from natural gas engines by 2015.

In addition to its natural engine strategy, China Yuchai is also introducing compressed natural gas and liquid natural gas engines. In its second quarter earnings call, the company indicated that there were 100 liquefied natural gas or LNG filling stations in China and that the number was expected to increase to 380 by the end of 2012.

Confirming that China Yuchai has made the right decision in expanding to natural gas, liquefied natural gas and compressed natural gas engines, Cummins Westport Inc., a joint venture of Cummins Inc. (NYSE:CMI), and Westport Innovations Inc. (NASDAQ:WPRT) also has initiated a natural gas engine strategy. As a leading supplier of natural gas engines, Cummins Westport Inc. has indicated that it is continuing to expand its product range to supply the growing demand. The company recently announced the development of a mid-range, 6.7 liter, natural gas engine. Cummins Westport sees an increasing demand for this engine for on-highway vehicles powered by what it stated in its October 4th news release as "lower cost, cleaner and increasingly abundant natural gas."

The Company's Joint Venture with Caterpillar Inc.

China Yuchai's joint venture with Caterpillar Inc. (NYSE:CAT) is also worth noting. The joint venture has in development the first phase of an engine remanufacturing facility approximating 151,000 square feet. It expects the facility to be fully operational in 2014, at which time it will employ around 400.

Company management indicated on its most recent earnings call that, in addition to meeting customer needs, engine remanufacturing has a "green" component to it, in that it will reduce the usage of raw materials.

The Company's CIMC-Chery Joint Venture

China Yuchai has also established a joint venture with Jirui United Heavy Industry Co., Ltd., a company that is owned by publicly-traded China International Marine Containers Group Ltd, (Shenzhen:200039), Chery Automobile Co. and Shenzhen City Jiusi Investment Management Co., Ltd.

The CIMC-Chery joint venture manufactures 450 to 500 horsepower engines for the heavy-duty truck market, and intends to manufacture a total of 3500 of these larger engines this year. While the demand for heavy-duty engines in China is currently depressed, the joint venture's production capability is 15,000 engines annually. China Yuchai also indicated in its second quarter earnings call that it intends to increase its market share in the Chinese heavy-duty vehicle market, with an objective of being one of China's four largest heavy-duty engine manufacturers by 2015.

Conclusion

China's latest economic stimulus will definitely have an effect on the country's economy, but it is likely that it will take some time for it to have an impact. While I believe that there will be an increase in China's economic activity in the fourth quarter, it's likely that China Yuchai's third and fourth quarter financial results will be similar to those of the second quarter.

As the market leader in the diesel engine industry in China with the country's most comprehensive product line, China Yuchai is "best of breed." It's also impressive that the company's joint venture partners are well known companies including Chery Automotive and Caterpillar.

I believe that it's likely that 2013 will see China Yuchai returning to revenue and income of 2011, if not exceeding those results. As a result I see China Yuchai as a basic industry play tied to China being the engine that will fuel global economic growth, especially as economic growth in the United States and Europe continues to likely be problematic.

Caution

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. The company is a U.S. reporting issuer, and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.

Source: A Basic Industry Play: China Yuchai International Manufactures Over 500,000 Diesel Engines Annually

Additional disclosure: Amounts stated in U.S. dollars are the result of currency conversion rates utilized.