Despite BYD's Recent Downturn, Its Future Is Electric

| About: BYD Co., (BYDDF)

On Monday, October 29, Chinese battery, solar panel and vehicle manufacturer BYD (OTCPK:BYDDF) reported a 94 percent decline in third-quarter profit compared to Q3 of 2011. Further, BYD forecast that the company's annual earnings might fall by as much as 98 percent on the back of continued weakness in Chinese demand for cars and reduced European buying that was hurting its handset battery and solar businesses. Despite this substantial decline in quarterly profit, BYD appears to be a strong long-term investment that is poised to benefit from years of future growth within most of its businesses, both in China and internationally.

BYD's Q3 net profit came in at 4.6 million yuan or $734,000, a 94% decline from Q3 of 2011, while revenue declined 11% to 10.53 billion yuan or $1.68 billion. The company also sustained a similar decline last quarter. Demand weaknesses in China, and increased Chinese competition in the vehicle market have been problematic for BYD this year. Similarly, European economic weakness reduced demand for solar energy cells. Additionally, a territorial conflict with Japan may have resulted in reduced ordering of BYD batteries and various other components by Japanese manufacturers.

Another issue for BYD this year has been a fatal accident involving an e6 taxi in Shenzhen, China, which instigated concerns that the vehicle's battery may be a fire hazard. A subsequent Chinese government investigation indicated that the battery is not a fire hazard and did not cause that fire, but consumers may still be wary.

Beyond vehicles, BYD's lithium-ion battery and handset component businesses have also been under fire during the last several quarters, as demand for batteries and phone parts has declined. The problem is not one of quality or performance regarding BYD's lithium-ion batteries and components, but rather due to declining market share by many of its customers, causing them to buy less components than they otherwise would.

For example, one of BYD's largest customers for mobile components, including batteries, is Nokia (NYSE:NOK), which has seen its product line lose share to smartphones including Apple's (NASDAQ:AAPL) iPhone and the many options running a version of Google's (NASDAQ:GOOG) Android OS. Other major customers of BYD's mobile components and batteries include Huawei Technologies and ZTE, both of which recently came under scrutiny by the U.S. House Intelligence Committee. Huawei was subsequently left out of the Microsoft (NASDAQ:MSFT) Windows Phone 8 device launch. This could cause further weakness in lithium-ion battery demand for BYD from Huawei in the near term.

Issues such as the out of favor status of some of BYD's mobile phone customers and the fire hazard concerns that hit its electric vehicles are very real, but at least some of these concerns are also very likely to be temporary conditions. While Nokia and Huawei may have current problems, either's issues could resolve themselves in due time. Alternatively, if these buyers of BYD's batteries and components cannot get their respective houses in order, other customers will likely emerge and lay claim to BYD's battery and device component supply chain. Other major customers of BYD's handset component and assembly business already include Apple, Google's Motorola, HTC and ZTE, among others, and any of these component customers could expand their relationship with BYD in the coming quarters, especially if their market share increases.

BYD's automobile division appears to still be in the downward part of its product cycle, but that could soon change. The negative publicity the company faced from concerns over vehicle battery flammability must have had a substantial influence on BYD's vehicle sales, but that influence is likely mostly over now. Nonetheless, it is also common for a company to recognize demand weakness for existing products in advance of the anticipated launching of new products. As a result, it appears quite possible that BYD's auto sales will bottom out in the second half of 2012 and subsequently begin to increase as its newer models grow in availability and gain traction in the marketplace.

Further, the company will likely enact measures to improve vehicle quality, while also continuing to offer interesting added technological features, like the ability to drive some BYD vehicles with a remote control. These measures should help BYD domestically, though it is still unclear whether BYD will increase its Chinese market share in the near term. In the meanwhile, BYD's all-electric e6 has found some international interest. BYD received an order to supply 50 e6 electric cabs to Greentomatocars, London's second-largest minicab company, in 2013. Greentomatocars previously composed its fleet of Toyota (NYSE:TM) Prius hybrid vehicles, where the e6 is all electric and therefore theoretically greener. If the e6 is successful for the minicab business, many citizens of London, and tourists, may grow more comfortable with the brand.

Similarly, BYD has begun to find traction in its international sale of electric buses, including signing some large multi-year orders. BYD inked one deal with Israel's Dan Bus for 700 electric buses, and an order for 500 buses from the government of Uruguay. Mayor Gilberto Kassab of Sao Paulo, Brazil, also indicated that Sao Paulo is interested in BYD's electric buses, and that it may soon contract to procure some.

These bus orders will not only be the first BYD vehicles in most of these new international markets, but also the first all electric vehicles. Their potential success among these early adopters could make BYD's electric buses a standard option for many new markets, and help the company globally grow brand awareness. BYD vehicles should also soon undergo significant growth in terms of availability to consumers throughout the United States and many other nations, with few of these consumers knowing much of anything about BYD. Most Americans who are familiar with the company only know of it because MidAmerican Energy Holdings, a unit of Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), acquired a 9.9 percent stake in BYD in 2008. Of course, for some investors, that is all they need to know.

Disclosure: I am long OTCPK:BYDDY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.