BYD Electronic: Back On The Path Of Growth

Summary

  • After reporting disappointing earnings in 1H2019, BYD Electronic looks to be back on the path of growth after a strong set of results for 3Q2019, with multiple growth drivers.
  • There are also long term growth opportunities with the company's non-core businesses such as new intelligent products and automotive intelligent systems.
  • BYD Electronic trades at 15.0 times consensus forward FY2020 P/E which represents a premium to its historical five-year average forward P/E of approximately 12 times.
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Elevator Pitch

Hong Kong-listed Chinese electronics manufacturing services or EMS provider BYD Electronic (International) Company Limited (OTCPK:BYDIF) (OTC:BYDIY) [285:HK] currently trades at 15.0 times consensus forward FY2020 P/E which represents a premium to its historical five-year average forward P/E of approximately 12 times. The stock also offers a consensus forward FY2020 dividend yield of 1.4%. BYD Electronic's share price is up +47% and +78% (excluding dividends) for the past three months and one year respectively, after it delivered a strong set of results for 3Q2019 after reporting disappointing earnings for 1H2019.

I assign a "Neutral" rating to BYD Electronic, as the company's solid 3Q2019 results and strong growth momentum have been priced in at current valuations. The stock is an interesting investment candidate, taking into account medium term growth drivers for its core smartphone & notebooks PC business and long term growth opportunities with the company's non-core businesses such as new intelligent products and automotive intelligent systems. I prefer to wait for a more attractive entry price, before considering an investment in BYD Electronic.

Readers are advised to trade in BYD Electronic shares listed on the Hong Kong Stock Exchange with the ticker 285:HK where average daily trading value for the past three months exceeds $15 million and market capitalization is above $4.5 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers, Fidelity, Charles Schwab or local brokers operating in their respective domestic markets.

Company Description

Started in 2002 and listed on the Hong Kong Stock Exchange in 2007, BYD Electronic, a subsidiary of BYD Company Limited (OTCPK:BYDDF) (OTCPK:BYDDY) [1211:HK], is a leading electronics manufacturing services or EMS provider in China. The company has three major business segments, namely smartphones & notebook PCs, new intelligent products and automotive intelligent systems, which accounted for 86%, 11% and 3% of its 1H2019 revenue respectively.

Turnaround For Core Smartphones & Notebook PCs Business In 3Q2019

BYD Electronic's core smartphones & notebook PCs business, which contributed the bulk of the company's 1H2019 revenue, is engaged in the manufacture and sales of smartphone and notebook components and modules (e.g. metal and plastic parts, 3D glass and ceramics etc), and the provision of hardware design and assembly services for electronic products.

The company's 1H2019 results were a disappointment, as net profit declined -49% YoY to RMB575 million despite a +19% YoY increase in revenue to RMB23,280 million. The key factor for the sharp fall in earnings was BYD Electronic's gross margin which decreased from 10.2% in 1H2018 and 10.1% in 2H2018 to 6.7% in 1H2019. On a quarterly basis, the company's 2Q2019 net profit was down -71% YoY, while its gross margin for 2Q2019 was 5.5%. BYD Electronic attributed the decline in gross margin for 1H2019 to "changes in product structure" in the company's 1H2019 interim report.

The change in product mix responsible for the gross margin compression was likely due to a decrease in higher margin metal casing revenue and an increase in lower margin assembly services revenue. Huawei Technologies, one of BYD Electronic's clients, was added to the US Entity List in May 2019, which affected Huawei's use of the Android operating system and its import of chips from US companies. Huawei subsequently removed Flex Ltd. (FLEX), its largest smartphone assembler, from its supply chain, and BYD took over part of Flex's assembly services business for Huawei, as reported by the media. At the same time, Huawei's addition to the US Entity List had an effect on its smartphone sales, especially outside China, which led to a decline in BYD Electronic's metal casing revenue.

However, there was a turnaround for BYD Electronic in 3Q2019 based on the company's 9M2019 results released on October 29, 2019. BYD Electronic's net profit was up +141% QoQ in 3Q2019, and represented a narrower YoY decline of -35% (versus -49% YoY for 1H2019 and -71% YoY for 2Q2019). The company's gross margin improved from 5.5% in 2Q2019 and 6.7% in 1H2019 to 7.0% in 3Q2019. BYD Electronic's revenue also rose +17% QoQ and +51% YoY in the most recent quarter. The stabilization in Huawei smartphone shipments and related orders for BYD Electronics in 3Q2019 likely played a key role in BYD Electronic's turnaround in the recent quarter.

Multiple Growth Drivers In The Medium Term

Looking ahead, following a solid set of results for 3Q2019, BYD Electronic looks to be back on the path of growth with multiple growth drivers in the medium term.

Firstly, BYD Electronic's assembly services revenue is growing rapidly as evidenced by a +17% QoQ and +51% YoY growth in total revenue for 3Q2019, after taking over part of Flex's assembly services business for Huawei in 2Q2019 as mentioned earlier. Sell-side analysts from Guosen Securities (Hong Kong) have guided for a +50% increase in BYD Electronic's revenue contribution from Huawei in 2019; BYD Electronic assembles smartphones for the Huawei P and Mate series. There are synergies between assembly services and smartphone component orders, and an increase in low margin assembly services revenue could translate to more higher margin smartphone component orders for BYD Electronic due to the integrated nature of the company's solutions.

Secondly, BYD Electronic's metal, plastic and glass casing products should see strong growth going forward with an increase in new 5G smartphone launches. The company noted in its 1H2019 interim report that "the requirement of manufacturing precision and product performance of metal, plastic and glass components of 5G phones are higher, which is expected to increase the added-value of handset products."

Specifically, the company's glass casing products have a long growth runway, as an increasing number of lower-priced smartphones are starting to use glass casing, while glass casing was mainly used for high-end and flagship smartphone models in the past.

Counterpoint Research forecasts that the global penetration rate for smartphones with glass backs will increase from 26% in 2018 to 60% by end-2020. Unlike metal or plastic casing solutions, the Chinese glass casing market is a more concentrated market dominated by Lens Technology [300433:CH] and Biel Crystal which had an estimated 60% market share (two companies combined) of the 3D glass market in China in 2018. BYD Electronic was a late entrant in the glass casing market, but it is now among the top three glass cover suppliers for Android phones together with Lens Technology and Biel Crystal.

Also, margins for glass casing products are likely to increase going forward, domestic Chinese suppliers compete with Corning Incorporated (GLW), which used to be the sole supplier of 3D glass, and help to lower BYD Electronic's input costs.

Thirdly, BYD Electronic is actively expanding into non-smartphone products for its existing smartphone clients. According to a report by Ming-Chi Ku, a sell-side analyst at TF International Securities, BYD Electronic will be the sole assembler of Apple's (AAPL) iPod Touch and be responsible for assembling 10%-20% of iPads as well in 2020.

Also, BYD Electronic's parent, BYD Company Limited, signed a strategic cooperation agreement with Huawei in March 2019, to collaborate on multiple areas like 5G, cloud computing, artificial intelligence and big data among others. BYD Electronic is expected to be a key manufacturer of 5G base transceiver stations for Huawei.

Long Term Growth Opportunities With Non-Core Businesses

As highlighted earlier, BYD Electronic's non-core businesses, new intelligent products and automotive intelligent systems, contributed 11% and 3% of the company's 1H2019 revenue respectively. Revenue for the new intelligent products and automotive intelligent systems business segments grew by +55.0% and +54.9% YoY respectively in 1H2019, and the two businesses have a long growth runway ahead.

BYD Electronic's new intelligent products business manufactures products such as cleaning robots, smart speakers and graphic cards for companies like iRobot Corporation (IRBT), Amazon (AMZN) and NVIDIA Corporation (NVDA), according to a May 2019 sell-side report published by Industrial Securities. Based on research by International Data Corporation, the number of intelligent home devices is expected to grow by a five-year CAGR of +18.5% to 939 million by 2022.

The automotive intelligent systems business is also benefiting from secular tailwinds. It is expected that 28 million internet-connected cars will be sold in China in 2025 with a penetration rate of 80%, according to forecasts by the China Society of Automotive Engineers. BYD Electronic's automotive intelligent systems business produces in-car multimedia systems, intelligent networking system, communications modules, sensor modules to Tier-1 automotive suppliers, with the end-products used in vehicle models for brands like BMW (OTCPK:BMWYY) and Audi (OTCPK:AUDVF). A new product launched by the automotive intelligent systems business in 2019 was an intelligent car cabin system equipped with the 90 degrees auto-adjusting and self-rotating center console screen.

Looking ahead, BYD Electronic has set an ambitious growth target to grow its revenue from RMB41 billion in FY2018 to RMB200 billion by FY2024, of which 25% (versus 14% in 1H2019) of revenue is expected to be contributed by the non-core businesses, new intelligent products and automotive intelligent systems.

Valuation

BYD Electronic trades at 21.9 times consensus forward FY2019 P/E and 15.0 times consensus forward FY2020 P/E based on its share price of HK$16.96 as of January 9, 2020. The stock's forward FY2020 P/E is at a premium to its historical five-year average forward P/E of approximately 12 times.

BYD Electronic offers consensus forward FY2019 and FY2020 dividend yields of 0.9% and 1.4% respectively.

Variant View

The key risk factors for BYD Electronic are weaker-than-expected demand for smartphones, stiffer-than-expected competition, lower-than-expected profit margins, and non-core businesses performing below expectations.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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