- China Yuchai's 2H 2020 earnings were a disappointment, and the company's FY 2021 earnings outlook seems too optimistic.
- The market values China Yuchai at 6.6 times consensus forward FY 2021 P/E, and it boasts a consensus dividend of 5.0% for FY 2021.
- Special dividends and a secondary listing could be positive surprises and potential re-rating catalysts for the stock.
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I retain my Neutral rating for China Yuchai International Limited (NYSE:CYD).
China Yuchai's share price has declined by -6% from $17.04 as of December 4, 2020, to $16.00 as of April 7, 2021, since I published my initiation article for the company on December 7, 2020. The market values China Yuchai at 6.6 times consensus forward FY 2021 P/E, and it boasts a consensus dividend of 5.0% for FY 2021.
China Yuchai's 2H 2020 earnings were a disappointment, and the company's FY 2021 earnings outlook seems too optimistic. On the other hand, special dividends and a secondary listing could be positive surprises and potential re-rating catalysts for the stock.
I think that China Yuchai deserves a Neutral rating, after considering the market's overly-optimistic expectations of its FY 2021 earnings growth, and also the potential upside associated with positive surprises re-rating the stock.
2H 2020 Earnings Were Below Market Expectations
China Yuchai announced the company's 2H 2020 results on February 24, 2021, its bottom line in the second half of last year failed to meet market expectations.
Its revenue grew by +18% YoY from RMB9.0 billion in 2H 2019 to RMB10.6 billion in 2H 2020. In my initiation article, I had noted that the company's "key operating subsidiary Guangxi Yuchai Machinery Company was the third largest China VI emissions standard heavy duty truck engine manufacturer in China", and a +32% YoY increase in sales volume 217,138 units in the second half of FY 2020 for Guangxi Yuchai Machinery Company was a key driver of China Yuchai's strong top line growth.
China Yuchai's 2H 2020 revenue growth met market expectations, but the company's earnings in the second half of 2020 were not as good as expected. China Yuchai's earnings per share declined by -6% YoY from RMB6.36 in 2H 2019 to RMB5.95 or $0.91 in 2H 2020, which was -3% lower than sell-side analysts' forecasts of $0.94 in 2H 2020 earnings per share. On a full-year basis, the company's FY 2020 earnings per share of RMB 13.43 or $2.06 was -16% below market consensus' full-year FY 2020 earnings per share estimates of $2.44.
At its FY 2020 earnings call on February 24, 2021, China Yuchai attributed the earnings decline in 2H 2020 to an unfavorable sales mix which lowers the company's overall profitability and a -RMB64.5 billion loss of share from joint ventures. Specifically, China Yuchai mentioned at the recent results briefing that there was "good growth in our agricultural segment" in 2H 2020 which "has a slightly lower margin compared to the truck segment." Also, a rise in prices of "precious metals, like platinum, rhodium and palladium" and one-off issues with "one of the gas engine products" led to losses for China Yuchai's joint ventures.
FY 2021 Earnings Growth Expectations Seem Too Optimistic
Based on S&P Capital IQ data, market consensus sees China Yuchai growing the company's earnings per share by +18% YoY to $2.44. This seems too optimistic in my opinion.
China Yuchai's gross profit margin contracted from 17.2% in FY 2019 to 15.5% in FY 2020, and the company explained in its FY 2020 earnings release that this was the result of "changes in the sales mix (increase in sales contribution from lower-margin agricultural segment as highlighted above) and higher material costs."
Notably, negative factors that were a drag on China Yuchai's gross profit margin in FY 2020 are expected to persist in FY 2021. With expectations of an inflationary environment in 2021, material costs could remain high and depress China Yuchai's profitability. Furthermore, China Yuchai's gross margin this year could continue to be negatively impacted by an unfavorable sales mix. The company has guided for the "agriculture segment to grow in the year 2021" and highlighted that "we might see some decline" in the truck segment this year.
On the positive side of things, China Yuchai's sales of the new higher-margin China VI emissions standard HDT (Heavy Duty Trucks) engines are expected to continue growing in FY 2021 (evidenced by higher order numbers in 2M 2021) and improve the profitability of the truck segment as a whole, and the company expects research & development costs to be lower on a YoY basis in the current year.
However, this does not justify sell-side analysts forecasting a +80 basis points expansion in gross profit margin to 16.3% for China Yuchai in FY 2021. I believe that there could be room for further earnings disappointment for the stock in 2H 2021.
The market values China Yuchai at 6.6 times consensus forward FY 2021 P/E and 6.1 times consensus forward FY 2022 P/E based on its share price of $16.00 as of April 7, 2021. As a comparison, the stock's three-year and five-year average consensus forward next twelve months' P/E ratios were 5.1 times and 6.5 times, respectively. China Yuchai also offers a consensus dividend yield of 5.0% for the current fiscal year.
Sell-side analysts expect China Yuchai to generate ROEs of 7.6% and 7.5% for FY 2021 and FY 2022, respectively. All of the forward-looking consensus estimates referred to in this article are sourced from S&P Capital IQ.
China Yuchai is much cheaper than its peers based on forward P/E multiples, but its forward ROEs are also significantly lower than the peer group.
China Yuchai's Peer Valuation Comparison
|Stock||Consensus Current Year P/E Multiple||Consensus Forward One-Year P/E Multiple||Consensus Current Year ROE||Consensus Forward One-Year ROE|
|Weichai Power Co., Ltd. (OTCPK:WEICY) (OTCPK:WEICF) [2338:HK]||11.9||10.9||18.5%||17.5%|
|Sinotruk (Hong Kong) Limited (OTCPK:SHKLY) [3808:HK]||8.4||8.1||17.6%||16.4%|
|Cummins Inc. (CMI)||18.3||15.6||25.4%||28.2%|
Special Dividends And Secondary Listing Could Be Positive Surprises And Potential Re-rating Catalysts
Apart from the company's lower ROEs and 2H 2020 earnings disappointment, there are other reasons why China Yuchai trades at a discount to its peers.
One reason is that China Yuchai has a "lazy balance sheet" with net cash of RMB4.2 billion or $640 million (close to its current market capitalization of $653 million) on its books as of December 31, 2020. If China Yuchai chooses to return a significant portion of its excess cash to shareholders, it could serve as a key positive re-rating catalyst for the stock. That said, I acknowledge that China Yuchai could face challenges repatriating most of its cash out of Mainland China due to capital control issues.
Another reason for China Yuchai's cheapness is that it is a foreign company listed in the US, while its key peers like Weichai Power and Sinotruk are listed in Hong Kong. China Yuchai could potentially reduce the "foreign company discount" assigned to its US-listed shares by doing a secondary listing of its shares on the Hong Kong Stock Exchange. If China Yuchai shares do command a higher valuation in Hong Kong subsequently, this could help to re-rate its US-listed shares as well.
However, it is noteworthy that China Yuchai has not discussed the possibility of either a special dividend or a secondary listing publicly, so I only view these as "positive surprises" and "potential re-rating catalysts" at the moment.
China Yuchai's key risk factors include lower-than-expected gross profit margin in FY 2021 as a result of higher proportion of sales derived from the lower-margin agricultural segment and higher material costs, and potential re-rating catalysts such as special dividends and a secondary listing not being realized.
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This article was written by
The Value Pendulum is an Asian equity market specialist with over a decade of experience on both the buy and sell sides.
He is the author of the investing group Asia Value & Moat Stocks, providing ideas for value investors seeking investment opportunities listed in Asia, with a particular focus on the Hong Kong market. He hunts for deep value balance sheet bargains and wide moat stocks and provides a range of watch lists with monthly updates within his investing group.
Analyst’s 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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