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Elevator Pitch
I continue to have a Hold investment rating assigned to China Yuchai International Limited's (NYSE:CYD) stock. I discussed about China Yuchai's expected topline contraction and gross profit margin improvement in my prior March 8, 2022 update for the stock.
China Yuchai didn't perform very well in the recent interim period, and it will take some time for the company to realize the growth opportunities associated with new products like range extenders. My view is that the outlook for China Yuchai in the near term is uncertain, which justifies a Hold rating for CYD.
Headline Financial Metrics For 1H 2022 Were Poor
China Yuchai published a press release detailing its financial results for the first half of this year on August 10, 2022, Wednesday before trading hours.
CYD's topline decreased by -32% YoY from RMB12,629 million in the first half of the prior year to RMB8,569 million in the most recent interim period. This was much worse than China Yuchai's -19% YoY sales contraction in 2H 2021 and its +27% YoY revenue increase for 1H 2021. More significantly, this was the largest interim revenue decline for CYD on a YoY basis in the last 10 years in RMB terms as per historical financial data sourced from S&P Capital IQ. CYD's 1H 2022 revenue also came in -6% below the market's consensus topline projection in USD terms, according to an August 10, 2022 Seeking Alpha News article.
Its earnings per share or EPS fell by -63% YoY from RMB6.21 in 1H 2021 to RMB2.29 in 1H 2022. As a comparison, China Yuchai's bottom line declined by a milder -17% YoY in the first half of 2021. In USD terms, CYD's 1H 2022 EPS turned out to be -47% lower than the sell-side's EPS expectations as highlighted in the Seeking Alpha News article that was published on August 10, 2022 and referred to earlier.
Notably, CYD's share price still increased by +3% from $8.46 as of August 9, 2022 to $8.70 as of August 10, 2022, and its shares rose by another +1% to close at $8.82 on August 11, 2022. This means that China Yuchai's stock price actually ran up by +4% in the next two trading days after it announced its below-expectations 1H 2022 financial results.
Finding Bright Spots Amidst Poor Headline Results
I think that investors found a number of bright spots within China Yuchai's recent interim earnings report, and this resulted in CYD's stock price rising post-earnings announcement.
The first bright spot is that China Yuchai might have some new revenue growth drivers.
CYD's engine sales volume dropped by -37% YoY from 285,342 units in 1H 2021 to 180,911 units for 1H 2022. The first half of last year was a high base for China Yuchai, as a result of "the surge in demand for engines to meet China's new emission standards for heavy-duty vehicles" in 1H 2021 as I mentioned in my early-March 2022 article for CYD. As such, China Yuchai is unlikely to generate a similarly strong sales growth for heavy-duty vehicle engines anytime soon, as there isn't expected to be another major change in emission standards in the near term.
Instead, the range extender products might provide upside surprises for China Yuchai's sales growth in the future. CYD announced earlier in a May 17, 2022, media release that "Macau has begun operating 222 new energy buses equipped with Yuchai's range extenders," and it also disclosed that over "600 units of Yuchai's core range extenders have been ordered for the Macau auto market."
This could be just the beginning of a ramp-up in orders and sales contribution relating to the range extender products for China Yuchai. At its 1H 2022 investor call on August 10, 2022, CYD emphasized that there is "quite a fair bit of potential" for range extenders, and it noted that it is "still developing the bigger range for this product." But it will naturally take time for range extenders to be a meaningful source of revenue contribution for the company.
The second bright spot is that there was an improvement in CYD's gross profit margin in the recent interim period.
Gross margin for China Yuchai expanded by +300 basis points YoY and +40 basis points HoH (Half-on-Half) to 15.9% in 1H 2022. CYD credited the higher gross margin for the company in the first half of the year to "improved margin in National VI engine sales and also to the increase in sales mix in the off-road segment," as highlighted in its interim earnings press release.
The third bright spot is that CYD's worse-than-expected EPS drop for 1H 2022 was attributable to both investments to support future growth and accounting issues.
China Yuchai's Research & Development or R&D costs rose by +29% YoY from RMB316 million in 1H 2021 to RMB409 million in 1H 2022. The company explained at its recent interim results briefing that "new energy vehicle technologies to accelerate product development" and "experimental costs primarily for the engines used for marine and power generation applications" were the main reasons for its higher R&D costs. In other words, China Yuchai has been investing more to drive new growth opportunities, and hopefully, that could translate into a faster pace of topline expansion going forward.
Also, it is important to note that China Yuchai's total R&D investments, including both expensed and capitalized costs, increased by a much more modest +6% YoY to RMB477 million in the first half of this year. This implies that CYD's below-expectations 1H 2022 earnings and higher-than-expected R&D costs might be partly attributable to the fact that the company expensed a higher proportion of R&D investments, as opposed to capitalizing them. This is more of an accounting issue, and China Yuchai's R&D investments didn't really increase as much as what the jump in its R&D costs indicates.
Concluding Thoughts
China Yuchai is a Hold. CYD's results for the first half of the year were poor, but there were encouraging signs such as new product orders and an improvement in gross profit margin. Moving ahead, it is tough to determine how long it will take for China Yuchai to return to positive earnings growth again. China Yuchai's engine sales are closely linked to the health of the Chinese economy, so the country's zero-COVID policy and woes relating to the property market create significant uncertainty with respect to China Yuchai's near-term outlook.
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