BYD company is the most recent direct investment Warren Buffett has made in China. BYD’s stock is listed in Hong Kong(1211.hk). Its American Depositary Receipts are traded on the pink sheets under the symbol of BYDDY.PK. Revelation of Buffett’s 10% ownership helped drive the stock toward its height in April, 2010. Since then, the stock price has declined by 50%. Forward price-earnings ratio estimated by Bloomberg shrank to 17, more closely in line with the reduced growth rate of 15%. Most of the bad news may have been priced into the stosck. While the company is working to resolve it short- term operational issues, the basic investment thesis that attracted Buffett to the company has not changed. With its low-cost battery technology, BYD remains well-positioned for the future of electric vehicles and alternative energy solutions. For long-term investors, BYD is now at a reasonable price for a partial new position.
BYD stumbled badly in 2010. It sold only 519,000 cars, falling far short of its original target of 800,000, due to quality problem and over-extended dealership network. In the most recent financial report(9 months ended September, 2010), revenue increased 31%. Gross and net margins, however, declined from year ago(19.4% and 7.1% versus 21% and 8.9%). Costs of selling, distribution and administration jumped 40% as BYD overbuilt its sales infrastructure. Alarmingly, inventory increased 63% from last year. Management has admitted to mistakes and is now working to improve car quality and trim dealership network. As an early sign of improvement, BYD’s CEO on January 15 stated that car sales have stabilized and will grow 10-20% in 2011. BYD also had to postpone its highly-anticipated launch of electric cars in China and the US. But, in Detroit Auto Show early this month, BYD announced that a redesigned electric car will be launched in the US in 2012. In December last year, the City of Beijing announced measures to limit car permits in order to control traffic congestion. This set off fear that other cities might follow Beijing. This, however, has not happened. Car industry is still expected to grow by 15% this year, down from +35% in 2010. Car industry in China is still in early development. Car ownership is only 52 per thousand people versus an average of 500 in developed countries.
Looking ahead, sentiment may improve in second half of this year when BYD lists its “A” shares in Shenzen to build a domestic shareholder base. Another positive catalyst may be the improving business condition in its Electronic Handset and Assembly Service Division(37% of total revenue, 2009). Morgan Stanley recently upgraded the price target on BYD Electronic(285.HK) which is separately listed and partly owned by BYD.
All the bad news that hit BYD’s traditional car business(53% of total revenue, 2009) have obscured the main attraction of BYD. It has superior rechargeable battery technology and is applying it to the production of electric cars at much lower cost than global competitors. High cost of battery is one of the key obstacles to the mass production of electric cars. In the next 5-Year Plan (2011-2015) announced in China recently, energy-efficient cars are targeted for priority development. Massive resources will now be available to this industry, in which BYD is an early leader. The large size of the Chinese market is important. The government support and large domestic market now provide BYD a huge advantage against its global competitors. In 2010, BYD also secured supply of an important rare material used in advanced car battery by investing in a local Vanadium producer. China is the top source of this rare material.
Importantly, BYD is extending its battery technology beyond electric vehicles. It is applying it to solar and electric grid energy storage. This is already producing revenue and has global business prospects as the world seeks alternative energy solutions. The growth potential of this small business division(currently only 10% of total revenue, 2009) may not have been fully appreciated by the investment community.
In Conclusion, BYD appears fairly priced for its traditional car and electronic handset business. But, much of its great prospect in alternative energy solutions, such as electric vehicles and solar energy storage, may not have been fully priced in. For investors that seek participation in alternative energy and long- term growth of China, BYD is a good candidate. For those accustomed to the American standard of corporate governance and transparency, it helps to know that Berkshire Hathaway has an officer that sits on BYD’s board and that BYD is listed in Hong Kong. Further short-term downside is possible. Full-year report for 2010 is due in March. The troubled car business may take longer to get back on track. But for a fast-growing company, occasional setback is not uncommon. For long-term investors, a great company is now available at a better than fair price.
Disclosure: I am long OTCPK:BYDDY.
Additional disclosure: I am long BYDDY.PK