CYD - China Yuchai International

[Kuhndan]

CYD is one of the largest manufacturers of diesel engines for heavy equipment, trucks, buses and automobiles in China. I work closely with primary US heavy equipment manufacturers on the banking side and first became aware of CYD when the company announced a joint venture agreement with Caterpillar last year. CAT is the gold standard in the heavy equipment world and their support is the good housekeeping stamp of approval in my book. The company reported US dollar sales of $2.4 billion at 12/31/10 and a net profit of $170 million. Q1 11 profits were a disappointment with engine sales down and net profit dropping to $35 million from $41 million the same period one year ago. It also announced last week that the company's president was retiring and the current CFO was taking over. The stock sold down over $3 to $21 on Friday and the stock is down over 40 percent over the past two weeks since they reported earnings. The total market cap is $783 million. Total cash on the balance sheet at 3/30/11 totaled $647 million while bank debt of $226 million yields net cash of $421 million and an adjusted market cap of just $362 million. Based on 2010 profits the adjusted PE is just 2. Cummins Engine would be the closest American comparison to CYD. Cummins has a Chinese presence and competes with the company there. Cummins sports a $20 billion market cap and posted net profits of $1 billion. Cummins is only 5.8x more profitable than CYD but is valued 55x greater.

 

This all being said, there are the typical challenges here when investing in most Chinese companies. CYD only owns approximately 75 percent of the underlying operating entity with the remaining 25 percent owned by the local "majority owner". The arrangement has often times worked against the 75 percent "majority owner". Also like many Chinese companies, their accounting is not up to speed and they have received a qualified opinion. The management shake up is an added level of uncertainty. The company's business will also be impacted by increasing inflation in China.

 

Unlike many of the reverse merger Chinese companies, CYD is a legitimate business. They recently paid a $1.50 dividend representing a 7.1 percent yield. I think the downside here is limited given the recent sell off and upside for the long term is very promising.  

[MrB]

http://www.deutz-engine.com/analysis-of-chinese-automotive-engine-industry-in-2011.html

[MrB]

First marine engine

http://www.yuchai.com/English/press/1330687893181305.htm

[MrB]

http://www.vipglobalresearch.com/TWST-Investing_Strategies_Report-2012.pdf

[ItsAValueTrap]

Unlike many of the reverse merger Chinese companies, CYD is a legitimate business. They recently paid a $1.50 dividend representing a 7.1 percent yield. I think the downside here is limited given the recent sell off and upside for the long term is very promising. 

 

Sino Forest also paid a dividend.  To be somewhat fair, Sino Forest was raising capital all the time where CYD does not.

 

However, there are some things about China Yuchai that don't make sense to me.  Here is an excerpt from related party transactions:

During 2004, Yuchai granted loans of Rmb 205 million to YMCL, a subsidiary of Coomber, with an interest rate of 5.58% for one year. The loans were guaranteed by Coomber and the State Holding Company as Guarantors. The loans were repaid in 2005 and were subsequently re-loaned with a maturity date of June 1, 2007 and further extended to May 30, 2008. In July 2007, Yuchai’s Board of Directors agreed in principle to a proposal by the State Holding Company to settle the loans due from YMCL, along with various other accounts receivable from YMCL (collectively, the “receivables”), by forgiving the receivables in exchange for the transfer of 100% of the equity ownership in a hotel in Yulin, PRC and YMCL’s central office building in Guilin, PRC. On December 25, 2007, Yuchai, pursuant to the execution of a share transfer contract with YMCL, Coomber and State Holding Company, acquired all the outstanding share capital of Yulin Hotel Company for Rmb 245.6 million. In March 2008, agreements were entered into by Yuchai to effect the repayment of the Rmb 205 million loans against the purchase of 100% equity interest in Yulin Hotel Company for Rmb 245.6 million and offsetting of the balance payable against certain trade receivables due from YMCL, the Guarantors and other related parties. As a result of the acquisition of 100% equity of Yulin Hotel Company, the loan agreements with YMCL have been terminated and the guarantees provided by the Guarantors have been discharged. The acquisition by Yuchai of Yulin Hotel Company was ratified by the Board of Directors of Yuchai and its shareholders subject to the original shareholders of Yulin Hotel Company obtaining approval for the transaction from the regulatory agency in China by November 30, 2008 which was subsequently extended to June 30, 2009 by Yuchai’s Board of Directors and shareholders. If such approval from the provincial government regulatory agency in charge of state-owned assets administration in China was not obtained by June 30, 2009, Yuchai would have had the right to sell to the State Holding Company, who would have been obligated to buy, 100% of the equity interest in Yulin Hotel Company at the original purchase price of Rmb 245.6 million. This condition is contained in a guarantee letter provided by the original shareholders of Yulin Hotel Company. However, on January 13, 2009, Yuchai received approval from the provincial government regulatory agency in charge of state-owned assets administration in China for its acquisition of 100% equity interest in Yulin Hotel Company.

 

For fiscal year 2008, there was an impairment charge of Rmb 46.0 million recognized pertaining to the hotel in Yulin and the Guilin Office buildings. The goodwill of Rmb 5.7 million arising from the acquisition of the Yulin Hotel Company was fully impaired during 2008. The provision of Rmb 203 million for uncollectible loans to a related party was reclassified as deferred gain in the statement of financial position. The deferred gain was recorded in the Statement of Operations in 2009 when it was realized on receipt of the approval from the provincial government. On April 27, 2011, Yulin Hotel Company entered into a sale and purchase agreement with a third party to sell the Guilin Office building for a total consideration of Rmb 120 million. Upon the disposal of the Guilin Office building, an accumulated impairment loss of Rmb 26.5 million was included in the determination of loss on disposal.

 

It doesn't make business sense to make a related party loan and then receive payment in a hotel.  Why are they getting into the hotel business?!?!  It also seems that they lost money on this hotel investment, though I only skimmed CYD's financials.

[Green King]

that doesn't seems abnormal in terms of Chinese business conduct. Some times when don't have cash to pay your get real estate in return better than writing the whole this down. Although there are a lot rich people and companies in China most of them are cash poor. Also that is a small amount or the discount to IV. do you have proof of it falsifying its cash ,  Creating earnings out of thin air, or lying about its market dominance ?

 

Disclosure no position

I don't know how to proof etiher way from here in Canada. Just wondering how ? Can you show me ?

[Kuhndan]

Cash at 6/30/12 was $932 million, short and long term debt was $469 million yielding net cash of $463 million. Current market value value $488 million. For $25 million you get the #1 heavy duty engine manufacturer in China which earned $37 million through the first six months of the year. Take a look at how Komatsu, Cummins and CAT are doing in China compared CYD. Foreign companies are down significantly more. I don't like the hotel deal either. That being said, it isn't material to the operation.

[Green King]

Recent Webcast

Listen to the Q&A a analyst was hammering about the cash around 50 mins and questions about why no buy backs at the end.

 

http://edge.media-server.com/m/p/43evgs8t/lan/en

[king888]

China Yuchai is a subsidiary of  Hong Leong Asia Ltd which is based in Singapore.

Hong Leong is one of biggest conglomerate in South East Asia. It is unlikely that they are an outright fraud .But it is known that Hong Leong usually put its own interest ahead of all other shareholders.

It is not uncommon practices for conglomerate in Asia.

 

There was a group of US investors tried to do an activist on CYD back in 2008 . But I think these group does not exist anymore. Most of them sold shares in the peak at 2010 except Shah Capital.

http://seekingalpha.com/article/63357-why-i-m-looking-forward-to-china-yuchai-s-agm

 

 

[Green King]

Thanks. Sounds good. If they where shareholder friendly it would not be that cheap. :)

 

 

[MrB]

Just a few comments to balance your views...

Yulin Hotel

A few years ago the directors of the local Chinese operating sub issued loans to a newly created sub of the opco with less than best intentions. However, since Hong Leong owns the golden share, which allows them to imbed at least six of their own people in the control functions at the opco they caught on fairly quickly and within about 18 months forced the directors of the opco to formally recognize the loans in writing, followed by personal guarantees, followed by personal security. At this first missed payment security was taken (Yulin Hotel and HQ building) and over subsequent years this was sold off, with a minor loss to CYD.

I see it as a glass half full/half empty argument. For the former, I don't think I have ever seen a case of "enforcement of shareholder rights" like this in China, especially considering the Singaporeans are not exactly considered local in Yulin City.

 

Does it exist?

Yes, because it is the largest supplier of diesel engines with one of the most recognizable brands in China and supplies to OEM manufacturers, so unless the largest supplier of buses in China, Geely, Caterpillar etc are rolling out trucks and buses without engines this thing is real. Caterpillar is in JV with them too. Interestingly the recent turnaround was done by Boo Guan Saw; previous job..CEO of Cummins Westport based in Vancouver.

 

Cash

Read the attached CC transcript. They have a lot of cash yes, but they have bond redemptions  coming and they play around with the discounting of receivables, which they can only do with significant cash on the balance sheet. They specifically make the point that they are being conservative due to the slowdown and with sales being down 20%-30% it is the prudent thing to do. They also have significant capex commitments coming up. Lastly, they just paid a $0.90 dividend a month ago...as I always tell my children...finish your food before you ask for more.

 

 

So not dismissing your concerns, just balancing them.

My main concern with CYD is 2nd degree fraud...at one of their clients which means they take a huge hit on the receivables/cash side. Scale of enterprise fraud always a worry too. Finally, China slowdown is real and these guys are feeling it big time.

2012Q2.pdf

[Ross812]

Step 1: before investing in a Chinese company make sure it exists.

Step 2: Check for red flags indicating fraud

Step 3: Discount for the reality that as a foreign minority shareholder in a Chinese company you are seen by management as a free bank loan not as a part owner of the company.

Step 4: Establish the company's competitive advantage. Is the advantage easily coppied? If you had cash equal to the market cap of the company could you build a similar company and gain significant market share away from the company you are analyzing?

Step 5: What is the company worth now? Five years from now? Ten years from now? Can you answer the question confidently? What is an acceptable margin of safety? Establish a buy price and add the company to your watchlist and wait patiently for the right price.

 

Until steps 1-3 can be eliminated from consideration, it doesnt make a lot of sense to waste any time pondering steps 4 and 5. Until China enforces laws that protect foreign shareholders, it would be prudent to ignore the country as a whole. Chinese frauds have tricked professional investors who have traveled to the country and seen the actual operations of the company. There is no chance of being able to prove the legitimacy of a Chinese company while sitting behind a computer.

[ItsAValueTrap]

If there is a real business, insiders can still misappropriate money from the company such that shareholders don't make anything.

 

There's just been an incredible amount of fraud in the Chinese reverse merger stocks (almost all of them are fraudulent) and the Chinese authorities haven't really taken a strong stance to protect non-Chinese investors.  I don't think a single person has gone to jail even though so many frauds have been uncovered so far.  At least in the US and Canada, people sometimes go to jail (Barry Minkow, Bernie Ebbers, etc.).  China is not the US or Canada.  Maybe in the future they will take fraud seriously, but right now they don't.  If there are no consequences to stealing from non-Chinese investors, insiders may do it.  Who is going to stop them?

 

*I have no position in this stock.  I wish you all the best of luck.

[MrB]

If there is a real business, insiders can still misappropriate money from the company such that shareholders don't make anything.

 

There's just been an incredible amount of fraud in the Chinese reverse merger stocks (almost all of them are fraudulent) and the Chinese authorities haven't really taken a strong stance to protect non-Chinese investors.  I don't think a single person has gone to jail even though so many frauds have been uncovered so far.  At least in the US and Canada, people sometimes go to jail (Barry Minkow, Bernie Ebbers, etc.).  China is not the US or Canada.  Maybe in the future they will take fraud seriously, but right now they don't.  If there are no consequences to stealing from non-Chinese investors, insiders may do it.  Who is going to stop them?

 

*I have no position in this stock.  I wish you all the best of luck.

 

I agree and it contributes to why CYD is cheap. It is tainted with the same (Chinese reverse merger) brush; Yet it is the first foreign Chinese enterprise to list on the New York stock exchange, back in 1994. Also, I think the story is interesting for exactly that last question you raised, "Who is going to stop them?" Hong Leong did stop local management. In about 18 months flat they got them to put hand to paper and acknowledge personal liability for inter-company loans, then put up personal security and then grabbed the security with the first missed payment. Think about that...and HL folk are foreigners....I don't think I have ever heard of that happening in China.

[Maple Fun]

Hi, I am trying to reactivate this topic :P

 

A few progresses since 2012:

 

1. The largest/controlling shareholder, Hong Leong Asia, consistently increases their stake, now stands at 40.9% (compared with 34.9% at 2012);

2. Shah capital also increasing: now at 8.46% v.s 6.2% at 2012;

3. CYD's peers (listed in HK/China) reported very favorable Q3 earnings.

[Maple Fun]

Q3 out a few days ago, very favorable, EPS is $0.29 compared with 0.00 yoy.

 

Below is a short note I wrote two weeks ago: any thoughts welcome!

 

Its competitor, Weichai Power (HK listed: 02338), is currently valued at 1.27X PB and 28.52X PE.

 

I am assigning a 1-Year target price of $20 for CYD. At $20, CYD would be valued at a P/B ratio of 0.71X and an EV/EBIT multiple of 5X. Moreover, with a 10 year average EPS of $2.4 for CYD, $20 would mean 8.3X P/E ratio, which can be easily justified by the strong of the business and management. If CYD can get a similar valuation as Weichai Power, then this scenario would lead to $35 per share for CYD.

 

Why CYD is so deeply undervalued?

 

A few reasons: First, CYD is a pure China play, but it’s listed in NYSE. Therefore, it’s far away from its typical investor base. Secondly, CYD has a limited float and under-followed by analysts. Third, it’s in a cyclical business.

 

CYD is controlled by Hong Leong Asia (HLA), which has a stake of 41.63% and HLA is constantly increasing its stake in CYD. HLA is a family owned conglomerate listed in Singapore. HLA is somehow counting on dividends from CYD to build or maintain its own empire. Other noteworthy shareholders include Shah Capital (8.78%), Brandes Investment (3.35%), and Fosun Group (2.89%).

 

Shah is much more optimistic than me, he values CYD as $50, and he has been gradually increasing his position. CYD is Shah’s largest holding and takes up 21% of his portfolio. More background information about Shah Capital and CYD:

http://blogs.wsj.com/moneybeat/2013/06/18/shah-capital-urges-changes-at-china-yuchai-international/?mg=id-wsj

 

I would rate the management of CYD as 4 out of 5. They have been disciplined: in recent years, GYMCL has generated a lot of free cash flows (e.g., 198 MM in FY 2015 or more than 45% of the current market cap) and the management is not expanding the business or in a diversification mode (which is excellent!). Capital expenditure has been reduced heavily. Instead, they are returning cash to debtholders and shareholders gradually. Interest bearing debt has been decreasing from 587.35 mm in FY 2011 to 131.28 mm in Q2 2016. Cash and short-term investment have been stable around 550 mm since 2009. A large portion of cash is located in Singapore rather than China. They also paid $1.5, $0.9, $0.9, $1.2, $1.2, and $0.85 per share to shareholders for FY 2010 to FY 2015, respectively.

 

FY 2005 is the bottom of last cycle. In that year, CYD has a market price of $7.83, negative EPS of -0.11, P/B of 0.92, Net Debt of 28 MM, Net working capital of 102 MM.

I believe FY 2015-2016 would be the bottom of this cycle. In FY 2015, CYD has a market price of 11.12, EPS of 1.36, P/B of 0.39, Net Cash of 421.4 MM, Net working capital of 558.77 MM. Again, it’s dirty cheap this cycle.

 

CYD is a great place to have exposure about emerging market and China. For those of you who are concerned about the devaluation of Chinese Yuan: Since CYD is a pure China play, it’s suffering from a weak Chinese Yuan. However, it’s easy to get a hedge protection. Currency future contracts are available in Hong Kong, Singapore, and Chicago exchanges. The annualized hedging cost is around 2%-3% now. For institutional players, more OTC products are available in any mainstream international bank.

 

As for historical issues related to the minority interests (state owned company in GuangXi) in GYMCL: I am not concerned about it. First, the problem has been solved. Now, CYD or Hong Leong has controlled the board of GYMCL. Secondly, the golden share held by Hong Leong can ensure GYMCL as a free cash flow machine rather than a diworsification disaster given that China’s economy is slowing down. Third, the cooperation with state owned company provides CYD with an excellent position to do business in China since many of GYMCL/CYD’s clients are also owned/controlled by the state. 

 

 

 

[Maple Fun]

My detailed write-up is attached.

CYD_Write-up.pdf

[rukawa]

Finally, China slowdown is real and these guys are feeling it big time.

 

This is what really bothers me. I view what is happening in China as roughly equivalent to the Great Depression or Japan's long period of no growth. And I would expect heavily equipment managers to get massacred. 

[Maple Fun]

At least at some point, the price can compensate the risk, right?

 

This is what really bothers me. I view what is happening in China as roughly equivalent to the Great Depression or Japan's long period of no growth. And I would expect heavily equipment managers to get massacred.

[awindenberger]

You've gotten me interested Maple Fun. I'll take a look at the company over the weekend.

[Maple Fun]

You've gotten me interested Maple Fun. I'll take a look at the company over the weekend.

 

Nice to know you are interested. Any thoughts after DD?

[awindenberger]

You've gotten me interested Maple Fun. I'll take a look at the company over the weekend.

 

Nice to know you are interested. Any thoughts after DD?

 

I got busy and didn't have a chance to read. Maybe over TG.