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GM, BYD and The Chinese Automobile Market
Posted by: Josh Zachariah (IP Logged)
Date: May 20, 2012 09:08AM
GM and BYD are two automobile companies that appear on the Berkshire Hathaway (BRK.A)(BRK.B) portfolio. GM was likely an investment by Todd Combs or Ted Weschler and BYD is clearly Charlie Munger’s pick. The two companies couldn’t be more different from one another, but they do share common ground as competitors in the blossoming Chinese auto market.
GM counts numerous joint ventures with Chinese automobile companies and the income from those ventures has contributed some 20% to this and last years earnings (after netting out the gain on sale from New Delphi). This year GM showed $1.5 billion in “equity income” from its Chinese joint venture, up 16% from 2010. Despite this significant contribution to earnings the Chinese operations receive not more than 2 pages of discussion in the annual report. G.E. Anderson gives a clearer picture of the Chinese automobile industry in his book Designated Drivers: How China Plans to Dominate the Global Auto Industry.
An interesting point in the book is how far behind the Chinese are compared to their pacific rim competitors in their first 20 years. Anderson compared the Chinese market to South Korea and Japan and showed that the two Pacific rim countries were able to export a significant amount of cars to developed countries in that time. China, however, has been limited largely to exporting to developing countries as it has been unable to meet the standards of developed countries. Further, the Chinese continue to be dependent on foreigners for complex parts though they have become adept at producing the less complex ones.
Part of this feeds into the foreign auto companies in China and their role in production. China’s initial plan for the foreigners was for them to bring their technical ability so Chinese companies could be competitive globally. What has generally happened is that Chinese companies have instead used the foreigner’s capital in developing cars. Anderson notes, “selling foreign-branded cars is still a much more profitable activity than is pouring resources into development of Chinese brands.” Foreign auto companies such as Toyota have been very resistant to sharing their technology whereas GM is one of the few that has been very open with its technology. Anderson concludes that this may be the reason why Toyota is 4th in China behind VW, GM and Hyundai. GM currently has a 13% market share in the crowded Chinese market.
Anderson writes that the Chinese government has been pushing to consolidate the auto industry. The industry has been characterized as the Big 4 and Small 4. In the upper tiers are the likes of Shanghai Auto (GM’s partner in GM-SAIC) and Dongfeng. In the ranks of the Small 4 are companies like Chery and Sinotruk. All 8 are state owned and after these giants come the private companies like BYD and Geely (private in the sense the state doesn’t have a direct stake in them).
The state owned companies like most Chinese state owned companies have preferential advantages in that their debt is implicitly guaranteed by the central government. This gives them an edge over the private companies even though private companies like BYD do get some perks such as discounted and sometimes “free” land from local governments. Anderson quotes an auto executive on exactly how critical support from the central government is, “all auto companies have the support of their local governments, but the central government offers a kind of support that no local government can give. The central government is the only government that controls national media – local government only control local media - and favorable news stories about a car company can have a big influence.”
This comment is what makes Berkshire Hathaway’s investment in BYD so uncharacteristic. Even though Charlie Munger was behind the investment, BYD has very little “moats” around its business. In fact more moats tend to surround the large state-owned automobile companies. In defining BYD’s value, Munger is quick to point out the tens of thousands of engineers that BYD employs, but as their recent lackluster sales figures have shown, the talent has not translated into earning power.
In Munger’s defense, BYD is still a much finer business than its larger competitors. Anderson quoted an analyst on the contrast between state-held and private companies, “the tragedy of the Chinese auto industry is that you have private players who have passion, but no money and you have SOEs [state-owned enterprises] with money but no passion.”
BYD has been credited with tenacious cost control and a candid admission of their reverse engineering and copying of competitors cars. BYD also makes much of their parts in house. The Chinese magazine Caixin was quoted as saying “BYD typically makes one or two serious, large orders of models, materials, or components but never orders again. That’s because it just starts making whatever it bought.”
BYD’s niche is its ability to produce batteries cheaper than most including the Japanese. Though its productivity per worker is lower, its overall unit cost per battery is about 1/5th to 1/6th that of the Japanese company because the company substitutes cheap labor for the robots, clean rooms and other costs the Japanese incur.
The Chinese automobiles market is restricted in foreign ownership in that a foreign partner can own no more than 50% in a Chinese automobile company (however, parts manufacturing can be 100% foreign owned). Liu Shufu, CEO of the private Chinese automobile company Geely had commented that the foreign ownership restriction should be axed. This request on first glance seemed unusual. Why would any business owner encourage competition, especially that of a higher caliber?
Anderson reasoned that the logic between such a comment was that Shufu believed his own company to be competitive with foreign companies. But secondly, he reasoned that in the event of increased foreign competition, the companies that would likely fall would not be the well run private ones, but the heavily subsidized state operated companies. Were such a scenario to unfold perhaps the companies like Geely and BYD which ran solid operations may find themselves to be a coveted asset. Its an interesting thought, but a thoroughly unlikely scenario as the Chinese government surely does not want to see its automobile profits move offshore.
Anderson’s book is certainly worth a read for anyone curious about the Chinese automobile industry or for that matter how Chinese business and industry operate. But in the case of GM and BYD shares, I’ll be watching from the sidelines.
Stocks Discussed: GM,
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